UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION




WASHINGTON,
D.C. 20549




FORM
20-F


(Mark
One)




 ̈
            REGISTRATION STATEMENT PURSUANT
      TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF
      1934





OR





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





For the
fiscal year ended June 30, 2009




OR





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




For the transition period from
___________ to ___________.





OR





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




Date of
event requiring this shell company report _________________________




For the transition period from
___________ to ___________.




Commission
file number: 001-33602




HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.


(Exact
name of Registrant as specified in its charter)




Not
Applicable


(Translation
of Registrant’s name into English)




British Virgin
Islands


(Jurisdiction
of incorporation or organization)




10
Jiancaicheng Middle Road


Xisanqi,
Haidian District


Beijing,
People's Republic of China, 100096


(Address of principal
executive offices)





Securities
registered or to be registered pursuant to Section 12(b) of the
Act.




Title
      of each class
              
              Name
      of each exchange on which registeredOrdinary
      Shares
              
              The
      NASDAQ Global Select Market





Securities
registered or to be registered pursuant to Section 12(g) of the
Act.





None





(Title of
Class)




Securities
for which there is a reporting obligation pursuant to Section 15(d) of the
Act.





None




Indicate
the number of outstanding shares of each of the issuer’s classes of capital or
common stock as of the close of the period covered by the annual report (June
30, 2009): 41,942,61  ordinary shares.




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


 ̈Yes   x No




If this
report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934.


 ̈Yes   x No




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.


xYes   ̈ No




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). o Yes  o No





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.




Large
      accelerated filer  ̈
            Accelerated
      filer  ̈
            Non-accelerated
      filer x




Indicate
by check mark which basis of accounting the registrant has used to prepare the
financial statements included in this filing:





U.S.
      GAAP x
            International
      Financial Reporting Standards as issued by the International Accounting
      Standards Board  ̈
            Other
       ̈





If
“Other” has been checked in response to the previous question, indicate by check
mark which financial statement item the registrant has elected to
follow.





 ̈ Item
17              ̈ Item 18





If this
is an annual report, indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Exchange Act).


oYes       x No









HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.


ANNUAL
REPORT ON FORM 20-F





TABLE
OF CONTENTS




PagePART
      IITEM
      1.
                IDENTITY
      OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
                5ITEM
      2.
                OFFER
      STATISTICS AND EXPECTED TIMETABLE
                5ITEM
      3.
                KEY
      INFORMATION
                5ITEM
      4.
                INFORMATION
      ON THE COMPANY
                19ITEM
      4A.
                UNRESOLVED
      STAFF COMMENTS
                34ITEM
      5.
                OPERATING
      AND FINANCIAL REVIEW AND PROSPECTS
                34ITEM
      6.
                DIRECTORS,
      SENIOR MANAGEMENT AND EMPLOYEES
                51ITEM
      7.
                MAJOR
      SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
                59ITEM
      8.
                FINANCIAL
      INFORMATION
                60ITEM
      9.
                THE
      OFFER AND LISTING
                61ITEM
      10.
                ADDITIONAL
      INFORMATION
                62ITEM
      11.
                QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                72ITEM
      12.
                DESCRIPTION
      OF SECURITIES OTHER THAN EQUITY SECURITIES
                73PART
      IIITEM
      13.
                DEFAULTS,
      DIVIDEND ARREARAGES AND DELINQUENCIES
                73ITEM
      14.
                MATERIAL
      MODIFICATIONS TO THE RIGHTS OF SECURITIES HOLDERS AND USE OF
      PROCEEDS
                73ITEM
      15T.
                CONTROLS
      AND PROCEDURES
                73ITEM
      16A.
                AUDIT
      COMMITTEE FINANCIAL EXPERT
                75ITEM
      16B.
                CODE
      OF ETHICS
                75ITEM
      16C.
                PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
                75ITEM
      16D.
                EXEMPTIONS
      FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
                76ITEM
      16E.
                PURCHASES
      OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
    PURCHASERS
                76ITEM
      16F.
                CHANGE
      IN REGISTRANT’S CERTIFYING ACCOUNTANT
                76ITEM
      16G.
                CORPORATE
      GOVERNANCE
                76PART
      IIIITEM
      17.
                FINANCIAL
      STATEMENTS
                76ITEM
      18.
                FINANCIAL
      STATEMENTS
                76ITEM
      19.
                EXHIBITS
                76


i





USE
OF CERTAIN DEFINED TERMS




Except as
otherwise indicated by the context, references in this annual report
to:




·
              “Beijing
      Haotong” are references to Beijing Haotong Science and Technology
      Development Co., Ltd.;
 ·
              “Beijing
      Helitong” are references Beijing Helitong S&T Exploration Co.,
      Ltd.;
 ·
              “Beijing
      Hollysys” are references to Beijing Hollysys Co.,
  Ltd.;
 ·
              “Beijing
      Hollysys S&T” are references to Beijing Hollysys S&T Exploration
      Co., Ltd.;
 ·
              “BVI”
      are references to the British Virgin
Islands;
 ·
              “China”
      and “PRC,” are references to the People’s Republic of China and references
      to “Hong Kong,” are references to the Hong Kong Special Administrative
      Region of China;
 ·
              “Clear
      Mind” are references to Clear Mind Limited, a BVI
  company;
 ·
              “Exchange
      Act” are references to the Securities Exchange Act of 1934, as
      amended;
 ·
              “Gifted
      Time” are references to Gifted Time Holdings Limited, a BVI
      company;
 ·
              “Hangzhou
      Hollysys” are references to Hangzhou Hollysys Automation Co.,
      Ltd.;
 ·
              “Hollysys”
      “we,” “us,” or “our,” and the “Company,” are references to the combined
      business of Hollysys Automation Technologies Ltd., a British Virgin
      Islands company, and its wholly-owned subsidiaries, Singapore Hollysys and
      Gifted Time; Gifted Time’s 60% majority-owned subsidiary, Hangzhou
      Hollysys; Gifted Time’s wholly-owned subsidiary, Clear Mind; Clear Mind’s
      wholly-owned subsidiary, World Hope; World Hope’s wholly-owned Chinese
      operating subsidiary, Beijing Helitong; Beijing Helitong’s wholly-owned
      operating subsidiary, Beijing Jin Qiao; Beijing Jin Qiao’s 74.11%
      majority-owned subsidiary, Beijing Hollysys; Beijing Jin Qiao’s
      wholly-owned Chinese operating subsidiary, Hollysys Automation; and
      Beijing Hollysys’ 70% majority-owned subsidiary, Beijing
      Haotong;
 ·
              “Hollysys
      Automation” are references to Beijing Hollysys Automation & Drive Co.,
      Ltd.;
 ·
              “RMB,”
      are references to Renminbi, the legal currency of China and “U.S.
      dollars,” “$” and “US$” are to the legal currency of the United
      States;
 ·
              “Securities
      Act,” are references to the Securities Act of 1933, as
      amended;
 ·
              “Singapore
      Hollysys” are references to Hollysys (Asia Pacific) Pte Limited, a
      Singapore company; and
 ·
              “World
      Hope” are references to World Hope Enterprises Limited, a Hong Kong
      company.




FORWARD-LOOKING
INFORMATION





This
annual report contains forward-looking statements and information relating to us
that are based on the current beliefs, expectations, assumptions, estimates and
projections of our management regarding our company and
industry.  When used in this annual report, the words “may”, “will”,
“anticipate”, “believe”, “estimate”, “expect”, “intend”, “plan” and similar
expressions, as they relate to us or our management, are intended to identify
forward-looking statements.  These statements reflect management's
current view of us concerning future events and are subject to certain risks,
uncertainties and assumptions, including among many others: our potential
inability to achieve similar growth in future periods as we did historically, a
decrease in the availability of our raw materials, the emergence of additional
competing technologies, changes in domestic and foreign laws, regulations and
taxes, changes in economic conditions, uncertainties related to China’s legal
system and economic, political and social events in China, a general economic
downturn, a downturn in the securities markets, and other risks and
uncertainties which are generally set forth under the heading, “Key information
— Risk Factors” and elsewhere in this annual report.  Should any of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those described as
anticipated, estimated or expected in this annual report.




All
forward-looking statements included herein attributable to us or other parties
or any person acting on our behalf are expressly qualified in their entirety by
the cautionary statements contained or referred to in this section. Except to
the extent required by applicable laws and regulations, we undertake no
obligations to update these forward-looking statements to reflect events or
circumstances after the date of this annual report or to reflect the occurrence
of unanticipated events.




4




PART I




ITEM
      1.
            IDENTITY
      OF DIRECTORS, SENIOR MANAGEMENT AND
ADVISERS





Not
applicable.





ITEM
      2.
            OFFER
      STATISTICS AND EXPECTED TIMETABLE





Not
applicable.





ITEM
      3.
            KEY
      INFORMATION




Selected
Consolidated Financial Data





The
following table presents selected financial data regarding our
business.  It should be read in conjunction with our consolidated and
unconsolidated financial statements and related notes contained elsewhere in
this annual report and the information under Item 5, “Operating and Financial
Review and Prospects.”  The selected consolidated statement of income
data for the fiscal years ended June 30, 2009, 2008 and 2007 and the
consolidated balance sheet data as of June 30, 2009 and 2008 have been derived
from the audited consolidated financial statements of Hollysys that are included
in this annual report beginning on page F-1.





The
audited consolidated financial statements for the years ended June 30, 2009,
2008 and 2007 are prepared and presented in accordance with generally accepted
accounting principles in the United States, or U.S. GAAP.  The
selected financial data information is only a summary and should be read in
conjunction with the historical consolidated financial statements and related
notes of Hollysys contained elsewhere herein.  The financial
statements contained elsewhere fully represent our financial condition and
operations; however, they are not indicative of our future
performance.





Years Ended June 30,2009
                      
                      
                      2008
                      
                      
                      2007Statement of Income DataRevenue
                      
                      
                      157,502,067
                      
                      
                      
                      121,498,752
                      
                      
                      
                      101,885,486Operating
      income (loss)
                      
                      
                      (7,310,502
                      )
                      
                      
                      2,685,309
                      
                      
                      
                      21,525,875Income
      (loss) before income taxes
                      
                      
                      (5,603,121
                      )
                      
                      
                      2,248,419
                      
                      
                      
                      18,646,368Net
      income (loss)(1)
                      
                      
                      (13,851,064
                      )
                      
                      
                      (1,677,178
                      )
                      
                      
                      13,084,751Add:
      Amortization of discount and interest on notes payable related to bridge
      loan
                      
                      
                      -
                      
                      
                      
                      3,244,434
                      
                      
                      
                      6,401,975Stock-based
      compensation cost for incentive shares
                      
                      
                      39,240,000
                      
                      
                      
                      17,000,000
                      
                      
                      
                      -Stock-based
      compensation cost for options
                      
                      
                      319,026
                      
                      
                      
                      84,473
                      
                      
                      
                      -Non-GAAP
      net income
                      
                      
                      25,707,962
                      
                      
                      
                      18,651,729
                      
                      
                      
                      19,486,726Weighted
      average common shares
                      
                      
                      44,950,883
                      
                      
                      
                      37,658,437
                      
                      
                      
                      22,200,000Weighted
      average number of diluted common shares
                      
                      
                      44,950,883
                      
                      
                      
                      37,658,437
                      
                      
                      
                      22,883,836Basic
      earnings per share(1)
                      
                      
                      (0.31
                      )
                      
                      
                      (0.04
                      )
                      
                      
                      0.59Diluted
      earnings per share(1)
                      
                      
                      (0.31
                      )
                      
                      
                      (0.04
                      )
                      
                      
                      0.57Non-GAAP
      basic earnings per share
                      
                      
                      0.57
                      
                      
                      
                      0.50
                      
                      
                      
                      0.88Non-GAAP
      diluted earnings per share
                      
                      
                      0.57
                      
                      
                      
                      0.50
                      
                      
                      
                      0.85Cash
      dividends declared per share
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      0.03Balance Sheet DataTotal
      current assets
                      
                      
                      283,971,473
                      
                      
                      
                      214,320,514
                      
                      
                      
                      128,404,729Total
      assets
                      
                      
                      345,443,522
                      
                      
                      
                      252,734,095
                      
                      
                      
                      154,930,570Total
      current liabilities
                      
                      
                      101,121,574
                      
                      
                      
                      71,028,772
                      
                      
                      
                      101,419,000Total
      liabilities
                      
                      
                      149,424,388
                      
                      
                      
                      87,794,820
                      
                      
                      
                      104,703,288Minority
      Interest
                      
                      
                      22,479,241
                      
                      
                      
                      17,645,377
                      
                      
                      
                      13,200,169Stockholders’
      equity
                      
                      
                      173,539,893
                      
                      
                      
                      147,293,898
                      
                      
                      
                      37,027,113





(1)  We
have no discontinued operations, therefore net income and net income per share
has been provided in lieu of income from continuing operations and income
(loss) from continuing operations per share


5


Exchange
Rate Information





The
conversion of RMB into U.S. dollars in this annual report is based on the noon
buying rate in the city of New York for cable transfers of RMB as certified for
customs purposes by the Federal Reserve Bank of New York. We make no
representation that any RMB or U.S. dollar amounts could have been, or could be,
converted into U.S. dollars or RMB, as the case may be, at any particular rate,
the rates stated below, or at all. The PRC government imposes controls over its
foreign currency reserves in part through direct regulation of the conversion of
RMB into foreign exchange and through restrictions on foreign
trade.





The
following table sets forth various information concerning exchange rates between
the RMB and the U.S. dollar for the periods indicated.  These rates
are provided solely for your convenience and are not necessarily the exchange
rates that we used in this annual report or will use in the preparation of our
periodic reports or any other information to be provided to you.  The
source of these rates is the Federal Reserve Bank of New York.  As of
September 18, 2009, the noon buying rate was RMB 6.8270 to US$1.00.





Noon Buying RateRenminbi per U.S. Dollar
                                                      
                                                      Average(2)
                                                      
                                                      
                                                      High
                                                      
                                                      
                                                      Low
                                                      
                                                      
                                                      Period-end2005
      (1)
                                                      
                                                      
                                                      8.2766
                                                      
                                                      
                                                      
                                                      8.2770
                                                      
                                                      
                                                      
                                                      8.2764
                                                      
                                                      
                                                      
                                                      8.27652006
      (1)
                                                      
                                                      
                                                      8.0570
                                                      
                                                      
                                                      
                                                      8.2765
                                                      
                                                      
                                                      
                                                      7.9943
                                                      
                                                      
                                                      
                                                      7.99432007
      (1)
                                                      
                                                      
                                                      7.7960
                                                      
                                                      
                                                      
                                                      8.0018
                                                      
                                                      
                                                      
                                                      7.6120
                                                      
                                                      
                                                      
                                                      7.61202008
      (1)
                                                      
                                                      
                                                      7.2375
                                                      
                                                      
                                                      
                                                      7.6181
                                                      
                                                      
                                                      
                                                      6.8591
                                                      
                                                      
                                                      
                                                      6.85912009
      (1)
                                                      
                                                      
                                                      6.5738
                                                      
                                                      
                                                      
                                                      6.8842
                                                      
                                                      
                                                      
                                                      6.7800
                                                      
                                                      
                                                      
                                                      6.8302March
      2009
                                                      
                                                      
                                                      6.8360
                                                      
                                                      
                                                      
                                                      6.8438
                                                      
                                                      
                                                      
                                                      6.8240
                                                      
                                                      
                                                      
                                                      6.8329April
      2009
                                                      
                                                      
                                                      6.8306
                                                      
                                                      
                                                      
                                                      6.8361
                                                      
                                                      
                                                      
                                                      6.8180
                                                      
                                                      
                                                      
                                                      6.8180May
      2009
                                                      
                                                      
                                                      6.8235
                                                      
                                                      
                                                      
                                                      6.8326
                                                      
                                                      
                                                      
                                                      6.8176
                                                      
                                                      
                                                      
                                                      6.8278June
      2009
                                                      
                                                      
                                                      6.8334
                                                      
                                                      
                                                      
                                                      6.8371
                                                      
                                                      
                                                      
                                                      6.8264
                                                      
                                                      
                                                      
                                                      6.8302July
      2009
                                                      
                                                      
                                                      6.8317
                                                      
                                                      
                                                      
                                                      6.8342
                                                      
                                                      
                                                      
                                                      6.8300
                                                      
                                                      
                                                      
                                                      6.8319August
      2009
                                                      
                                                      
                                                      6.8323
                                                      
                                                      
                                                      
                                                      6.8358
                                                      
                                                      
                                                      
                                                      6.8299
                                                      
                                                      
                                                      
                                                      6.8299September
      2009 (through September 18, 2009)
                                                      
                                                      
                                                      6.3405
                                                      
                                                      
                                                      
                                                      6.8303
                                                      
                                                      
                                                      
                                                      6.8247
                                                      
                                                      
                                                      
                                                      6.8270





(1)All
periods end June 30 of the stated year.





(2)Averages
for a period are calculated by using the average of the exchange rates on the
end of each month during the period.  Monthly averages are calculated
by using the average of the daily rates during the relevant period.


Capitalization
and Indebtedness
 
 Not
applicable.


6




Reasons
for the Offer and Use of Proceeds





Not
applicable.





Risk
Factors




An
investment in our capital stock involves a high degree of risk. You should
carefully consider the risks described below, together with all of the other
information included in this annual report, before making an investment
decision. If any of the following risks actually occurs, our business, financial
condition or results of operations could suffer. In that case, the trading price
of our capital stock could decline, and you may lose all or part of your
investment.


RISKS
RELATED TO OUR BUSINESS





We
will need to commit greater resources to new product and service development in
order to stay competitive, and we may fail to offset the increased cost of such
development with a sufficient increase in net sales or margins.





The
success of our business depends in great measure on our ability to keep pace
with, or even lead, changes that occur in our
industry.  Traditionally, the automation and control systems business
was relatively stable and slow moving.  Successive generations of
products offered only marginal improvements in terms of functionality and
reliability.  However, the emergence of computers, computer networks
and electronic components as key elements of the systems that we design and
build has accelerated the pace of change in our industry. Where there was
formerly as much as a decade or even more between successive generations of
automation systems, the time between generations is now as little as two to
three years.  Technological advances and the introduction of new
products, new designs and new manufacturing techniques by our competitors could
adversely affect our business unless we are able to respond with similar
advances.  To remain competitive, we must continue to incur
significant costs in product development, equipment and facilities and to make
capital investments.  These costs may increase, resulting in greater
fixed costs and operating expenses than we have incurred to date.  As
a result, we could be required to expend substantial funds for and commit
significant resources to the following:





·
            Research
      and development activities on existing and potential product
      solutions;





·
            Additional
      engineering and other technical
personnel;





·
            Advanced
      design, production and test
equipment;





·
            Manufacturing
      services that meet changing customer
needs;





·
            Technological
      changes in manufacturing processes;
and





·
            Expansion
      of manufacturing capacity.





Our
future operating results will depend to a significant extent on our ability to
continue providing new product solutions that compare favorably on the basis of
time to market, cost and performance, with competing third-party suppliers and
technologies.  Our failure to increase net sales sufficiently to offset the
increased costs needed to achieve those advances would adversely affect our
operating results.




We
may experience trade barriers in expanding to our targeted emerging markets and
may be subject to tariffs and taxes that will result in significant additional
costs for our business and products.
 
 We may
experience barriers to conducting business and trade in our planned expansion to
emerging markets.  These barriers may be in the form of delayed
customs clearances, customs duties or tariffs.  In addition, we may be
subject to repatriation taxes levied upon the exchange of income from local
currency into foreign currency, substantial taxes of profits, revenues, assets
and payroll, as well as value-added tax.  The markets into which we
may expand may impose onerous and unpredictable duties, tariffs and taxes on our
business and products.  These barriers or expenses could have an
adverse effect on our operations and financial results.


7




We
do not have long-term purchase commitments from our customers, so our customers
are free to choose products from our competitors, which would result in a loss
of revenue and profitability.





We are
engaged in the design, production and installation of automation and process
control systems.  As a result, our revenues result from numerous
individual contracts that, once completed, typically produce only a limited
amount of ongoing revenues for maintenance and other
services.  Furthermore, customers may change or delay or terminate
orders for products without notice for any number of reasons unrelated to us,
including lack of market acceptance for the products to be produced by the
process our system was designed to control.  As a result, in order to
maintain and expand our business, we must be able to replenish the orders in its
pipeline on a continuous basis. It is possible that some of our potential
customers could choose the products of our competitors. Should they do so, we
would suffer a decline in revenues and profitability.





The
success of our business depends heavily on securing a steady stream of new
customers.





Our
average contract is worth approximately $100,000. While some of those contracts
are for upgrades and additions to existing control systems, most of them are for
new installations. In order for our business to continue to succeed and grow, we
need to secure contracts with new customers on a regular basis. We may not be
successful in securing new contracts.





A
lack of adequate engineering resources could cause our business to lose
profitability and potential business prospects.





One of
the competitive advantages that we enjoy is the relatively low cost of our
engineering staff compared to those of our Western and Japan-based competitors.
The plentiful supply of affordable engineering talent in China is a key element
of our overall business strategy. However, if the available supply of engineers
were to be absorbed by competing demands, then the cost of hiring, training and
retaining capable engineers would likely increase. This could result in a
reduction in our profitability and business prospects, or could even cause a
change in our business strategy.





Our
products may contain design or manufacturing defects, which could result in
reduced demand for our products or services, customer claims and uninsured
liabilities.





We
manufacture spare parts for maintenance and replacement purposes after
completion of integrated solution contracts to our customers’ requirements,
which can be highly complex and may at times contain design or manufacturing
errors or defects. Any defects in the spare parts we manufacture may result in
returns, claims, delayed shipments to customers or reduced or cancelled customer
orders.  If these defects occur, we will incur additional costs, and
if they occur in large quantity or frequently, we may sustain additional costs,
loss of business reputation and legal liability.  Moreover, we are in
the process of entering both the nuclear power generation and railway control
systems sectors. Each of these sectors poses a substantially higher risk of
liability in the event of a system failure, than was present in the industrial
process controls markets in which we traditionally compete.





We may
not be able to obtain adequate insurance coverage to protect us against these
and other risks associated with our business. The typical practice of the
industries with which we are involved is for the customers to obtain insurance
to protect their own operational risks. Therefore, we currently do not carry any
insurance coverage to protect against the risks related to product failure.
However, it is possible that such customers or their insurers could assert
claims against us for any damages caused by a failure in one of our systems, and
as a result, the failure of any of our products could result in a liability that
would seriously impair our financial condition or even force us out of
business.


8





Our
failure to adequately protect our intellectual property rights may undermine our
competitive position, and litigation to protect our intellectual property rights
may be costly.





Our
business is based on a number of proprietary products and systems, some of which
are patented, others of which we protect as trade secrets. We strive to
strengthen and differentiate our product portfolio by developing new and
innovative products and product improvements. As a result, we believe that the
protection of our intellectual property will become increasingly important to
our business as the functionality of automation systems increases to meet
customer demand and as we try to open new markets for our products.
Implementation and enforcement of intellectual property-related laws in China
has historically been lacking due primarily to ambiguities in PRC intellectual
property law. Accordingly, protection of intellectual property and proprietary
rights in China may not be as effective as in the United States or other
countries. Currently, we hold 18 PRC utility patents that relate to various
product configurations and product components and have 20 pending PRC patent
applications. We will continue to rely on a combination of patents, trade
secrets, trademarks and copyrights to provide protection in this regard, but
this protection may be inadequate.





For
example, our pending or future patent applications may not be approved or, if
allowed, they may not be of sufficient strength or scope. As a result, third
parties may use the technologies and proprietary processes that we have
developed and compete with us, which could negatively affect any competitive
advantage we enjoy, dilute our brand and harm our operating
results.





In
addition, policing the unauthorized use of our proprietary technology can be
difficult and expensive. Litigation may be necessary to enforce our intellectual
property rights and given the relative unpredictability of China’s legal system
and potential difficulties enforcing a court judgment in China, there is no
guarantee litigation would result in an outcome favorable to us. Furthermore,
any such litigation may be costly and may divert management attention away from
our core business. An adverse determination in any lawsuit involving our
intellectual property is likely to jeopardize our business prospects and
reputation. We have no insurance coverage against litigation costs so we would
be forced to bear all litigation costs if we cannot recover them from other
parties. All of the foregoing factors could harm our business and financial
condition.





We
may develop new products that do not gain market acceptance, which would result
in the failure to recover the significant costs for design and manufacturing
services for new product solutions, thus adversely affecting operating
results.





We
operate in an industry characterized by increasingly frequent and rapid
technological advances, product introductions and new design and manufacturing
improvements. As a result, we must expend funds and commit resources to research
and development activities, possibly requiring additional engineering and other
technical personnel; purchasing new design, production, and test equipment; and
enhancing our design and manufacturing processes and techniques. We may invest
in equipment employing new production techniques for existing products and new
equipment in support of new technologies that fail to generate adequate returns
on the investment due to insufficient productivity, functionality or market
acceptance of the products for which the equipment may be used. We could,
therefore, incur significant costs for design and manufacturing services for new
product solutions that do not generate a sufficient return on that investment,
which would adversely affect our future operating results. Our future operating
results will depend significantly on our ability to provide timely design and
manufacturing services for new products that compete favorably with design and
manufacturing capabilities of third party suppliers.




RISKS
RELATING TO THE INDUSTRY IN WHICH WE OPERATE
 
 Our
plans for growth rely on an increasing emphasis on railroad and nuclear power
sectors, and these sectors present fewer business opportunities, so we may not
be successful in growing these new markets.
 
 While the
principal focus of our business until recently has been to provide Distributed
Control Systems, or DCS to industrial and manufacturing companies, our plans for
growth include an increasing emphasis on railroad control systems and nuclear
power generation control systems. These sectors generally present fewer business
opportunities during a given period relative to the industrial and manufacturing
sectors. However, the average size of contracts in those sectors tends to be
much larger, and as a result, the competition for such contracts is substantial.
We may not be successful in entering these new markets and, if it were unable to
do so, our revenues and profits would decline, resulting in a decreased value of
our stock.


9




Many
of our competitors have substantially greater resources than we do, allowing
them to be able to reduce their prices, which would force us to reduce our
prices.





We
operate in a very competitive environment with many major international and
domestic companies, such as Honeywell, General Electric, ABB, Siemens, Emerson
and Hitachi. Many of our competitors are much better established and more
experienced than we are, have substantially greater financial resources, operate
in many international markets and are much more diversified than we are. As a
result, they are in a strong position to compete effectively with us by, for
example, reducing their prices, which could force us to reduce our prices. These
large competitors are also in a better position than we are to weather any
extended weaknesses in the market for automation and control systems. Other
emerging companies or companies in related industries may also increase their
participation in our market, which would add to the competitive pressures that
we face.





A
decrease in the rate of growth in Chinese industry and the Chinese economy in
general may lead to a decrease in our revenues because industrial companies in
China are the principal current source of revenues for us.





Industrial
companies operating in China are the principal current source of revenues for
us.  Our business has benefited in the past from the rapid expansion
of China’s industrial activity, which has created additional demand from
existing companies and led to the formation of numerous additional companies
that have need for our products and services.  China’s industrial
expansion has been fueled in large measure by international demand for the
low-cost goods that China is able to produce due to labor advantages and other
comparative advantages, such as governmental subsidies to offset research and
development expenses and taxes and reduced land use/facilities costs for
targeted industries.  The Chinese economy may not be able to sustain
this rate of growth in the future, and any reduction in the rate of China’s
industrial growth or a shrinking of China’s industrial base could adversely
affect our revenues. The resulting increase in competition for customers might
also cause erosion of profit margins that we have been able to achieve
historically.





Our
plans to enter the international automation market may not prove successful, and
we may waste capital resources and needlessly divert management’s time and
attention from our principal market.





To date
we have conducted nearly all of our business within China. However, we have
plans to enter international markets in the near future. While the manner in
which we plan to do so will likely not involve large expenditures of capital and
resources, it will also require meaningful amounts of management time and
attention. Our  products and our overall approach to the automation and
controls system business may not be accepted in other markets to the extent
needed to make that effort profitable. In addition, the additional demands on
our management from these activities may detract from our efforts in the
domestic Chinese market, causing the operating results in our principal market
to be adversely affected.





We
depend heavily on key personnel, and loss of key employees and senior management
could harm our business.





Our
future business and results of operations depend in significant part upon the
continued contributions of our key technical and senior management personnel,
including Dr. Changli Wang, our Chairman, Chief Executive Officer and President,
and Mr. Peter Li, our Chief Financial Officer.  They also depend in
significant part upon our ability to attract and retain additional qualified
management, technical, marketing and sales and support personnel for our
operations. If we lose a key employee, if a key employee fails to perform in his
or her current position or if we are not able to attract and retain skilled
employees as needed, our business could suffer. Turnover in our senior
management could significantly deplete institutional knowledge held by our
existing senior management team and impair our operations.


In
addition, if any of these key personnel joins a competitor or forms a competing
company, we may lose some of our customers. We have entered into confidentiality
and non-competition agreements with all of these key personnel. However, if any
disputes arise between these key personnel and us, it is not clear, in light of
uncertainties associated with the PRC legal system, what the court decisions
will be and the extent to which these court decisions could be enforced in
China, where all of these key personnel reside and hold some of their assets.
See “—Risks Related to Doing Business in China—Uncertainties with respect to the
PRC legal system could limit the legal protections available to you and
us.”


10




We
may be exposed to potential risks relating to our internal controls over
financial reporting and our ability to have those controls attested to by our
independent auditors.





As
directed by Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, the
Securities and Exchange Commission, or the SEC, adopted rules requiring public
companies to include a report of management on the company’s internal controls
over financial reporting in their annual reports, including Form 20-F.  In
addition, the independent registered public accounting firm auditing a company’s
financial statements must also attest to and report on the effectiveness of the
company’s internal controls over financial reporting. Under current law, we are
required to include a management report beginning with our annual report for the
2009 fiscal year and to include our independent registered public accounting
firm’s attestation report beginning with our annual report for the 2010 fiscal
year.  Our management may conclude that our internal controls over our
financial reporting are not effective. Even if our management concludes that our
internal controls over financial reporting are effective, our independent
registered public accounting firm may issue a report that is qualified if it is
not satisfied with our controls or the level at which our controls are
documented, designed, operated or reviewed, or if it interprets the relevant
requirements differently from us.





We can
provide no assurance that we will be in compliance with all of the requirements
imposed by SOX 404 or that we will receive a positive attestation from our
independent auditors. In the event we identify significant deficiencies or
material weaknesses in our internal controls that we cannot remediate in a
timely manner or we are unable to receive a positive attestation from our
independent auditors with respect to our internal controls, investors and others
may lose confidence in the reliability of our financial statements.





RISKS
RELATED TO DOING BUSINESS IN CHINA





Substantially all of our operating
assets are located in China and substantially all of our revenue will be derived
from our operations in China so our business, results of operations and
prospects are subject to the economic, political and legal policies,
developments and conditions in China.





The PRC’s
economic, political and social conditions, as well as government policies, could
impair our business.  The PRC economy differs from the economies of
most developed countries in many respects.  China’s GDP has grown
consistently since 1978 (National Bureau of Statistics of
China).  However, we cannot assure you that such growth will be
sustained in the future. If, in the future, China’s economy experiences a
downturn or grows at a slower rate than expected, there may be less demand for
spending in certain industries. A decrease in demand for spending in certain
industries could impair our ability to remain profitable.  The PRC’s
economic growth has been uneven, both geographically and among various sectors
of the economy. The PRC government has implemented various measures to encourage
economic growth and guide the allocation of resources. Some of these measures
benefit the overall PRC economy, but may have a negative effect on
us.  For example, our financial condition and results of operations
may be hindered by PRC government control over capital investments or changes in
tax regulations.





The PRC
economy has been transitioning from a planned economy to a more market-oriented
economy. Although in recent years the PRC government has implemented measures
emphasizing the use of market forces for economic reform, the reduction of state
ownership of productive assets and the establishment of sound corporate
governance in business enterprises, a substantial portion of productive assets
in China is still owned by the PRC government. In addition, the PRC government
continues to play a significant role in regulating industry development by
imposing industrial policies. It also exercises significant control over PRC
economic growth through the allocation of resources, controlling payment of
foreign currency-denominated obligations, setting monetary policy and providing
preferential treatment to particular industries or companies.


If
the China Securities Regulatory Commission, or CSRC, or another PRC regulatory
agency, determines that CSRC approval of our recent merger was required or if
other regulatory obligations are imposed upon us, we may incur sanctions,
penalties or additional costs which would damage our business
 
 On August
8, 2006, six PRC regulatory agencies, including the CSRC, promulgated the
Regulations on Mergers and Acquisitions of Domestic Companies by Foreign
Investors, which became effective on September 8, 2006. Under these regulations,
the prior approval of the CSRC is required for the overseas listing of offshore
special purpose vehicles that are directly or indirectly controlled by PRC
companies or individuals and used for the purpose of listing PRC onshore
interests on an overseas stock exchange.


11




On
September 20, 2007, we completed a merger transaction with Chardan North China
Acquisition Corporation, or Chardan, which resulted in our current ownership and
corporate structure.  We believe that CSRC approval was not required
for our merger transaction or for the listing and trading of our securities on a
trading market because we are not an offshore special purpose vehicle that is
directly or indirectly controlled by PRC companies or
individuals.  Although the merger and acquisition regulations provide
specific requirements and procedures, there are still many ambiguities in the
meaning of many provisions.  Further regulations are anticipated in
the future, but until there has been clarification either by pronouncements,
regulation or practice, there is some uncertainty in the scope of the
regulations and the regulators have wide latitude in the enforcement of the
regulations and approval of transactions.  If the CSRC or another PRC
regulatory agency subsequently determines that the CSRC’s approval was required,
we may face sanctions by the CSRC or another PRC regulatory
agency.  If this happens, these regulatory agencies may impose fines
and penalties on our operations in China, limit our operating privileges in
China, restrict or prohibit payment or remittance of dividends paid by Hollysys,
or take other actions that could damage our business, financial condition,
results of operations, reputation and prospects, as well as the trading price of
our securities.





If
the PRC imposes restrictions designed to reduce inflation, future economic
growth in the PRC could be severely curtailed which could hurt our business and
profitability.





While the
economy of the PRC has experienced rapid growth, this growth has been uneven
among various sectors of the economy and in different geographical areas of the
country.  Rapid economic growth often can lead to growth in the supply
of money and rising inflation.  In order to control inflation in the
past, the PRC has imposed controls on bank credits, limits on loans for fixed
assets and restrictions on state bank lending.  Imposition of similar
restrictions may lead to a slowing of economic growth, a decrease in demand for
our products and generally damage our business and profitability.





Fluctuations
in exchange rates could harm our business and the value of our
securities.





The value
of our securities will be indirectly affected by the foreign exchange rate
between U.S. dollars and RMB and between those currencies and other currencies
in which our sales may be denominated. Because substantially most of our
earnings and cash assets are denominated in RMB and our financial results are
reported in U.S. dollars, fluctuations in the exchange rate between the U.S.
dollar and the RMB will affect our balance sheet and our earnings per share in
U.S. dollars.  In addition, appreciation or depreciation in the value
of the RMB relative to the U.S. dollar would affect our financial results
reported in U.S. dollar terms without giving effect to any underlying change in
our business or results of operations.  Fluctuations in the exchange
rate will also affect the relative value of any dividend we issue that will be
exchanged into U.S. dollars as well as earnings from, and the value of, any U.S.
dollar-denominated investments we make in the future.  Since July
2005, the RMB has no longer been pegged to the U.S. dollar. Although the
People’s Bank of China regularly intervenes in the foreign exchange market to
prevent significant short-term fluctuations in the exchange rate, the RMB may
appreciate or depreciate significantly in value against the U.S. dollar in the
medium to long term. Moreover, it is possible that in the future PRC authorities
may lift restrictions on fluctuations in the RMB exchange rate and lessen
intervention in the foreign exchange market.


Very
limited hedging transactions are available in China to reduce our exposure to
exchange rate fluctuations. To date, we have not entered into any hedging
transactions. While we may enter into hedging transactions in the future, the
availability and effectiveness of these transactions may be limited, and we may
not be able to successfully hedge our exposure at all. In addition, our foreign
currency exchange losses may be magnified by PRC exchange control regulations
that restrict our ability to convert RMB into foreign currencies.
 
 Exchange
controls that exist in the PRC may limit our ability to utilize our cash flow
effectively.
 
 We are
subject to the PRC’s rules and regulations on currency conversion.  In
the PRC, the State Administration for Foreign Exchange, or SAFE, regulates the
conversion of the Renminbi into foreign currencies. Currently, foreign
investment enterprises, or FIEs, are required to apply to the SAFE for “Foreign
Exchange Registration Certificates for FIEs.”  We believe Beijing
Helitong is an FIE. With such registration certificates, which need to be
renewed annually, FIEs are allowed to open foreign currency accounts including a
“basic account” and “capital account.” Currency conversion within the scope of
the “basic account,” such as remittance of foreign currencies for payment of
dividends, can be effected without requiring the approval of the SAFE. However,
conversion of currency in the “capital account,” including capital items such as
direct investment, loans and securities, still require approval of the SAFE. We
cannot assure you that the PRC regulatory authorities will not impose further
restrictions on the convertibility of the Renminbi. Any future restrictions on
currency exchanges may limit our ability to use our cash flow for the
distribution of dividends to our shareholders or to fund operations it may have
outside of the PRC.


12




A
failure by our shareholders or beneficial owners who are PRC citizens or
residents in China to comply with certain PRC foreign exchange regulations could
restrict our ability to distribute profits, restrict our overseas and
cross-border investment activities or subject us to liability under PRC
laws.





Notice on
Issues Relating to Administration of Foreign Exchange in Fund-raising and
Reverse Investment Activities of Domestic Residents Conducted via Offshore
Special Purpose Companies, or Notice 75, was issued on October 21, 2005 by SAFE
(that replaced two previously issued regulations on January 24, 2005 and April
8, 2005, respectively) that requires approvals from, and registrations with, PRC
government authorities in connection with direct or indirect offshore investment
activities by PRC residents and PRC corporate entities. The SAFE regulations
require retroactive approval and registration of direct or indirect investments
previously made by PRC residents in offshore companies. In the event that a PRC
shareholder with a direct or indirect stake in an offshore parent company fails
to obtain the required SAFE approval and make the required registration, the PRC
subsidiaries of such offshore parent company may be prohibited from making
distributions of profit to the offshore parent and from paying the offshore
parent proceeds from any reduction in capital, share transfer or liquidation in
respect of the PRC subsidiaries. Further, failure to comply with the various
SAFE approval and registration requirements described above, as currently
drafted, could result in liability under PRC law for foreign exchange
evasion.





Although
SAFE issued an implementation Notice No. 106, or Notice 106, on May 29, 2007 to
local branches or agencies, because of the uncertainty as to when and how the
new procedure and requirements will take effect or be enforced, and uncertainty
concerning the reconciliation of the new regulations with other approval
requirements, it remains unclear how these existing regulations, and any future
legislation concerning offshore or cross-border transactions, will be
interpreted, amended and implemented by the relevant government authorities.
Although we are committed to complying with the relevant rules, we cannot assure
you that we will never have shareholders or beneficial owners who are PRC
citizens or residents, or that such persons have always complied with and will
in the future make or obtain any applicable registrations or approvals required
by SAFE Circular 75, Notice 106 or other related
regulations.   Failure by such shareholders or beneficial owners
to comply with SAFE Circular 75 and Notice 106 could subject us to fines or
legal sanctions, restrict our overseas or cross-border investment activities,
limit our subsidiary’s ability to make distributions or pay dividends or affect
our ownership structure, which could adversely affect our business and
prospects.





Because
Chinese law governs many of our material agreements, we may not be able to
enforce our rights within the PRC or elsewhere, which could result in a
significant loss of business, business opportunities or capital.





Chinese
law governs many of our material agreements, some of which may be with Chinese
governmental agencies. We cannot assure you that we will be able to enforce any
of our material agreements or that remedies will be available outside of the
PRC.  The system of laws and the enforcement of existing laws and
contracts in the PRC may not be as certain in implementation and interpretation
as in the United States. The Chinese judiciary is relatively inexperienced in
enforcing corporate and commercial law, leading to a higher than usual degree of
uncertainty as to the outcome of any litigation. The inability to enforce or
obtain a remedy under any of our future agreements could result in a significant
loss of business, business opportunities or capital.


Our
management is unfamiliar with United States securities laws and will have to
expend time and resources becoming familiar with such laws which could lead to
various regulatory issues.
 
 Many
members of our management team are not familiar with United States securities
laws and will have to expend time and resources becoming familiar with such
laws. This could be expensive and time-consuming and could lead to various
regulatory issues and a diversion of management attention, which may harm our
operations.


13




The
ability of our Chinese operating subsidiary to pay certain foreign currency
obligations, including dividends, is subject to restrictions.





Our
ability to pay dividends may be restricted due to the foreign exchange control
policies and availability of cash balances. Since substantially all of our
operations are conducted in China and a majority of our revenues are generated
in China, a significant portion of our revenue earned and currency received are
denominated in Renminbi.  The Chinese government imposes controls on
the convertibility of Renminbi into foreign currencies and, in certain cases,
the remittance of currency out of China. Renminbi is currently not a freely
convertible currency. Shortages in the availability of foreign currency may
restrict our ability to remit sufficient foreign currency to pay dividends, if
any, on our ordinary shares or otherwise satisfy foreign currency denominated
obligations. Under existing Chinese foreign exchange regulations, payments of
current account items, including profit distributions, interest payments and
expenditures from the transaction, can be made in foreign currencies without
prior approval from the State Administration of Foreign Exchange by complying
with certain procedural requirements. However, approval from appropriate
governmental authorities is required where Renminbi is to be converted into
foreign currency and remitted out of China to pay capital expenses such as the
repayment of bank loans denominated in foreign currencies.  The
Chinese government may also at its discretion restrict access in the future to
foreign currencies for current account transactions.  If the foreign
exchange control system prevents us from obtaining sufficient foreign currency
to satisfy our currency demands, we may not be able to pay certain of our
expenses as they come due.  In addition, current regulations in China
permit Chinese subsidiaries to pay dividends to us only out of their accumulated
distributable profits, if any, determined in accordance with Chinese accounting
standards and regulations. In addition, Chinese subsidiaries are required to set
aside at least 10% of its accumulated profits each year.  Such reserve
account may not be distributed as cash dividends.





If
any dividend is declared in the future and paid in a foreign currency, you may
be taxed on a larger amount in U.S. dollars than the U.S. dollar amount that you
will actually ultimately receive.





If you
are a U.S. holder, you will be taxed on the U.S. dollar value of your dividends
at the time you receive them, even if you actually receive a smaller amount of
U.S. dollars when the payment is in fact converted into U.S. dollars.
Specifically, if a dividend is declared and paid in a foreign currency, the
amount of the dividend distribution that you must include in your income as a
U.S. holder will be the U.S. dollar value of the payments made in the foreign
currency, determined at the conversion rate of the foreign currency to the U.S.
dollar on the date the dividend distribution is includible in your income,
regardless of whether the payment is in fact converted into U.S. dollars. Thus,
if the value of the foreign currency decreases before you actually convert the
currency into U.S. dollars, you will be taxed on a larger amount in U.S. dollars
than the U.S. dollar amount that you will actually ultimately
receive.





Our
business could be severely harmed if the Chinese government changes its
policies, laws, regulations, tax structure or its current interpretations of its
laws, rules and regulations relating to our operations in China.





Our
manufacturing facility is located in China and virtually all of our assets are
located in China.  We generate our sales revenue only from customers
located in China.  Our results of operations, financial state of
affairs and future growth are, to a significant degree, subject to China’s
economic, political and legal development and related uncertainties. Our
operations and results could be materially affected by a number of factors,
including, but not limited to





·
            Changes
      in policies by the Chinese government resulting in changes in laws or
      regulations or the interpretation of laws or
  regulations,


·
              changes
      in taxation,
 ·
              changes
      in employment restrictions,
 ·
              restrictions
      on imports and sources of supply,
 ·
              import
      duties, and
 ·
              currency
      revaluation.
 
 Over the
past several years, the Chinese government has pursued economic reform policies
including the encouragement of private economic activities and greater economic
decentralization. If the Chinese government does not continue to pursue its
present policies that encourage foreign investment and operations in China, or
if these policies are either not successful or are significantly altered, then
our business could be harmed.  Following the Chinese government’s
policy of privatizing many state-owned enterprises, the Chinese government has
attempted to augment its revenues through increased tax
collection.  It also exercises significant control over China’s
economic growth through the allocation of resources, controlling payment of
foreign currency-denominated obligations, setting monetary policy and providing
preferential treatment to particular industries or
companies.  Continued efforts to increase tax revenues could result in
increased taxation expenses being incurred by us.  Economic
development may be limited as well by the imposition of austerity measures
intended to reduce inflation, the inadequate development of infrastructure and
the potential unavailability of adequate power and water supplies,
transportation and communications.  In addition, the Chinese
government continues to play a significant role in regulating industry by
imposing industrial policies.


14




The
Chinese laws and regulations which govern our current business operations are
sometimes vague and uncertain and may be changed in a way that hurts our
business.





China’s
legal system is a civil law system based on written statutes, in which system
decided legal cases have little value as precedents, unlike the common law
system prevalent in the United States. There are substantial uncertainties
regarding the interpretation and application of Chinese laws and regulations,
including but not limited to the laws and regulations governing our business, or
the enforcement and performance of our arrangements with customers in the event
of the imposition of statutory liens, death, bankruptcy and criminal
proceedings.  The Chinese government has been developing a
comprehensive system of commercial laws, and considerable progress has been made
in introducing laws and regulations dealing with economic matters such as
foreign investment, corporate organization and governance, commerce, taxation
and trade.  However, because these laws and regulations are relatively
new, and because of the limited volume of published cases and judicial
interpretation and their lack of force as precedents, interpretation and
enforcement of these laws and regulations involve significant uncertainties. New
laws and regulations that affect existing and proposed future businesses may
also be applied retroactively.   We are considered an FIE under
Chinese laws, and as a result, we must comply with Chinese laws and
regulations.  We cannot predict what effect the interpretation of
existing or new Chinese laws or regulations may have on our
business.  If the relevant authorities find us to be in violation of
Chinese laws or regulations, they would have broad discretion in dealing with
such a violation, including, without limitation: levying fines; revoking our
business and other licenses; requiring that we restructure our ownership or
operations; and requiring that we discontinue any portion or all of our
business.





A
slowdown or other adverse developments in the Chinese economy may materially and
adversely affect our customers’ demand for our services and our
business.





All of
our operations are conducted in China and all of our revenues are generated from
sales to businesses operating in China.  Although the Chinese economy
has grown significantly in recent years, such growth may not continue. we do not
know how sensitive we are to a slowdown in economic growth or other adverse
changes in Chinese economy which may affect demand for our
products.  A slowdown in overall economic growth, an economic downturn
or recession or other adverse economic developments in China may materially
reduce the demand for our products and in turn reduce our results of
operations.





Controversies
affecting China’s trade with the United States could depress the price of our
securities.





While
China has been granted permanent most favored nation trade status in the United
States through its entry into the World Trade Organization, controversies and
trade disagreements between the United States and China may arise that depress
our the price of our securities.  Political or trade friction between
the United States and China, whether or not actually affecting our business,
could also materially and adversely affect the prevailing market price of our
securities.




There
can be no guarantee that China will comply with the membership requirements of
the World Trade Organization, which could leave us subject to retaliatory
actions by other governments and reduce our ability to sell our products
internationally.
 
 China has
agreed that foreign companies will be allowed to import most products into any
part of China. In the sensitive area of intellectual property rights, China has
agreed to implement the trade-related intellectual property agreement of the
Uruguay Round. There can be no assurances that China will implement any or all
of the requirements of its membership in the World Trade Organization in a
timely manner, if at all. If China does not fulfill its obligations to the World
Trade Organization, we may be subject to retaliatory actions by the governments
of the countries into which it sell our products, which could render its
products less attractive, thus reducing revenues and profits.


15




The
implementation of the new PRC employment contract law and increases in the labor
costs in China may hurt our business and profitability.





A new
employment contract law became effective on January 1, 2008 in China. It imposes
more stringent requirements on employers in relation to entry into fixed-term
employment contracts, recruitment of temporary employees and dismissal of
employees. In addition, under the newly promulgated Regulations on Paid Annual
Leave for Employees, which also became effective on January 1, 2008, employees
who have worked continuously for more than one year are entitled to paid
vacation ranging from 5 to 15 days, depending on the length of the employee’s
service. Employees who waive such vacation entitlements at the request of the
employer will be compensated for three times their normal daily salaries for
each vacation day so waived. As a result of the new law and regulations, our
labor costs may increase. There is no assurance that disputes, work stoppages or
strikes will not arise in the future. Increases in the labor costs or future
disputes with our employees could damage our business, financial condition or
operating results.





The
Chinese government has been adopting increasingly stringent environmental,
health and safety protection requirements, which could hurt our
business.





The
continuance of our operations depends upon compliance with the applicable
environmental, health and safety, fire prevention and other
regulations.  Any change in the scope or application of these laws and
regulations may limit our production capacity or increase our cost of operation
and could therefore have an adverse effect on our business operations, financial
condition and operating results.  Our failure to comply with these
laws and regulations could result in fines, penalties or legal proceedings.
There can be no assurance that the Chinese government will not impose additional
or stricter laws or regulations, compliance with which may cause us to incur
significant capital expenditures, which it may not be able to pass on to our
customers.





Under
the New EIT Law, we may be classified as a “resident enterprise” of
China.  Such classification will likely result in unfavorable tax
consequences to us and our non-PRC shareholders.





China
passed a new Enterprise Income Tax Law, or the New EIT Law, and its implementing
rules, both of which became effective on January 1, 2008.  Under the
New EIT Law, an enterprise established outside of China with “de facto
management bodies” within China is considered a “resident enterprise,” meaning
that it can be treated in a manner similar to a Chinese domestic enterprise for
enterprise income tax purposes.  The implementing rules of the New EIT
Law define de facto management as “substantial and overall management and
control over the production and operations, personnel, accounting, and
properties” of the enterprise.




On April
22, 2009, the State Administration of Taxation issued the Notice Concerning
Relevant Issues Regarding Cognizance of Chinese Investment Controlled
Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria
of de facto Management Bodies, or the Notice, further interpreting the
application of the New EIT Law and its implementation non-Chinese enterprise or
group controlled offshore entities.  Pursuant to the Notice, an
enterprise incorporated in an offshore jurisdiction and controlled by a Chinese
enterprise or group will be classified as a “non-domestically incorporated
resident enterprise” if (i) its senior management in charge of daily operations
reside or perform their duties mainly in China; (ii) its financial or personnel
decisions are made or approved by bodies or persons in China; (iii) substantial
assets and properties, accounting books, corporate chops, board and shareholder
minutes are kept in China; and (iv) at least half of its directors with voting
rights or senior management often resident in China.  A resident
enterprise would be subject to an enterprise income tax rate of 25% on its
worldwide income and must pay a withholding tax at a rate of 10% when paying
dividends to its non-PRC shareholders.  However, it remains unclear as
to whether the Notice is applicable to an offshore enterprise incorporated by a
Chinese natural person.  Nor are detailed measures on imposition of
tax from non-domestically incorporated resident enterprises are
available.  Therefore, it is unclear how tax authorities will
determine tax residency based on the facts of each case.




16





We may be
deemed to be a resident enterprise by Chinese tax authorities.  If the
PRC tax authorities determine that Hollysys is a “resident enterprise” for PRC
enterprise income tax purposes, a number of unfavorable PRC tax consequences
could follow. First, we may be subject to the enterprise income tax at a rate of
25% on our worldwide taxable income as well as PRC enterprise income tax
reporting obligations.  In our case, this would mean that income such
as interest on financing proceeds and non-China source income would be subject
to PRC enterprise income tax at a rate of 25%. Second, although under the New
EIT Law and its implementing rules, dividends paid to us from our PRC
subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such
dividends will not be subject to a 10% withholding tax, as the PRC foreign
exchange control authorities, which enforce the withholding tax, have not yet
issued guidance with respect to the processing of outbound remittances to
entities that are treated as resident enterprises for PRC enterprise income tax
purposes. Finally, it is possible that future guidance issued with respect to
the new “resident enterprise” classification could result in a situation in
which a 10% withholding tax is imposed on dividends we pay to our non-PRC
shareholders and with respect to gains derived by our non-PRC shareholders from
transferring our shares.





We do not
expect any impact on our business and operations under the new EIT Law and its
implementing rules as we do not have non-PRC income.





RISKS
RELATED TO OUR SHARES





The market price
of our common stock is volatile, leading to the possibility of its value being
depressed at a time when
you want to sell your holdings.





The
market price of our common stock is volatile, and this volatility may
continue.  Numerous factors, many of which are beyond our control, may
cause the market price of our ordinary shares to fluctuate significantly. These
factors include:





·
            our
      earnings releases, actual or anticipated changes in our earnings,
      fluctuations in our operating results or our failure to meet the
      expectations of financial market analysts and
  investors;


·
            changes
      in financial estimates by us or by any securities analysts who might cover
      our stock;


·
            speculation
      about our business in the press or the investment
    community;


·
            significant
      developments relating to our relationships with our customers or
      suppliers;


·
            stock
      market price and volume fluctuations of other publicly traded companies
      and, in particular, those that are in the same industry as we
      are;


·
            customer
      demand for our products;


·
            investor
      perceptions of the industry in general and our company in
      particular;


·
            the
      operating and stock performance of comparable
  companies;


·
            general
      economic conditions and trends;


·
            major
      catastrophic events;


·
            announcements
      by us or our competitors of new products, significant acquisitions,
      strategic partnerships or
divestitures;


·
            changes
      in accounting standards, policies, guidance, interpretation or
      principles;


·
            loss
      of external funding sources;


·
            failure
      to maintain compliance with Nasdaq
rules;


·
              sales
      of our ordinary shares, including sales by our directors, officers or
      significant shareholders; and
 ·
              additions
      or departures of key personnel.
  Securities
class action litigation is often instituted against companies following periods
of volatility in their stock price. This type of litigation could result in
substantial costs to us and divert our management’s attention and
resources.
 
 Moreover,
securities markets may from time to time experience significant price and volume
fluctuations for reasons unrelated to operating performance of particular
companies. For example, from October until June 2009, securities markets in the
United States, China and throughout the world experienced a historically large
decline in share price. These market fluctuations may adversely affect the price
of our ordinary shares and other interests in our company at a time when you
want to sell your interest in us.


17




We
are a “foreign private issuer,” and have disclosure obligations that are
different than those of other U.S. domestic reporting companies so you should
not expect to receive the same information about us at the same time as a U.S.
domestic reporting company may provide.





We are a
foreign private issuer and, as a result, we are not subject to certain of the
requirements imposed upon U.S. domestic issuers by the SEC. For example, we are
not required to issue quarterly reports or proxy statements.  Through
the fiscal year ending June 30, 2010, we are allowed six months to file our
annual report with the SEC and thereafter must file our annual report within
four months of our fiscal year end.  We are not required to disclose
certain detailed information regarding executive compensation that is required
from U.S. domestic issuers. Further, our directors and executive officers are
not required to report equity holdings under Section 16 of the Securities
Act.  As a foreign private issuer, we are also exempt from the
requirements of Regulation FD (Fair Disclosure) which, generally, are meant to
ensure that select groups of investors are not privy to specific information
about an issuer before other investors. We are, however, still subject to the
anti-fraud and anti-manipulation rules of the SEC, such as Rule
10b-5.  Since many of the disclosure obligations required of us as a
foreign private issuer are different than those required by other U.S. domestic
reporting companies, our shareholders should not expect to receive information
about us in the same amount and at the same time as information is received
from, or provided by, other U.S. domestic reporting companies.  We are
liable for violations of the rules and regulations of the SEC which do apply to
us as a foreign private issuer. Violations of these rules could affect our
business, results of operations and financial condition.





You
may have difficulty enforcing judgments obtained against us.





We are a
BVI company and substantially all of our assets are located outside of the
United States. Virtually all of our assets and a substantial portion of our
current business operations are conducted in the PRC.  In addition,
almost all of our directors and officers are nationals and residents of
countries other than the United States. A substantial portion of the assets of
these persons are located outside the United States. As a result, it may be
difficult for you to effect service of process within the United States upon
these persons.  It may also be difficult for you to enforce in
U.S. courts judgments obtained in U.S. courts based on the civil
liability provisions of the U.S. federal securities laws against us and our
officers and directors, many of whom are not residents in the United States and
whose assets are located in significant part outside of the United States. In
addition, there is uncertainty as to whether the courts of the British Virgin
Islands or the PRC would recognize or enforce judgments of U.S. courts
against us or such persons predicated upon the civil liability provisions of the
securities laws of the United States or any state.  In addition, it is
uncertain whether such British Virgin Islands or PRC courts would be competent
to hear original actions brought in the British Virgin Islands or the PRC
against us or such persons predicated upon the securities laws of the United
States or any state.


Because
we are incorporated under the laws of the BVI, it may be more difficult for our
shareholders to protect their rights than it would be for a shareholder of a
corporation incorporated in another jurisdiction.
 
 Our
corporate affairs are governed by our Memorandum and Articles of Association and
by the BVI Business Companies Act, 2004 of the BVI.  Principles of law
relating to such matters as the validity of corporate procedures, the fiduciary
duties of management and the rights of our shareholders differ from those that
would apply if we were incorporated in the United States or another
jurisdiction.  The rights of shareholders under BVI law are not as
clearly established as are the rights of shareholders in many other
jurisdictions.  Under the laws of most jurisdictions in the United
States, majority and controlling shareholders generally have certain fiduciary
responsibilities to the minority shareholders. Shareholder action must be taken
in good faith, and actions by controlling shareholders which are obviously
unreasonable may be declared null and void. BVI law protecting the interests of
minority shareholders may not be as protective in all circumstances as the law
protecting minority shareholders in US jurisdictions.  In addition,
the circumstances in which a shareholder of a BVI company may sue the company
derivatively, and the procedures and defenses that may be available to the
company, may result in the rights of shareholders of a BVI company being more
limited than those of shareholders of a company organized in the
US.  Furthermore, our directors have the power to take certain actions
without shareholder approval which would require shareholder approval under the
laws of most US jurisdictions.  The directors of a BVI corporation,
subject in certain cases to court approval but without shareholder approval, may
implement a reorganization, merger or consolidation, the sale of any assets,
property, part of the business, or securities of the corporation.  The
ability of our board of directors to create new classes or series of shares and
the rights attached by amending our Memorandum of Association and Articles of
Association without shareholder approval could have the effect of delaying,
deterring or preventing a change in our control without any further action by
the shareholders, including a tender offer to purchase our ordinary shares at a
premium over then current market prices. Thus, our shareholders may have more
difficulty protecting their interests in the face of actions by our board of
directors or our controlling shareholders than they would have as shareholders
of a corporation incorporated in another jurisdiction.


18




We
may be classified as a passive foreign investment company, which could result in
adverse United States federal income tax consequences to U.S.
shareholders.





We
believe that we are not considered a “passive foreign investment company,” or
PFIC, for United States federal income tax purposes for our tax year ending June
30, 2009.  However, each year we must make a separate determination as
to whether we are a PFIC.  We cannot assure you that we will not be a
PFIC for our tax year ending June 30, 2009 or any following tax
year.  If a non-U.S. corporation either (i) at least 75% of its gross
income is passive income for a tax year or (ii) at least 50% of the value of its
assets (based on an average of the quarterly values of the assets during a tax
year) is attributable to assets that produce or are held for the production of
passive income, then the non-U.S. corporation will be deemed a
PFIC.  The market value of our assets may be determined to a large
extent by the market price of our ordinary shares, which is likely to fluctuate
after this offering. Furthermore, how we spend as well as how quickly we spend
the proceeds from the offering will affect the composition of our income and
assets.  If we are treated as a PFIC for any tax year during which
U.S. shareholders hold ordinary shares, certain adverse United States federal
income tax consequences could apply to such U.S. holders.





ITEM
4.            INFORMATION
ON THE COMPANY




A.
History and Development of the Company





We were
established under the laws of the BVI on February 6, 2006, as HLS Systems
International, Ltd., in order to merge with Chardan North China Acquisition
Corporation, or Chardan, a Delaware special purpose acquisition company, or
SPAC, originally established on March 10, 2005, with the primary purpose of
effecting a business combination with an unidentified operating business that
has its primary operating facilities located in China, in any city or province
north of Yangtze River. On September 20, 2007, we acquired all of the issued and
outstanding common stock of Gifted Time, a BVI
company.  Simultaneously with the acquisition, Chardan merged with and
into us, all of the common stock of Chardan was converted into our ordinary
shares, on a one-to-one basis, and we assumed the then outstanding Chardan
warrants.  As a result of the foregoing transactions: we acquired a
controlling interest in Beijing Hollysys and Hangzhou Hollysys, and an indirect
interest in their majority and minority owned subsidiaries, and the consolidated
financial statements of Beijing Hollysys and Hangzhou Hollysys became our
historical financial statements for reporting purposes.   On July 17,
2009, we changed our name to Hollysys Automation Technologies, Ltd, to more
accurately reflect our core value of leveraging proprietary technologies to
provide state-of-the-art automation and control solutions for our
clients.


Gifted
Time and Subsidiaries
 
 Gifted
Time was established under the laws of the BVI on September 21, 2005, as a
holding company for our indirect PRC subsidiaries, Beijing Hollysys and in
Hangzhou Hollysys.
 
 Beijing
Hollysys was established in September 1996 as a domestic Chinese company based
in Beijing, China. From inception, Beijing Hollysys has been engaged in
designing, developing and manufacturing automation control systems for customers
throughout China.  Beijing Hollysys offers integrated automation solutions
for many industries, including electric power generation, transmission and
distribution, manufacturing (including metallurgy, construction materials,
petrochemical and pharmaceutical industries), and railroad transportation.
 Beijing Hollysys’ integrated automation systems and solutions have enabled
customers to improve the safety, reliability and efficiency of their
manufacturing processes and significantly enhance the customers’ overall
profitability.  Hangzhou Hollysys was established as an equity joint
venture under Chinese laws in September 2003.  The operations of Hangzhou
Hollysys emphasize industrial automation and integrated solutions.


19




During
the period from December 2007 to March 2008, Hollysys established a series of
wholly owned subsidiaries, namely (i) Beijing S&T, a newly established
Chinese domestic enterprise which acquired the original shareholders’ 74.11%
equity interest in Beijing Hollysys; (ii) Beijing Helitong, a newly established
wholly foreign owned enterprise in China which acquired the original
shareholders’ 100% equity interest in Beijing S&T; (iii) World Hope
Enterprises Limited, a newly established Hong Kong company which acquired the
original shareholders’ 100% equity interest in Beijing Helitong; (iv) Clear Mind
Limited, a newly established BVI company which acquired the original
shareholders’ 100% equity interest in World Hope, and Clear Mind Limited is 100%
owned by Gifted Time.  Through this series of ownership arrangement,
Hollysys obtained the 74.11% legal ownership of Beijing Hollysys instead of
through consignment agreements. However, there can be no assurance that the PRC
authorities will not, in future, challenge the appropriateness of the procedures
of the transferring of the ownership of the PRC subsidiaries as the Company did
not directly go through the procedures required by the “Regulation of Merger and Acquisition
of PRC Enterprises by Foreign Investors.”





Singapore
Hollysys





On
November 19, 2007, Hollysys entered into a sales and purchase agreement with
Fulbond Systems Pte Ltd., or Fulbond Systems, a Singapore based company
partially owned by Mr. Kiam Fee Yau, one of our directors, to acquire a 100%
interest of Fulbond Systems for a price of SGD$1,066,234 (approximately
$744,596).  Pursuant to the sales and purchase agreement, the closing day
of this acquisition was November 30, 2007 and after the ownership transfer, we
changed the name of Fulbond Systems to “Hollysys (Asia Pacific) Pte Ltd.”
 The purchase price was paid in cash on December 11, 2007.  As a
result of the transaction, Singapore Hollysys becomes our wholly owned
subsidiary and the operating results of Singapore Hollysys is included in our
consolidated financial statements, effective from December 1, 2007.  We
acquired Singapore Hollysys to serve as our Asia Pacific headquarters to market
our automation products within the region as well as in other overseas
countries.





B.  Business
Overview





Hollysys
Automation Technologies Ltd. is a leading provider of automation and control
technologies and applications in China that enables its diversified industry and
utility customers to improve operating safety, reliability and efficiency.
Founded in 1993, Hollysys has approximately 2,100 employees with 9 sales centers
and 13 service centers in 21 cities in China, and serves over 1700 customers in
the industrial, railway and nuclear industries. Its proprietary technologies are
applied in product lines, including Distributed Control Systems (DCS) and
Programmable Logic Controllers (PLC), high-speed railway Train Control Centers
(TCC) and Automatic Train Protection (ATP), and safety control product NMS for
nuclear power plants. Hollysys is the only certified domestic automation control
systems provider to the nuclear industry in China. Hollysys is also one of only
five automation control systems and products providers approved by China’s
Ministry of Railways in the 200km to 250km high-speed rail segment, and is one
of only two automation control systems and products providers approved in the
300km to 350km high-speed rail segment.




We have
historically focused our efforts in the area of Distributed Control Systems, or
DCS, which are networks of controllers, sensors, actuators and other devices
that can be programmed to control outputs based on input conditions and/or
algorithms, with a primary concentration in power plant and chemical plant
automation systems. However, we also have a significant market presence in the
basic materials, pharmaceutical and food and beverage processing industries.
Over the past five years, we have devoted significant resources to research and
development and sales efforts for rail transportation and nuclear power segments
that we believe will have the greatest growth and margin protection over the
coming 10 years. We believe that our present leadership position in the
high-growth segments is attributable to our vision, execution, and strong
research and development capabilities.
 
 We have a
reputation in the industry for our comprehensive capabilities in the PRC
domestic industrial automation market and have concentrated our focus on the
development of this market. We sell our products and services to, or carry out
engineering projects for, national or multi-provincial companies with
subsidiaries located across 30 provinces in China. To date, we have served more
than 1,700 industrial enterprise customers and have undertaken over 8,000
projects.  We believe that the quality of our systems is unsurpassed by
local Chinese competitors and is comparable to high-end foreign suppliers of DCS
and the history of our projects supports that view.   For example, after
three years of review and analysis, BASF, a large multi-national company, has
designated us as a potential qualified DCS vendor for the company, a distinction
shared with large multinationals such as ABB and Emerson.


20




Our
revenue increased from $102 million in fiscal year 2007, to $121.5 million in
fiscal year 2008 and $157.5 million in fiscal year 2009, representing a
compounded annual growth rate of approximately 24.3%.  These significant
increases reflect our success in exploring new business areas and our increasing
market penetration.  We continually seek to broaden our market reach by
introducing new technology and improving our profit margin through new business
areas such as railway control systems and nuclear power plant
control.





Strategy





Our goal
is to become one of the world's leading automation and process system companies.
 To meet this goal we plan to enhance the core competencies that have made
us a leading domestic automation system provider in China, as reflected by our
top rank among Chinese producers of DCS in 2007, the only Chinese company
qualified to design and manufacture control systems for nuclear power plants,
and a leader in the high-speed rail and subway sector.   The principal
elements of our core business strategies are as follows:





·
            Maintaining a leadership
      position in China’s DCS Market –  We seek to maintain and
      further strengthen our position in China as a leading provider of DCS
      platforms for clients in various industries. Since the majority of our
      customers operate in a wide range of process industries, especially in
      infrastructure industries, we stand to be a prime beneficiary of the
      Chinese government stimulus program of RMB 4 trillion and the macro trend
      of growth of China's economy.  We plan to aggressively expand our
      business to fully exploit the anticipated growing demand for DCS products
      in areas favored by government spending, such as clean energy and other
      environmentally friendly industries, and infrastructure industries.
       Our combination of patented technologies, strong research and
      development capabilities, ability to leverage strategic alliance to enter
      and penetrate new market segments, and a comprehensive understanding of
      the Chinese market should allow us to capitalize on these growth
      opportunities.





·
            Enhancing a leadership
      position in technology – Hollysys has long been recognized as a
      pioneer in the development of DCS technology as well as applications.
       We are continuously seeking ways to improve our existing product
      lines while being committed to the development of new applications. In
      order to maintain our leadership position in technology, we have devoted
      and will continue to devote significant resources to the research and
      development process that is undertaken by a group of highly trained and
      skilled engineers.  We plan to concentrate our research and
      development resources on our core end market related technologies and
      products, and new upcoming growth industries, including the 5th
      generation of proprietary DCS platform, subway signaling system, wind
      energy related control products and application, and high-speed rail
      products to compliment our existing high-speed product
      portfolio.




·
            Expansion to Adjacent
      Markets – In addition to aiming for a global leadership position,
      our secondary goal is to carefully expand or migrate to adjacent markets
      that can share or strengthen our core business. We have successfully
      leveraged our technological foundation and strategic alliance and have
      expanded our end markets from industrial, to nuclear, to rail over the
      past 10 years.  We plan to continue duplication of this
      successful strategy to enter some high-growth and high-margin end-markets,
      such as wind energy, alternative energy, and waste
    management.





Products
and Services





As a
leading provider of automation and control technology and applications in China,
we provide our customers with our standard and customized products and
corresponding services based on each client’s specific requirements.  We
are committed to providing reliable, advanced and cost-effective solutions to
help customers optimize their processes to achieve higher quality, greater
reliability and better productivity and profitability.





DCS
Products:   Our major offering is a comprehensive suite of
automation systems for a wide market. Our industrial market clientele ranges
from petrochemical, thermal power industries, to cement production and paper
making industries, and etc. The two mainstream products for this market segment
are our DCS products and our Programmable Logic Controllers, or
PLCs.  DCS are a network of controllers, sensors, actuators and other
devices that can be programmed to control outputs based on input conditions
through logic calculations. In an automated production line, sensors or
so-called “instrumentations” are distributed across the production facility to
monitor sub-systems like the robots, CNC machines, logistic tools,
etc.  These sensors are like human eyes, which monitor the process,
and detect any abnormal situations. The information collected from those sensors
is then transmitted to the DCS for centralized data processing through
communication networks. The brain processes information and generates commands,
based on sophisticated algorithm and pre-set parameters.  These
commands are then sent to actuators (muscles/bones) through communication
devices to execute the orders and maintain production flow.  PLCs are
small computer devices installed on machines or equipment, for example, on a
factory assembly line, for manufacturing automation.


21




TCC and ATP
Products:  Over the years, Hollysys has successfully scaled its
automation application from industrial manufacturing to rail and subway
industry, with proprietary product lines including, our Train Control Center, or
TCC, product and our Automation Train Protection, or ATP, system.  An
ATP essentially acts as the train over-speed protection mechanism, which
collects real-time information like speed limit ahead, train operation status,
line data, instructions from train control center, then combines with the train
parameters to produce train protection curves.  In case of any human
errors, like driver’s negligence at the red light, it applies emergency brakes
automatically.  TCCs are an on-ground control center at railway
stations which monitors route condition, track status, train schedules, distance
between trains, and the working status of other essential function devices, and
then through logic calculation, generates control instructions and
commands.  The command information from the TCC is then transmitted to
the ATP located on the locomotives/trains, through track circuits and electronic
beacons located at various points along the railway line.





Nuclear
Products:  As the only certified domestic automation control
systems provider to the nuclear power industry in China, we provide our HOLLiAS
NMS product to China’s nuclear power industry.  A nuclear power
station is identical in most respects to a normal thermal power station in the
sense that steam is used to turn the turbines, which drive the generators, which
is called a “conventional island.”  The difference is in the boiler
that produces the steam, is the nuclear reactor, which is called the “nuclear
island.” In a nuclear station, the nuclear island operates to transform nuclear
energy to heat energy, and pass on the steam generated by the steam generator to
the conventional island, where steam drives the turbine to generate the
electricity, and pass on to the transformer for loading onto the
grid.  Our HOLLiAS NMS proprietary control systems are now used in
conventional islands for safety and operation control. The know-how was
accumulated from our industrial DCS applications in high-end power plants, with
much more sophisticated software and hardware specifications, and more stringent
production and inspection process. Our safety control product for nuclear
islands is currently undergoing development at our 50/50 joint venture with the
leading PRC domestic nuclear operator, China Guangdong Nuclear Power Holdings
Corporation.





Subway
Products:  We have provided our Surveillance Control and Data
Acquisition (SCADA) system to China’s subway market for many years, included to
customers like the Beijing Subway, Shanghai Metro, Guangzhou Metro, and Shenzhen
Metro. SCADA is an open software platform to enable integrated and unified
monitoring of all necessary sub-systems of the subway, including the Power
Supervisory Control and Data Acquisition System, Building Automatic System, Fire
Alarm System, Platform Screen Door System, Access Control System, Closed Circuit
Television, Passenger Information System, Passenger Train Information System,
and Alarm System.  Given the exponential growth in China’s subway
market and the continued growth expected for the decades to come, Hollysys is
developing its proprietary Subway Signaling System, based on its strong research
and development capability and technical know-how of signaling application
accumulated from high-speed rail. The current subway signaling market is
predominantly occupied by multi-national corporations, such as
Siemens.


Management and Control Integrated
Solutions: Based on our careful research of the demand and requirements
of manufacturing industries for information technology, we also offer management
and control integrated solutions. Our solutions are based on the HOLLiAS
(Hollysys Integrated Industrial Automation System) platform, which includes
features for the fourth generation of DCS and functions for the international
mainstream DCS. HOLLiAS is an open system software platform that integrates
various management functions and control systems with procured peripheral
equipment, self-produced core hardware and the customer’s existing hardware and
software. Using the HOLLiAS platform, we can provide customized solutions to
meet the application requirements of different industries.




22




We
established a project group for each potential customer, which has a team of
systems engineers and managers engaged in providing total integrated solutions
to our customers to meet their specific requirements. Each project group is
staffed with a dedicated team of sales engineers, technical engineers and
project management professionals. The sales engineers and technical engineers
work together to offer the best customized solutions as a result of their
understanding of the customer’s detailed requirements through on-site studies.
The technical engineers are responsible for hardware assembly, software
configuration, testing and installation, commissioning and trial operation, and
start-up and training; while the project management professionals oversee
budgetary matters, coordinate the work force, ensure adequacy of resources and
monitor progress and quality to ensure the timely completion of each project.
 Our integrated solutions projects involve one or more of the following
activities:





·
            Solution planning – We
      provide our customers with strategic and tactical reviews of their current
      operations and future requirements.  We do much of this work before
      the customer awards the contract to assist the customer in developing an
      appropriate request for proposal and to improve Hollysys’ chances of
      winning the contract. The planning includes defining client business
      requirements, developing appropriate hardware and software and selecting
      preferred technology.





·
            Solution
      design  – We detail the industry specifications and
      implementation tactics necessary to achieve our customer’s objectives.
      Hollysys also considers how the new technology will integrate hardware and
      software integrated in the solution with the customer’s existing hardware
      and software and how it will be managed on an ongoing basis. Examples of
      these services include defining functional requirements for the system and
      our components, developing integration plans and designing of
      customer-specific system and services
  applications.





·
            Solution implementation
      – We install the recommended systems to meet our customers' specific
      requirements. Key activities include project management, hardware
      procurement and production, software development, configuration and field
      installation and testing, and development of customized system and
      services management applications.





·
            Maintenance and support
      services – We emphasize creating value for our clients by providing
      high quality tailored services.  Our professional, prompt and
      long-term services include technical services, engineering services to
      specific industries, application development services and maintenance
      services.  We provide maintenance and technical support in connection
      with all of our systems integration projects. These services currently
      include assistance with the implementation of new system platforms,
      configuration and programming services for new business processes, and
      assistance with technology upgrading.   We believe that our
      policy of on-going maintenance and technical support will help foster
      long-term relationships with our customers and eventually create
      significant business opportunities.





·
            Training – We also
      incorporate customer training and an ongoing service component into our
      product offerings.  We provide technical training for our customers
      and strategic partners to increase their awareness and knowledge of DCS
      technologies in the Chinese industrial automation market and to support
      the operations of our customers' integrated automation systems. The
      training helps to ensure that customers derive the greatest amount of
      benefit possible from their new automation system.  As a result, this
      training leads to increased value, which in turn generates customer
      satisfaction and loyalty.


Our
integrated solutions based on our proprietary technology and products create
value for and improve the competitive strengths of our customers
by:
 
 ·
              Generating
      synergy and improving efficiency of our customers through integrating
      communications, marketing and service
functions;
 
 ·
              Utilizing
      our industry and process knowledge to develop customized solutions that
      improve the efficiency of our
customers;
 
 ·
              Providing
      a software platform for the optimization of management operations, which
      provides real-time automation and information solutions throughout a
      business; and
 23




·
            Offering
      maintenance and training services to our customers, which help to cut
      costs and improve operating
efficiency.




We
customize our floor plans based on careful on-site studies, build
design-specific network systems using our advanced DCS technology and
proprietary software, and offer manufacturing execution system services to
ensure that real-time management control is available to our customers in a
streamlined and easy-to-use manner.





We
believe that our product design and applications that are integrated in the
solutions are unmatched among our domestic competitors.  We also believe
that the sophistication and quality of our products rival those of the
multi-national automation and control product suppliers, while our ability to
understand and meet the needs of our Chinese customers gives it a leading edge
over foreign competitors.  The value of this combination is reflected in
our strong revenue and profit growth over the years.





Market
for Automation and Controls Solutions





DCS
Market





According
to the ARC Advisory Group, or ARC, an industry research group, the DCS market in
China, as measured by revenue, exceeded $780 million in 2005 and will grow at a
compounded annual growth rate of approximately 12% through 2010. ARC further
projects that the DCS market, as measured by revenue, will exceed $1400 million
by 2010.  The chart below shows the forecast of the DCS market size in
China.











Source:
ARC Advisory Group





We agree
with ARC’s assessment that, “China, in contrast to most other countries,
provides robust growth prospects for DCS suppliers. With new investments
continuing to take place in its core process industry sector, the market has
excellent growth potential in both the near and long-term. Almost a quarter of a
billion people with their growing disposable income are generating an exploding
demand for a wide range of products. Domestic and global manufacturers, lured by
this opportunity, have created new, world-class production facilities in almost
all vertical industries. They are going beyond the near term opportunity for
obtaining low cost labor. They are pursuing the best available control system
technology and attaining a sustainable competitive advantage.”




24




Currently,
the vast majority of the global automation market is still controlled by a
handful of multi-national companies, most of them with western roots. Our
competition includes some very recognizable names: Honeywell (US); Siemens
(Germany); General Electric (US); ABB (Sweden); Rockwell (US); Westinghouse
(US); and Hitachi (Japan). The western roots of automation are not surprising,
as that is also where industrialization began and progressed the farthest during
the 19th and 20th centuries.  However, a new focus of the automation
market is China, where the tremendous growth of industrialization is by now a
very familiar story. Manufacturing jobs in the US and other western economies
over the past two decades have steadily decreased, while China’s industrial base
has expanded at the rate of 8.5% annually since 1991. China’s shift from a
developing country to one of the world’s leading manufacturers of industrial
equipment and consumer goods has created a substantial and growing demand for
the automation systems that help to make those manufacturing processes more
efficient, reliable and safe.





The
industrial automation market was estimated to grow at an annual rate of 16.1%
between 2005 and 2009, by ARC. Given the economic downtown experienced over the
past year, the growth rate in China DCS market for these two years should be
approximately around -5% to flat. In industrial side of our business, our
current market share is 10.6%, which was measured by industrial customer brand
name usage, from a third party report. Up to date we have implemented over 6500
projects with over 1700 customers.  Clientele base for this segment
includes large State-owned enterprises, multi-national companies, and other
domestic companies. Our main competitors in this field are global players such
as ABB, Siemens, and Emerson, and also Supcon from local.  We believe
that the Hollysys brand recognition and market reputation, and our strong
research and development capabilities will enable us to enter and penetrate
high-margin market segments currently dominated by foreign companies, and will
ensure our revenue from this industrial market to grow at a rate continuously
exceeding the industry average.




High-Speed
Rail and Subway Market
 
 Another
exciting end-market for Hollysys is high-speed rail market in China, where we
command leading position in providing high-speed passenger train control and
protection systems. High-speed rail is a relatively new development in China.
The Ministry of Rail of China developed its own high-speed rail signaling
technological specifications, one is called C2 for 200-250km/hour train speed
category, the other is called C3 for 300-350km/hour train
speed.  There are few lines in operation in C2 category in China and
there is no operating line for the C3 category.  However, there are 3
lines currently under construction in the C3 category: the Zhengzhou-Xian line,
Wuhan-Guangzhou line, and Shenzhen-Guangzhou line. Hollysys is contracted to
provide automation and control products for the Zhengzhou-Xian line, and the
Shenzhen-Guangzhou line.
 
 China is
planning to have 13,000 kilometers of high-speed railways in operation in the
year of 2012, exceeding the current capacity of total high-speed railway
kilometers of 11,345 kilometers in operation in 19 countries in the
world.  According to China’s Ministry of Rail, there are 54 high-speed
rail lines planned to be built in China till 2012, among which are expected to
be, 16 lines under the C3 category and 38 lines under the C2
category.  The lines are generally described as “4 Horizontals and 4
Verticals,” referring to their positions on the map of China.  The
Four Vertical lines include the Beijing-Guangzhou line, Beijing–Shanghai line,
Haerbin-Dalian-Shenyang-Beijing line, and Shanghai-Hangzhou-Shenzhen
line.  The Four Horizontal lines include the
Lanzhou-Xian-Zhengzhou-Beijing line, Shanghai-Wuhan-Chongqiong-Chengdu line,
Hangzhou-Changsha-Kunming line, and Shijiazhuang-Qingdao line.  The
high-speed rail build-out plan also includes inter-city high-speed lines at the
Zhu Jiang River Delta, Yangtze River Delta, and Beijing-Tianjin-Tangshan areas.
As one of the five automation products providers under C2 category, and one of
the only two automation products providers to C3 segment, we believe that
Hollysys is well positioned to benefit from this unprecedented high-speed
railway build-out in the world.
 
 Hollysys
also provides its proprietary software platform and solutions of Surveillance
Control and Data Acquisition (SCADA) to subway market. China subway market is
expected to receive significant government spending due to urbanization and
environmental concerns of urban public transit system. According to China’s
Ministry of Housing and Urban-Rural Development, China subway market will grow
from 776 kilometers in 2008 to 4,189 kilometers in 2015, with government
estimated investment amounting to $129 billion in the period. With Hollysys more
than 5 years of experience in this market and well-recognized brand name,
Hollysys is putting in place a strategy to capture this fast-growing
market.


25




Nuclear
Market





Hollysys
is well-positioned to benefit from China’s nuclear build-out. At present,
China’s nuclear power sector is relatively underdeveloped, with the vast
majority of power generated by coal-fired power plants. There are currently 11
nuclear stations in operation, providing approximately 9 GW of power, in
comparison to the total electricity-generating capacity in China of
approximately 700 GW.  This represents a meager 1.3% of the total
electricity generated by nuclear energy, lagging far behind the world average of
15% power generated from the nuclear energy, with France being the highest with
70% of its power generated from nuclear.





Driven by
clean energy initiatives and the PRC government’s stimulus plan, China’s
installed nuclear power generating capacity is expected to reach 70 GW by 2020.
Approximately, 1 nuclear reactor generates 1GW electricity. Hollysys has formed
a 50/50 joint venture with China’s leading nuclear station operator, China
Guangdong Nuclear Power Holdings Corporation, to provide its proprietary
non-safety automation and control products to the nuclear stations constructed
by China Guangdong Nuclear Power Holdings Corporation. This strategic alliance
positions Hollysys to be the dominant nuclear automation system provider in
China. China Guangdong Nuclear Power currently owns and operates 4 of the 11
reactors in operation and 14 of the 20 nuclear reactors currently approved for
construction.





Integrated
Contracts





The main
channel through which we get our automation system business is the bidding
process. Customers seeking bids propose their requirements and specifications in
legal bidding documents and those companies that are interested in obtaining
these contracts make a bid in written form. If we win the bidding, we get the
integrated contract.  We derive over 90% of our total consolidated
revenues, mainly from the integrated contracts that we win through the bidding
process.  In addition, because product sales are not part of the integrated
contracts, we gain another revenue stream through the sale of spare parts and
component products to customers for maintenance and replacement purposes after
the completion of the integrated solution contract.


The
purpose of an integrated contract is to furnish an automation system that
provides the customer with a total solution for the automation or process
control requirement being addressed. The automation system and total solution
that we offer consists of hardware, software and services, all of which are
customized to meet the particular needs and technical specifications of our
customers.  None of hardware, software and service has independent
functionality, and therefore cannot be sold separately to
customers.
 
 The major
terms of an integrated solution contract include solution planning and design,
system installation, customer acceptance, payment milestones and warranty. The
process of fulfilling an integrated contract consists of the following four
stages:
 
 1.
              Solution planning and
      design - We provide customers with a customized plan for achieving
      the required solution by establishing a project group for each contract.
      The project group includes system engineers who propose and discuss and
      agree on the system design and implementation plan with the technical
      personnel of the customers.
 
 2.
              System manufacturing and
      installation - Based on the design and implementation plan, and in
      accordance with the project schedule, we enter into the process of
      purchasing the necessary hardware, manufacturing components for the
      hardware, developing software platform, re-configuring the software
      embedded in the hardware, and fabricating the integrated hardware into
      cabinets, on-site installation and testing, and training customer’s
      personnel about how to use the automation and total
    solution.
 
 3.
              Customer acceptance -
      The procedures for customer inspection and acceptance of the system are
      typically contained in the contracts. The initial inspection usually
      occurs when the hardware is delivered to the customer’s site for the
      purpose of detecting any obvious physical damage during shipping and to
      confirm that the entire order was delivered. A final acceptance will be
      performed upon the satisfaction of integrated solution
      testing.
 
 4.
              Warranty period - The
      integrated solution contracts customarily provide our customers with a
      one-year warranty (although sometimes the warranty period may be two years
      per the customers’ requests), which runs from the date of the final
      customer acceptance. The end of warranty period represents fulfillment of
      the entire contract.


26




Because
of the nature of customized integrated contracts, a customer does not have the
right to return the products that we deliver, so long as such products conform
and perform to the customer’s specification. Prior to delivering our products to
a customer’s site, we perform an internal test to ensure that the automation
system works as intended. After installing the products on a customer’s site,
any problems are solved during trial runs. Once the testing requirements have
been satisfied, a customer will sign and date a customer acceptance document,
which begins the warranty period. Due to the nature of this process, many
companies in the automation systems business generally do not carry product
liability insurance.





The size
of an integrated contract is determined by a customer’s needs in terms of the
amount of equipment needed and the complexity of integrated solution. The size
of an integrated contract drives the revenues generated by the contract.
 Because certain contracts will require working periods longer than one
year, the best way to measure the contract revenue realized is to use the
percentage-of-completion method.  Ultimately, our revenue stream will be
driven by the average price of an integrated contract and how many integrated
contracts have started in each reporting period.





Our
backlog of contracts presents the amount of unrealized revenue to be earned from
the contracts that we have won.  Accordingly, any increase or decrease in
new contracts won by us, or any change of scheduled delivery dates will have a
future impact on our future revenue streams.  In the event of a delay of
delivery schedule, then the time of inspection, installation, trial run and
customer acceptance will be delayed accordingly, all of which will affect our
revenue recognition. If the delay of delivering the specified automation systems
was a result of our inability to deliver the system on a timely basis, then will
be held responsible for this delay, in accordance with the terms specified in
respective integrated contracts.


Competition
 
 We
compete with various domestic and international producers offering automation
systems to the Chinese market.  We believe that our proprietary technology
and products provide us with a strong competitive advantage over our domestic
Chinese competitors. However, a number of multinational companies, some of whom
have substantially greater financial and other resources than we currently have,
have been offering first rate automation systems to Chinese customers before us.
 We believe that our primary competitors in the market for our products are
ABB, Honeywell, Emerson and Siemens.
 
 When
compared to our competitors, we believe that we have the following competitive
advantages:
 
 ·
              Emphasis on
      Engineering.  Engineers are a critical element of effective
      design of both hardware and software components of automation equipment
      and systems.  For western companies, they are also a very costly
      element of the process.  Even the largest western companies face
      constraints in the size of their engineering staff due to the high
      salaries and attendant costs.  One of our competitive advantages has
      been the low cost of engineers in China relative to those in the west to
      increase the sophistication of its products and to accelerate their
      development. Applying high levels of engineering effort to each product
      enables us to provide a solution that is tailored not only to the industry
      in which the customer operates, but also to the customer’s specific needs.
      That custom solution is provided at a cost that is typically lower than
      the generic products of its
competitors.
 
 ·
              Industry Process
      Knowledge.  We devote substantial time and effort to
      understanding our customers and their business. This knowledge helps to
      ensure that the systems we design will provide the optimum in benefits for
      the customers.  We maintain this information in an extensive “library” of industry
      process information that we utilize to speed up the system design process
      and to maximize the quality of the result, while at the same time
      minimizing costs.  As a result, we were able to take into account the
      widely varying degrees of sophistication and resources that our Chinese
      customers possess. The result of this strategy is to broaden our potential
      customer base and to consistently deliver products that are of value to
      these customers.


27




·
            Integration Services.
       Western automation system companies are principally system platform
      suppliers and the role of integrating the systems into the customer’s
      overall management information system is generally left to independent
      firms.  While such firms are widespread in western countries, China
      does not have a large number of systems integration companies to perform
      this work, as these companies have been historically unprofitable in
      China.  We have bridged this gap by providing a vertically integrated
      solution to our customers that include integration of our hardware into
      the customers’ overall manufacturing and information systems. This
      combination of the two aspects of system design and installation take
      further advantage of the low cost of engineering services in China and
      provides another benefit, as the design and integration teams can work
      together to produce the best result more quickly and efficiently, again
      lowering costs.





·
            Core Technologies.
       Although we deliver tailored systems, our systems are based on basic
      modules of automation technology that are common across a broad array of
      industries and applications.  Using these modules as a starting
      point, development of an industry and customer-specific product is both
      more efficient and produces a better result than starting from scratch
      each time. That means that, with our labor cost advantages, we can provide
      a highly customized automation product at a very favorable
      cost.





·
            Use of Engineering Sales
      Personnel.  The use of trained engineers in product and system
      design is complemented by the use of engineers in the sales process as
      well. The advantages of doing so are substantial. They include the ability
      to understand from the beginning the needs of the customer and how to
      address them and the ability to convey that information to the team that
      will ultimately develop the system to be
  installed.




·
              Accounting for the Broad Array
      of Chinese Customers’ Capabilities.  China’s rapid growth and
      industrialization distinguish it from other manufacturing nations in some
      ways. There are many “established” Chinese
      companies that operate in facilities that are decades old, many companies
      that operate in new or recently upgraded facilities, and the largest
      number that fall somewhere in between.  We understand, to a greater
      extent than our western competitors, the full range of needs and
      capabilities that Chinese customers possess, and we have designed our
      business to meet them.  As a result, we are able to offer even the
      most basic control systems solution while also providing the most
      sophisticated systems available to applications that meet the rigorous
      requirement of the highly complex and demanding nuclear power
      industry.
 
 ·
              Pace of Product
      Development.   Another way that we keep ahead of our
      competitors is by our pace of development.  HOLLiAS is the fourth
      generation of controller systems developed by us, and it took us only a
      little more than a decade after our first operational system to achieve
      this breakthrough.  We believe that our competitors are frequently
      hampered by institutional factors that slow the product development
      process, and as a result, their products cannot incorporate the latest
      advances in electronics.
 
 ·
              Maintenance Services.
       Automation systems require regular maintenance to operate within
      customer guidelines.  Older analog systems were well within the
      capability of many customers to maintain on their own.  However, as
      automation systems shift to electronic components utilizing custom
      software and digital signaling, their complexity has increased and have
      made it less easy for customers to maintain their systems independently.
        To meet this growing customer need we offer our customers
      maintenance services along with our products.  Our regional sales and
      services offices place us within easy reach of a very high proportion of
      our customer and potential customer base, which makes it possible for a
      single maintenance technician to cover maintenance calls for several
      different customers each week.  An added advantage to offering
      maintenance services is the benefits derived from the strengthened
      relationship with our customers.  Effective maintenance services,
      leads to increased customer satisfaction, customer loyalty, and increased
      business opportunities. Offering ongoing services, which not only create
      the opportunity to generate additional revenue, but enable us to
      troubleshoot installations effectively, help to ensure that maximum
      benefit is derived from the system, and gives us the ability to identify
      the need for new products and services that will benefit the customer and
      generate additional business for
us.


28




Manufacturing
and Raw Materials





We
assemble our products from subcomponents provided by others or we outsource the
production to qualified vendors.  We acquire advanced printed circuit board
components from high quality suppliers.  We rely on our manufacturing
management department to coordinate the procurement of raw materials and
outsourced processing, including the procurement of components and standard
parts (such as cables and connectors), and outsourced processing of Polyvinyl
Chloride (PVC) coating, shells, and printed circuit boards.  Our products
are subjected to rigorous testing in our facilities prior to
shipment.





In 1997,
Beijing Hollysys passed the ISO9001 international quality assurance system
certification.  And in 2002, Beijing Hollysys obtained the ISO9001:2000
certificate, which covers all the processes including research and development,
sales and distribution, manufacturing, engineering, technical support and repair
service, etc.





Seasonality





Our
operating results and operating cash flows historically have not been subject to
seasonal variations. This pattern may change, however, as a result of new market
opportunities or new product introductions.  Revenues of our business as a
whole do not tend to fluctuate significantly by season, although compared to
other quarters, our third quarter is relatively slow due to the Chinese New Year
holidays.





Regulation





We
operate our business in China under a legal regime that consists, at the
national level, of the State Council, which is the highest authority of the
executive branch of the PRC central government, and several ministries and
agencies under its leadership, including: the Ministry of Agriculture and its
local authorities; the Ministry of Commerce and its local authorities; SAFE and
its local authorities; the State Administration of Industry and Commence and its
local authorities; and the State Administration of Taxation, and the Local
Taxation Bureau.  The following sets forth a summary of significant
regulations or requirements that affect our business activities in China and our
shareholders’ right to receive dividends and other distributions from us.


·
              Foreign Currency
      Regulations. We are subject to the PRC’s foreign currency
      regulations.  The PRC government has control over RMB reserves
      through, among other things, direct regulation of the conversion of RMB
      into other foreign currencies.  Although foreign currencies which are
      required for “current account” transactions can be bought freely at
      authorized Chinese banks, the proper procedural requirements prescribed by
      Chinese law must be met.  At the same time, Chinese companies are
      also required to sell their foreign exchange earnings to authorized
      Chinese banks and the purchase of foreign currencies for capital account
      transactions still requires prior approval of the Chinese
      government.
 
 ·
              Taxation.On March 16,
      2007, the National People’s Congress, the Chinese legislature, passed the
      new Enterprise Income Tax Law, or New EIT Law, which became effective on
      January 1, 2008. The New EIT Law applies a unified enterprise income tax,
      or EIT, rate at 25% to both FIEs and domestic invested enterprises.
      According to a grandfathering provision of the Notice on Transitional
      Preferential Policies of Enterprise Income Tax published by the State
      Council, enterprises that are subject to an EIT rate below 25% may
      continue to enjoy such lower rate which will be gradually transitioned to
      the new EIT rate within five years of the effective date of the New EIT
      Law, and enterprises that are currently entitled to exemptions from, or
      reductions in, applicable EIT for a fixed term may continue to enjoy such
      treatment until the fixed term expires.  Under the New EIT Law,
      companies designated as High- and New-Technology Enterprises may enjoy a
      reduced national enterprise income tax of 15%. “Administrative Measures
      for Assessment of High-New Tech Enterprises,” or Measures, and “Catalogue
      of High/New Tech Domains Strongly Supported by the State,” or Catalogue
      (2008), jointly issued by the Ministry of Science and Technology and the
      Ministry of Finance and State Administration of Taxation set forth general
      guidelines regarding criteria as well as application procedures for
      qualification as a High- and New-Tech Enterprise under the New EIT
      Law.Both
      Beijing Hollysys and Hangzhou Hollysys have met the qualifications for the
      High- and New-Technology Enterprise designation and are accordingly
      subject to a reduced national enterprise income tax of
  15%.


29




·
            Dividend Distribution.
       Under PRC law, FIEs in China, including Hangzhou Hollysys, may pay
      dividends only out of their accumulated profits, if any, determined in
      accordance with PRC accounting principles. In addition, FIEs in China are
      required to set aside at least 10% of their after-tax profit based on PRC
      accounting standards each year for their general reserves until the
      accumulative amount of such reserves reaches 50% of registered capital.
      These reserves are not distributable as cash dividends.  The board of
      directors of a FIE has the discretion to allocate a portion of its
      after-tax profits to staff welfare and bonus funds, and expansion
      (development) funds which may not be distributed to equity owners except
      in the event of liquidation.  In addition, under the new EIT Law,
      effective as of January 2008, dividends from Beijing Hollysys to us will
      be subject to a withholding tax of 5%, whereas those from Hangzhou
      Hollysys will be subject to a withholding tax of 10%.





The
foregoing summary does not purport to be complete and is qualified by reference
to the relevant provisions of applicable law in the jurisdictions in which we
operate.  We believe that we are currently in compliance with all
applicable laws and regulations relating to our business.





Marketing,
Sales and Customer Support





Our
marketing and sales activities are focused on the Chinese domestic market where
there is a growing demand for automation and control products, systems and
services.  Because our market strategy is to tailor products to specific
customer needs, our sales teams consist of a complementary group of sales
personnel and hardware and software engineers from a variety of disciplines.
 Employing a pool of skilled personnel at this early stage accelerates the
design and the subsequent production of a particular customized solution,
typically exceeding that of our competitors. Our sales team possess significant
hands-on, industry-specific experience which permit them to do on-site process
analyses, which in turn, makes the design and implementation of upgrades
simpler.   The result is a system that is more effective, efficient
and reliable, which in turn leads to a truly satisfied customer.


Our
direct sales force is organized into three groups, as follows:
 
 ·
              Department
      of Region Sales: there are 10 geographic sales regions covering 30
      provinces in China. The direct sales professionals provide business
      consulting, promote pre-sale activity and serve as customer
      contacts.
 
 ·
              Department
      of Customer Service is in charge of managing relations with all contracted
      customers, and improving customer satisfaction by coordinating responses
      to the client’s information request, sale of supplemental parts or
      components, and customer visits.
 
 ·
              Department
      of Marketing Plan has been established to facilitate strategic cooperation
      with certain specialized manufacturers, in order to expand the specific
      fields, such as Digital Electro-Hydraulic Control Systems, air separation
      and desulphurization.
 
 Currently,
the programmable logic controller products are in an early marketing stage, and
we are using several contracted distributors and developing more distributors to
expand sales of its programmable logic controller products.
 
 We
identify and target market segments and select target sales opportunities on a
national level, and we also conduct sales opportunity studies to ensure that
adequate regional sales resources are available.  Sales quotas are assigned
to all sales personnel according to annual sales plans.  We classify market
segments and target opportunities on national and regional levels.  This
classification helps us to determine our primary sales targets and to prepare
monthly and quarterly sales forecasts.  Then, the sales team approves
target projects, develops detailed sales promotion strategies and prepares
reports on order forecasts, technical evaluation, sales budgeting expense,
schedules and competition analysis. After the report has been approved, a sales
team is appointed consisting of sales personnel and technicians.
 
 Our
market strategy focuses on building strategic cooperative relationships with its
customers, educating them about technological developments and reflecting their
interests in our products and services.  We employ marketing personnel to
conduct market research, to analyze user requirements and to organize marketing
communications.  Our marketing team engages in a variety of marketing
activities, including:


30


·
            publishing
      internal research reports and customer
  newsletters;




·
            conducting
      seminars and conferences;




·
            conducting
      ongoing public relations programs;
and




·
            creating
      and placing advertisements.




We
actively participate in technology-related conferences and demonstrate our
products at trade shows or at exhibitions targeted at our existing and potential
customers.  We also evaluate a range of joint-marketing strategies and
programs with our business partners in order to take advantage of their
strategic relationships and resources.  We also support our customers by
offering field services such as maintenance and training services, which help
customers to cut cost and improve operating efficiency.  As of June
30, 2009, we employed 205 direct sales personnel who were assigned to three
business areas: railway transportation, nuclear power, and DCS.  Sales
activities are coordinated from our offices in Beijing and Hangzhou.  All
sales staff are responsible for implementing the sales policies established at
headquarters.





C.
Property, Plants and Equipment





Our
principal executive offices are located 10 Jiancaicheng Middle Road, Xisanqi,
Haidian District, Beijing, China.  We lease or own the land use rights to
property at the following principal locations, each of which contains principal
administrative offices, sales and marketing offices, research and development
facilities, and manufacturing facilities:




Location
                Approximate
      Sq. Meters
                OwnershipBeijing
                18,000
                OwnedBeijing
                4,937
                LeasedHangzhou
                25,000
                Owned





We lease
the 4,937 square meter space in Beijing, subject to a five-year factory lease
agreement, dated as of May 22, 2006, between Beijing Hollysys and Beijing
Lighting Fixture Co., Ltd., or Beijing Lighting, at a monthly rate of
approximately RMB100,000.  The lease will expire on July 19, 2011.





The
manufacturing facilities at the above locations are used for system integration
production, including hardware testing instruments, auxiliary material
processing, packaging and shipping, and for self-made product integration
production, including inspection and testing.





Due to
rapid growth of our business, we have outgrown our current Beijing facilities
and we are currently constructing a new 150,000 square meter facility in the
Beijing Yizhuang Economic Development Zone which will have one new production
line and sufficient space for addition of another production line as
needed.  We have budgeted $51 million for capital expenditure in
connection with the construction of this new facility and at June 30 2009, we
had already utilized $25 million of this amount.  We expect that the
bulk of the remaining capital will be expended in fiscal years 2010 and 2011,
which we believe will be well covered by cash generated by our
operations.


31




D.
Organizational Structure





The
following diagram illustrates our corporate structure as of the date of this
annual report.  We are a holding company with no operations of our
own.  We conduct our operations in China through our Chinese operating
companies, Beijing Hollysys, Hangzhou Hollysys and Hollysys
Haotong.











Our
corporate headquarters are located at 10 Jiancaicheng Middle Road, Xisanqi,
Haidian District, Beijing, 100096, China.  Our telephone number is (+86) 10
58981386.  We maintain a website at http://www.Hollysys.com,
that contains information about our company, but that information is not a part
of this annual report.




32




ITEM
      4A.
            UNRESOLVED
      STAFF COMMENTS




Not
Applicable





ITEM
      5.
            OPERATING
      AND FINANCIAL REVIEW AND PROSPECTS




You
should read the following discussion and analysis of our financial condition and
results of operations in conjunction with our consolidated financial statements
and the related notes included elsewhere in this annual report on Form
20-F.  This discussion may contain forward-looking statements based
upon current expectations that involve risks and uncertainties.  Our
actual results may differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those set
forth under “Item 3. Key Information—D. Risk Factors” or in other parts of
this annual report on Form 20-F.





Overview





Through
our Chinese operating subsidiaries, we are one of the leading automation systems
providers in China, developing a number of core technologies and completing
numerous projects utilizing a wide array of automation products.  With
our philosophy of sincere concern for customers and our technical innovation
capabilities, we specialize in the research, development, production, sale and
distribution of industrial automation for digital railway signals and
information systems, e-government, motor drive transmissions and safety controls
for nuclear power reactors.





The main
channel through which we get our automation system business is the bidding
process.  Customers seeking bids propose their requirements and
specifications in legal bidding documents and those companies that are
interested in obtaining these contracts make a bid in written
form.  If we win the bidding, we get the integrated
contract.





We derive
our revenue mainly from the integrated contracts we have won through the bidding
process, which accounts for over 90% of the total consolidated
revenue.  In addition, we also sell spare parts and component products
to customers for maintenance and replacement purposes after the completion of
the integrated solution contract.  Product sales are not part of
the integrated contracts.  Therefore, it is another stream of revenue
but minor in volume.





The
purpose of an integrated contract is to furnish an automation system that
provides the customer with a total solution for the automation or process
control requirement being addressed.  The automation system and total
solution we offer consists of hardware, software and services, all of which are
customized to meet the customer’s particular needs and technical
specifications.  None of hardware, software and service has
independent functionality, and therefore cannot be sold separately to
customers.  The following table sets forth the information regarding
the contracts we won during the last three fiscal years and backlog at the dates
indicated:





Years Ended June 30,2007
                      
                      2008
                      
                      2009Number
      of new contracts won during the year
                      
                      
                      1,161
                      
                      
                      
                      1,293
                      
                      
                      
                      1,194Total
      amount of new contracts (mm)
                      
                      $
                      138.77
                      
                      
                      $
                      216.40
                      
                      
                      $
                      201.66Average
      price per contract
                      
                      $
                      119,526
                      
                      
                      $
                      167,364
                      
                      
                      $
                      168,892




As of June 30,Backlog Situation:
                      
                      2007
                      
                      
                      2008
                      
                      
                      2009Contracts
      newly entered and unfinished (mm)
                      
                      $
                      67.60
                      
                      
                      $
                      124.42
                      
                      
                      $
                      115.52Contracts
      started in the prior year and unfinished (mm)
                      
                      $
                      34.32
                      
                      
                      $
                      54.03
                      
                      
                      $
                      73.42Total
      amount of backlog (mm)
                      
                      $
                      101.92
                      
                      
                      $
                      178.45
                      
                      
                      $
                      188.94





33




As
indicated above, both the amount of new contracts won and the amount of backlog
have been increasing steadily during the past three years.





As a
growing company, we have achieved significant progress in the past three
years.  Our total consolidated revenues for the fiscal year ended June
30, 2009 was $157.50 million, compared to $121.50 million for the prior fiscal
year, representing an increase of 29.6%, followed by a growth of 19.3 % from
$101.89 million in fiscal 2007.





Recent
Developments





Subsequent
to the fiscal year ended June 30, 2009, the Company completed the acquisition of
1.78% minority interest in Beijing HollySys, by cash consideration of RMB 18
million in June and July, 2009.  In view of the intended acquisition,
the cash consideration prepaid in June was classified as Deposit for acquisition
of equity interest from minority interest on the consolidated balance sheet as
of June 30, 2009.





Key
Factors Affecting Our Growth, Operating Results and Financial
Condition





Our
future growth, operating results and financial condition will be affected by a
number of factors including:





·
            The
      ability in developing new products and systems in order to improve
      competitiveness, which can increase both in sales revenue and
      margins.  The success of our business depends in great measure
      on our ability to keep pace with or even lead changes that occur in our
      industry.





·
            The
      success in expanding our business in targeted emerging markets and
      overseas market, which may require us to overcome domestic competitions
      and any trade barriers.





·
            Our
      ability to retain our existing customers and to explore additional
      business opportunities.  Since we do not have long-term purchase
      commitments from customers, so our customers can shift to other
      competitors for future projects.  It is important to maintain
      our customer base in order to sustain and expand our
    business.





·
            The
      success of our business also depends on securing a steady stream of new
      customers.  In order for our business to continue to succeed and
      grow, it is vital to secure contracts with new customers on a regular
      basis.





·
            The
      ability to secure adequate engineering resources and relatively low cost
      engineering staff can increase our profitability and potential business
      prospects.  One of the competitive advantages that we enjoy is
      the access to lower cost engineering staff as compare to those of our
      Western and Japan-based competitors.  The plentiful supply of
      affordable engineering talent in China is a key element of our overall
      business strategy.





·
            Further
      improvement in product design and maintaining high standard of quality
      control, which can reduce or avoid product defects.  Any product
      defects will incur additional costs and cause damage to business
      reputation.





·
            The
      ability in securing and protecting our intellectual property rights will
      be critical, as our business is based on a number of proprietary products
      and systems, and we strive to strengthen and differentiate our product
      portfolio by developing new and innovative products and product
      improvements.




·
            The
      success in penetrating into the railway and nuclear power market sectors
      can bring in revenues and margins.  In addition to the
      traditional industrial automation business, our plan for future growth
      includes an increasing emphasis on rail control systems and nuclear power
      generation control systems.




34




·
            The
      ability to obtain greater financial resources to match or even exceed our
      major competitors, in order to compete effectively with them, and to
      weather any extended weaknesses in the automation and control
      market.





·
            The
      continued growth in Chinese industry and Chinese economy in
      general.  This continued growth will create more business
      opportunities for us, as industrial companies in China are our principal
      source of revenues.





·
            The
      ability to maintain key personnel and senior management, who will have
      significant impact and contribution to our future business.  The
      ability to attract and retain additional qualified management, technical,
      sales and marketing personnel will be
vital.





·
            The
      continuation of the preferential tax treatment and subsidies currently
      available to our PRC subsidiaries will be critical to our future operating
      results.  If governmental subsidies were reduced or eliminated,
      our after-tax income would be adversely
  affected.





·
            The
      continued appreciation in Renminbi (RMB) against US dollars will result in
      future translation gain as most of our assets are denominated in
      RMB.  In addition, some of our raw materials, components and
      major equipment are imported from overseas.  In the event that
      the RMB appreciate against other foreign currencies, our costs will
      decrease and it will increase our
profitability.





Critical
Accounting Policies





Principles
of Consolidation and Basis of Presentation





The
consolidated financial statements include the financial statements of the
Company and its subsidiaries.  All significant inter-company
transactions and balances are eliminated during the process of
consolidation.  Investments in investee companies in which the Company
does not have a controlling interest (interest holding by the Company from 20%
up to 50%), or in which the Company holds more than 51% interest, however, the
minority interest in that entity has participation rights defined in EITF 96-16,
are accounted for using the equity method.  The Company’s shares of
earnings (losses) of these investee companies are included in the accompanying
consolidated statement of income.  These consolidated financial
statements have been prepared in accordance with the accounting principles
generally accepted in the United States of America (“U.S. GAAP”).





Revenue
Recognition





Revenues
generated from designing, building, and delivering customized integrated
industrial automation systems and providing relevant solutions are recognized
over the contractual terms based on the percentage of completion
method.  The contracts for designing, building, and delivering
customized integrated industrial automation systems are legally enforceable
binding agreements between the Company and customers.  Performance of
these contracts will often extend over long periods, and the Company’s right to
receive payments depends on its performance in accordance with these contractual
agreements.  The duration of contracts the Company performs is
depending on the contract size in terms of dollar amounts.  In
general, the bigger the contract size is, the longer the duration of that
contract is.  The duration of a small contract is less than one year
without including warranty period.  The duration of a large contract
is longer than one year without including warranty period.  Including
the warranty period, all of contracts have their duration longer than one year,
ranging from 16 months to 61 months.   The operating cycle of the
Company is determined by a composite of many individual contracts in various
stage of completion and is measured by the duration of the average time
intervening between the acquisition of materials or service entering the
construction process and the substantial completion of
contracts.  Based on the historical experience, the operating cycle of
the Company exceeds one year.


In
accordance with AICPA’s SOP 81-1, “Accounting for Construction Contracts and
Certain Production-Type Contracts,” revenue recognition is based on an estimate
of the income earned to date, less income recognized in earlier
periods.  Estimates of the degree of completion are based on the costs
incurred to date comparing to the expected total costs for the
contracts.  Revisions in the estimated profits are made in the period
in which the circumstances requiring the revision become
known.  Provisions, if any, are made currently for anticipated loss on
the uncompleted contracts.  Revenue in excess of billings on the
contracts is recorded as costs and estimated earnings in excess of
billings.  Billings in excess of revenues recognized on the contracts
are recorded as deferred revenue until the above revenue recognition criteria
are met.  Billings are rendered based on agreed milestones included in
the contracts with customers.  There are different milestones among
the contracts the Company has won.  In general, there are four
milestones: 1) system manufacturing, 2) system delivery, 3) installation,
trial-run, and customer acceptance, and 4) expiration of a warranty
period.  The amount to be billed when each of the specified milestones
is reached has been specified in a contract.  All contracts have the
first milestone, but not all contracts have a prepayment.


35




The
Company recognizes 100% of the contractual revenue at the end of customer
acceptance stage as the Company estimates that no further major costs will incur
under a contract, a signed customer acceptance document has been obtained, and a
warranty period starts to count.  Revenues are presented net of taxes
collected on behalf of government.





Revenue
generated from sales of electronic equipment is recognized when persuasive
evidence of an arrangement exists, delivery of the products has occurred,
customer acceptance has been obtained, which means the significant risks and
rewards of the ownership have been transferred to the customer, the price is
fixed or determinable and collectability is reasonably assured.





Inventories





Inventories
are composed of raw materials and low value consumables, work in progress, and
purchased and manufactured finished goods.  Inventories are stated at
the lower of cost or the market value.





On
January 1, 2009, the Company elected to change the “costing method” for
purchased inventories previously accounted for on the “weighted average basis”
to the “first-in, first-out basis”.  The percentage of purchased
inventories accounted for under the weighted average method shared approximately
64% of the closing inventories at December 31, 2008.  The Company
believe that purchased inventories measured based on first-in first-out basis
can better reflect the current value of purchased inventories on the
Consolidated Balance Sheet and enhances the matching of future cost of sales
with revenues. Since the change of the inventories costing method did not result
in a material cumulative difference or a material difference in any one
reporting period, and consequently the prior periods figures have not been
restated.  The cumulative effect of the accounting change, which was
immaterial, was reflected in the results of operations in the year ended June
30, 2009.





The
Company makes provisions for estimated excess and obsolete inventory based on
its regular reviews of inventory quantities on hand and the latest forecasts of
product demand and production requirements from its customers.  The
Company writes down inventories for not saleable, excess or obsolete raw
materials, work-in-process and finished goods by charging such write-downs to
cost of sales.  In addition to write-downs based on newly introduced
parts, statistics and judgments are used for assessing a provision on the
remaining inventory based on salability and obsolescence..





Warranty




Warranty
is a major term under an integrated contract, which will last, in general, for
twelve months or be specified under a contract. The Company estimates a warranty
liability under a contract using a percentage of revenue recognized, which is
derived from its historical experience, in order to recognize a warranty cost
for a contract in the proper period of time.  In addition, at the end
of each reporting period, the Company estimates whether or not the accrued
warranty liabilities are adequate based on 1) the outstanding warranty time
period of a contract which has entered into the warranty period, 2) the total
revenue has recognized on a contract which has been under the warranty period,
and 3) all contracts which have been under the warranty period.  The
Company adjusts the accrued warranty liabilities in line with the result of its
assessment.




36




Accounts
Receivable and Cost and estimated earnings in excess of billings





Performance
of the contracts often will extend over long periods and the Company’s right to
receive payments depends on its performance in accordance with these contractual
agreements.  The Company bills a customer in accordance with the
amount specified under the contract from the cost and estimated earnings in
excess of billings when the Company’s performance has reached a
milestone.  In general, among four milestones, each interval of two
contiguous billings under a contract is within one year (under certain railway
control system contracts, the interval of two contiguous billings is longer than
one year) and the last billing to be issued for a contract is at the end of the
warranty period.  When a customer makes a prepayment at the start of a
contract, the amount received will be recorded as deferred
revenue.  The deferred revenue would be recognized as revenue under
the percentage of completion method along with the progress of a
contract.  If no prepayment is received by the Company, revenue would
be recognized through cost and estimated earnings in excess of
billings.  Accordingly, when a particular milestone is reached, a
particular amount of cost and estimated earnings in excess of billings will be
transferred into accounts receivable.  Cost and estimated earnings in
excess of billings are usually billed within one year.  The Company
does not specify credit terms in its invoices and expect that its customers will
make their payments upon receipt even though the contract terms say that a
specific amount is due when a milestone is reached.  The Company does
not require collateral from its customers.  Based on the prevailing
collection practice in China, it is a reasonable expectation for the enterprises
in automation industry to take over one year to collect accounts
receivable.





The
Company issues invoices to its customers without specifying credit terms and
consequential interests charge for late payments by its
customers.  The Company reviews the status of contracts periodically
and decided how much allowance for doubtful accounts should be made based on
factors surrounding the credit risk of customers, as well as its historical
experience.  The Company set up bad debt allowance for an individual
customer if there is a deterioration of the customer’s creditability and the
assessed probability of default is higher than the historical
experience.





Impairment
of Long-Lived Assets





The
Company adopts the provisions of SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets”, which requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets.  Whenever any such impairment exists, an
impairment loss will be recognized for the amount by which the carrying value
exceeds the fair value.  Losses on long-lived assets to be disposed of
are determined in a similar manner, except that fair market values are reduced
for the cost to dispose.





Goodwill
and Impairment Test





Goodwill
resulting from an acquisition is measured at the excess of the cost of the
business combination over the fair value of the assets acquired and liabilities
assumed.  Goodwill will not be amortized, instead be tested for
impairment at least annually as prescribed by SFAS No. 142.  When
impairment occurs, the carrying value of goodwill is written down and a charge
is recorded against net income.  .





Income
Taxes




The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes”, which requires an entity to recognize deferred tax
liabilities and assets.  Deferred tax assets and liabilities are
recognized for the future tax consequence attributable to the difference between
the tax bases of assets and liabilities and their reported amounts in the
financial statements.  Deferred tax assets and liabilities are
measured using the enacted tax rate expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that included the
enactment date.  Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be realized. Current
income taxes are provided for in accordance with the laws of the relevant tax
authorities.


The
Company adopted the FASB’s Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (FIN 48). FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in an enterprise’s financial statements in accordance
with SFAS No. 109. FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on de-recognition of tax benefits, classification on the balance sheet,
interest and penalties, accounting in interim periods, disclosure, and
transition. The Company’s policy on classification of all interest and penalties
related to unrecognized tax benefits, if any, as a component of income tax
provisions.


37




Share-based
compensation





The
Company adopted SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), ‘‘Share-based
Payment’’, which requires that share-based payment transactions with employees,
such as share options, be measured based on the grant-date fair value of the
equity instrument issued and recognized as compensation expense over the
requisite service period, with a corresponding addition to equity. Under this
method, compensation cost related to employee share options or similar equity
instruments is measured at the grant date based on the fair value of the award
and is recognized over the period during which an employee is required to
provide service in exchange for the award, which is generally the vesting
period.





Recent
Accounting Pronouncements





In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business
Combinations” (“SFAS No. 141(R)”).  SFAS No. 141(R) changes accounting
for acquisitions that close beginning in 2009.  SFAS No. 141R broadens
the guidance of SFAS No. 141, extending its applicability to all transactions
and other events in which one entity obtains control over one or more other
businesses.  It broadens the fair value measurement and recognition of
assets acquired, liabilities assumed, and interests transferred as a result of
business combinations.  SFAS No. 141R expands on required disclosures
to improve the statement users’ abilities to evaluate the nature and financial
effects of business combinations.  SFAS No. 141R is effective for
fiscal years beginning on or after December 15, 2008. The Company is currently
evaluating the potential impact on the adoption of SFAS No. 141(R) that may have
on its financial position, result of operations and cash flow.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, An Amendment of ARB No. 51” (“SFAS No.
160”).  SFAS No. 160 requires that a noncontrolling interest in a
subsidiary be reported as equity and the amount of consolidated net income
specifically attributable to the noncontrolling interest be identified in the
consolidated financial statements.  It also calls for consistency in
the manner of reporting changes in the parent’s ownership interest and requires
fair value measurement of any non-controlling equity investment retained in a
deconsolidation.  SFAS No. 160 requires retroactive adoption of the
presentation and disclosure requirements for existing minority interests. SFAS
160 is effective for fiscal years beginning after December 15, 2008. The Company
does not anticipate that the adoption of SFAS No. 160 will have significant
impact on the Company’s financial disclosures.





In March
2008, FASB released SFAS No. 161, “Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133” (“SFAS No. 161”).
SFAS No. 161 is intended to improve financial reporting about derivative
instruments and hedging activities by requiring enhanced disclosures to enable
investors to better understand their effects on an entity’s financial position,
financial performance, and cash flows. It is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008,
with early application encouraged and is required to be adopted by the Company
in the first quarter of fiscal year 2010. The Company does not anticipate that
the adoption of SFAS No. 161 will have significant impact on the Company’s
financial disclosures.





In
April 2009, the FASB issued FSP 157-4, “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 157-4”). FSP
157-4 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. FSP 157-4 also includes guidance on identifying
circumstances that indicate a transaction is not orderly. FSP 157-4 is effective
for interim and annual reporting periods ending after June 15, 2009, with
early adoption permitted for periods ending after March 15, 2009. FSP 157-4 does
not require disclosures for earlier periods presented for comparative purposes
at initial adoption. In periods after initial adoption, FSP 157-4 requires
comparative disclosures only for periods ending after initial adoption. The
adoption of FSP 157-4 in the fourth quarter of fiscal 2009 did not have a
material impact on the Company’s financial position or results of
operations.




38




In May
2009, the FASB issued SFAS No. 165 “Subsequent Events” (“SFAS No. 165”), 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. SFAS No. 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. This
disclosure should alert all users of financial statements that an entity has not
evaluated subsequent events after that date in the set of financial statements
being presented. SFAS No. 165 is effective for interim and annual periods ending
after June 15, 2009. The adoption of SFAS No. 165 in the fourth quarter of
fiscal 2009 did not have a material impact on the Company’s financial position
or results of operations.





In June
2009, the FASB issued SFAS No. 166 “Accounting for Transfers of Financial
Assets” (“SFAS No. 166”). This statement is intended to improve the relevance,
representational faithfulness, and comparability of the information that a
reporting entity provides in its financial reports about a transfer of financial
assets; the effects of a transfer on its financial position, financial
performance, and cash flows; and a transferor’s continuing involvement in
transferred financial assets. This Statement must be applied as of the beginning
of each reporting entity’s first annual reporting period that begins after
November 15, 2009. Earlier application is prohibited. This Statement must be
applied to transfers occurring on or after the effective date. The Company is
currently evaluating the potential impact on the adoption of SFAS No. 166 may
have on the Company’s financial position, result of operations and cash
flow.





In June
2009, the FASB issued SFAS No. 167 “Amendments to FASB Interpretation No. 46(R)”
(“SFAS No. 167”). SFAS 167 seeks to improve financial reporting by enterprises
involved with variable interest entities. SFAS No. 167 is applicable for annual
periods after November 15, 2009 and interim periods therein and
thereafter. The Company is currently evaluating the potential impact on the
adoption of SFAS No. 167 may have on the Company’s financial position, result of
operations and cash flow.





In June
2009, the FASB issued SFAS No. 168 “The FASB Accounting Standards CodificationTM
and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS No.
168”).  The FASB approved the FASB Accounting Standards Codification
(the “Codification”) as the single source of authoritative non-governmental U.S.
GAAP to be launched on July 1, 2009. 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. All existing accounting standard documents will be superseded and
all other accounting literature not included in the Codification will be
considered nonauthoritative. The Codification is effective for interim and
annual periods ending after September 15, 2009. The Company does not anticipate
that the adoption of SFAS No. 168 will have significant impact on the Company’s
financial position, result of operations and cash flow.





Financial
Position





The
following are some financial highlights for the fiscal year ended June 30,
2009:




·
            Total
      assets increased by $92.71 million, from $252.73 million as of June 30,
      2008 to $345.44 million as of June 30, 2009.  The increase was
      mainly due to a significant increase of $64.63 million in cash and cash
      equivalents, an increase of $8.44 million in cost and estimated earnings
      in excess of billings, an increase of $2.64 million in amount due from
      related parties, an increase of $19.32 million in property, plant and
      equipment, and an increase of $3.81 million in long-term
      investment.




·
            Accounts
      receivable at June 30, 2009 was $56.55 million, a decrease of $3.85
      million, or 6.4%, compared to $60.40 million at June 30,
      2008.  The decrease was mainly due to our increased efforts made
      in accounts collection.





·
            Cost
      and estimated earnings in excess of billings as of June 30, 2009 were
      $51.09 million compared to $42.65 million as of June 30, 2008,
      representing an increase of $8.44 million, or 19.8%. The increase was
      mainly attributable to the increase in total
  revenues.




39




·
            Inventory
      as of June 30, 2009 was $18.84 million, a decrease of $5.83 million, or
      23.6%, compared to $24.67 million at June 30,
  2008.





·
            Property,
      plant and equipment increased by $19.32 million, or 69.5%, from $27.78
      million at June 30, 2008, to $47.10 million at June 30, 2009, mainly due
      to significant input in construction of the new facility, which in
      expected to be completed in fiscal year
2010.





·
            Long-term
      investment at June 30, 2009 was $13.57 million, an increase of $3.81
      million, or 39.0%, compared to $9.76 million at June 30, 2008. The
      increase in long-term investment was mainly due to an additional cash
      injection of $3.66 million (equivalent to RMB 25 million) made to Beijing
      Techennergy Co., Ltd..





·
            Total
      liabilities at June 30, 2009 were $149.42 million, increased by $61.63
      million, or 70.2%, compared to $87.79 million at June 30, 2008. The
      increase in liabilities was mainly due to an increase of $35.91 million in
      short-term and long-term bank loans, an increase of $14.24 million in
      accounts payable, and an increase of $10.93 million in construction costs
      payable.





·
            Bank
      loans at June 30, 2009 increased by $35.91 million, or 307.87%, from
      $11.66 million in fiscal year 2008 to $47.57 million in fiscal year 2009.
      Of the total increase, $36.59 million (equivalent to RMB 250 million) was
      a government-subsidized special-purpose loan in connection with the new
      facility in construction.





·
            Construction
      costs payable related to the new facility was $10.93 million and nil as of
      June 30, 2009 and 2008, respectively, as the construction progress
      improved significantly in fiscal
2009.





·
            Accounts
      payable at June 30, 2009 was $37.42 million, representing an increase
      $14.24 million, or 61.4%, compared to $23.18 million at June 30,
      2008.




Operating
Results





Comparison
of Fiscal Years Ended June 30, 2009 and 2008





Operating
Revenues:  For the year ended June 30, 2009, total revenues
amounted to $157.50 million, an increase of $36.00 million, compared to $121.50
million for the prior fiscal year, representing a significant increase of
29.6%.





Integrated
contract revenue accounted for $149.30 million of total revenues, an increase of
$36.95 million, or 32.9%, compared to $112.36 million for the prior fiscal
year.  The increase in revenues was mainly attributable to a
significant increase of $30.47 million in railway automation and control and
system integration projects for subway systems. Such contracts were for larger
contract amounts and at a higher gross profit rate.





Approximately
$8.20 million of total revenues related to product revenue, a decrease of $0.94
million, or 10.3%, compared to $9.14 million in product revenue for the prior
year.  Product revenue depends on overall demand for the Company’s
spare parts for customers’ maintenance and replacement purposesduring the 2009 fiscal
year.





Revenue
Backlog:  An important measure of the stability and growth of
the Company’s business is the size of its backlog, which represents the total
amount of unrecognized revenue associated with existing
contracts.  Any deferral of revenue recognition is reflected in an
increase in backlog as of the end of current period.  Our backlog as
of June 30, 2009, amounted to $188.94 million, representing an increase of
$10.49 million, or 5.9%, compared to $178.45 million as of June 30,
2008.





Of the
total backlog as of June 30, 2009, the unrecognized revenue associated with new
contracts signed in the 2009 period was $115.52 million and the carry forward
amount of the outstanding contracts from the prior year was $73.42
million.  The total backlog as of June 30, 2008 comprised of $124.42
million from new contracts signed in fiscal year 2008, and $54.03 million from
contracts carried forward from prior year.




40




Cost of
Revenues:  Cost of revenues can be divided into cost of
integrated contracts and cost of products sold, in line with the categories of
revenues.  For the year ended June 30, 2009, the total cost of
revenues amounted to $102.92 million, an increase of $18.05 million, or 21.3%,
compared to $84.87 million for the prior fiscal year.  The increase
was due to an $18.01 million increase in the cost of integrated contracts, and a
$0.04 million year over year increase in the cost of products sold.





The cost
of integrated contract revenue consists primarily of three components: cost of
equipment and materials, labor costs and other manufacturing expenses incurred
from designing, building and delivering customized automation solutions to
customers. The total cost of integrated contracts was $99.42 million for the
fiscal year ended June 30, 2009, compared to $81.41 million for the prior fiscal
year, representing an increase of $18.01 million, or 22.1%.  The
increase was primarily due to an increase of $18.08 million in the cost of
equipment and materials related to the higher cost of equipment imported for the
railway automation and control projects and system integration projects for
subway systems during the 2009 period. Labor cost accounted for 4.8% of the cost
of integrated contract revenue for the 2009 period, compared to 7.5% for the
prior fiscal year; cost of equipment and materials accounted for 78.7%, compared
to 73.9% for the prior fiscal year; and other manufacturing expenses accounted
for 16.4%, compared to 18.5% for the prior fiscal year. Labor cost accounted for
3.2%of the
integrated contract revenue for the 2009 period, compared to 5.5% for the prior
fiscal year, which the change was caused by the components of cost of integrated
contracts which varied in accordance with customer specifications in the 2009
period.Cost of
equipment and materials accounted for 52.4%, compared to 53.6% for the prior
fiscal year.  Other manufacturing expenses accounted for 10.9%, which
decreased from 13.4% for the prior fiscal year, mainly due to the Company’s
efficiency improved during the 2009 fiscal year. The cost components of
integrated contracts were determined and varied according to requirements of
different customers.





Sales of
products represent sales of spare parts (either self-made or purchased from
outside vendors) to customers for maintenance and replacement
purposes.  The products purchased from outside vendors have different
functions and capabilities from our self-made products.  We decide
whether or not to purchase from outside vendors or make the necessary products
ourselves, based on the needs and preferences of different customers and
efficiency considerations.  Therefore, as a percentage of the cost of
products sold, the self-made products and outsourced products have varied
significantly from time to time.  As our self-made products generally
contribute higher margins than products purchased from outside vendors, sales of
a greater portion of self-made products generally result in lower costs of
products sold.  The cost of products sold for fiscal year ended June
30, 2009 was $3.50 million, an increase of $0.04 million, compared to $3.46
million for the prior fiscal year.





Gross Margin:  For
the year ended June 30, 2009, as a percentage of total revenues, the overall
gross margin was 34.7%, compared 30.1% for the prior fiscal year, primarily
because of the increase in gross margin for integrated contracts.  The
gross margin for integrated contracts was 33.4% for the year ended June 30,
2009, compared to 27.5% for the prior year.  The increase in gross
margin for integrated contracts was due mainly to our different sales mix during
the 2009 period, as a higher proportion of railway automation and control
projects generated a higher margin.  The gross margin for products
sold was 57.3% for the fiscal year ended June 30, 2009, compared to 62.2% for
the prior fiscal year.





Selling
Expenses:  Selling expenses mainly consist of compensation,
traveling and administrative expenses related to marketing and sales and
promotion activities of the Company’s marketing and credit
departments.  Selling expenses were approximately $10.02 million for
the fiscal year ended June 30, 2009, an increase of 3.5%, or $0.34 million,
compared to $9.68 million for the prior fiscal year, mainly due to increase in
payroll expense for sales personnel during the 2009 period.  As a
percentage of total revenues, selling expenses accounted for 6.4% and 8.0% for
the fiscal year ended June 30, 2009 and 2008, respectively.  The
Company has established guidelines to monitor and evaluate sales performance for
its products to customers in different industries and regions to control selling
expenses.




General and administrative
expenses:  General and administrative expenses mainly include
compensation, traveling and other administrative expenses of non-sales-related
departments, such as the planning and finance department, information systems
department and human resources department.  General and administrative
expenses amounted to $48.98 million for the fiscal year ended June 30, 2009,
representing an increase of $22.39 million, or 84.2%, compared to $26.59 million
for the prior fiscal year.  The increase in general and administrative
expenses was mainly due to the increase of $22.24 million in the stock
compensation expense on the modification of earn-out shares and granted options.
Excluding stock compensation expenses and option expenses, general and
administrative expenses should be $9.42 million and $9.50 million, or 6.0% and
7.8% as a percentage to total revenues, for the fiscal years ended June 30, 2009
and 2008, respectively.




41




Pursuant
to the stock purchase agreement under the re-domestication merger, the Company
agreed to issue 2 million shares to the original stockholders of Gifted Time if
the Company could achieve or exceed an after-tax profit of $32 million for the
12 months ended December 31, 2008.  After-tax profit was computed
using US GAAP and referred to comprehensive income, excluding (i) any after-tax
profits from any acquisition by the Company or its subsidiaries that involved
the issuance of securities that had a dilutive effect on the holders of common
stock of the Company, and (ii) any expenses related to the issue of the
aforesaid shares.  Management determined that the Company achieved
such earn-out target for the abovementioned period and the board approved the
issuance of the earn-out shares.  The Company has accounted for the
fair value of the aforesaid shares to be issued for the year ended June 30, 2009
as stock compensation expenses and $17.0 million was recorded in the statement
of income. On June 15, 2009, the Company and the original stockholders of Gifted
Time agreed to amend the stock purchase agreement to cancel the remaining 7
million incentive shares issuable to the original Gifted Time stockholders under
the stock purchase agreement for the calendar years ended December 31, 2009,
2010, and 2011, in exchange for the immediate issuance of 4 million shares to
the original Gifted Time stockholders. The Company has accounted for the fair
value of the aforesaid 4 million shares as stock compensation expenses and
$22.24 million was recorded in the statement of income.





Research and Development
Expenses: Research and development expenses comprise mostly employee
compensation, materials consumed and experiment expenses for specific new
product research and development, and any expenses incurred for basic research
on advanced technologies. For the fiscal year ended June 30, 2009, research and
development expenses were $8.83 million, compared to $3.83 million for the prior
fiscal year. The $5.0 million, or 130.3%, increase was mainly due to increased
R&D activities during the 2009 period.  As a percentage of total
revenues, research and development expenses was 5.6% and 3.2% for the fiscal
years ended June 30, 2009 and 2008, respectively.





VAT Refunds:  The
local governments in Beijing and Hangzhou provide financial subsidies out of the
value added tax they collect in order to encourage the research and development
efforts of certain enterprises.  Beijing HollySys and Hangzhou
HollySys both received such refunds.  All VAT refunds were accounted
for based on hard evidence that the operations of those companies were entitled
to receive these refunds or that cash had been received.  For the
fiscal year ended June 30, 2009, VAT refunds were $5.94 million, compared to
$6.16 million for the prior fiscal year, decreased by $0.22 million, or
3.5%.  As a percentage of total revenues, VAT refunds were 3.8% and
5.1% for the fiscal years ended June 30, 2009 and 2008,
respectively.





Income (loss) from
Operations:  Income from operations decreased by $10.00
million, or 372.2%, from $2.69 million for the fiscal year ended June 30, 2008,
to a loss of $7.31 million for the fiscal year ended June 30,
2009.  The decrease in income from operations was primarily due to the
increase in stock compensation expenses related to the 4 million share issuance
as a result of cancellation of future years’ incentive share program and option
grants.  Excluding stock compensation expenses, operating income as a
percentage of total revenues for the fiscal year ended June 30, 2009 was $32.25
million, or 20.5%, as compared to $19.77 million, or 16.3% as a percentage of
total revenues for the prior year, an increase that was mainly due to the
increase in gross margin level.




Interest Expenses,
Net:  For the year ended June 30, 2009, net interest expenses
decreased by $3.35 million, or 77.8%, from $4.30 million for the prior year, to
$0.95 million for the current period.  The decrease was primarily due
to the recognition of $3.24 million in the amortization of discounts and
interests on notes payable related to a bridge loan for prior fiscal year, as
compared to nil for the current year.  Excluding the interests and
amortization of discounts on notes payable related to a bridge loan, net
interest expense as a percentage of total revenue would be 0.6% and 0.9% for the
fiscal year ended June 30, 2009 and 2008, respectively.





Government Subsidy: The local
governments in Beijing and Hangzhou provide financial subsidies to encourage
development of certain enterprises.  Beijing HollySys and Hangzhou
HollySys both received such subsidies.  All subsidies were accounted
for based on hard evidence that the operations of those companies were entitled
to receive these subsidies or that cash had been received.Gross subsidy income
received from the government amounted to $1.76 million and $3.16 million for the
fiscal year ended June 30, 2009 and 2008, respectively, a decrease of $1.40
million, or 44.3%.




42




Income Tax
Expenses:  For the year ended June 30, 2009, the Company’s
income tax expense was $3.06 million for financial reporting purposes, an
increase of $1.97 million, as compared to an income tax expense of $1.09 million
for the prior year.  Such increase of income tax expenses was mainly
due to a deferred tax adjustments recorded in the prior year.





Minority
Interest:  The minority interest of the Company includes other
parties’ interests in Beijing HollySys, Hangzhou HollySys and
Haotong.  The weighted average minority interests in these operating
entities were 25.89%, 10.36% and 31.45%, respectively, for fiscal year ended
June 30, 2009, as compared to 25.89%, 10.36% and 48.12%, respectively, for the
prior fiscal year. The decrease in minority interest in Haotong is mainly due to
the acquisition of the remaining 30% share capital of Haotong by the Company
during the year. The minority interest for the fiscal year ended June 30, 2009
was $5.19 million, an increase of $2.35 million, or 83.1%, from $2.83 million
for the prior year. Such increase was primarily due to more profit contributed
by Beijing HollySys and Hangzhou Hollysys for the current year.





Net income (loss) and Earnings
(loss) per share:  For the fiscal year ended June 30, 2009, the
Company’s net loss amounted to $(13.85) million or $(0.31) per diluted share, a
decrease of $12.17 million, or $0.27 per diluted share, as compared to a net
loss of $(1.68) million, or $(0.04) per diluted share, for the prior
year.  Such decrease was primarily due to the increase of $22.47
million in stock compensation expenses related to incentive shares and granted
options, offset by the decrease of $3.24 million in amortization of discounts
and interests on notes payable related to the bridge loan during the 2008
period.





Comparison
of Fiscal Years Ended June 30, 2008 and 2007





Operating
Revenues:  For the year ended June 30, 2008, total revenues
amounted to $121.50 million, an increase of $19.61 million, compared to $101.89
million for the prior fiscal year, representing a significant increase of
19.3%.  Of the total revenues of $121.50 million, the integrated
contract revenue accounted for $112.36 million, an increase by $14.98 million,
compared to $97.38 million for the prior fiscal year, representing a 15.4%
increase.  The increase of revenue was due to a greater number of
integrated contracts being performed during the 2008 fiscal
year.  There were 2,378 contracts being performed for the year ended
June 30, 2008 compared to 2,089 contracts for the prior fiscal year, a 13.8%
increase.  Such increase was mainly contributed by a significant
increase of $12.30 million in system integration projects for subway
systems.  Of the $121.50 million of total revenues, approximately
$9.14 million related to product revenue, an increase of approximately $4.63
million, compared to $4.51 million of product revenue for the prior year, a
102.9% increase.  Such increase reflects an increasing demand for the
Company’s equipment and parts for customers’ maintenance and replacement
purposes during this fiscal year.





Revenue
Backlog:  An important measure of the stability and growth of
the Company’s business is the size of its backlog, which represents the total
amount of unrecognized revenue associated with existing
contracts.  Any deferral of revenue recognition is reflected in an
increase in backlog as of the end of current period.  The backlog as
of June 30, 2008 amounted to $178.45 million, representing an increase of
75.09%, compared to $101.92 million as of June 30, 2007.  Of the total
backlog as of June 30, 2008, the unrecognized revenue associated with new
contracts signed in the current period was $124.42 million and the carry forward
amount of the outstanding contracts from the prior year was $54.03 million,
while the total backlog as of June 30, 2007 comprised of $67.60 million from new
contracts signed in fiscal year 2007, and $34.32 million from contracts carried
forward from prior year, respectively.




Cost of
Revenues:  For the year ended June 30, 2008, the total cost of
revenues amounted to $84.87 million, an increase by $18.77 million, compared to
$66.10 million for the prior fiscal year, representing a 28.39%
increase.  The increase was due to the facts that cost of integrated
contracts increased by $17.13 million, and cost of products sold increased by
$1.64 million year over year.  Cost of revenues can be divided into
cost of integrated contracts and cost of products sold, in line with the
categories of revenues.  The cost of integrated contract revenue
consists primarily of three components: cost of equipment and materials, labor
costs and other manufacturing expenses incurred from designing, building and
delivering customized automation solutions to customers.  The total
cost of integrated contracts was $81.41 million for the fiscal year ended June
30, 2008, compared to $64.28 million for the prior fiscal year, representing an
increase of $17.13 million, or a 26.6% increase.  The increase was
primarily due to the following factors: 1) an increase of $16.48 million in cost
of equipment and materials, as higher cost of equipment imported for the system
integration projects for subway systems; and 2) an increase of $1.14 million in
labor cost, primarily due to the increase in average labor salary and welfare
costs.




43




As a
percentage to cost of integrated contract revenue, labor cost accounted for
7.5%, compared to 7.8% for the prior fiscal year; cost of equipment and
materials accounted for 73.9%, compared to 68.0% for the prior fiscal year; and
other manufacturing expenses accounted for 18.5%, compared to 24.2% for the
prior fiscal year.  As a percentage to integrated contract revenue,
labor cost accounted for 5.5%, compared to 5.1% for the prior fiscal year, which
the change was caused by the increase in average labor salary and welfare
costs.  Cost of equipment and materials accounted for 53.6%, compared
to 44.9% for the prior fiscal year, the increase was driven by increase in
imported equipment for system integration projects for subway
systems.  Other manufacturing expenses accounted for 13.4%, which
decreased from 16.0% for the prior fiscal year, mainly due to the components of
cost of integrated contracts varied in the current period. The cost components
of integrated contracts were determined and varied according to requirements of
different customers.





Sales of
products represent sales of spare parts (either self-made or purchased from
outside vendors) to customers for maintenance and replacement
purposes.  The outside purchased products and self-made products have
different functions and capabilities.  The Company decides whether or
not to purchase from outside vendors or make the necessary products itself based
on the needs and preferences of different customers and efficiency
considerations.  Therefore, as a percentage of the cost of products
sold, the self-made products and outsourced products have varied significantly
from time to time.  As self-made products generally contribute higher
margin than outside purchased products, sales of a greater portion of self-made
products generally result in lower cost of products sold.  Cost of
products sold for the fiscal year ended June 30, 2008 was $3.46 million, an
increase of $1.64 million, compared to $1.82 million for the prior fiscal
year.  The increase in cost of products sold was consistent with the
increase in product sales revenue.





Gross Margin:  For
the year ended June 30, 2008, as a percentage of total revenues, the overall
gross margin was 30.1%, compared 35.1% for the prior fiscal year, primarily
because of the drop in gross margin for integrated contracts.  The
gross margin for integrated contracts was 27.5% for the year ended June 30, 2008
compared to 34.0% for the prior year.  The decrease in gross margin
for integrated contracts was due mainly to different sales mix, as a higher
proportion of system integration projects on subway systems which generated a
lower margin of around 11%, which is much lower than the average margin level of
above 30% for industrial automation projects.  The gross margin for
products sold was 62.2% for the fiscal year ended June 30, 2008 compared to
59.6% for the prior fiscal year.





Selling
Expenses:  Selling expenses mainly consist of compensation,
traveling and administrative expenses related to marketing and sales and
promotion activities of the Company’s marketing and credit
departments.  Selling expenses were approximately $9.68 million for
the fiscal year ended June 30, 2008, an increase of 27.8%, or approximately
$2.10 million, compared to approximately $7.58 million for the prior fiscal
year.  Of the total increase, $1.10 was related to payroll expense of
sales personnel, $0.21 million was for travel expense, $0.36 million was for
sales promotion and advertisement, and $0.44 million was for other selling
expenses and overheads.  As a percentage of total revenues, selling
expenses accounted for 8.0% and 7.4% for the fiscal year ended June 30, 2008 and
2007, respectively.  The Company has established guidelines to monitor
and evaluate sales performance for its products to customers in different
industries and regions to control selling expenses.




General and administrative
expenses:  General and administrative expenses mainly include
compensation, traveling and other administrative expenses of non-sales-related
departments, such as the planning and finance department, information systems
department and human resources department.  The legal and accounting
expenses associated with the efforts of the Company to enter into a business
combination with HollySys are also a component of general and administrative
expenses.





General
and administrative expenses amounted to $26.54 million for the fiscal year ended
June 30, 2008, an increase of $19.40 million, compared to $7.14 million for the
prior fiscal year, representing an increase of 273.8%.  The increase
in general and administrative expenses was mainly due to the stock compensation
expense on earn-out shares of $17.0 million incurred for fiscal year 2008 while
nil for the prior year, and an increase of $2.32million in allowance for
doubtful debts. As a percentage to total revenues, general and administrative
expenses were 21.8% and 7.0% for the fiscal years ended June 30, 2008 and 2007,
respectively.  Excluding the stock compensation expenses, general and
administrative expenses as a percentage to total revenues would be 7.9% for the
fiscal year ended June 30, 2008.




44




Pursuant
to the stock purchase agreement under the re-domestication merger, the Company
will issue 2 million shares to the original stockholders of Gifted Time if the
Company can achieve or exceed an after-tax profit of $23 million for the 12
months ended December 31, 2007.  After-tax profit shall be computed
using US GAAP and refers to the comprehensive income; provided that the
computation shall exclude (i) any after-tax profits from any acquisition by the
Company or its subsidiaries that involved the issuance of securities that has a
dilutive effect on the holders of common stock of the Company, and (ii) any
expenses related to the issue of the aforesaid shares.  Management
determined that the Company has achieved such earn-out target for the
abovementioned period and the issuance of the earn-out shares is subject to
Board approval.  The Company has accounted for the fair value of the
aforesaid shares to be issued for the year ended June 30, 2008 as stock
compensation expenses and $17.0 million was recorded in the statement of
income.





Research and Development
Expenses:  Research and development expenses comprise mostly
employee compensation, materials consumed and experiment expenses for specific
new product research and development, and any expenses incurred for basic
research on advanced technologies.  For the fiscal year ended June 30,
2008, research and development expenses were $3.83 million, compared to $3.86
million for the prior fiscal year. As a percentage to total revenues, gross
research and development expenses was 3.2% and 3.8% for the fiscal years ended
June 30, 2008 and 2007, respectively.





VAT Refunds:  The
local governments in Beijing and Hangzhou provide financial subsidies out of the
value added tax they collect in order to encourage the research and development
efforts of certain enterprises.  Beijing HollySys and Hangzhou
HollySys both received such refunds.  All VAT refunds were accounted
for based on hard evidence that the operations of those companies were entitled
to receive these refunds or that cash had been received. For the fiscal year
ended June 30, 2008, VAT refunds were $6.16 million, compared to $4.31 million
for the prior fiscal year, increased by $1.85 million, or 42.8%. As a percentage
to total revenues, VAT refunds were 5.1% and 4.2% for the fiscal years ended
June 30, 2008 and 2007, respectively.





Income (loss) from
Operations:  Income from operations decreased by $18.84
million, or 87.5%, from $21.53 million for the fiscal year ended June 30, 2007
to $2.69 million for the fiscal year ended June 30, 2008, was primarily due to
the stock compensation expenses recognized. Excluding the $17.0 million stock
compensation expenses, as a percentage to total revenues, the operating income
for the fiscal year ended June 30, 2008 was 16.2% compared to 21.1% for the
prior year.  The decrease as a percentage of total revenues was mainly
due to the decline in gross margin level.





Interest Expenses,
Net:  For the year ended June 30, 2008, net interest expenses
decreased by $3.31 million, or 43.4%, from $7.61 million for the prior year to
$4.30 million for the current period.  The decrease was primarily due
to the decrease of $3.16 million in the amortization of discounts and interests
on notes payable.  As a percentage of total revenues, the net interest
expense for the fiscal year ended June 30, 2008 was 3.5%, compared to 7.5% for
the prior fiscal year. Excluding the interests and amortization of discounts on
notes payable, as a percentage to total revenue, the net interest expense would
be 0.9% and 1.2% for the fiscal year ended June 30, 2008 and 2007,
respectively.




Government
Subsidy:  The local governments in Beijing and Hangzhou provide
financial subsidies to encourage development of certain
enterprises.  Beijing HollySys and Hangzhou HollySys both received
such subsidies.  All subsidies were accounted for based on hard
evidence that the operations of those companies were entitled to receive these
subsidies or that cash had been received.Gross subsidy income
received from the government amounted to $3.16 million and $4.19 million for the
fiscal year ended June 30, 2008 and 2007, respectively, decreased by $1.03
million, or 24.5%.





Income Tax
Expenses:  For the year ended June 30, 2008, the Company’s
income tax expense was $1.09 million for financial reporting purposes, a
decrease by $1.41 million whereas the income tax expense was $2.50 million for
the prior year.  Such decrease of income tax expenses was due mainly
to a special PRC tax benefit on research and development expenditures of and
deferred tax adjustments recorded during this period.





45




Minority
Interest:  The minority interest of the Company includes other
parties’ interests in Beijing HollySys, Hangzhou HollySys and
Haotong.  The ownership interests of minorities in these two operating
entities were 25.89%, 10.36% and 48.12%, respectively.  The minority
interest for the fiscal year ended June 30, 2008 was $2.83 million, slightly
decrease by $0.23 million from $3.06 million for the prior year.





Net income (loss) and Earnings
(loss) per share:  For the fiscal year ended June 30, 2008, the
Company’s net loss amounted to $(1.68) million or $(0.04) per diluted share, a
decrease by $14.76 million or $0.61 per diluted share as compared to a net
income of $13.08 million or $0.57 per diluted share for the prior
year.  Such decrease was primarily due to the $17.0 million in stock
compensation expenses, offset by the decrease of $3.24 million in amortization
of discounts and interests on notes payable.




Liquidity
and Capital Resources




Cash
Flow and Working Capital





As of
June 30, 2009 and 2008 we had approximately $128.89 million and $64.25 million,
respectively, in cash and cash equivalents. We believe our working capital is
sufficient to meet our present requirements.  To date, we have
financed our operations primarily through cash flows from financing and
operating activities. As of June 30, 2009, we
had total assets of $345.44 million, of which cash amounted to $128.89 million,
accounts receivable amounted to $56.55 million and inventories amounted to
$18.84 million. While working capital was approximately $182.85 million, equity
amounted to $173.54 million and our current ratio was approximately
2.81.




The
following table shows our cash flows with respect to operating activities,
investing activities and financing activities for the 12-month periods ended
June 30, 2007, 2008 and 2009:




Cash Flow
      Item
                    
                    Fiscal
      Years Ended June 30,2007
                    
                    
                    2008
                    
                    
                    2009Net
      cash (used in) provided by operating activities
                    
                    
                    3,772,439
                    
                    
                    
                    (3,931,073
                    )
                    
                    
                    40,127,458Net
      cash (used in) provided by investing activities
                    
                    
                    (34,853,478
                    )
                    
                    
                    (11,865,752
                    )
                    
                    
                    (11,940,293
                    )Net
      cash (used in) provided by financing activities
                    
                    
                    29,539,350
                    
                    
                    
                    59,208,327
                    
                    
                    
                    35,882,189Effect
      of exchange rate changes on cash and cash equivalents
                    
                    
                    2,231,202
                    
                    
                    
                    9,170,295
                    
                    
                    
                    562,754Net
      increase (decrease) in cash and cash equivalents
                    
                    
                    689,513
                    
                    
                    
                    52,581,797
                    
                    
                    
                    64,632,108Cash
      and cash equivalents, beginning of year
                    
                    
                    10,979,248
                    
                    
                    
                    11,668,761
                    
                    
                    
                    64,250,558Cash
      and cash equivalents, end of year
                    
                    
                    11,668,761
                    
                    
                    
                    64,250,558
                    
                    
                    
                    128,882,666





Operating
Activities




For the
year ended June 30, 2009 net cash provided by operating activities
was $40.13 million, compared to net cash used in operating activities of
$3.93 million for prior fiscal year 2008.  The net cash inflow from
operating activities in fiscal year 2009 was primarily due to a decrease in
inventories of $5.31 million, an increase in accounts payable of $13.06 million,
an increase in tax payable of $3.02 million, and the reconciling item in net
income of $39.56 million in stock compensation expenses; which were partially
offset by an increase in cost and estimated earnings in excess of billings of
$8.3 million, an increase in amount due from related parties of $4.58 million.
The decrease in inventories was mainly due to increase in revenues and costs,
the increase in accounts payable was primarily due to better credit terms
provided by suppliers. The increase in accounts receivable was consistent with
increase in revenues.





46




For the
year ended June 30, 2008 net cash used in operating activities was $3.93
million, compared to net cash provided by operating activities of $3.77 million
for prior fiscal year 2007.  The net cash outflow from operating
activities in fiscal year 2008 was primarily due to an increase in accounts
receivables of $18.56 million, an increase in inventories of $11.0 million,
which were partially offset by an increase in advance from customers of $9.05
million, and the reconciling item in net income of $17.0 million in stock
compensation expenses.  The increase in accounts receivables was
primarily due to the increase in revenues, the increase in inventories was
primarily due to higher products demand expected in future and the increase in
procurement for imported equipment for subway projects.  The increase
in advance from customers was consistent with a higher revenue backlog at the
fiscal year end.





For the
year ended June 30, 2007 net cash provided by operating activities
was $3.77 million, compared to net cash provided by operating activities of
$7.29 million for prior fiscal year 2006.  The net cash inflow from
operating activities in fiscal year 2007 was primarily due to the net income for
the year of $13.08 million together with the reconciled non-cash items of
amortization of discount to notes payable of $4.82 million and minority interest
of $3.06 million, an increase in accounts payable of $5.77 million, an increase
in advance from customers of $2.02 million and increase in accruals and other
payable of $2.21 million; which were partially offset by an increase in accounts
receivable of $20.71 million, and an increase in inventories of $5.87
million.  The increase in accounts receivables was primarily due to
the increase in revenues, the increase in inventories was primarily due to
higher products demand expected in future.  The increase in accounts
payable was primarily due to the better credit terms that we were able to get
from our suppliers and an increase in our business volume.  The
increase in advance from customers was consistent with a higher revenue backlog
at the fiscal year end.





Investing
Activities





For the
year ended June 30, 2009 and 2008, net cash used in investing activities
was $11.94 million and $11.87 million, respectively.  The net
cash used in investing activities for the fiscal year 2009 consisted mainly of a
cash outflow of $8.73 million in the purchase of fixed assets, a cash outflow of
$3.90 million in the acquisition of long term investments, a cash outflow of
$2.20 million prepaid for minority interest, and cash proceeds of $2.10 million
from disposal of an equity investee.





For the
year ended June 30, 2008 and 2007, net cash used in investing activities
was $11.87 million and $34.85 million, respectively.  The net
cash used in investing activities for the fiscal year 2008 consisted mainly of a
cash outflow of $10.03 million in purchase of fixed assets and an increase in
amounts due from related parties of $2.34 million in connection with an advance
payment for the sourcing of construction materials for our new
headquarters.





For the
year ended June 30, 2007, net cash used in investing activities was $34.85
million.  The net cash used in investing activities for the fiscal
year 2007 consisted mainly of an increase in a note receivable from the then
sole stockholder of $30 million and a $3.06 million addition in long-term
investments.





Financing
Activities





For the
year ended June 30, 2009 and 2008, net cash provided by financing activities was
$35.88 million and $59.21 million, respectively.  The net cash inflow
from financing activities in fiscal year 2009 primarily comprise proceeds from
long-term bank loans of $36.61 million related to the ongoing construction
of our new facility, with interest subsidized by the government.





For the
year ended June 30, 2008 and 2007, net cash provided by financing activities
was $59.21 million and $29.54 million, respectively.  The cash
generated by financing activities in fiscal year 2008 consisted mainly
of:


·
            A
      cash inflow of $57.21 million raised from warrants exercised during the
      period from October 17 to December 17, 2007, in connection with the
      Company’s call of warrants issued by Chardan during the Chardan IPO
      process and the subsequent exercise of warrants to purchase 11,442,614
      shares at $5.0 per share and the redemption of warrants to 57,386 shares
      at $0.01 per share, and the Company’s collection of cash proceeds of
      $57.21 million and paid $573.86 to the holders of 57,386 shares of
      warrants for redemption purposes;




47


·
            A
      net cash inflow of $32.06 million related to proceeds from reorganization
      and recapitalization, as we completed our re-domestication merger with
      Hollysys on September 20, 2007, and Hollysys acquired the net assets of
      Chardan as of the acquisition date, which amounted to $32.06 million in
      cash.




·
            A
      net cash inflow of $11.48 million raised from issuing bonds in connection
      with a RMB80 million three-year, 6.68% (payable semiannually) corporate
      bond issuance by Beijing HollySys on December 25,
      2007, with maturity on December 28, 2010.  In
      connection with the bond issuance, Beijing Zhongguancun Science and
      Technology Guaranty Co., Ltd. undertook joint and several guarantee
      liabilities in full in favor of Beijing HollySys. Concurrently, the
      China Development Bank has authorized its business department to undertake
      joint and several guarantee liability in respect of the guarantee
      liabilities of Beijing Zhongguancun Science and Technology Guaranty Co.,
      Ltd. Beijing HollySys also pledged its property located in Beijing with a
      net book value of $5.4 million, as at June 30, 2008, to Beijing
      Zhongguancun Science and Technology Guaranty Co., Ltd. as a
      collateral;




·
            A
      cash outflow of $29.987 million used to pay off the principal and related
      interest of the bridge loan, which was incurred prior to fiscal year
      2007;




·
            A
      net cash outflow of $12.92 million in repayments to short-term bank loans;
      and




·
            A
      cash proceed of $4.76 million and repayments of $3.40 million from / to
      long-term bank loans.




For the
year ended June 30, 2007, net cash provided by financing activities was $29.54
million.  The net cash inflow from financing activities in fiscal year
2007 primarily consisted of proceeds from notes payable of $29.987 million
related to a bridge loan, proceeds from short term bank loans of $6.49 million,
and was partially offset by repayments to long term bank loans of $5.10 million
and dividend paid to then shareholders and minority interests of $1.91
million.





Research
and Development, Patents and Licenses, Etc.





Research
and Development Efforts





As a
high-technology company, our business and long-term development rely highly on
our research and development capabilities. Our research and development process
is based on Capability Maturity Model Integration Level 2&3 and can be
classified into the following seven phases:





·
            Study
      phase




·
            Requirement
      phase




·
            Designing
      phase




·
            Implementation
      phase




·
            Testing
      Phase




·
            Inspection
      Phase




·
            Maintaining
      phase




We use
standard project development life cycle models, including the waterfall model,
increment model, iterative model and prototype. As a technology leader we
continually develop and patent new automation technologies.  We also
continually review and evaluate technological changes affecting the automation
and integrated system industries and invest substantially in application-based
research and development. We currently employ over 490 staff in the research and
development department or engaged in research and development work.





Our core
technologies achieved from our research and development efforts
include:





1.
            Large
      scale software platform architecture
design;




2.
            Proprietary
      network design and development
technologies;




48


3.
            Safety
      computer platform design and
manufacturing;




4.
            Efficient
      I/O (Input/Output) signal processing design technology;
  and




5.
            Embedded
      system design and manufacturing.




We are
committed to incorporating the latest advances in electronics and information
system technology into its products and, whenever possible, developing
state-of-the-art proprietary products based on its extensive internal expertise
and research efforts.  We currently spend approximately 3-6% of our
annual revenues on research and development.  Our recent major
research and development focuses include:





·
            Process
      Control;




·
            Nuclear
      Power Automation System;




·
            Transportation
      Automation; and




·
            Manufacturing
      Automation.




Our
research and development efforts have led to the invention of several
proprietary systems in the fields of DCS and transportation automation
systems.  Our core technologies provide a platform that is designed to
enable the rapid and efficient development of our technologies for specific
applications that are quickly, efficiently and affordably tailored to particular
industries and to the needs of our customers. Our software development tools
enable us to custom program our systems rapidly, allowing us to apply digital
technologies that take advantage of the tremendous advances in electronics and
information technology to improve quality and reliability while reducing cost.
The market for our products includes, not only the large number of factories
that are continually under construction in China’s rapidly expanding industrial
base, but also extends to the replacement and upgrading of outdated legacy
systems to bring a higher degree of control and efficiency to the automation of
processes, delivering increasing benefits to customers as they meet increased
competition.





Intellectual
Property Rights





We rely
on a combination of copyright, patent, trademark and other intellectual property
laws, nondisclosure agreements and other protective measures to protect our
proprietary rights.  We also utilize unpatented proprietary know-how
and trade secrets and employ various methods to protect our trade secrets and
know-how. As of June 30, 2009, we held 59 software copyrights, 62 authorized
patents, 11 patent applications and 23 registered trademarks.  Our
earliest software copyrights will expire in 2048.  Our invention
patents have terms of 20 years (with the first issued patent expiring in 2010),
and our utility patents and design patents have terms of 10 years (with the
first issued patent expiring in 2010).





Although
we employ a variety of intellectual property in the development and
manufacturing of products, we believe that only a few of our intellectual
property rights are critical to our current operations. However, when taken as a
whole, we believe that our intellectual property rights are significant and that
the loss of all or a substantial portion of such rights could have a material
adverse effect on our results of operations.  Also, from time to time,
we may desire or be required to renew or to obtain licenses from others in order
to further develop and manufacture commercially viable products
effectively.





We market
our DCS products mainly under the brand name of “HOLLiAS.”  Our brand
name is well-established and is recognized an associated with high quality and
reliable products by industry participants and customers. We have obtained
trademark protection for our brand name “HOLLiAS” in the PRC. In addition, we
have also registered or applied for a series of trademarks including brand names
for us and our products. The trademarks are issued for 10-year periods (and may
be renewed prior to expiration).


49


Market
Trends





Other
than as disclosed in the foregoing disclosures and elsewhere in this annual
report, we are not aware of any trends, uncertainties, demands, commitments or
events for the year 2009 that are reasonably likely to have a material adverse
effect on our net revenues, income, profitability, liquidity or capital
resources, or that caused the disclosed financial information to be not
necessarily indicative of future operating results or financial
conditions.





Off-Balance
Sheet Arrangements





We do not
believe that there are any off-balance sheet arrangements that have or are
reasonably likely to have a material effect on our financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources.





Tabular
Disclosure of Contractual Obligations





The
following table sets forth our contractual obligations, including long-term and
short-term loans and operating leases and capital and operational commitments as
of June 30, 2009.





Total
                  
                  
                  Less than 1 year
                  
                  
                  1-3 years
                  
                  
                  3-5 years
                  
                  
                  5-7 yearsShort-Term
      Bank Loans
                  
                  
                  5,854,887
                  
                  
                  
                  5,854,887
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Long-Term
      Bank Loans
                  
                  
                  41,716,067
                  
                  
                  
                  5,123,026
                  
                  
                  
                  6,586,748
                  
                  
                  
                  14,637,216
                  
                  
                  
                  15,369,077Long-Term
      Bonds Payable and Related Interests
                  
                  
                  12,843,982
                  
                  
                  
                  782,213
                  
                  
                  
                  12,061,769
                  
                  
                  
                  -
                  
                  
                  
                  -Operating
      Lease Obligations
                  
                  
                  947,265
                  
                  
                  
                  522,996
                  
                  
                  
                  401,356
                  
                  
                  
                  22,913
                  
                  
                  
                  -Purchase
      Obligations
                  
                  
                  68,339,226
                  
                  
                  
                  68,339,226Total
                  
                  
                  129,701,427
                  
                  
                  
                  80,622,348
                  
                  
                  
                  19,049,873
                  
                  
                  
                  14,660,129
                  
                  
                  
                  15,369,077





Other
than the contractual obligations and commercial commitments set forth above, we
did not have any other long-term debt obligations, operating lease obligations,
capital commitments, purchase obligations or other long-term liabilities as of
June 30, 2009.





Operating
Lease Commitment





The
Company leases premises under various operating leases.  Rental
expenses under operating leases included in the statement of income were
$345,715, $545,796 and $1,105,473 for the years ended June 30, 2007, 2008 and
2009, respectively.





At June
30, 2009, the Company was obligated under operating leases requiring minimum
rentals as follows:





Years Ending June 30,2010
                      
                      $
                      522,9962011
                      
                      
                      345,4292012
                      
                      
                      55,9272013
                      
                      
                      22,9132014
      and onward
                      
                      
                      -Total
      minimum lease payments
                      
                      $
                      947,265





Purchase
Commitment





As of
June 30, 2009, the Company had approximately $68 million in purchase obligations
for the coming fiscal year, for purchases of equipment, mainly for fulfillment
of in-process or newly entered contracts resulting from the expansion of our
operations. Other than the contractual obligation and commercial commitments set
forth above, we do not have any other long-term debt obligations, operating
lease obligations, purchase obligations or other long-term
liabilities.


50


Safe
Harbor





All
information included in Item 5.E of this Item is deemed to be a “forward looking
statement” as that term is defined in the statutory safe harbors, except for
historical facts.  The safe harbor provided in Section 27A of the
Securities Act and Section 21E of the Exchange Act shall apply to all
forward-looking information provided in Item 5.E and F of this
Item.





ITEM
      6.
            DIRECTORS,
      SENIOR MANAGEMENT AND EMPLOYEES




A.
Directors and Senior Management





The
following table sets forth certain information regarding our directors and
senior management as of the date of this annual report.





Name
            
            Age
            
            PositionLi
      Qiao
            
            51
            
            Chairman
      of the BoardChangli
      Wang
            
            45
            
            Chief
      Executive Officer and DirectorPeter
      Li
            
            44
            
            Chief
      Financial OfficerKerry
      S. Propper
            
            34
            
            DirectorKiam
      Fee Yau
            
            63
            
            DirectorColin
      Sung
            
            42
            
            Independent
      DirectorJerry
      Zhang
            
            37
            
            Independent
      DirectorLeonard
      Hafetz
            
            69
            
            Independent
      DirectorJianyun
      Chai
            
            47
            
            Independent
      DirectorQingtai
      Chen
            
            71
            
            Independent
      Director





Madame Qiao Li has been our
Chairperson since September 2007.  Madame Qiao Li also currently the
Chairperson of Beijing Good To Great Investment Co., Ltd., a PRC investment
company.  Madame Qiao Li served as the Vice-President of Beijing Venture
Capital Co., Ltd. from 1999 to 2000.  She received her Bachelor’s degree
from Capital Normal University and has a Master’s degree in Business
Administration from Capital University of Economics and Business in Beijing,
China.  Madame Qiao received an International Executive MBA from the Hong
Kong University of Science and Technology in 2002.





Dr. Wang Changli has been our
director and Chief Executive Officer since September 2007. Prior to
founding Beijing Hollysys in 1993, Dr. Wang worked for the No. 6 Institute of
Electronic Industry Department, the predecessor of Beijing Hollysys.  Dr.
Wang also has been the Vice Chairman of the Chinese Automation Association since
2003.  Dr. Wang received his Bachelor’s degree in Automation from Tianjin
University in 1984 and his PhD in Automation from Lancaster University in
1988.





Mr. Peter Li has been our
Chief Financial Officer since February 1, 2009.  Mr. Li has also
served, since August 2008, as a Director of CS China Acquisition Corp.
(CSACF.OB), an OTCBB listed company engaging in seeking business combination
with a Chinese operating company; has served since November 2008, as an
independent director and audit committee chairman for China Valves Technology,
Inc. (CVVT.OB), an OTCBB listed company of manufacturing metal valves in China;
and has served since June 2008, as an independent director and audit committee
chairman for Yuhe International Inc., an OTCBB listed company (YUII.OB) in the
broiler breeding business in China.  Prior to joining us, Mr. Li
served Yucheng Technologies Ltd. ("Yucheng") (NASDAQ: YTEC), a leading IT
service provider to banking industry in China as a Senior Advisor, from February
2008 to February 28, 2009, and as CFO from October 2004 through February
2008.  Prior to his tenure at Yucheng, Mr. Li worked in corporate
financial management with various companies, including as Internal Controller at
Lenovo, one of the world’s largest makers of personal computers.  Mr.
Li graduated from Beijing Foreign Studies University with a B.A. and received a
Master of Education from the University of Toronto.  Mr. Li is a
Certified General Accountant in Ontario, Canada, and is fluent in English and
Mandarin.


51


Mr. Kerry S. Propper has been
our director since September 2007.  He was a founder and has been the
Executive Vice President and a director of Chardan since its inception in
December 2003.  From March 2005 through September 2005, Mr. Propper served
as the Chief Financial Officer, secretary and a member of the board of directors
of Chardan North China Acquisition Corp.  Since March 2005, Mr. Propper has
been the chief executive officer, secretary and a member of the board of
directors of Chardan South China Acquisition Corp.  Mr. Propper has been
the owner and chief executive officer of Chardan Capital Markets LLC (formerly
known as Gramercy Group), a New York based broker-dealer, since July 2003.
 He has also been a managing member of SUJG, Inc., an investment company,
since April 2005.  Since November 2006, Mr. Propper has served as the
executive vice president of mergers and acquisitions of Shine Media Acquisition
Corp., a blank-check company listed on the OTCBB.  Since December, 2005,
Mr. Propper has served as a special advisor to Jaguar Acquisition Corp., a
blank-check company listed on the OTCBB.  Mr. Propper also sits on the
board of directors of China Cablecom Ltd., or China Cablecom, a Shandong
Province based cable operator and consolidator.  Mr. Propper was a founder,
and from February 1999 to July 2003 owner and managing director of Windsor
Capital Advisors, a full service brokerage firm also based in New York.
 Mr. Propper also founded The Private Capital Group LLC, a small private
investment firm specializing in hard money loans and convertible preferred debt
and equity offerings for small public companies, in May 2000 and was affiliated
with it until December 2003.  From July 1997 until February 1999, Mr.
Propper worked at Aegis Capital Corp., a broker-dealer and member firm of the
NASD.  Mr. Propper is on the advisory board of NTWK, a software company
with operations in Pakistan.  Mr. Propper received his B.A. in Economics
and International Studies from Colby College.





Mr. Colin Sung has been our
director and the Chair of our Audit Committee since February 2008.  Mr.
Sung is currently the Chief Financial Officer and President of China Cablecom, a
U.S. public company that provides provider cable television services in China.
 He previously served as Chief Financial Officer of Linktone Ltd. from June
2005 to January 2008.  He also served as the acting Chief Executive Officer
of Linktone from February 2006 to April 2006.  From June 2004 until April
2005, Mr. Sung served as Corporate Controller of UTi United States, Inc., a
subsidiary of UTi Worldwide Inc., a global integrated logistics company.
 From August 2001 until May 2004, he was the Vice President of Finance and
Corporate Controller of USF Worldwide, Inc., a subsidiary of USF Corporation, a
transportation industry leader, which was acquired by GPS Logistics in October
2002.  Prior to that, he was Vice President and Corporate Controller of the
US operations of Panalpina Inc.  Mr. Sung is a Certified Public Accountant
and has a Bachelor of Science degree from William Paterson University and a
Master of Business Administration degree from American Intercontinental
University.





Ms. Jerry Zhanghas been our
director since September 2007.  Ms. Zhang is currently the China Business
Director of FIL Investment Management (Hong Kong) Limited under Fidelity
International since September 2008.  She previously served as the Head of
Investors & Intermediaries, Financial Institutions for the Standard
Chartered Bank in China.  In that role, she is responsible for relationship
management of broker dealers, insurance companies, fund managers, development
organizations, finance/trust companies and professional firms throughout China.
 Prior to that, Ms. Zhang was a senior relationship manager at Standard
Chartered Bank, specializing in financial institution clients and regulators in
China.  She also worked to develop Standard Chartered Bank’s custody
products in China from 2000 up to 2008.  Over the years, Ms. Zhang has
established an extensive network with both regulators and market players.
 Ms. Zhang received her Bachelor’s degree in electronic and mechanical
engineering and obtained an MBA from Lancaster University in the United Kingdom
in 2000.





Mr. Leonard Hafetz has been
our director since September 2007.  Mr. Hafetz is the principal and founder
of L&P Consulting, a software product consulting firm specializing in
hands-on development, design, triage, product evaluation and release processes
of software products which he founded in 2003.  Prior to founding L&P
Consulting, Mr. Hafetz was the Vice President of Engineering and Software
Product Management at EMC Corporation.  Mr. Hafetz has had a broad range of
experience in business development, product technology development, executive
management, engineering management, product management and sales.  He holds
a B.S. and M.S. degree in mechanical engineering and a Ph.D. in fluid mechanics
from the University of Connecticut.





Mr. Kiam Fee Yauhas been our director
since September 2007.  Prior to joining us Mr. Yau was the founder and
director of Fulbond Systems Pte. Ltd., from 1997 to November 2007, when we
acquired 100% of the interest in that company from Mr. Yau and changed its name
to Hollysys (Asia Pacific) Pte. Ltd.   Mr. Yau has also served in
executive management positions with various General Electric companies in the
PRC, Taiwan and Japan and has served in engineering, marketing and sales
positions with General Electric and the Port of Singapore.  He holds a
B.Sc. in Engineering from the National Taiwan University and a M.Sc. in
Management from the Sloan School of MIT.


52


Dr. Jianyun Chaihas been our director
since June 2, 2008.  Dr. Chai is currently a professor and the head of the
Institute of Power Electronic and Electrical Machine System at Tsinghua
University in China. Before he joined Tsinghua University as an Associate
Professor in 1999, Dr. Chai spent eight years working in the motor and
information industries in Japan. Dr. Chai is also a member of various societies
and organizations, including the China Renewable Energy Society, the Chinese
Society for Electrical Engineering, and the Chinese Wind Energy Association. Dr.
Chai received a Bachelors degree and a PhD in Electrical Engineering from
Tsinghua University in 1984 and 1989, respectively.





Mr. Qingtai Chenhas been our director
since June 2, 2008.  Mr. Chen has worked for the Dong Feng Motor Group for
over 22 years and served as its General Manager prior to joining the Company.
While employed by the Dong Feng Motor Group, Mr. Chen also served in various
positions, including as a member of the First Session of the Monetary Policy
Committee of the People’s Bank of China, as a deputy director of the State
Council Economic and Trade Office, as a deputy director of the State Economic
and Trade Commission, and as a deputy director of the Development Research
Center of the State Council. Mr. Chen also served from 2000 to 2006 as an
independent director of Sinopec Corp. Mr. Chen received his Bachelors of Science
degree in power and dynamics engineering from Tsinghua University and has been
recognized as a National Excellent Entrepreneur and National Economic Reform
Talent in China. Mr. Chen currently serves as a standing member of National
Committee of the Chinese People’s Political Consultative Conference and as the
Dean of the School of Public Policy and Management at Tsinghua University.
 He also serves as an independent director for the Bank of Communications,
which is listed on both Shanghai Stock Exchange and Hong Kong Stock Exchange,
and as an independent director of Mindray Medical International Limited, which
is listed on New York Stock Exchange.





B.
Compensation





Executive
Compensation





The
aggregate cash compensation paid to our executive officers as a group was
$488,799.  Except options to purchase 450,000 ordinary shares granted
to our CFO Peter Li on January 20, 2009, which were priced at $2.24 per share,
and with expiry period of 10 years from the date of grant and vest over a period
of 3 years, we have not granted any stock options or stock appreciation rights,
any awards under long-term incentive plans, or any other non-cash compensation
to any of our executive officers during this period.





Director
Compensation





We pay
each of our independent directors who are not employees a monthly fee as
compensation for the services to be provided by them as independent
directors.  We pay $4,000 a month to Colin Sung, $3,000 to Jerry Zhang
and $2,000 to each of other independent directors.  We also reimburse
our independent directors for out-of-pocket expenses incurred in attending
meetings.  As additional consideration, we grant to each of the
Independent Directors an option to purchase a certain amount of shares of the
Company’s common stock, which vest in equal installments on a quarterly basis
over a three-year period beginning on the grant date.  Specifically,
we granted a stock option to Colin Sun for the purchase of 45,000 shares of our
common stock, Jerry Zhang for the purchase of 36,000 shares of our common stock
and each of other independent directors for the purchase of 30,000 shares of our
common stock.





For the
fiscal year ended June 30, 2009, the aggregate cash compensation paid to our
directors as a group was approximately $204,000.





2006
Equity Plan





On
September 7, 2007, the stockholders of Chardan approved the
2006 Equity Plan (the “Equity Plan”).  The Equity Plan was assumed by
Hollysys as of the closing of the merger of Chardan with and into Hollysys.
 The Equity Plan reserves 3,000,000 shares of our ordinary shares for
issuance in accordance with the plan’s terms.  A description of the
Equity Plan is set forth in the Proxy Statement/Prospectus of our Registration
Statement on Form S-4 (No. 333-132826), under the heading “Chardan 2006 Equity
Plan”, and is incorporated herein by reference.  No options,
restricted stock or other awards under the Equity Plan have been issued to
date.


53


Employment
Agreements





Our
subsidiary, Gifted Time, has entered into a three-year employment agreement with
each of Dr. Changli Wang and Madame Li Qiao.  Dr. Wang was employed as
the chief executive officer, and Madame Qiao Li was the chairperson. The
executives are also entitled to insurance benefits, five weeks vacation, a car
and reimbursement of business expenses and, if necessary, relocation expenses.
The agreements are terminable by Gifted Time for death, disability and cause.
 The executive may terminate for good reason, which includes Gifted Time
breach, the executive’s not being a member of the board of directors, and change
of control.  The agreements contain provisions for the protection of
confidential information and a three-year-after employment non-competition
period within China. On January 20, 2009, we also entered into a three-year
employment agreement with Mr. Peter Li, pursuant to which Mr. Li agreed to serve
as our Chief Financial Officer, effective as of February 1, 2009.  In
addition to management of our corporate finances, Mr. Li’s duties include
oversight of our corporate strategy, investor relationship management and
acquisitions.  His compensation includes salaries, options, benefits,
and bonuses.





On and
effective June 2, 2008, the Company entered into separate letter agreements with
each of our two new independent directors, Messrs Jianyun Chai and Qingtai Chen,
pursuant to which the Company agreed to pay a monthly fee of $2,000 to each of
them, as compensation for the services to be provided by them as independent
directors.  In addition, the Company agreed to grant to each of them
an option to purchase 30,000 shares of the Company’s ordinary shares at an
exercise price equal to the closing price as reported on the OTC Bulletin Board
on the grant date of the option.  The options will vest in equal
installments on a quarterly basis over a three-year period.





C.
Board Practices





Terms
of Directors and Executive Officers





Our board
consists of nine directors.  Our directors are not subject to a term
of office limitation, and hold office until the next annual meeting of members
or until such director’s earlier resignation, removal from office, death or
incapacity.  Any vacancy on our board resulting from death, resignation,
removal or other cause, and any newly created directorship resulting from any
increase in the authorized number of directors between meetings of members, may
be filled either by the affirmative vote of a majority of all the directors then
in office (even if less than a quorum) or by a resolution of
members.





Our
executive officers are appointed by our board.  The executive officers
shall hold office until their successors are duly elected and qualified, but any
officer elected or appointed by the directors may be removed at any time, with
or without cause, by resolution of directors.  Any vacancy occurring in any
office may be filled by resolution of directors.





Independence
of Directors





We have
elected to follow the rules of NASDAQ to determine whether a director is
independent.  Our board will also consult with counsel to ensure that our
board’s determinations are consistent with those rules and all relevant
securities and other laws and regulations regarding the independence of
directors.  Rule 5605(a)(2) of Listing Rules of The Nasdaq Stock
Market, Inc., or the Nasdaq Listing Rules, defines an “independent director”
generally as a person, other than an officer of the Company, who does not have a
relationship with the Company that would interfere with the director’s exercise
of independent judgment.  Consistent with these considerations, our
board has affirmatively determined that, Messrs. Colin Sung, Leonard Hafetz,
Jerry Zhang, Jianyun Chai and Qingtai Chen are our independent
directors.





Board
Committees





Our board
has established an audit committee, a compensation committee and a corporate
governance and nominating committee.  Each committee is comprised
solely of independent directors within the meaning of Rule 5605(a)(2) of the
Nasdaq Listing Rules, and meet the criteria for independence set forth in Rule
10A-3(b)(1) of the Exchange Act.


54


Audit
Committee





Our audit
committee consists of Messrs. Colin Sung, Qingtai Chen and Jerry Zhang with Mr.
Sung serving as the Chair.  Our board has determined that all of our
audit committee members are independent directors within the meaning of
applicable NASDAQ listing rules, and meet the criteria for independence set
forth in Rule 10A-3(b)(1) of the Exchange Act.





Our board
has determined that each of Messrs. Sung, Chen and Zhang has an understanding of
generally accepted accounting principles and financial statements, the ability
to assess the general application of such principles in connection with our
financial statements, including estimates, accruals and reserves, experience in
analyzing or evaluating financial statements of similar breadth and complexity
as our financial statements, an understanding of internal controls and
procedures for financial reporting, and an understanding of audit committee
functions.





Our board
believes that Mr. Sung qualifies as an “audit committee financial expert” within
the meaning of all applicable rules.  Our board believes that Mr. Sung has
financial expertise from his degrees in business, his activities as a chief
executive officer and chief financial officer of various companies, and his
consulting activities in the areas of accounting, corporate finance, capital
formation and corporate financial analysis.





We
adopted an audit committee charter under which the committee is responsible for
reviewing the scope, planning and staffing of the audit and preparation of the
financial statements.  This includes consultation with management, the
auditors and other consultants and professionals involved in the preparation of
the financial statements and reports.  The committee is responsible for
performing oversight of relationship with our independent auditors.  The
committee also has a general compliance oversight role in assuring that our
directors, officers and management comply with our code of ethics, reviewing and
approving of related party transactions, dealing with complaints regarding
accounting, internal controls and auditing matters, and complying with
accounting and legal requirements applicable to us.




Pursuant
to the terms of its charter, the audit committee’s responsibilities include,
among other things:




·
            selecting
      our independent auditors and pre-approving all auditing and non-auditing
      services permitted to be performed by our independent
      auditors;




·
            reviewing
      with our independent auditors any audit problems or difficulties and
      management’s response;




·
            reviewing
      and approving all proposed related-party
  transactions;




·
            discussing
      the annual audited financial statements with management and our
      independent auditors;




·
            reviewing
      major issues as to the adequacy of our internal controls and any special
      audit steps adopted in light of significant internal control
      deficiencies;




·
            annually
      reviewing and reassessing the adequacy of our audit committee
      charter;




·
            such
      other matters that are specifically delegated to our audit committee by
      our board of directors from time to
time;




·
            meeting
      separately and periodically with management and our internal and
      independent auditors; and




·
            reporting
      regularly to the full board of
directors.




Compensation
Committee





Our
compensation committee consists of Messrs. Jerry Zhang, Jianyun Chai and Colin
Sung, with Jerry Zhang serving as its Chair.  Our board has determined
that all of our compensation committee members are independent directors within
the meaning of applicable NASDAQ listing rules, and meet the criteria for
independence set forth in Rule 10A-3(b)(1) of the Exchange Act.





Our
compensation committee assists the board in reviewing and approving the
compensation structure of our executive officers, including all forms of
compensation to be provided to our executive officers.  Our chief executive
officer may not be present at any committee meeting during which his
compensation is deliberated.  The Compensation Committee is responsible
for, among other things:


55





·
            approving
      and overseeing the compensation package for our executive
      officers;





·
            reviewing
      and approving corporate goals and objectives relevant to the compensation
      of our chief executive officer, evaluating the performance of our chief
      executive officer in light of those goals and objectives, and setting the
      compensation level of our chief executive officer based on this
      evaluation;





·
            reviewing
      periodically and making recommendations to the Board regarding any
      long-term incentive compensation or equity plans, programs or similar
      arrangements, annual bonuses, employee pension and welfare benefit plans;
      and





·
            reviewing
      and making recommendations to the Board regarding succession plans for the
      chief executive officer and other senior
  officers.





Corporate Governance and
Nominating Committee





Our
corporate governance and nominating committee consists of Messrs. Jerry Zhang,
Jianyun Chai and Colin Sun, each of whom is “independent” as that term is
defined under the Nasdaq listing standards.  The corporate governance
and nominating committee assists the board of directors in identifying
individuals qualified to become our directors and in determining the composition
of the board and its committees.  The corporate governance and
nominating committee is responsible for, among other things:





·
            identifying
      and recommending to the Board nominees for election or re-election to the
      board, or for appointment to fill any
vacancy;





·
            reviewing
      annually with the board the current composition of the board in light of
      the characteristics of independence, age, skills, experience and
      availability of service to us;





·
            identifying
      and recommending to the board the directors to serve as members of the
      board’s committees; and





·
            monitoring
      compliance with our Corporate Governance
  Guidelines.





D.
Employees





We had
1,736, 1,689 and 1,276 employees as of June 30, 2009, 2008 and 2007,
respectively.  Substantially all of our employees are located in
China.  The following table sets forth our employees as of June 30,
2009 based on their functional area within the Company:





Category
                  
                  Number of EmployeesSales
      & Marketing
                  
                  
                  257Research
      and development
                  
                  
                  517Engineering
                  
                  
                  482Production
                  
                  
                  207Management
                  
                  
                  273Total
                  
                  
                  1,736





We
believe that our relationship with our employees is good.  The
remuneration payable to employees includes basic salaries and
bonuses.  We have not experienced any significant problems or
disruption to our operations due to labor disputes, nor have we experienced any
difficulties in recruitment and retention of experienced staff. As required by
applicable Chinese laws, we have entered into employment contracts with all of
our officers, managers and employees.





Our
employees in China participate in a state pension scheme organized by Chinese
municipal and provincial governments.  We also contribute to social
insurance for our employees each month, which includes pension, medical
insurance, unemployment insurance, occupational injuries insurance and housing
providence fund in accordance with PRC regulations.


56


E.
Share Ownership





The
following table sets forth information, as of September 25, 2009, with respect
to the beneficial ownership of our ordinary shares by (i) each person who is
known by us to beneficially own more than 5% of our ordinary shares; (ii) by
each of our officers and directors; and (iii) by all of our officers and
directors as a group.  The address of each of the persons set forth
below is in care of Hollysys Automation Technologies Ltd., 10 Jiancaicheng
Middle Road, Xisanqi, Haidian District, Beijing, People's Republic of China,
100096.





Name & Address of
                                                              Beneficial Owner
                                                            
                                                            Office, if Any
                                                            
                                                            Title of Class
                                                            
                                                            Amount &
                                                              Nature of
                                                              Beneficial
                                                              Ownership(1)
                                                            
                                                            
                                                            Percent of
                                                              Class(2)Officers
      and DirectorsChangli
      Wang
                                                            
                                                            CEO
      and
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            6,590,718
                                                            (3)
                                                            
                                                            
                                                            14.35
                                                            %DirectorLi
      Qiao
                                                            
                                                            Chairman
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            3,619,104
                                                            (4)
                                                            
                                                            
                                                            7.88
                                                            %Peter
      Li
                                                            
                                                            CFO
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            150,000
                                                            (5)Kerry
      Propper
                                                            
                                                            Former
      CFO,
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            242,000
                                                            (6)
                                                            
                                                            
                                                            *c/o
      Chardan Capital Markets
                                                            
                                                            Director17
      State Street, Suite 2575New
      York, NY 10004Colin
      Sung
                                                            
                                                            Director
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            30,000
                                                            (7)
                                                            
                                                            
                                                            *Jerry
      Zhang
                                                            
                                                            Director
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            24,000
                                                            (8)
                                                            
                                                            
                                                            *Leonard
      Hafetz
                                                            
                                                            Director
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            20,000
                                                            (9)
                                                            
                                                            
                                                            *Yau
      Kiam Fee
                                                            
                                                            Director
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            20,000
                                                            (10)
                                                            
                                                            
                                                            *Qingtai
      Chen
                                                            
                                                            Director
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            12,500
                                                            (11)
                                                            
                                                            
                                                            *Jianyun
      Chai
                                                            
                                                            Director
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            12,500
                                                            (12)
                                                            
                                                            
                                                            *All
      officers and directors as a group
                                                            
                                                            
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            10,720,822
                                                            (13)
                                                            
                                                            
                                                            23.19
                                                            %(13)(10
      persons named above)5%
      Securities HolderShengheng
      Xu
                                                            
                                                            
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            2,328,660
                                                            (14)
                                                            
                                                            
                                                            5.07
                                                            %c/o
      Acclaimed Insight InvestmentsLimited102
      Xingshikou Rd, Haidian DistrictBeijing,
      China 100093Changli
      Wang
                                                            
                                                            CEO
      and
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            6,590,718
                                                            (3)
                                                            
                                                            
                                                            14.35
                                                            %DirectorXuesong
      Song
                                                            
                                                            
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            6,342,988
                                                            (15)
                                                            
                                                            
                                                            13.81
                                                            %c/o
      Allied Earn Investments LimitedRm
      1109, 67 Beishuan Xilu Dadi,Scientific
      & Technological MansionHaidian
      District,Beijing,
      China 100080Plus
      View Investments Limited
                                                            
                                                            
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            5,265,535
                                                            (17)
                                                            
                                                            
                                                            11.46
                                                            %Rm
      1103, 67 Beishuan Xilu Dadi,Scientific
      & Technological MansionHaidian
      District,Beijing,
      China 100080Time
      Keep Investments Limited
                                                            
                                                            
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            4,066,825
                                                            (15)
                                                            
                                                            
                                                            8.85
                                                            %Rm
      1109, 67 Beishuan Xilu Dadi,Scientific
      & Technological MansionHaidian
      District,Beijing,
      China 100080Li
      Qiao
                                                            
                                                            Chairman
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            3,619,104
                                                            (4)
                                                            
                                                            
                                                            7.88
                                                            %Ace
      Lead Profits Limited
                                                            
                                                            
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            2,971,662
                                                            (3)
                                                            
                                                            
                                                            6.47
                                                            %Jack
      Silver
                                                            
                                                            
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            2,657,000
                                                            (16)
                                                            
                                                            
                                                            5.78
                                                            %c/o
      SIAR Capital LLC660
      Madison AvenueNew
      York, NY 10021All
      persons named above as a group
                                                            
                                                            
                                                            
                                                            Ordinary
      Shares
                                                            
                                                            
                                                            27,315,005
                                                            
                                                            
                                                            
                                                            58.80
                                                            %




57


* Less
than 1%.





(1)
            Beneficial
      Ownership is determined in accordance with the rules of the Securities and
      Exchange Commission and generally includes voting or investment power with
      respect to securities.  Except as otherwise indicated, each of
      the beneficial owners listed above has direct ownership of and sole voting
      power and investment power with respect to our ordinary
      shares.





(2)
            A
      total of 45,942,614 shares of our ordinary shares as of September 25, 2009
      are outstanding pursuant to SEC Rule 13d-3(d)(1).  For each
      beneficial owner above, any options or warrants exercisable within 60 days
      have been included in the
denominator.





(3)
            The
      securities reported as held by Dr. Wang represent 2,971,662 shares of our
      common stock held indirectly through Ace Lead Profits Limited, 681,471
      shares held indirectly through Billion Bright International Limited,
      681,471 shares held indirectly through Excellent Link Enterprises Limited,
      681,471 held indirectly through Golden Result Enterprises Limited, 681,471
      held indirectly through Long Result Limited and 893,172 held indirectly
      through Sure Grow Profits Limited.  The foregoing entities are all
      British Virgin Islands entities that are wholly-owned and controlled by
      Dr. Wang therefore he may be deemed to be the beneficial owner of the
      ordinary shares held by them.





(4)
            The
      securities reported as held by Mme. Qiao represent 889,344 ordinary shares
      held by Faith Best Profits Limited, 682,440 shares held by OSCAF
      International Company Limited, 682,440 shares held by Glory Pearl
      International Limited, 682,440 shares held by Jumbo Growth International
      Limited, and 682,440 shares held by Pearl Success Investments Limited.
       The foregoing entities are all British Virgin Islands entities that
      are wholly-owned and controlled by Mme. Qiao. Therefore Mme. Qiao may be
      deemed to be the beneficial owner of the ordinary shares held by
      them.





(5)
            The
      securities reported as held by Mr. Li include options to purchase 150,000
      ordinary shares that are vested or are to be vested within 60 days from
      the date hereof.





(6)
            The
      securities reported as held by Mr. Propper include 222,000 ordinary shares
      owned directly by Mr. Propper and options to purchase 20,000 shares of our
      Common Stock that are vested or are to be vested within 60 days from the
      date hereof.





(7)
            The
      securities reported as held by Mr. Sung include options to purchase 30,000
      ordinary shares that are vested or are to be vested within 60 days from
      the date hereof.





(8)
            The
      securities reported as held by Mr. Zhang include options to purchase
      24,000 ordinary shares that are vested or are to be vested within 60 days
      from the date hereof.





(9)
            The
      securities reported as held by Mr. Hafetz include options to purchase
      20,000 ordinary shares that are vested or are to be vested within 60 days
      from the date hereof.





(10)
            The
      securities reported as held by Mr. Yau include options to purchase 20,000
      ordinary shares that are vested or are to be vested within 60 days from
      the date hereof.





(11)
            The
      securities reported as held by Mr. Chen include options to purchase 12,500
      ordinary shares that are vested or are to be vested within 60 days from
      the date hereof.




58


(12)
            The
      securities reported as held by Mr. Chai include options to purchase 12,500
      ordinary shares that are vested or are to be vested within 60 days from
      the date hereof.





(13)
            The
      securities reported as held by officers and directors as a group includes
      options to purchase ordinary shares that are vested or that will vest
      within the next 60 days and the percentage of ownership assumes that such
      options have been exercised.





(14)
            The
      securities reported as held by Shengheng Xu represent ordinary shares
      include 606,951 ordinary shares owned directly by Mr. Xu and 1,721,709
      ordinary shares held by Acclaimed Insight Investments Limited, or
      Acclaimed Insight, a BVI company, which is owned and controlled by Mr. Xu;
      therefore Mr. Xu may be deemed to be the beneficial owner of the ordinary
      shares beneficially owned by Acclaimed
Insight.





(15)
            The
      securities reported as held by Xuesong Song represent ordinary shares held
      by entities owned and controlled by Mr. Song as follows: 1,032,300 shares
      held by Allied Earn Investments Limited, a BVI company; 4,066,825 shares
      held by Time Keep Investments Limited, a BVI company, 843,863 shares held
      by Upper Mix Investments Limited, a BVI company and 400,000 shares held by
      Waybest Profits Limited, a BVI company; therefore Mr. Song may be deemed
      to be the beneficial owner of the ordinary shares beneficially owned by
      each of them.





(16)
            The
      securities reported as held by Jack Silver represent ordinary shares held
      by Sherleigh Associates Inc. Profit Sharing Plan, a trust of which Mr.
      Silver is the trustee, therefore Mr. Silver may be deemed to be the
      beneficial owner of the ordinary shares beneficially owned by Sherleigh
      Associates Inc. Profit Sharing
Plan.





(17)
            Plus
      View Investments Limited is a BVI company owned and controlled by An Luo;
      therefore An Luo may be deemed to be the beneficial owner of the ordinary
      shares beneficially owned by Plus View Investments
  Limited.





None of
our major shareholders have different voting rights from other
shareholders.  We are not aware of any arrangement that may, at a
subsequent date, result in a change of control of our company.





ITEM
      7.
            MAJOR
      SHAREHOLDERS AND RELATED PARTY
TRANSACTIONS




A.
Major Shareholders





Please
refer to Item 6.E “Directors, Senior Management and Employees — Share
Ownership.”





B.
Related Party Transactions





·
            Acquisition of Singapore
      Hollysys:On November 19, 2007, we entered into a sales and
      purchase agreement with Fulbond Systems Pte Ltd., or Fulbond Systems, a
      Singapore based company partially owned by Mr. Yau Kiam Fee, a member of
      our Board of Directors, pursuant to which we agreed to acquire 100%
      interest of Fulbond Systems for a purchase price of SGD$1,066,234
      (equivalent to $744,596).  Pursuant to the sales and purchase
      agreement, the closing day of this acquisition was November 30, 2007 and
      after the ownership transfer, Fulbond System was renamed to Hollysys (Asia
      Pacific) Pte Ltd.  The purchase price of $744,596 was paid in
      cash on December 11, 2007.  Singapore Hollysys became our wholly
      owned subsidiary and its operating results were included in our
       consolidated financial statements, effective from December 1, 2007.
       We acquired Singapore Hollysys to establish an Asia Pacific
      headquarters from which to market our automation products within the
      region and other overseas
countries.




59





·
            Dismissal Agreement:On March 19, 2008, APH and Dr. Changli Wang, individually and
      on behalf of the parties which had previously been shareholders of Gifted
      Time, entered into a dismissal agreement, or Dismissal Agreement. The
      Dismissal Agreement resulted in: (i) the dismissal and termination of the
      agreement by which APH acquired the Gifted Time shares from the
      shareholders, (ii) the assignment to the former shareholders of Gifted
      Time of the shares of Hollysys stock held by APH and the rights to the
      earnout shares issuable under the stock purchase agreement, in the event
      specified after-tax operating profit goals are met, and (iii) the
      termination and cancellation of the $200 million note issued by APH in
      connection with its acquisition of the Gifted Time shares.  As a
      result, the 22,200,000 shares of Hollysys held by APH have been
      transferred to Shengheng Xu (4,898,652), Qinglin Mei (1,224,552), An Luo
      (2,016,648), Dr. Changli Wang (6,441,108), Li Qiao (3,536,904) Xuesong
      Song (4,082,136).




·
            On
      June 5, 2009, the Company and the original shareholders of Gifted Time
      agreed to amend the amended and restated securities purchase agreement,
      dated February 9, 2007, between the Company and the original shareholders
      of Gifted Time, to terminate the Company’s obligation to issue up to 7
      million remaining shares in aggregate to the original shareholders, if the
      Company achieves certain pre-determined performance thresholds for fiscal
      years 2009, 2010, and 2011. The original selling shareholders previously
      earned 4 million shares under this plan when the Company achieved the
      performance thresholds set for  2007 and 2008.  As a
      condition to and as consideration for such termination of the Company’s
      obligation, the Company agreed to enter into a side letter agreement,
      dated as of June 5, 2009, with the original shareholders, pursuant to
      which the Company agreed to immediately issue 4 million shares to the
      original shareholders.





Except as
set forth in our discussion above, none of our directors, director nominees or
executive officers has been involved in any transactions with us or any of our
directors, executive officers, affiliates or associates which are required to be
disclosed herein.





C.
Interests of Experts and Counsel





Not
applicable.





ITEM
      8.
            FINANCIAL
      INFORMATION




A.
Consolidated Statements and Other Financial Information





We have
appended consolidated financial statements filed as part of this Annual Report.
See Item 18 “Financial Statements.”





Legal
Proceedings





We are
currently not a party to any material legal or administrative proceedings, and
we are not aware of threatened material legal or administrative proceedings
against us.  We may from time to time become a party to various legal
or administrative proceedings arising in the ordinary course of our
business.





Dividend
Policy





We
anticipate that we will retain all of our future earnings, if any, for use in
the expansion and operation of our business and do not anticipate paying cash
dividends in the foreseeable future.  Any future determination relating to
our dividend policy will be made at the discretion of our board of directors,
based on our financial condition, results of operations, earnings, contractual
restrictions, capital requirements, business prospects and other factors our
board of directors may deem relevant.




60


B.
Significant Changes
 
 We have
not experienced any significant changes since the date of our audited
consolidated financial statements included in this annual report.


ITEM
      9.
            THE
      OFFER AND LISTING




A.
Offer and Listing Details





The
common stock, warrants and units of Chardan, our predecessor, were quoted on the
Over-the-Counter Bulletin Board maintained by the National Association of
Securities Dealers, under the symbols of CNCA, CNCAW and CNCAU,
respectively.  Chardan units commenced public trading on August 3,
2005 and common stock and warrants commenced public trading on August 31,
2005.  On September 20, 2007, we merged with and into Chardan
simultaneously with our acquisition of Gifted Time.  From September
20, 2007 to July 31, 2008, our ordinary shares were quoted on the OTCBB under
the symbol “HLSYF.OB.”  On August 1, 2008, our ordinary shares were
approved to be listed on the Nasdaq Global Select Market, under the symbol
“HOLI”.





The
following table provides the high and low trading prices for our ordinary shares
and the historical prices for our common stock, warrants and units prior to the
merger, for the periods indicated below.




The
      OTCBB
                    Price
      per
                    Common
                    Stock/Ordinary
                    Shares
                  
                  
                  The
      OTCBB
                    Price
      per
                    Warrant
                  
                  
                  The
      OTCBB
                    Price
      per Unit
                  
                  
                  Nasdaq
      (2)
                    Price
      per
                    ShareHigh
                  
                  
                  Low
                  
                  
                  High
                  
                  
                  Low
                  
                  
                  High
                  
                  
                  Low
                  
                  
                  High
                  
                  
                  LowAnnual
      Market PricesYear
      2005 (from August 3, 2005)
                  
                  $
                  6.00
                  
                  
                  $
                  5.15
                  
                  
                  $
                  1.86
                  
                  
                  $
                  0.70
                  
                  
                  $
                  9.30
                  
                  
                  $
                  6.15
                  
                  
                  
                  N/A
                  
                  
                  
                  N/AYear
      2006
                  
                  $
                  12.90
                  
                  
                  $
                  5.74
                  
                  
                  $
                  7.45
                  
                  
                  $
                  1.65
                  
                  
                  $
                  27.50
                  
                  
                  $
                  9.10
                  
                  
                  
                  N/A
                  
                  
                  
                  N/AYear
      2007 (until September 20, 2007)
                  
                  $
                  8.70
                  
                  
                  $
                  7.20
                  
                  
                  $
                  3.65
                  
                  
                  $
                  2.46
                  
                  
                  $
                  15.85
                  
                  
                  $
                  12.29
                  
                  
                  
                  N/A
                  
                  
                  
                  N/AYear
      2008 (from September 21, 2007 through June 30, 2008)(1)
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/AYear
      2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  7.30
                  
                  
                  $
                  2.03Quarterly
      Market PricesFirst
      Quarter 2008 ended September 30, 2007
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/ASecond
      Quarter 2008 ended December 31, 2007
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/AThird
      Quarter 2008 ended March 31, 2008
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/AFourth
      Quarter 2008 ended June 30, 2008
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/AFirst
      Quarter 2009 ended September 30, 2008
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  7.30
                  
                  
                  $
                  3.50Second
      Quarter 2009 ended December 31, 2008
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  4.24
                  
                  
                  $
                  2.03Third
      Quarter 2009 ended March 31, 2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  3.30
                  
                  
                  $
                  2.17Fourth
      Quarter 2009 ended June 30, 2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  6.78
                  
                  
                  $
                  3.08First
      Quarter 2010 ended September 25, 2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  10.10
                  
                  
                  $
                  5.27Monthly
      Market PricesApril
      2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  4.30
                  
                  
                  $
                  3.08May
      2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  5.74
                  
                  
                  $
                  4.48June
      2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  6.78
                  
                  
                  $
                  5.18July
      2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  6.90
                  
                  
                  $
                  5.52August
      2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  7.03
                  
                  
                  $
                  6.00September
      2009
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  
                  N/A
                  
                  
                  $
                  10.10
                  
                  
                  $
                  6.00







(1) On
September 20, 2007, we changed our fiscal year end from December 31 to June 30,
in connection with the acquisition of Gifted Time and our redomestication to the
BVI.


(2) Since
August 1, 2008, our ordinary shares have been traded on the NASDAQ Global Select
Market.


61




There
were originally 11,500,000 warrants issued in connection with our August 2005
initial public offering.  Each warrant entitled the holder to purchase
one share of our common stock at an exercise price of $5.00.  Prior to
redemption, a total of 11,442,614 warrants were exercised, equal to
approximately 99.5% of all warrants originally issued.  The remaining
57,386 warrants were cancelled at redemption on December 17, 2007 and the
holders of those warrants were paid the sum of $0.01 per warrant.





C.
Markets





See our
disclosures under “Item 9. A. Offer and Listing.”





ITEM
      10.
            ADDITIONAL
      INFORMATION




A.
Share Capital





Not
applicable





B.
Memorandum and Articles of Association





The
following represents a summary of certain key provisions of the Company’s
amended and restated memorandum and articles of association.  The
summary does not purport to be a summary of all of the provisions of our
memorandum and articles of association and of all relevant provisions of BVI law
governing the management and regulation of BVI companies.





Register





The
Company was incorporated in the BVI on February 6, 2006 under the BVI Business
Companies Act, 2004, or the 2004 Act.  The Company’s memorandum of
association authorizes the issuance of up to 100,000,000 ordinary shares of
$0.001 par value, and (ii) 1,000,000 preferred shares of $0.001 par
value.





Objects
and Purposes





The
Company’s a memorandum of association grants the Company full power and capacity
to carry on or undertake any business or activity and do any act or enter into
any transaction not prohibited by the 2004 Act or any other BVI
legislation.





Directors





A
director must, immediately after becoming aware of the fact that he is
interested in a transaction entered into or to be entered into by us, disclose
such interest to the board of directors, unless (i) the transaction or proposed
transaction is between the director and (ii) the transaction or proposed
transaction is or is to be entered into in the ordinary course of our business
and on usual terms and conditions.  The director who is interested in
a transaction entered into or to be entered into by the Company may (i) vote on
a matter relating to the transaction; (ii) attend a meeting of directors at
which a matter relating to the transaction arises and be included in the quorum;
and (iii) sign a document on behalf of the company, or do any other thing in his
capacity as a director, that relates to the transaction.





The
directors may fix their compensation for services rendered to us.





By a
resolution of directors, the directors may exercise all our powers to borrow
money, mortgage or charge our undertakings and property, issue debentures,
denture stock and other securities whenever money is borrowed or as security for
any debt, liability or obligation occurred by us or of any third
party.


62


Each
director holds office until his successor takes office or until his earlier
death, resignation or removal by the members or a resolution passed by the
majority of the remaining directors.





A
director shall not require a share qualification.





To the
fullest extent permitted by the 2004 Act, none of our directors shall be
personally liable to the Company or its shareholders for or with respect to any
acts or omissions in the performance of his or her duties as a director of the
Company.





Rights
and Obligations of Shareholders





Dividends





Subject
to the 2004 Act, the directors may, by resolution of directors, declare
dividends and distributions by the Company to members and authorize payment on
the dividends or distributions so long as that immediately after the
distribution, the value of the Company’s assets exceeds its liabilities and the
Company is able to pay its debts as they fall due.  Any distribution
payable in respect of a share which has remained unclaimed for three years from
the date when it became due for payment shall, if the board of the directors so
resolves, be forfeited and cease to remain owing by the Company.  The
directors may, before authorizing any distribution, set aside out of the profits
of the Company such sum as they think proper as a reserve fund, and may invest
the sum so set apart as a reserve fund upon such securities as they may
select.





The
holder of each ordinary share has the right to an equal share in any
distribution paid by the Company.





Voting
Rights





Each
ordinary share confers on the shareholder the right to one vote at a meeting of
the members or on any resolution of members on all matters before the
shareholders of the Company.





Rights in the event of
winding up





The
holder of each ordinary share is entitled to an equal share in the distribution
of the surplus assets of the Company on a winding up.





Redemption





The
Company may purchase, redeem or otherwise acquire and hold its own shares with
the consent of members whose shares are to be purchased, redeemed or otherwise
acquired unless the Company is permitted by the 2004 Act or any provision of the
amended and restated memorandum of association or the amended and restated
articles of association to purchase, redeem or otherwise acquire the shares
without their consent.





The
Company may purchase, deem or otherwise acquire its shares at a price lower than
the fair value if permitted by, and then only in accordance with, the terms of
the amended and restated memorandum of association or the amended and restated
articles of association or a written agreement for the subscription for the
shares to be purchased, redeemed or otherwise acquired.




63





Changes
in the rights of shareholders





The
directors are authorized to issue new classes or series of shares and the rights
attached thereto.  However, the rights attached to any class or series
of shares (unless otherwise provided by the terms of issue of the shares of that
class or series), whether or not the Company is being wound-up, must be varied
with the consent in writing of all the holders of the issued shares of that
class or series or with the sanction of a resolution passed by a majority of the
votes cast at a separate meeting of the holders of the shares of the class or
series.





Meetings





An annual
meeting of members must be held each year at such date and time as may be
determined by the directors and if requested to do so by members holding at
least 30%  of the voting rights in respect of the matter for which the
meeting is being held.  No less than ten days and not more than sixty
days notice of meetings is required to be given to members.





A meeting
of members is properly constituted if at the commencement of the meeting there
are two members present in person or by proxy or (in the case of a member being
a corporation) by its duly authorized representative representing not less than
one third of the votes of the shares or class or series of shares entitled to
vote on resolutions of members to be considered at the meeting.





A member
shall be deemed to be present at the meeting if he participates by telephone or
other electronic means and all members participating in the meeting are able to
hear each other.





An
ordinary resolution of members may be approved at a duly constituted meeting of
members by the affirmative vote of a simple majority of the votes of those
members entitled to vote and voting on the resolution.





A special
resolution of members may be approved at a duly constituted meeting of members
by a vote of not less than two-thirds of votes of those members entitled to
vote.





A meeting
of members convened to consider a special resolution (other than an annual
general meeting) may be called on short notice if members holding not less than
90% of the total number of shares entitled to attend the meeting and vote on all
matters to be considered at the meeting waive the required notice for the
meeting.  Attendance at the meeting is deemed to constitute
waiver.





The
inadvertent failure of the directors to give notice of a meeting to a member, or
the fact that a member has not received notice, does not invalidate the
meeting.





A member
may be represented at a meeting of members by a proxy who may speak and vote on
behalf of the member.  A written instrument giving the proxy such
authority must be produced at the place appointed for the meeting before the
time for holding the meeting at which such person proposes to vote.





Limitations
on Ownership of Securities





There are
no limitations on the right of non-residents or foreign persons to own the
Company’s securities imposed by BVI law or by the Company’s amended and restated
memorandum of association and articles of association.




64





Change
in Control of Company





A special
resolution of members is required for the Company to issue shares of the Company
or securities convertible into shares of the Company resulting in a change of
control of the Company.  Additionally, the board of directors has the
power to issue preferred shares with such rights attaching to them as they
decide and that this power could be used in a manner that would delay, defer of
prevent a change of control of our company.





Ownership
Threshold





There are
no provisions governing the ownership threshold above which shareholder
ownership must be disclosed.





Changes
in Capital





Subject
to the provisions of the 2004 Act, we may, by a resolution of directors or
members, amend the Company’s memorandum and articles of association to increase
or decrease the number of shares authorized to be issued.  The
directors of the Company may, by resolution, authorize a distribution (including
a capital distribution) by the Company at a time, of an amount, and to any
members they think fit if they are satisfied, on reasonable grounds, that the
Company will, immediately after the distribution, satisfy the solvency
test.  The solvency test is satisfied if the value of the Company’s
assets exceeds its liabilities, and the Company is able to pay its debts as they
fall due.





Differences
in Corporate Law





The
companies law of the BVI differs from laws applicable to U.S. corporations and
their shareholders.  Set forth below is a summary of the significant
differences between the provisions of the companies law applicable to us and the
laws applicable to companies incorporated in the United States and their
shareholders.





Protection for minority
shareholders





Under the
laws of most U.S. jurisdictions, majority and controlling shareholders of a
company generally have certain “fiduciary” responsibilities to the minority
shareholders.  Corporate actions taken by majority and controlling
shareholders which are unreasonable and materially detrimental to the interests
of minority shareholders may be declared null and void.  Minority
shareholders may have less protection for their rights under BVI law than they
would have under U.S. law.





Powers of
directors





Unlike
most U.S. jurisdictions, the directors of a BVI company, subject in certain
cases to court’s approvals but without shareholders’ approval, may implement the
sale, transfer, exchange or disposition of any asset, property, part of the
business, or securities of the company, with the exception that shareholder
approval is required for the disposition of over 50% in the value of the total
assets of the company.





Conflict of
interests





Similar
to the laws of most U.S. jurisdictions, when a director becomes aware of the
fact that he has an interest in a transaction which the company is to enter
into, he must disclose it to our board.  However, with sufficient
disclosure of interest in relation to that transaction, the director who is
interested in a transaction entered into or to be entered into by the Company
may (i) vote on a matter relating to the transaction; (ii) attend a meeting of
directors at which a matter relating to the transaction arises and be included
in the quorum; and (iii) sign a document on behalf of the company, or do any
other thing in his capacity as a director, that relates to the
transaction.




65





Written consent and
cumulative voting





Similar
to the laws of most U.S. jurisdictions, under the BVI law, shareholders are
permitted to approve matters by way of written resolution in place of a formal
meeting.  BVI law does not make a specific reference to cumulative
voting, and our current Memorandum and Articles of Association have no provision
authorizing cumulative voting.





Independent
directors





There is
no requirement for a majority of the directors of the company to be independent
as a matter of BVI law.





Redemption





Our
ordinary shares are not redeemable at a shareholder’s option.  We may
redeem our shares only with the consent of the shareholders whose shares are to
be redeemed, except that the consent from the shareholders is not needed under
the circumstances of compulsory redemption, which occurs at the request of the
shareholders holding 90% of the votes of the outstanding ordinary shares
entitled to vote, of the remaining issued shares.





Takeover
provisions





The
Memorandum and Articles of Association of our company does not alter the general
provisions of BVI law and therefore measures such as a “poison pill” would have
to be in place before a takeover offer, as, if not, the directors could be seen
as exercising their powers for an improper purpose in trying to introduce such a
measure.





Furthermore,
the creation of additional class of shares would require an amendment to the
Memorandum of Association of our Company, which would usually require a special
resolution of shareholders.  However, our directors are empowered to
amend the relevant clauses of the Memorandum of Association for the purposes of
creating new classes or series of shares and the rights attached thereto and may
amend the Articles of Association to take into account of any ancillary changes
required, provided that the directors do not however, have the power to amend
the memorandum and articles to (a) restrict the rights or powers of the members
to amend the memorandum or articles, (b) to change the percentage of members
required to pass a resolution to amend the memorandum and articles, or (c) in
circumstances where the memorandum or articles cannot be amended by the
members.





Shareholder’s access to
corporate records





A
shareholder is entitled, on giving written notice to the Company, to inspect the
Company’s (i) Memorandum and Articles of Association; (ii) register of members;
(iii) register of directors; and (iv) minutes of meetings and resolutions of
members and of those classes of members of which the shareholder is a
member.





The
directors may, if they are satisfied that it would be contrary to the company’s
interests to allow a member to inspect any document listed above (or any part
thereof), refuse the member to inspect the document or limit the inspection of
the document.  Our board may also authorize a member to review the
company account if requested.





Indemnification





Under our
Memorandum and Articles of Association, we must indemnify our directors or any
person who is or was, at the request of the Company, serving as a director of,
or in any other capacity is or was acting for, another body corporate or a
partnership, joint venture, trust or other enterprise against expenses
(including legal fees), judgments, fines and amounts paid in settlement actually
and reasonably incurred by such persons in connection with legal, administrative
or investigative proceedings to which they are a party or are threatened to be
made a party by reason of their acting as our directors or agents.  To
be entitled to indemnification, these persons must have acted honestly and in
good faith and in what he believes to be the best interest of the Company, and
they must have had no reasonable cause to believe their conduct was
unlawful.





Insofar
as indemnification for liabilities arising under the Securities Act may be
permitted to directors, officers or persons controlling us under the foregoing
provisions, we have been advised that in the opinion of the SEC, such
indemnification is against public policy as expressed in the Securities Act and
is therefore unenforceable.




66





Mergers and similar
arrangements





Under the
laws of the BVI, two or more companies may merge or consolidate in accordance
with Section 170 of the 2004 Act.  A merger means the merging of two
or more constituent companies into one of the constituent companies, and a
consolidation means the uniting of two or more constituent companies into a new
company.  In order to merge or consolidate, the directors of each
constituent company must approve a written plan of merger or consolidation which
must be authorized by a resolution of shareholders.





While a
director may vote on the plan even if he has a financial interest in the plan of
merger of consolidation, in order for the resolution to be valid, the interest
must have been disclosed to our board forthwith upon him becoming aware of such
interest.  The transaction will not be avoidable if the shareholders
approve or ratify it.





Shareholders
not otherwise entitled to vote on the merger or consolidation may still acquire
the right to vote if the plan of merger or consolidation contains any provision
which, if proposed as an amendment to the memorandum or articles of association,
would entitle them to vote as a class or series on the proposed
amendment.  In any event, all shareholders must be given a copy of the
plan of merger or consolidation irrespective of whether they are entitled to
vote at the meeting or consent to the written resolution to approve the plan of
merger or consolidation.





The
shareholders of the constituent companies are not required to receive shares of
the surviving or consolidated company, but may receive debt obligations or other
securities of the surviving or consolidated company, or other assets, or a
combination thereof.  Furthermore, some or all of the shares of a
class or series may be converted into a kind of asset while the other shares of
the same class or series may receive a different kind of asset.  As
such, not all the shares of a class or series must receive the same kind of
consideration.





After the
plan of merger or consolidation has been approved by the directors and
authorized by a resolution of the shareholders, articles of merger or
consolidation are executed by each company and filed with the Registrar of
Corporate Affairs in the BVI.





A
shareholder may dissent from a mandatory redemption of his shares, an
arrangement (if permitted by the court), a merger (unless the shareholder was a
shareholder of the surviving company prior to the merger and continues to hold
the same or similar shares after the merger) and a consolidation.  A
shareholder properly exercising his dissent rights is entitled to payment of the
fair value of their shares.





A
shareholder dissenting from a merger or consolidation must object in writing to
the merger or consolidation before the vote by the shareholders on the merger or
consolidation, unless notice of the meeting was not given to the
shareholder.  If the merger or consolidation is approved by the
shareholders, the company must within 20 days give notice of this fact to
each shareholder who gave written objection, and to each shareholder who did not
receive notice of the meeting.  Such shareholders then have
20 days to give to the company their written election in the form specified
by the BVI Business Companies Act to dissent from the merger or consolidation,
provided that in the case of a merger, the 20 days starts when the plan of
merger is delivered to the shareholder.





Upon
giving notice of his election to dissent, a shareholder ceases to have any
rights of a shareholder except the right to be paid the fair value of his
shares.  As such, the merger or consolidation may proceed in the
ordinary course notwithstanding the dissent.





Within
seven days of the later of the delivery of the notice of election to dissent and
the effective date of the merger or consolidation, the company must make a
written offer to each dissenting shareholder to purchase his shares at a
specified price that the company determines to be their fair
value.  The company and the shareholders then have 30 days to agree
upon the price.  If the company and a shareholder fail to agree on the
price within the 30 days, then the company and the shareholder shall each
designate an appraiser and these two appraisers shall designate a third
appraiser.  These three appraisers shall fix the fair value of the
shares as of the close of business on the day before the shareholders approved
the transaction without taking into account any change in value as a result of
the transaction.




67





Shareholders’
suits





Similar
to the laws of most U.S. jurisdictions, BVI law permits derivative actions
against its directors.  However, the circumstances under which such
actions may be brought, and the procedures and defenses available may result in
the rights of shareholders of a BVI company being more limited than those of
shareholders of a company incorporated and/or existing in the United
States.





The court
of the BVI may, on the application of a shareholder of a company, grant leave to
that shareholder to bring proceedings in the name and on behalf of that company,
or intervene in proceedings to which the company is a party for the purpose of
continuing, defending or discontinuing the proceedings on behalf of the
company.  In determining whether to grant leave, the High Court of the
BVI must take into account (i) whether the shareholder is acting in good
faith; (ii) whether the derivative action is in the interests of the company
taking account of the views of the company’s directors on commercial matters;
(iii) whether the proceedings are likely to succeed; (iv) the costs of the
proceedings in relation to the relief likely to be obtained; and (v) whether an
alternative remedy to the derivative claim is available.





Leave to
bring or intervene in proceedings may be granted only if the High Court of the
BVI is satisfied that (i) the company does not intend to bring, diligently
continue or defend, or discontinue the proceedings, as the case may be; or
(ii) it is in the interests of the company that the conduct of the
proceedings should not be left to the directors or to the determination of the
shareholders as a whole.





In
determining whether to grant leave to a shareholder in these circumstances, the
BVI Court must take the following matters into account:





(a)
            whether
      the member is acting in good faith;




(b)
              whether
      the derivative action is in the interests of the company taking account of
      the views of the company’s directors on commercial
  matters;




(c)
            whether
      the proceedings are likely to
succeed;




(d)
            the
      costs of the proceedings  in relation to the relief likely to be
      obtained; and




(e)
            whether
      an alternative remedy to the derivative claim is
  available.





C.
Material Contracts





We have
not entered into any material contracts other than in the ordinary course of
business and other than those described in Item 4, “Information on the Company,”
Item 7, “Major Shareholders and Related Party Transactions,” or Item 5.
Operating And Financial Review And Prospects – Contractual Obligations,” or
filed (or incorporated by reference) as exhibits to this annual report or
otherwise described or referenced in this annual report.





D.
Exchange Controls





BVI
Exchange Controls





There are
no material exchange controls restrictions on payment of dividends, interest or
other payments to the holders of our ordinary or preferred shares or on the
conduct of our operations in the BVI, where we were
incorporated.  There are no material BVI laws that impose any material
exchange controls on us or that affect the payment of dividends, interest or
other payments to nonresident holders of our ordinary or preferred
shares.  BVI law and our Amended and Restated Memorandum and Articles
of Association do not impose any material limitations on the right of
non-residents or foreign owners to hold or vote our ordinary or preferred
shares.




68





Exchange
Controls in China





Under the
Foreign Currency Administration Rules promulgated in 1996 and revised in 1997,
and various regulations issued by State Administration of Foreign Exchange, or
SAFE, and other relevant PRC government authorities, RMB is convertible into
other currencies without prior approval from SAFE only to the extent of current
account items, such as trade related receipts and payments, interest and
dividends and after complying with certain procedural
requirements.  The conversion of RMB into other currencies and
remittance of the converted foreign currency outside PRC for the purpose of
capital account items, such as direct equity investments, loans and repatriation
of investment, requires the prior approval from SAFE or its local
office.  Payments for transactions that take place within China must
be made in RMB.  Unless otherwise approved, PRC companies must
repatriate foreign currency payments received from
abroad.  Foreign-invested enterprises may retain foreign exchange in
accounts with designated foreign exchange banks subject to a cap set by SAFE or
its local office.  Unless otherwise approved, domestic enterprises
must convert all of their foreign currency proceeds into RMB.





On
October 21, 2005, SAFE issued the Notice on Issues Relating to the
Administration of Foreign Exchange in Fund-raising and Reverse Investment
Activities of Domestic Residents Conducted via Offshore Special Purpose
Companies, which became effective as of November 1, 2005.  According
to the notice, a special purpose company, or SPV, refers to an offshore company
established or indirectly controlled by PRC residents for the special purpose of
carrying out financing of their assets or equity interest in PRC domestic
enterprises.  Prior to establishing or assuming control of an SPV,
each PRC resident, whether a natural or legal person, must complete the overseas
investment foreign exchange registration procedures with the relevant local SAFE
branch.  The notice applies retroactively.  As a result, PRC
residents who have established or acquired control of these SPVs that previously
made onshore investments in China were required to complete the relevant
overseas investment foreign exchange registration procedures by March 31,
2006.  These PRC residents must also amend the registration with the
relevant SAFE branch in the following circumstances: (i) the PRC residents have
completed the injection of equity investment or assets of a domestic company
into the SPV; (ii) the overseas funding of the SPV has been completed; (iii)
there is a material change in the capital of the SPV.  Under the
rules, failure to comply with the foreign exchange registration procedures may
result in restrictions being imposed on the foreign exchange activities of the
violator, including restrictions on the payment of dividends and other
distributions to its offshore parent company, and may also subject the violators
to penalties under the PRC foreign exchange administration
regulations.





E.
Taxation





The following is a general summary
of certain material BVI, China and U.S. federal income tax
considerations.  The discussion is not intended to be, nor should it be construed as, legal
or tax advice to any particular prospective
shareholder.  The discussion is based on laws and relevant
interpretations thereof in
effect as of the date hereof, all of which are subject to change or different
interpretations, possibly with retroactive effect.





BVI
Taxation




The BVI
does not impose a withholding tax on dividends paid by us to holders of our
ordinary shares, nor does the BVI levy any capital gains or income taxes on
us.  Further, a holder of our ordinary shares who is not a resident of
the BVI is exempt from the BVI income tax on dividends paid with respect to the
ordinary shares.  Holders of ordinary shares are not subject to the
BVI income tax on gains realized on the sale or disposition of the ordinary
shares.





Our
ordinary shares are not subject to transfer taxes, stamp duties or similar
charges in the BVI.  However, as a business company, we are required
to pay the BVI government an annual license fee based on the number of shares we
are authorized to issue.





There is
no income tax treaty or convention currently in effect between the United States
and the BVI.





Taxation
in China





In 2007,
the PRC government promulgated the new Enterprise Income Tax Law, or EIT Law,
and the relevant implementation rules, which became effective on January 1,
2008. Under the EIT Law and its implementation rules, all domestic and foreign
investment companies will be subject to a uniform enterprise income tax at the
rate of 25% and dividends from PRC subsidiaries to their non-PRC shareholders
will be subject to a withholding tax at a rate of 20%, which is further reduced
to 10% by the implementation rules, if the non-PRC shareholder is considered to
be a non-PRC tax resident enterprise without any establishment or place within
China or if the dividends payable has no connection with the non-PRC
shareholder’s establishment or place within China, unless any such non-PRC
shareholder’s jurisdiction of incorporation has a tax treaty with China that
provides for a different withholding arrangement. In addition, pursuant to the
EIT Law, enterprises established under the laws of non-PRC jurisdictions, but
whose “de facto management body” is located in the PRC, should be treated as
resident enterprises for PRC tax purposes However, it is currently uncertain
whether we may be deemed a resident enterprise, or how to interpret whether any
income or gain is derived from sources within China.  See “Risk
Factors - Under the New EIT Law, we may be classified as a “resident enterprise”
of China. Such classification will likely result in unfavorable tax consequences
to us and our non-PRC shareholders.”  If we, as a BVI company with
substantially all of our management located in China, were treated as a resident
enterprise for PRC tax purposes, we will be subject to PRC tax on our worldwide
income at the 25% uniform tax rate, which would have an impact on our effective
tax rate.





69





United States Federal
Taxation







The
following is a discussion of the material U.S. federal tax consequences of the
ownership of our ordinary shares by U.S. Holders (as described
below).  It does not purport to be a comprehensive description of all
of the tax considerations that may be relevant to a particular person’s
situation.  The discussion applies to investors in shares that hold
the shares as capital assets for U.S. federal income tax purposes and it does
not describe all of the tax consequences that may be relevant to holders subject
to special rules, such as:




·
            certain
      financial institutions;


·
            insurance
      companies;


·
            dealers
      and traders in securities or foreign
currencies;




·
            persons
      holding shares as part of a hedge, “straddle,” integrated transaction or
      similar transaction;




·
            persons
      whose functional currency for U.S. federal income tax purposes is not the
      U.S. dollar;




·
            partnerships
      or other entities classified as partnerships for U.S. federal income tax
      purposes;




·
            persons
      liable for the alternative minimum
tax;




·
            tax-exempt
      organizations;




·
            persons
      holding shares that own or are deemed to own 10% or more of our voting
      stock;




·
            persons
      who hold the shares in connection with a trade or business outside the
      United States; or




·
            persons
      who acquired our shares pursuant to the exercise of any employee stock
      option or otherwise as
compensation.




PROSPECTIVE
PURCHASERS ARE URGED TO CONSULT THEIR TAX ADVISORS ABOUT THE APPLICATION OF THE
U.S. FEDERAL TAX RULES TO THEIR PARTICULAR CIRCUMSTANCES AS WELL AS THE STATE,
LOCAL AND FOREIGN TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND
DISPOSITION OF ORDINARY SHARES.





This
discussion is based on the U.S. Internal Revenue Code of 1986, as amended, or
the Code, administrative pronouncements, judicial decisions and final, temporary
and proposed Treasury regulations, all as of the date hereof.  These
laws are subject to change, and can change on a retroactive
basis.  “U.S. Holder” means a beneficial owner of shares that, for
U.S. federal income tax purposes, is: a citizen or resident of the United
States; a corporation, or other entity taxable as a corporation, created or
organized in or under the laws of the United States or any political subdivision
thereof; or an estate or trust the income of which is subject to U.S. federal
income taxation, regardless of its source.  This discussion assumes
that we are not, and will not become, a passive foreign investment company, or a
PFIC, for U.S. federal income tax purposes, as described below.


70
  Taxation of
Dividends
 
 The gross
amount of any distributions paid with respect to shares, other than certain pro
rata distributions of shares, generally will be treated as foreign source
dividend income for U.S. federal income tax purposes.  U.S. Holders
will not be entitled to claim a dividends-received deduction with respect to
distributions paid by us.  Dividends will be included in a U.S.
Holder’s income on the date of such U.S. Holder’s receipt of the
dividend.
 
 If you
are a non-corporate U.S. Holder, subject to applicable limitations, you may be
eligible to be taxed at a maximum rate of 15% in respect of dividends received
in taxable years beginning before January 1, 2011.  Please consult
your tax advisors to determine whether you are subject to any special rules that
limit your ability to be taxed at this favorable rate.
 
 In the
event that we are deemed to be a Chinese “resident enterprise” under PRC tax
law, you may be subject to PRC withholding taxes on dividends paid to you with
respect to the ordinary shares.  In addition, subject to certain
conditions and limitations, PRC withholding taxes on dividends not in excess of
the rate allowed under the income tax treaty between the United States and the
PRC, or the Treaty, if applicable, may be treated as foreign taxes eligible for
credit against your U.S. federal income tax liability.  The rules
governing the foreign tax credit are complex.  You are urged to
consult your tax advisors regarding the availability of the foreign tax credit
in light of your particular circumstances.


Taxation of Capital
Gains





Upon sale
or other disposition of the ordinary shares, a U.S. Holder will generally
recognize capital gain or loss for U.S. federal income tax purposes in an amount
equal to the difference between such holder’s tax basis in the shares sold or
disposed of and the amount realized on the sale or other
disposition.  Such gain or loss will be long-term capital gain or loss
if the U.S. Holder has held the shares for more than one year and will generally
be U.S. source gain or loss for foreign tax credit purposes.  However,
if we are deemed to be a Chinese “resident enterprise” under PRC tax law, gains
on disposal may be subject to PRC tax.  In that event, a U.S. Holder
may be eligible for the benefits of the Treaty.  Under the Treaty, if
any PRC tax were to be imposed on any gain from the disposition of the shares,
the gain would be treated as PRC source income.  We urge you to
consult your tax advisors regarding the tax consequences if a foreign tax is
imposed on gain on a disposition of our shares, including the availability of
the foreign tax credit in light of your particular circumstances.





Passive Foreign Investment
Company Rules (PFIC)





We
believe that we were not a PFIC for United States federal income tax purposes
for our taxable year ended June 30, 2009.  However, since PFIC status
depends upon the composition of a company’s income and assets and the market
value of its assets (including goodwill) from time to time, there can be no
assurance that we will not be a PFIC for any taxable year.





In
general, if we were a PFIC for any taxable year during which a U.S. Holder held
shares, gain recognized by such U.S. Holder on a sale or other disposition
(including certain pledges) of the shares would be allocated ratably over the
U.S. Holder’s holding period for the shares.  The amounts allocated to
the taxable year of the sale or other disposition and to any year before we
became a PFIC would be taxed as ordinary income.  The amount allocated
to each other taxable year would be subject to tax at the highest rate in effect
for individuals or corporations, as appropriate, for such taxable year, and an
interest charge would be imposed on the amount allocated to such taxable
year.  Similar rules would apply to any distribution in respect of
shares in excess of 125% of the average of the annual distributions on shares
received by a U.S. Holder during the preceding three years or such holder’s
holding period, whichever is shorter.  Certain elections may be
available that would result in alternative treatments (such as a mark-to-market
treatment) of the shares.  U.S. Holders should consult their tax
advisers to determine whether such elections are available and, if so, what the
consequences of the alternative treatments would be in those holders' particular
circumstances.





71





Information Reporting and
Backup Withholding





Payment
of dividends and sales proceeds that are made within the United States or
through certain U.S.-related financial intermediaries generally are subject to
information reporting and to backup withholding unless (i) the U.S. Holder is a
corporation or other exempt recipient or (ii) in the case of backup withholding,
the U.S. Holder provides a correct taxpayer identification number and certifies
that backup withholding does not apply.





The
amount of any backup withholding from a payment to a U.S. Holder will be allowed
as a credit against the U.S. Holder’s U.S. federal income tax liability and may
entitle the U.S. Holder to a refund, provided that the required information is
furnished to the Internal Revenue Service.





F.
Dividends and Paying Agents





Not
applicable





G.
Statement by Expert





Not
applicable





H.
Documents on Display





We have
filed this Annual Report on Form 20-F with the SEC under the Exchange
Act.  Statements made in this Annual Report as to the contents of any
document referred to are not necessarily complete.  With respect to
each such document filed as an exhibit to this Annual Report, reference is made
to the exhibit for a more complete description of the matter involved, and each
such statement shall be deemed qualified in its entirety by such
reference.





We are
subject to the informational requirements of the Exchange Act as a foreign
private issuer and file reports and other information with the
SEC.  Reports and other information filed by us with the SEC,
including this Annual Report on Form 20-F, may be inspected and copied at the
public reference room of the SEC at 100 F. Street, N.E., Washington D.C.
20549.  You can also obtain copies of this Annual Report on Form 20-F
by mail from the Public Reference Section of the SEC, 100 F. Street, N.E.,
Washington D.C. 20549, at prescribed rates.  Additionally, copies of
this material may be obtained from the SEC’s Internet site at http://www.sec.gov.  The
SEC’s telephone number is 1-800-SEC-0330.





As a
foreign private issuer, we are exempt from the rules under the Exchange Act
prescribing the furnishing and content of quarterly reports and proxy
statements, and officers, directors and principal shareholders are exempt from
the reporting and short-swing profit recovery provisions contained in Section 16
of the Exchange Act.





I.
Subsidiary Information





Not
applicable.





ITEM
11.         QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK




Interest
Rate Risk





We are
exposed to interest rate risk primarily with respect to our short-term bank
loans.  Although the interest rates, which are based on the banks’
prime rates with respect to our short-term loans are fixed for the terms of the
loans, the terms are typically three to twelve months for short-term bank loans
and interest rates are subject to change upon renewal.  There were no
material changes in interest rates for short-term bank loans renewed during the
fiscal year ended June 30, 2009.





A
hypothetical 1.0% increase in the annual interest rates for all of our credit
facilities under which we had outstanding borrowings as of June 30, 2009, would
decrease net income before provision for income taxes by approximately $0.48
million for the fiscal year ended June 30, 2009.  Management monitors
the banks’ prime rates in conjunction with our cash requirements to determine
the appropriate level of debt balances relative to other sources of
funds.  We have not entered into any hedging transactions in an effort
to reduce our exposure to interest rate risk.


may be
magnified by PRC exchange control regulations that restrict its ability to
convert RMB into foreign currencies.





72





Foreign
Exchange Risk





While our
reporting currency is the U.S. Dollar, substantially all of our consolidated
revenues and consolidated costs and expenses are denominated in
RMB.  All of our assets are denominated in RMB except for
cash.  As a result, we are exposed to foreign exchange risk as our
revenues and results of operations may be affected by fluctuations in the
exchange rate between U.S. Dollars and RMB.  If the RMB depreciates
against the U.S. Dollar, the value of our RMB revenues, earnings and assets as
expressed in our U.S. Dollar financial statements will
decline.  Assets and liabilities are translated at exchange rates at
the balance sheet dates and revenue and expenses are translated at the average
exchange rates and shareholders’ equity is translated at historical exchange
rates.  Any resulting translation adjustments are not included in
determining net income but are included in determining other comprehensive
income, a component of shareholders’ equity.  An average appreciation
(depreciation) of the RMB against the U.S. dollar of 5% would increase
(decrease) our comprehensive income by $0.66 million based on our outstanding
revenues, costs and expenses, assets, and liabilities denominated in RMB as of
June 30, 2009.





Very
limited hedging transactions are available in China 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 enter into hedging transactions in the future, the
availability and effectiveness of these transactions may be limited, and it may
not be able to successfully hedge our exposure at all. In addition, our foreign
currency exchange losses




Inflation





Inflationary
factors such as increases in the cost of our product and overhead costs may
adversely affect our operating results.  Although we do not believe
that inflation has had a material impact on our financial position or results of
operations to date, a high rate of inflation in the future may have an adverse
effect on our ability to maintain current levels of gross margin and selling,
general and administrative expenses as a percentage of net revenues if the
selling prices of our products do not increase with these increased
costs.





ITEM
12.             DESCRIPTION
OF SECURITIES OTHER THAN EQUITY SECURITIES




Not
applicable





PART II




ITEM
13.             DEFAULTS,
DIVIDEND ARREARAGES AND DELINQUENCIES




None.





ITEM
14.             MATERIAL
MODIFICATIONS TO THE RIGHTS OF SECURITIES HOLDERS AND USE OF
PROCEEDS




None.





ITEM
15T.           CONTROLS
AND PROCEDURES




Disclosure
Controls and Procedures





As
required by Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act, our
management has carried out an evaluation, with the participation and under the
supervision of our chief executive officer and chief financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of June 30, 2009.





73





Disclosure
controls and procedures refer to controls and other procedures designed to
ensure that information required to be disclosed in the reports we file or
submit under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC and
that such information is accumulated and communicated to our management,
including our chief executive officer and chief financial officer, as
appropriate, to allow timely decisions regarding required
disclosure.  In designing and evaluating our disclosure controls and
procedures, management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management is required to apply
its judgment in evaluating and implementing possible controls and
procedures.





Management
conducted its evaluation of disclosure controls and procedures under the
supervision of our chief executive officer and our chief financial
officer.  Based upon, and as of the date of this evaluation, our chief
executive officer and chief financial officer concluded that our disclosure
controls and procedures were effective.





Management’s
Annual Report on Internal Control Over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act for our company.  Internal control
over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
consolidated financial statements in accordance with generally accepted
accounting principles and includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of a company’s assets, (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of consolidated financial statements in accordance with
generally accepted accounting principles, and that a company’s receipts and
expenditures are being made only in accordance with authorizations of a
company’s management and directors and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use or
disposition of a company’s assets that could have a material effect on the
consolidated financial statements.




Because
of its inherent limitations, a system of internal control over financial
reporting can provide only reasonable assurance with respect to consolidated
financial statement preparation and presentation and may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies and
procedures may deteriorate.




The
Company’s management assessed the effectiveness of the Company’s internal
control over financial reporting as of June 30, 2009. In making this assessment,
the Company’s management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework. Based on our assessment, management believes that,
as of June 30, 2009, the Company’s internal control over financial reporting was
effective based on those criteria.




There has
been no change in our internal control over financial reporting during the year
ended June 30, 2009 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.





Attestation
Report of the Independent Registered Public Accounting Firm





This
annual report does not include an attestation report of the company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the company to provide only
management’s report in this annual report.


Changes
in Internal Control over Financial Reporting
 
 There has
been no change in our internal control over financial reporting during the year
ended June 30, 2009, that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.


74




ITEM
16A.           AUDIT
COMMITTEE FINANCIAL EXPERT




Our board
of directors has determined that Mr. Colin Sung meets the criteria for an “audit
committee financial expert,” as established by the SEC. Mr. Sung will not be
deemed an “expert” for any other purpose, including, without limitation, for
purposes of Section 11 of the Securities Act, as a result of being designated or
identified as an audit committee financial expert.  The designation or
identification of Mr. Sung as an audit committee financial expert does not
impose on him any duties, obligations or liability that are greater than the
duties, obligations and liability imposed on him as a member of our Audit
Committee and board of directors in the absence of such designation or
identification.





ITEM
16B.           CODE OF
ETHICS




In March
2006, our board of directors adopted a code of conduct, or Code of Conduct,
which applies to all of our directors, officers and employees, including our
principal executive officer, principal financial officer, and principal
accounting officer.   Our Code of Conduct addresses, among other things,
honesty and ethical conduct, conflicts of interest, compliance with laws,
regulations and policies, confidentiality, and reporting of violations of the
code.  A copy of the Code of Ethics was filed as Annex G to our
registration statement on Form S-4 filed with the SEC on March 30, 2006 and is
incorporated herein by reference.





ITEM
16C.          PRINCIPAL
ACCOUNTANT FEES AND SERVICES




The
following table sets forth the aggregate fees by categories specified below in
connection with certain professional services rendered by our independent
registered public accounting firms, for the fiscal years ended June 30, 2009 and
2008:




2009
                    
                    
                    2008Audit
      fees(1)
                    
                    $
                    475,000
                    
                    
                    $
                    537,000Audit-related
      fees
                    
                    
                    0
                    
                    
                    
                    0Tax
      fees
                    
                    
                    0
                    
                    
                    
                    0All
      other fees
                    
                    
                    0
                    
                    
                    
                    0Total
                    
                    
                    475,000
                    
                    
                    
                    537,000





(1)
              Consists of the aggregate fees
      billed for each of the fiscal years ended June 30, 2009 and 2008 for
      professional services rendered by the principal accountant, BDO limited,
      for the audit of our annual financial statements or services that are
      normally provided by the accountant in connection with statutory and
      regulatory filings or engagements for the fiscal years ended June 30, 2009
      and 2008 were $250,000 and $270,000, respectively. And the fees for
      limited review procedures of our quarterly review of our quarterly
      financial information in each of the fiscal years ended June 30, 2009 and
      2008 were $225,000 and $267,000, respectively. Of the total review fee for
      fiscal 2008, $192,000 was paid to BDO Reanda, and $75,000 to BDO
      Limited.




Audit
Committee Pre-Approval Policies and Procedures





Our Audit
Committee pre-approves all auditing services and permitted non-audit services to
be performed for us by our independent auditor, including the fees and terms
thereof (subject to the de minimums exceptions for non-audit services described
in Section 10A(i)(l)(B) of the Exchange Act that are approved by our Audit
Committee prior to the completion of the audit).





75


ITEM
16D.          EXEMPTIONS FROM
THE LISTING STANDARDS FOR AUDIT COMMITTEES
  We have
not asked for nor have we been granted an exemption from the applicable listing
standards for our audit committee.
 
 ITEM
      16E.
              PURCHASES
      OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
    PURCHASERS
  There
were no purchases of equity securities by us or by any of our affiliates during
the period covered by this Annual Report.
 
 ITEM
16F.          CHANGE IN
REGISTRANT’S CERTIFYING ACCOUNTANT
  Application
of this Item does not apply until our annual report for the fiscal year ending
June 30, 2010.


ITEM
16G.          CORPORATE
GOVERNANCE




The
Company’s corporate governance practices have generally followed the
requirements of NASDAQ listing rules with respect to corporate
governance.




PART III




ITEM
17.             FINANCIAL
STATEMENTS




We have
elected to provide financial statements pursuant to Item 18.





ITEM
18.             FINANCIAL
STATEMENTS




The
Company’s Audited Financial Statements for the Years Ended June 30, 2009, 2008
and 2007 are included in this annual report.




ITEM
19.             EXHIBITS




Number
              
              Description1.1
              
              Memorandum
      of Association of Registrant (Incorporated by reference to Annex B of the
      Proxy Statement/Prospectus contained in Registration Statement S-4 (file
      no. 333-132826) filed with the Securities and Exchange Commission on March
      30, 2006).1.2
              
              Articles
      of Association of Registrant (Incorporated by reference to Annex C of the
      Proxy Statement/Prospectus contained in Registration Statement S-4 (file
      no. 333-132826) filed with the Securities and Exchange Commission on March
      30, 2006).1.3*
              
              Certificate
      of Change of Name4.1
              
              Agreement
      and Plan of Merger between Chardan North China Acquisition Corporation and
      Registrant (Incorporated by reference to Exhibit 2.2 of the Registration
      Statement S-4 (file no. 333-132826) filed with the Securities and Exchange
      Commission on March 30, 2006).4.2
              
              Amended
      and Restated Stock Purchase Agreement, by and between Chardan North China
      Acquisition Corporation and Advance Pacific Holdings Limited,
      dated  February 9, 2007 (Incorporated by reference to Annex A of
      the Proxy Statement/Prospectus contained in Registration Statement S-4
      (file no. 333-132826) filed with the Securities and Exchange Commission on
      March 30, 2006).


76




4.3
              
              Chardan
      North China Acquisition Corporation 2006 Equity Plan (Incorporated by
      reference to Annex D of the Proxy Statement/Prospectus contained in
      Registration Statement S-4 (file no. 333-132826) filed with the Securities
      and Exchange Commission on March 30, 2006).4.4
              
              Form
      of Stock Consignment Agreement (Incorporated by reference to Exhibit 10.2
      of the Registration Statement S-4/A (file no. 333-132826) filed with the
      Securities and Exchange Commission on June 28, 2006).4.5
              
              Form
      of Employment Agreement (Incorporated by reference to Exhibit 10.3 of the
      Registration Statement S-4 (file no. 333-132826) filed with the Securities
      and Exchange Commission on March 30, 2006).4.6
              
              Sale
      and Purchase Agreement in Relation to the Ownership Interest of Hangzhou
      Hollysys Automation Co., Ltd. between Team Spirit Industrial Limited and
      Gifted Time Holdings Limited, dated July 12, 2006 (Incorporated by
      reference to Exhibit 10.6 of the Registration Statement S-4/A(file no.
      333-132826) filed with the Securities and Exchange Commission on July 2,
      2007).


4.7
              
              Sale
      and Purchase Agreement in Relation to the Ownership Interest of Hangzhou
      Hollysys Automation Co., Ltd. between OSCAF International Co., Ltd. and
      Gifted Time Holdings Limited , dated January 12, 2006 (Incorporated by
      reference to Exhibit 10.7 of the Registration Statement S-4/A (file no.
      333-132826) filed with the Securities and Exchange Commission on July 2,
      2007).4.8
              
              Employment
      Agreement between Wang Changli and Hollysys Automation Technologies Ltd.
      (formerly known as HLS Systems International Ltd.) (Incorporated by
      reference to Exhibit 10.9 of the Registration Statement S-4/A (file no.
      333-132826) filed with the Securities and Exchange Commission on July 2,
      2007).4.9
              
              Employment
      Agreement between Qiao Li and Hollysys Automation Technologies Ltd.
      (formerly known as HLS Systems International Ltd.) (Incorporated by
      reference to Exhibit 10.10 of the Registration Statement S-4/A (file no.
      333-132826) filed with the Securities and Exchange Commission on July 2,
      2007).4.10
              
              Employment
      Agreement between Wang Changli and Beijing Hollysys (Incorporated by
      reference to Exhibit 10.11 of the Registration Statement S-4/A (file no.
      333-132826) filed with the Securities and Exchange Commission on July 2,
      2007).4.11
              
              Reorganization
      Agreement between Cheng Wusi, Wang Changli, Lou An, Shanghai Jingqiaotong
      Industrial Development Co., Ltd., Team Spirit Industrial Limited and OSCAF
      International Co., as amended (Incorporated by reference to Exhibit 10.12
      of the Registration Statement S-4/A (file no. 333-132826) filed with the
      Securities and Exchange Commission on July 2, 2007).4.12
              
              Financial
      Advisory Agreement by and among Beijing Hollysys Co., Ltd., Hangzhou
      Hollysys Automation Co., Ltd. and their shareholders and Upper Mix
      Investments Limited and Time Keep Investment Limited. (Incorporated by
      reference to Exhibit 10.14 of the Registration Statement S-4/A (file no.
      333-132826) filed with the Securities and Exchange Commission on February
      15, 2007).4.13
              
              Letter
      Agreement between Jianyun Chai and Hollysys Automation Technologies Ltd.
      (formerly known as HLS Systems International Ltd.), dated June 2, 2008
      (Incorporated by reference to Exhibit 10.1 of the Form 6-K filed with the
      Securities and Exchange Commission on June 27, 2008).4.14
              
              Letter
      Agreement between Qingtai Chen and Hollysys Automation Technologies Ltd.
      (formerly known as HLS Systems International Ltd.), dated June 2, 2008
      (Incorporated by reference to Exhibit 10.2 of the Form 6-K filed with the
      Securities and Exchange Commission on June 27,
  2008).


77




4.16
              
              Letter
      of Transmittal for Exchange Offer (Incorporated by reference to Exhibit
      10.15 of the Registration Statement S-4/A (file no. 333-132826) filed with
      the Securities and Exchange Commission on February 15,
    2007).4.17
              
              Form
      of promissory note used in bridge loan (Incorporated by reference to
      Exhibit 10.16 of the Registration Statement S-4/A (file no. 333-132826)
      filed with the Securities and Exchange Commission on May 11,
      2007).4.18
              
              Guarantee
      of Advance Pacific Holdings Limited (Incorporated by reference to Exhibit
      10.17 of the Registration Statement S-4/A (file no. 333-132826) filed with
      the Securities and Exchange Commission on May 11,
2007).4.19
              
              Voting
      Agreement between Advance Pacific Holdings, Ka Wa Cheng and Qiao Li, dated
      July 5, 2007 (Incorporated by reference to Exhibit 10.18 of the
      Registration Statement S-4/A (file no. 333-132826) filed with the
      Securities and Exchange Commission on July 23, 2007).8.1*
              
              List
      of subsidiaries11.1
              
              Code
      of Ethics (included as Annex G to the Proxy Statement/Prospectus contained
      in Registration Statement 333-132826 and incorporated by reference
      herein)12.1*
              
              CEO
      Certification Pursuant to Rule 13a-14(a) (17 CFR 240.13a-14(a)) (17 CFR
      240.13a-14(a)) or Rule 15d-1(a) (17 CFR
  240.15d-14(a))


12.2*
              
              CFO
      Certification Pursuant to Rule 13a-14(a) (17 CFR 240.13a-14(a)) or Rule
      15d-1(a) (17 CFR 240.15d-14(a))13.1*
              
              CEO
      Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
      200213.2*
              
              CFO
      Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
      200215.1
              
              Hollysys
      Automation Technologies Ltd. (formerly known as HLS Systems International,
      Ltd.) Audit Committee Charter, adopted June 20, 2008 (Incorporated by
      reference to Exhibit 99.1 of the Form 6-K filed with the Securities and
      Exchange Commission on June 27, 2008).15.2
              
              Hollysys
      Automation Technologies Ltd. (formerly known as HLS Systems International,
      Ltd.) Compensation Committee Charter, adopted June 20, 2008 (Incorporated
      by reference to Exhibit 99.2 of the Form 6-K filed with the Securities and
      Exchange Commission on June 27, 2008).15.3
              
              Hollysys
      Automation Technologies Ltd. (formerly known as HLS Systems International,
      Ltd.) Governance and Nominating Committee Charter, adopted June 20, 2008
      (Incorporated by reference to Exhibit 99.3 of the Form 6-K filed with the
      Securities and Exchange Commission on June 27,
  2008).





* Filed
with this annual report on Form 20-F





78





SIGNATURE





The
registrant hereby certifies that it meets all of the requirements for filing on
Form 20-F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.




HOLLYSYS
      AUTOMATION TECHNOLOGIES LTD./s/
      Changli WangChangli
      WangSeptember
      30, 2009
                Chief
      Executive Officer





79




HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.




Index
to Consolidated Financial Statements





PageReports
      of Independent Registered Public Accounting Firms
                
                F-2Consolidated
      Balance Sheets as of June 30, 2008 and 2009
                
                F-4Consolidated
      Statements of Income and Comprehensive Income for years ended June 30,
      2007, 2008 and 2009
                
                F-6Consolidated
      Statements of Cash Flows for years ended June 30, 2007, 2008 and
      2009
                
                F-7Consolidated
      Statement of Stockholders’ Equity for years ended June 30, 2007, 2008 and
      2009
                
                F-9Notes
      to Consolidated Financial Statements
                
                F-10


F-1




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Stockholders of


Hollysys
Automation Technologies Limited




We have
audited the accompanying consolidated balance sheets of Hollysys Automation
Technologies Limited as of June 30, 2008 and 2009 and the related consolidated
statements of income and comprehensive income, stockholders’ equity, and cash
flows for each of the two years in the period ended June 30, 2009. These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our audit.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting.  Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion.  Our audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation.  We believe that our audits
provide a reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Hollysys Automation
Technologies Limited at June 30, 2008 and 2009, and the results of its
operations and its cash flows for each of two years in the period ended June 30,
2009, in conformity with accounting principles generally accepted in the United
States of America.




BDO
Limited


Hong Kong


September
30, 2009


F-2


Report
of Independent Registered Public Accounting Firm





The Board
of Directors


Gifted
Time Holdings Limited




We have
audited the accompanying consolidated balance sheet of Gifted Time Holdings
Limited (the “Company”) as of June 30, 2007, and the related statements of
income and comprehensive income, stockholders’ equity and cash flows for the
year ended June 30, 2007.  These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements and schedule are free of material misstatement.  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting.  Accordingly, we express no such opinion.
 An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements.  We
believe that our audits provide a reasonable basis for our opinion.




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Gifted Time Holdings Limited, as of
June 30, 2007, the results of its operations and its cash flows for the year
ended June 30, 2007, in conformity with accounting principles generally accepted
in the United States of America.




BDO
Reanda




Beijing,
PRC


August
17, 2007


F-3





HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.


CONSOLIDATED
BALANCE SHEETS


(In
US Dollars)





June
      30,2008
                        
                        
                        2009ASSETSCurrent
      AssetsCash
      and cash equivalents
                        
                        $
                        64,250,558
                        
                        
                        $
                        128,882,666Contract
      performance deposit in banks
                        
                        
                        4,426,023
                        
                        
                        
                        5,504,375Accounts
      receivable, net of allowance for doubtful accounts of $5,285,529 and
      $6,276,670
                        
                        
                        60,396,360
                        
                        
                        
                        56,548,509Cost
      and estimated earnings in excess of billings,  net of allowance for
      doubtful accounts of $884,663  and $744,113 (note 5)
                        
                        
                        42,652,423
                        
                        
                        
                        51,094,660Other
      receivables, net of allowance for doubtful accounts of $222,664 and
      $178,532
                        
                        
                        3,471,107
                        
                        
                        
                        4,148,842Advances
      to suppliers
                        
                        
                        7,006,427
                        
                        
                        
                        7,867,856Amount
      due from related parties (note 18)
                        
                        
                        4,560,882
                        
                        
                        
                        7,203,058Inventories,
      net of provision of $596,446 and $1,114,140 (note 4)
                        
                        
                        24,666,453
                        
                        
                        
                        18,837,270Prepaid
      expenses
                        
                        
                        270,501
                        
                        
                        
                        1,368,918Deferred
      tax assets (note 16)
                        
                        
                        980,345
                        
                        
                        
                        319,737Assets
      held for sale (note 7)
                        
                        
                        1,639,435
                        
                        
                        
                        -Deposit
      for acquisition of equity interest from minority interest
                        
                        
                        -
                        
                        
                        
                        2,195,582Total
      current assets
                        
                        
                        214,320,514
                        
                        
                        
                        283,971,473Property,
      plant and equipment, net (note 6)
                        
                        
                        27,782,914
                        
                        
                        
                        47,102,749Long
      term investments (note 7)
                        
                        
                        9,761,168
                        
                        
                        
                        13,570,578Long
      term deferred expenses
                        
                        
                        152,359
                        
                        
                        
                        91,779Deferred
      tax assets (note 16)
                        
                        
                        717,140
                        
                        
                        
                        706,943Total
      assets
                        
                        $
                        252,734,095
                        
                        
                        $
                        345,443,522LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesShort-term
      bank loans (note 9)
                        
                        $
                        4,373,752
                        
                        
                        $
                        5,854,887Current
      portion of long-term bank loans (note 12)
                        
                        
                        2,186,876
                        
                        
                        
                        5,123,026Accounts
      payable
                        
                        
                        23,182,477
                        
                        
                        
                        37,421,717Construction
      cost payable
                        
                        
                        -
                        
                        
                        
                        10,929,116Deferred
      revenue
                        
                        
                        20,674,805
                        
                        
                        
                        21,072,540Accrued
      payroll and related expense
                        
                        
                        5,623,933
                        
                        
                        
                        4,162,851Income
      tax payable
                        
                        
                        1,625,546
                        
                        
                        
                        1,397,706Warranty
      liabilities (note 8)
                        
                        
                        2,051,397
                        
                        
                        
                        1,631,407Other
      tax payables
                        
                        
                        5,908,370
                        
                        
                        
                        9,152,197Accrued
      liabilities
                        
                        
                        3,501,349
                        
                        
                        
                        2,634,107Amounts
      due to related parties (note 18)
                        
                        
                        1,482,354
                        
                        
                        
                        1,464,683Deferred
      tax liabilities (note 16)
                        
                        
                        417,913
                        
                        
                        
                        277,337Total
      current liabilities
                        
                        
                        71,028,772
                        
                        
                        
                        101,121,574Long-term
      bank loans (note 12)
                        
                        
                        5,102,710
                        
                        
                        
                        36,593,041Long-term
      bonds payable (note 11)
                        
                        
                        11,663,338
                        
                        
                        
                        11,709,773Total
      liabilities
                        
                        
                        87,794,820
                        
                        
                        
                        149,424,388


F-4





HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.


CONSOLIDATED
BALANCE SHEETS


(In
US Dollars)





June 30,2008
                  
                  
                  2009Minority
      interest
                  
                  
                  17,645,377
                  
                  
                  
                  22,479,241Commitments
      and contingencies (note 21)
                  
                  
                  -
                  
                  
                  
                  -Stockholder’s
      equityCommon
      stock, par value $0.001 per share, 100,000,000 shares authorized,
      43,942,614 and 49,942,614 shares issued and outstanding (note
      13)
                  
                  
                  43,943
                  
                  
                  
                  49,943Additional
      paid-in capital
                  
                  
                  91,667,183
                  
                  
                  
                  131,220,209Appropriated
      earnings
                  
                  
                  11,676,276
                  
                  
                  
                  15,135,442Retained
      earnings
                  
                  
                  30,542,484
                  
                  
                  
                  13,232,254Accumulated
      comprehensive income - translation adjustments
                  
                  
                  13,364,012
                  
                  
                  
                  13,902,045Total
      stockholder’s equity
                  
                  
                  147,293,898
                  
                  
                  
                  173,539,893Total
      liabilities, minority interests and stockholders' equity
                  
                  $
                  252,734,095
                  
                  
                  $
                  345,443,522





See
accompanying notes to consolidated financial statements


F-5





HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME


(In
US Dollars)





Year Ended June 30,2007
                      
                      
                      2008
                      
                      
                      2009RevenuesIntegrated
      contract revenue
                      
                      $
                      97,380,399
                      
                      
                      $
                      112,357,126
                      
                      
                      $
                      149,303,309Products
      sales
                      
                      
                      4,505,087
                      
                      
                      
                      9,141,626
                      
                      
                      
                      8,198,758Total
      revenues
                      
                      
                      101,885,486
                      
                      
                      
                      121,498,752
                      
                      
                      
                      157,502,067Cost
      of integrated contracts
                      
                      
                      64,284,550
                      
                      
                      
                      81,414,648
                      
                      
                      
                      99,423,487Cost
      of products sold
                      
                      
                      1,818,715
                      
                      
                      
                      3,456,398
                      
                      
                      
                      3,500,471Gross
      profit
                      
                      
                      35,782,221
                      
                      
                      
                      36,627,706
                      
                      
                      
                      54,578,109Operating
      expensesSelling
                      
                      
                      7,577,371
                      
                      
                      
                      9,680,284
                      
                      
                      
                      10,021,832General
      and administrative
                      
                      
                      7,135,221
                      
                      
                      
                      26,588,771
                      
                      
                      
                      48,981,078Research
      and development
                      
                      
                      3,857,870
                      
                      
                      
                      3,833,925
                      
                      
                      
                      8,829,402VAT
      refunds
                      
                      
                      (4,314,116
                      )
                      
                      
                      (6,160,583
                      )
                      
                      
                      (5,943,701
                      )Total
      operating expenses
                      
                      
                      14,256,346
                      
                      
                      
                      33,942,397
                      
                      
                      
                      61,888,611Income
      (loss) from operations
                      
                      
                      21,525,875
                      
                      
                      
                      2,685,309
                      
                      
                      
                      (7,310,502
                      )Other
      income (expense), net
                      
                      
                      172,977
                      
                      
                      
                      14,936
                      
                      
                      
                      723,269Share
      of net income of equity investees
                      
                      
                      370,410
                      
                      
                      
                      693,115
                      
                      
                      
                      178,167Government
      subsidy
                      
                      
                      4,185,898
                      
                      
                      
                      3,159,229
                      
                      
                      
                      1,760,023Interest
      expense, net
                      
                      
                      (7,608,792
                      )
                      
                      
                      (4,304,170
                      )
                      
                      
                      (954,078
                      )Income
      (loss) before income taxes
                      
                      
                      18,646,368
                      
                      
                      
                      2,248,419
                      
                      
                      
                      (5,603,121
                      )Income
      taxes expenses (note 16)
                      
                      
                      2,501,104
                      
                      
                      
                      1,092,477
                      
                      
                      
                      3,061,141Income
      (loss) before minority interest
                      
                      
                      16,145,264
                      
                      
                      
                      1,155,942
                      
                      
                      
                      (8,664,262
                      )Minority
      interest
                      
                      
                      3,060,513
                      
                      
                      
                      2,833,120
                      
                      
                      
                      5,186,802Net
      income (loss)
                      
                      $
                      13,084,751
                      
                      
                      $
                      (1,677,178
                      )
                      
                      $
                      (13,851,064
                      )Net
      income (loss) per share (note 17)Weighted
      average number of common shares
                      
                      
                      22,200,000
                      
                      
                      
                      37,658,437
                      
                      
                      
                      44,950,833Weighted
      average number of diluted common shares
                      
                      
                      22,883,836
                      
                      
                      
                      37,658,437
                      
                      
                      
                      44,950,833Basic
      earnings (loss) per share
                      
                      $
                      0.59
                      
                      
                      $
                      (0.04
                      )
                      
                      $
                      (0.31
                      )Diluted
      earnings (loss) per share
                      
                      $
                      0.57
                      
                      
                      $
                      (0.04
                      )
                      
                      $
                      (0.31
                      )Other
      comprehensive income (loss)Net
      income (loss)
                      
                      $
                      13,084,751
                      
                      
                      $
                      (1,677,178
                      )
                      
                      $
                      (13,851,064
                      )Translation
      adjustments
                      
                      
                      2,723,504
                      
                      
                      
                      9,490,632
                      
                      
                      
                      538,033Comprehensive
      income  (loss)
                      
                      $
                      15,808,255
                      
                      
                      $
                      7,813,454
                      
                      
                      $
                      (13,313,031
                      )





See
accompanying notes to consolidated financial statements


F-6





HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(In
US Dollars)





Year ended June 30,2007
                
                
                2008
                
                
                2009Cash
      flows from operating activities:Net
      income (loss)
                
                $
                13,084,751
                
                
                $
                (1,677,178
                )
                
                $
                (13,851,064
                )Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:Minority
      interest
                
                
                3,060,513
                
                
                
                2,833,120
                
                
                
                5,186,802Depreciation
      and amortization
                
                
                1,566,876
                
                
                
                1,817,657
                
                
                
                2,241,344Allowance
      for doubtful accounts
                
                
                1,118,903
                
                
                
                3,439,486
                
                
                
                1,145,770Provision
      for inventories
                
                
                66,559
                
                
                
                207,660
                
                
                
                517,694Loss
      on disposal of property, plant and equipment
                
                
                37,109
                
                
                
                47,123
                
                
                
                58,133Impairment
      loss on goodwill
                
                
                -
                
                
                
                99,439
                
                
                
                -Share
      of net income from equity investees
                
                
                (370,410
                )
                
                
                (693,115
                )
                
                
                (178,167
                )Gain
      on disposal of long term investments
                
                
                -
                
                
                
                (112,113
                )
                
                
                (400,556
                )Dividend
      income
                
                
                -
                
                
                
                (160,599
                )
                
                
                -Amortization
      of expenses accrued for bond payable
                
                
                -
                
                
                
                30,472
                
                
                
                61,222Amortization
      of discount to notes payable
                
                
                4,819,326
                
                
                
                2,420,064
                
                
                
                -Stock-based
      compensation
                
                
                -
                
                
                
                17,084,473
                
                
                
                39,559,026Deferred
      tax assets / (liabilities), net
                
                
                162,418
                
                
                
                (1,752,773
                )
                
                
                530,229Loss
      on deemed acquisition of a subsidiary
                
                
                -
                
                
                
                -
                
                
                
                18,962Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                (20,453,394
                )
                
                
                (18,558,732
                )
                
                
                2,517,399Cost
      and estimated earnings in excess of billings
                
                
                (258,739
                )
                
                
                (366,146
                )
                
                
                (8,301,687
                )Inventories
                
                
                (5,871,319
                )
                
                
                (11,009,643
                )
                
                
                5,311,489Advance
      to suppliers
                
                
                (2,486,265
                )
                
                
                1,140,427
                
                
                
                (861,429
                )Other
      receivables
                
                
                (331,252
                )
                
                
                (670,490
                )
                
                
                (573,733
                )Deposits
      and other assets
                
                
                (1,002,649
                )
                
                
                (1,037,802
                )
                
                
                (1,975,917
                )Due
      from related parties
                
                
                -
                
                
                
                (2,079,884
                )
                
                
                (4,581,972
                )Accounts
      payable
                
                
                5,769,921
                
                
                
                851,596
                
                
                
                13,056,177Advance
      from customers
                
                
                2,016,054
                
                
                
                9,054,759
                
                
                
                397,735Accruals
      and other payable
                
                
                2,210,885
                
                
                
                (3,832,166
                )
                
                
                (2,748,314
                )Due
      to related parties
                
                
                (2,539
                )
                
                
                713,573
                
                
                
                (17,671
                )Tax
      payable
                
                
                635,691
                
                
                
                (1,720,281
                )
                
                
                3,015,986Net
      cash provided by (used in) operating activities
                
                
                3,772,439
                
                
                
                (3,931,073
                )
                
                
                40,127,458Cash
      flows from investing activities:Purchase
      of property, plant and equipment
                
                
                (1,370,533
                )
                
                
                (10,030,305
                )
                
                
                (8,728,334
                )Note
      receivable from the sole stockholder
                
                
                (30,000,000
                )
                
                
                -
                
                
                
                -Proceeds
      from disposing property, plant and equipment
                
                
                157,260
                
                
                
                181,416
                
                
                
                13,271Receipt
      from (Addition of) short-term investment, net
                
                
                (278,449
                )
                
                
                926,016
                
                
                
                -Repayment
      from (Advance to) related parties
                
                
                (304,340
                )
                
                
                (2,338,112
                )
                
                
                1,134,090Acquisition
      of long term investments
                
                
                (3,057,416
                )
                
                
                (693,980
                )
                
                
                (3,895,781
                )Proceeds
      from disposal of long term investments
                
                
                -
                
                
                
                225,487
                
                
                
                2,103,136Dividends
      from long term investments
                
                
                -
                
                
                
                160,599
                
                
                
                69,568Acquisition
      of a subsidiary, net of cash acquired
                
                
                -
                
                
                
                (296,873
                )
                
                
                (439,374
                )Deposit
      for acquisition of equity interest from  minority
      interest
                
                
                -
                
                
                
                -
                
                
                
                (2,196,869
                )Net
      cash used in investing activities
                
                
                (34,853,478
                )
                
                
                (11,865,752
                )
                
                
                (11,940,293
                )


F-7





HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.


CONSOLIDATED
STATEMENTS OF CASH FLOWS - Continued


(In
US Dollars)





Year
      ended June 30,2007
                        
                        
                        2008
                        
                        
                        2009Cash
      flows from financing activities:Proceeds
      from (Repayments of) notes payable
                        
                        
                        29,987,000
                        
                        
                        
                        (29,987,000
                        )
                        
                        
                        -Proceeds
      from (Repayments of) short-term loans
                        
                        
                        6,488,021
                        
                        
                        
                        (12,920,073
                        )
                        
                        
                        1,464,579Proceeds
      from long-term bank loans
                        
                        
                        -
                        
                        
                        
                        4,760,027
                        
                        
                        
                        36,614,479Repayments
      of long-term bank loans
                        
                        
                        (5,095,007
                        )
                        
                        
                        (3,400,019
                        )
                        
                        
                        (2,196,869
                        )Proceeds
      from issuance of bonds
                        
                        
                        -
                        
                        
                        
                        11,480,507
                        
                        
                        
                        -Due
      to related parties
                        
                        
                        59,473
                        
                        
                        
                        -
                        
                        
                        
                        -Dividend
      paid
                        
                        
                        (1,913,137
                        )
                        
                        
                        -
                        
                        
                        
                        -Proceeds
      from issuance of preferred shares
                        
                        
                        13,000
                        
                        
                        
                        -
                        
                        
                        
                        -Proceeds
      from exercise of warrants, net
                        
                        
                        -
                        
                        
                        
                        57,212,497
                        
                        
                        
                        -Net
      cash inflow from the Share Exchange Transaction
                        
                        
                        -
                        
                        
                        
                        32,062,388
                        
                        
                        
                        -Net
      cash provided by financing activities
                        
                        
                        29,539,350
                        
                        
                        
                        59,208,327
                        
                        
                        
                        35,882,189Effect
      of foreign exchange rate changes
                        
                        
                        2,231,202
                        
                        
                        
                        9,170,295
                        
                        
                        
                        562,754Net
      increase in cash and cash equivalents
                        
                        $
                        689,513
                        
                        
                        $
                        52,581,797
                        
                        
                        $
                        64,632,108Cash
      and cash equivalents, beginning of year
                        
                        
                        10,979,248
                        
                        
                        
                        11,668,761
                        
                        
                        
                        64,250,558Cash
      and cash equivalents, end of year
                        
                        $
                        11,668,761
                        
                        
                        $
                        64,250,558
                        
                        
                        $
                        128,882,666Supplementary
      disclosures of cash flow information:Cash
      paid during the year for:Interest,
      net of capitalized interest cost
                        
                        $
                        1,261,731
                        
                        
                        $
                        3,970,009
                        
                        
                        $
                        2,576,444Income
      tax
                        
                        
                        2,086,260
                        
                        
                        
                        4,129,065
                        
                        
                        
                        2,758,695Supplementary
      disclosures of significant non-cash transactions:Deemed
      collection of note receivable from the sole stockholder
                        
                        $
                        -
                        
                        
                        $
                        30,000,000
                        
                        
                        $
                        -Forgiveness
      of accounts payable from suppliers
                        
                        
                        3,231
                        
                        
                        
                        -
                        
                        
                        
                        -Donation
      of property, plant and equipment from an independent third
      party
                        
                        
                        3,421
                        
                        
                        
                        -
                        
                        
                        
                        -





See
accompanying notes to consolidated financial statements.


F-8





HOLLYSYS
AUTOMATION TECHNOLOGIES LTD.


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY


(In
US Dollars)





CommonStock
                    
                    
                    PreferredStock
                    
                    
                    AdditionalPaid-in
                      Capital
                    
                    
                    Note
                      Receivable
                    
                    
                    Appropriated
                      Earnings
                    
                    
                    Retained
                      Earnings
                    
                    
                    Accumulated
                      Comprehen-
                      siveIncome
                    
                    
                    TotalShares
                    
                    
                    Amount
                    
                    
                    Shares
                    
                    
                    AmountBalance
      at June 30, 2006
                    
                    
                    22,200,000
                    
                    
                    $
                    22,200
                    
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    11,978,463
                    
                    
                    $
                    -
                    
                    
                    $
                    6,316,795
                    
                    
                    $
                    25,093,814
                    
                    
                    $
                    1,149,876
                    
                    
                    $
                    44,561,148Issuing
      preferred shares
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,300,000
                    
                    
                    
                    1,300
                    
                    
                    
                    7,251,090
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    7,252,390Donation
      received
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    3,066
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    3,066Forgiveness
      of accounts payable
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,676
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,676Net
      income for the year
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    13,084,751
                    
                    
                    
                    -
                    
                    
                    
                    13,084,751Appropriation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    2,451,379
                    
                    
                    
                    (2,451,379
                    )
                    
                    
                    -
                    
                    
                    
                    -Dividends
      declared
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (599,422
                    )
                    
                    
                    -
                    
                    
                    
                    (599,422
                    )Note
      receivable
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (30,000,000
                    )
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (30,000,000
                    )Translation
      adjustments
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    2,723,504
                    
                    
                    
                    2,723,504Balance
      at June 30, 2007
                    
                    
                    22,200,000
                    
                    
                    
                    22,200
                    
                    
                    
                    1,300,000
                    
                    
                    
                    1,300
                    
                    
                    
                    19,234,295
                    
                    
                    
                    (30,000,000
                    )
                    
                    
                    8,768,174
                    
                    
                    
                    35,127,764
                    
                    
                    
                    3,873,380
                    
                    
                    
                    37,027,113Recapitalzation
      in connection with Share Exchange Transaction
                    
                    
                    7,000,000
                    
                    
                    
                    7,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    28,149,361
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    28,156,361Deemed
      collection of note receivable from sole stockholders
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    30,000,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    30,000,000Deemed
      distribution
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (30,000,000
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (30,000,000
                    )Incentive
      stock compensation
                    
                    
                    2,000,000
                    
                    
                    
                    2,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    17,082,473
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    17,084,473Conversion
      of preferred stock into common stock
                    
                    
                    1,300,000
                    
                    
                    
                    1,300
                    
                    
                    
                    (1,300,000
                    )
                    
                    
                    (1,300
                    )
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Issuance
      of common stock upon exercise of warrants
                    
                    
                    11,442,614
                    
                    
                    
                    11,443
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    57,201,054
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    57,212,497Net
      loss for the year
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,677,178
                    )
                    
                    
                    -
                    
                    
                    
                    (1,677,178
                    )Appropriation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    2,908,102
                    
                    
                    
                    (2,908,102
                    )
                    
                    
                    -
                    
                    
                    
                    -Translation
      adjustments
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    9,490,632
                    
                    
                    
                    9,490,632Balance
      at June 30, 2008
                    
                    
                    43,942,614
                    
                    
                    
                    43,943
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    91,667,183
                    
                    
                    
                    -
                    
                    
                    
                    11,676,276
                    
                    
                    
                    30,542,484
                    
                    
                    
                    13,364,012
                    
                    
                    
                    147,293,898Incentive
      stock compensation
                    
                    
                    6,000,000
                    
                    
                    
                    6,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    39,553,026
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    39,559,026Net
      loss for the year
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (13,851,064
                    )
                    
                    
                    -
                    
                    
                    
                    (13,851,064
                    )Appropriation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    3,459,167
                    
                    
                    
                    (3,459,167
                    )
                    
                    
                    -
                    
                    
                    
                    -Translation
      adjustments
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    538,033
                    
                    
                    
                    538,033Balance
      at June 30, 2009
                    
                    
                    49,942,614
                    
                    
                    $
                    49,943
                    
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    131,220,209
                    
                    
                    $
                    -
                    
                    
                    $
                    15,135,443
                    
                    
                    $
                    13,232,253
                    
                    
                    $
                    13,902,045
                    
                    
                    $
                    173,539,893





See
accompanying notes to consolidated financial statements


F-9





NOTE
1 - ORGANIZATION AND BUSINESS BACKGROUND





Hollysys
Automation Technologies Ltd. (“Hollysys” or the “Company”), formerly known as
HLS Systems International Ltd. was established under the laws of the British
Virgin Islands (“BVI”) on February 6, 2006 for the purpose to merge with Chardan
North China Acquisition Corporation (“Chardan”), and to hold 100% interest in
Gifted Time Holdings Limited (“GTH”) upon the completion of a share exchange
transaction (the “Share Exchange Transaction”) as details described in Note 2 to
the consolidated financial statements.  As of June 30, 2009, details
of the Company’s subsidiaries are as follows:





Name of company
                              
                              Place of
                                incorporation
                              
                              Date of
                                incorporation
                              
                              Percentage of
                                ownership interest
                                attributable to the
                                Company
                              
                              Principal activitiesDirectly
                              
                              
                              IndirectlyGifted
      Time Holdings Limited(“GTH”)
                              
                              BVI
                              
                              Sep
      21, 2005
                              
                              
                              100
                              %
                              
                              
                              -
                              
                              Investment
      holdingHollySys
      (Asia Pacific) Pte.Limited
      (“HAP”)
                              
                              Singapore
                              
                              Oct
      23, 1997
                              
                              
                              100
                              %
                              
                              
                              -
                              
                              Sale
      of integrated automation productsClear
      Mind Limited
                              
                              BVI
                              
                              Nov
      29, 2007
                              
                              
                              -
                              
                              
                              
                              100
                              %
                              Investment
      holdingWorld
      Hope EnterprisesLimited
                              
                              Hong
      Kong
                              
                              Sep
      17, 2007
                              
                              
                              -
                              
                              
                              
                              100
                              %
                              Investment
      holdingBeijing
      He Li Tong S&T Exploration Co., Ltd. (“BJHLT”)
                              
                              People’s
      Republic of China (“PRC”)
                              
                              Jan
      25, 2008
                              
                              
                              -
                              
                              
                              
                              100
                              %
                              Investment
      holdingBeijing
      Hollysys S&T Exploration Co., Ltd. (“BJHST”), formerly known as
      Beijing Jin Qiao Xun Tong S&T Exploration Co., Ltd.
                              
                              PRC
                              
                              Dec
      17, 2007
                              
                              
                              -
                              
                              
                              
                              100
                              %
                              Investment
      holdingBeijing
      HollySys Automation & Drive Co., Ltd. (“HollySys
      Automation”)
                              
                              PRC
                              
                              May
      13, 2008
                              
                              
                              -
                              
                              
                              
                              100
                              %
                              Manufacture
      and sale of integrated automation productsBeijing
      HollySys Co., Ltd.(“Beijing
      HollySys”)
                              
                              PRC
                              
                              Sep
      25, 1996
                              
                              
                              -
                              
                              
                              
                              74.11
                              %
                              Provision
      of integrated automation systems and servicesHangzhou
      HollySys Automation Co., Ltd. (“Hangzhou HollySys”)
                              
                              PRC
                              
                              Sep
      24, 2003
                              
                              
                              -
                              
                              
                              
                              89.64
                              %
                              Provision
      of integrated industrial automation products and
  servicesBeijing
      Haotong Science & Technology Development Company
      Limited  (“Haotong”)
                              
                              PRC
                              
                              Oct
      26, 2000
                              
                              
                              -
                              
                              
                              
                              74.11
                              %
                              Dormant





Beijing
HollySys was established on September 25, 1996 under the laws of PRC with a
registered capital of RMB100 million and a 30-year operation life. Beijing
HollySys has conducted its business focusing on industrial automation systems
which are used in many industries including power generating, electric grid,
computer controlled manufacturing, chemistry, cement, petrochemical, glass
manufacturing, pharmaceutical, etc. and integrated automation control systems
including monitoring systems, signal distributing systems and other control
systems mainly used in city railway transportation.


F-10





Hangzhou
HollySys, a foreign investment enterprise, was set up on September 24, 2003.
Beijing HollySys accounted for 40% and another two foreign investors accounted
for remaining 60% equity interest upon its incorporation.  Hangzhou
HollySys uses the technologies provided by Beijing HollySys and mainly
manufactures the integrated system automation products in Southern PRC for
expanding market share and market presence purpose.





GTH was
established under the laws of BVI on September 21, 2005 for the purpose of
acquiring interest of Beijing HollySys (74.11%) and Hangzhou HollySys (60%)
through reorganization arrangement.  Under the reorganization, GTH
entered into share transfer agreements with the two foreign owners in Hangzhou
HollySys, which is a foreign owned enterprise, by issuing the common shares of
GTH to their designated BVI companies for acquiring the 60% equity interest in
Hangzhou HollySys.  Since Beijing HollySys is a PRC domestic owned
enterprise, the control in Beijing HollySys was transferred pursuant to the
stock consignment agreements entered into between GTH and other BVI companies
established by the 74.11% original stockholders of Beijing HollySys. Upon the
completion of the reorganization, the initial beneficial owners of Beijing
HollySys and Hangzhou HollySys transferred their respective equity interests to
GTH and the seven designated BVI companies (the “Seven BVI Companies”) holds
100% equity interest of GTH.





In
accordance with SFAS No. 141 and Appendix D in SFAS No. 141, this reorganization
arrangement was accounted for under carry-over basis as there was a voting
together agreement among the stockholders of 74.11% equity interest in Beijing
HollySys and a voting together agreement between the two owners of 60% equity
interest in Hangzhou HollySys. Furthermore, these two executed voting together
agreements have given the voting control to the same individual, who is the
founder of Beijing HollySys.  Therefore, there is a control group
which has voting control over both entities.  As a result of
exchanging the ownership between GTH and the original stockholders, both Beijing
HollySys and Hangzhou HollySys became subsidiaries of
GTH.  Accordingly, the consolidated financial statements of the above
two entities became the historical financial statements of GTH.





Pursuant
to the stock consignment agreements for transferring the beneficial interest of
Beijing HollySys to GTH, upon the completion of Share Exchange Transaction, GTH
is able to obtain the voting right and the economic interests in Beijing
HollySys. However, if those stockholders are unwilling or unable to perform
their obligations under the stock consignment agreements, the Company may not
succeed in enforcing their rights under the stock consignment
agreements.  In the event that the stock consignment agreements are
not honored or enforced, the Company would not able to conduct the operations of
Beijing HollySys in the manner as planned and could lose the control of Beijing
HollySys.





The
Company therefore has to arrange the change of ownership in Beijing HollySys
into direct ownership instead of through stock consignment agreements after the
completion of Share Exchange Transaction.  Such ownership change may
involve the approval of an appropriate competency authority in PRC (Ministry of
Commerce or MOFCOM, at either central government level or provincial level) in
accordance with the “Regulation of Merger and Acquisition
of PRC Enterprises by Foreign Investors”, which was effective September
8, 2006, in order to ensure that a foreign investment enterprise in PRC must
have the capital sourced from foreign countries. Beijing HollySys is also
required to register the transfer with the Beijing Administration of Industry
and Commerce and go through certain registration formalities in the tax,
customs, land administration and foreign exchange administration
departments.





During
the period from December 2007 to March 2008, Hollysys has established a series
of wholly owned subsidiaries, namely (i) BJHST, a newly established Chinese
domestic enterprise which took up 74.11% ownership of Beijing HollySys from the
original stockholders; (ii) BJHLT, a newly established wholly foreign owned
enterprise in China which took up 100% ownership of BJHST; (iii) World Hope
Enterprises Limited, a newly established Hong Kong company which took up 100%
ownership of BJHLT; (iv) Clear Mind Limited, a newly established BVI company
which took up 100% ownership of World Hope Enterprises Limited, and Clear Mind
Limited is 100% owned by GTH.  Through this series of ownership
arrangement,  Hollysys obtained the 74.11% legal ownership of Beijing
HollySys instead of through consignment agreements. However, there can be no
assurance that the PRC authorities will not, in future, challenge the
appropriateness of the procedures completed in transferring the ownership of the
PRC subsidiaries as the Company did not directly go through the procedures
required by the “Regulation of
Merger and Acquisition of PRC Enterprises by Foreign
Investors”.





On
November 19, 2007, Hollysys entered into a sale and purchase agreement with
Fulbond Systems Pte Ltd (the “Fulbond Systems”), which is a Singapore based
company and partially owned by Mr. Yau Kiam Fee, who is a member of Board of
Directors of Hollysys, to acquire 100% interest of Fulbond Systems for a price
of SGD$1,066,234 (equivalent to $744,596).  Pursuant to the sale and
purchase agreement, the closing day of this acquisition was November 30, 2007
and after the ownership transfer, Fulbond System was renamed to HollySys (Asia
Pacific) Pte Ltd.  The purchase price of $744,596 was paid in cash on
December 11, 2007.  HAP becomes the wholly owned subsidiary of
Hollysys and the operating result of HAP was included in the Hollysys’s
consolidated financial statements with effective from December 1,
2007.  Hollysys acquired HAP and to establish the latter as an Asia
Pacific headquarter to market its automation products within the region and
other overseas countries.


F-11





The
Company hired a third party local valuation service provider to provide a
valuation report about the fair value of the assets acquired and liabilities
assumed.  Based on that valuation report, the purchase price was
allocated as follows:





November 30, 2007Property,
      plant and equipment, net
                        
                        $
                        18,092Goodwill
                        
                        
                        99,439Inventories
                        
                        
                        66,502Trade
      receivables
                        
                        
                        84,626Other
      receivables
                        
                        
                        58,087Cash
      and cash equivalents
                        
                        
                        447,723Trade
      payables
                        
                        
                        (21,052
                        )Other
      payables
                        
                        
                        (8,821
                        )Total
      purchase price
                        
                        $
                        744,596Satisfied
      by:Cash
      paid
                        
                        $
                        744,596





Analysis
of net outflow of cash and cash equivalents in respect of the purchase of the
subsidiary:





Cash
      consideration paid
                    
                    $
                    744,596Cash
      and bank balances acquired on consolidation
                    
                    
                    (447,723
                    )Total
      net cash paid in the acquisition
                    
                    $
                    296,873





The
goodwill from the acquisition of HAP is expected to be non-deductible for tax
purposes.





On May
13, 2008, BJHST invested RMB 70 million (equivalent to $10,205,421) to establish
a new wholly owned subsidiary, HollySys Automation, to engage in the automation
and drive businesses, with core products including industrial control motor,
servo and encoder, inverter, numeric and motion controls, with a view to sustain
future business growth of Hollysys and to expand its product lines.





On
October 6, 2008, Beijing HollySys and the 30% minority interest holder of
Haotong agreed to reduce paid-in capital of Haotong from RMB 10 million
(equivalent to $1,464,579) to RMB 7 million (equivalent to $1,025,205). Haotong
reduced the paid-in capital by paying RMB 3 million  (equivalent to
$439,374) to the 30%
minority interest holder. Upon completion of the reduction in capital, Haotong
became a wholly owned subsidiary of Beijing HollySys. The Company’s effective
equity interest in Haotong therefore increased from 51.88% to
74.11%.


F-12





NOTE
2 - COMPLETION OF SHARE EXCHANGE TRANSACTION





Chardan
Acquisition Corp. II (“Chardan II”) was incorporated in Delaware on March 10,
2005 as a blank check company whose objective is to acquire an operating
business that has its primary operating facilities in the PRC in any city or
province north of the Yangtze River.  Effective July 14, 2005, Chardan
II’s board of directors and initial stockholders authorized an amendment to the
Chardan II’s Certificate of Incorporation to change its name from Chardan China
Acquisition Corp. II to Chardan North China Acquisition
Corporation.





On
February 2, 2006, Chardan entered into a stock purchase agreement (the “Stock
Purchase Agreement”) with GTH to acquire 100% equity interest of GTH. The
agreement was amended subsequently, details are noted under Reorganization of
GTH prior to the completion of Share Transfer Transaction below.  Pursuant to the
amended Stock Purchase Agreement, Chardan was to effect re-domestication merger
by establishing a wholly-owned subsidiary on February 6, 2006 under the laws of
BVI, Hollysys.  Chardan was then merged with and into Hollysys for the
purpose of re-domestication out of the United States to secure future tax
benefits.  The re-domestication merger was achieved by a one-for-one
exchange of all the outstanding common stock of Chardan for common stock of
Hollysys and the assumption of all the rights and obligations of Chardan by
Hollysys, including assumption of the outstanding 11.5 million warrants of
Chardan on the same terms as they were originally issued.  Each
warrant entitles the holder to purchase one share of Hollysys common stock at a
price of $5.00 being exercisable immediately since September 20, 2007 and will
expire on December 17, 2007 or earlier upon redemption. In addition, Chardan
also granted the Unit Purchase Option (“UPO”) to the only underwriter pursuant
to which the underwriter can exercise such option to purchase an extra 250,000
unit at $7.50 per unit. Each unit represents one share of Chardan’s common stock
together with two warrants. The exercise price of these warrants was $6.65 per
share.





Concurrent
with the re-domestication merger, Hollysys acquired 100% equity interest of GTH
by issuing 23.5 million of Hollysys’ common shares and making cash payment of
$30 million; which made GTH a wholly owned subsidiary of Hollysys.  Of
the 23.5 million common shares, 22.2 million shares were issued to the owners of
GTH and the remaining 1.3 million shares were issued to the holders of 1.3
million preferred shares of GTH who already converted the preferred shares into
common stock of GTH on October 17, 2007. Those 1.3 million preferred share were
issued in conjunction with the bridge loan of $30 million. See details in
Reorganization of GTH prior to the completion of Share Transfer
Transaction.





As
additional purchase price, according to the latest amendment of the agreement
dated February 9, 2007, the stockholders of GTH and their designees will be
issued, on an all or none basis per year, an aggregate of 11 million common
shares of Hollysys (2 million shares each year for the first four years and 3
million shares for the fifth year), if, on a consolidated basis, Hollysys has
after-tax profits (excluding after-tax operating profits from any subsequent
acquisitions of securities that have a dilutive effect) in the following amounts
for the indicated 12-month periods ending December 31 below (the “Future Annual
Incentive Share Plan”):





12-Month Periods Ending December 31,
                      
                      After Tax Profit2007
                      
                      $
                      23,000,0002008
                      
                      
                      32,000,0002009
                      
                      
                      43,000,0002010
                      
                      
                      61,000,0002011
                      
                      
                      71,000,000





The
after-tax profits will be determined based on the accounting principles
generally accepted in the United States, adjusted to exclude after-tax operating
profits from any subsequent acquisition for securities that have a dilutive
effect and any charge to earnings that results from the issuance of such shares
for a prior year.


F-13





The
Company achieved the pre-determined after tax profit during the 12-month periods
ending December 31, 2007 and 2008, as a result, 2 million shares for each year
will be issued to the stockholders of GTH and their designees. In June 2009, the
Company has cancelled the Future Annual Incentive Share Plan for the remaining
terms of 12-month periods ending December 31, 2009, 2010 and 2011. Further
details have been set out in note 13 to the consolidated financial
statements.





On
September 7, 2007, the shareholders of Chardan held a special meeting to vote
for the Share Exchange Transaction.  Of the 7 million shares of common
stock outstanding, the holder of only two shares voted against for the Share
Exchange Transaction.  In terms of the voting result, Chardan merged
with and into Hollysys finishing the re-domestication merger and Hollysys
consummated the Share Exchange Transaction with GTH.





The
completion of the Share Exchange Transaction enabled the shareholders of GTH to
obtain a majority voting interest in Hollysys.  Generally accepted
accounting principles in the United States require that the company whose
shareholders retain the majority interest in a combined business be treated as
the acquirer for accounting purposes.  Accordingly, the aforementioned
Share Exchange Transaction was accounted for as a reverse acquisition of a
private operating company (GTH) with a non-operating public company (Chardan)
with significant amount of cash.  The reverse acquisition process
utilizes the capital structure of Hollysys and the assets and liabilities of GTH
are recorded at historical cost.  Although GTH is deemed to be the
accounting acquirer for financial accounting and reporting purposes, the legal
status of Hollysys as the surviving company do not change.





Under the
reverse acquisition accounting, the historical consolidated financial statements
of Hollysys for the
periods prior to September 20, 2007 are those of GTH and its
subsidiaries.  Since GTH is deemed as accounting acquirer, GTH’s
fiscal year replaced Hollysys’ fiscal
year.  The financial statements of Hollysys reflect the
aforementioned stock purchase transaction in the stockholders’ equity statement
through a line of reorganization and recapitalization to present the net assets
of Chardan as of September 20, 2007 and a line of deemed distribution to present
the $30 million cash payment.  The net assets of Chardan as of
September 20, 2007 were as follows:





September 20, 2007Net
      assets acquiredCash
                      
                      
                      $
                      32,062,388Other
      current assets
                      
                      
                      
                      60,000Accounts
      payable and accrued liabilities
                      
                      
                      
                      (2,266,112
                      )Tax
      effect due to the re-domestication transaction
                      Note
      (a)
                      
                      
                      (1,699,915
                      )$
                      28,156,361





Note
      (a)
            The
      $1,699,915 of tax effect due to the re-domestication transaction was
      actually based on the evidence and facts presented on the U.S. federal and
      state income returns filed by Chardan for the year ended December 31,
      2007.  An estimated amount of $1,903,509 was disclosed in previously
      filed Form 6-K.  Change of this tax effect had no impact on the
      Company’s consolidated statement of income for fiscal year ended June 30,
      2008.





Reorganization
of GTH prior to the completion of Share Transfer Transaction





In order
to effect the Share Exchange Transaction, the Stock Purchase Agreement entered
into between Chardan and GTH on February 2, 2006 was amended on March 25, 2006,
June 5, 2006, December 20, 2006, and February 9, 2007,
respectively.


F-14





In
November 2006, GTH and Chardan recognized that the closing of the Share Exchange
Transaction was going to be delayed far beyond what had been expected when the
Stock Purchase Agreement was originally signed in early February
2006.  The stockholders of GTH had obligations that required to be
satisfied by the end of 2006, and they discussed with Chardan ways to make that
cash consideration available.  Because Chardan believed that the
contemplated stock purchase was still in the best interest of its stockholders,
Chardan was willing to revise some aspects of the Stock Purchase Agreement to
accommodate the request from the stockholders of GTH.  As a result,
during the period from December 18 to 20, 2006, GTH, the owners (Seven BVI
Companies) of GTH and certain third parties completed a series of transactions
described below to change the ownership of GTH and to provide the former
stockholders of GTH with needed capital.  Chardan and Advance Pacific
Holdings Limited (“APH”), which became the sole stockholder of all of the issued
and outstanding ordinary shares of GTH as a result of these transactions,
reached consensus to amend the Stock Purchase Agreement to reflect the changed
stock ownership and the stock structure of GTH.





The first
transaction was the transfer by the Seven BVI Companies of their interests in
GTH to OSCAF International Limited (“OSCAF”), which is a related party and is
owned by Madame Qiao Li, who is the chairperson of Beijing HollySys. According
to the stock purchase agreement entered into among the Seven BVI Companies and
OSCAF on December 18, 2006, in exchange for GTH common stock, OSCAF will grant
the following consideration to the Seven BVI Companies: (a) upon the receipt by
OSCAF of cash payment of $30 million from APH, OSCAF shall make the payment of
$30 million and the accrued interest (if any) to the Seven BVI Companies
according to their respective proportion of shares in GTH; and (b) upon the
receipt by OSCAF of cash payment of $200 million from APH, OSCAF shall make the
payment of $200 million and the accrued interest (if any) to the Seven BVI
Companies in accordance with their stock proportion. This transfer was in
exchange for proportional interests in any consideration received by OSCAF
(including the principal and any interest payments on the promissory notes
issued by APH, as described below) on its sale of interests in GTH.





The
second transaction was the sale by OSCAF of 100% of the issued and outstanding
common stock of GTH, to APH, a BVI company, which is solely owned and controlled
by Mr. Cheng Ka Wa, a resident of Canada, on December 20, 2006.





APH
issued two notes, in exchange for the interest of GTH that it acquired both,
payable to OSCAF: (i) a note of $30 million and (ii) a note of $200
million.  In accordance with the stock purchase agreement between two
parties, APH expected to repay the notes from the combination of a bridge loan
of $30 million raised by GTH and the value of 22.2 million shares of the common
stock of Hollysys it would received upon closing of the contemplated stock
purchase transaction with Chardan. The amount of $200 million was derived from
the estimated value of 22.2 million shares of the common stock of Hollysys.
However, the closing price of Chardan’s stock on December 20, 2006 was $7.34,
which was below the price of $9.01 per share needed to pay the debt in full
(assuming that share price could be realized on all 22.2 million
shares).





Other
than its ownership of GTH’s shares, APH does not have any other material assets,
and Mr. Cheng did not provide any personal guarantee of payment of these two
notes issued to OSCAF.  In the event that APH defaults on the $30
million note, the GTH stock owned by APH would be returned through OSCAF to the
individual owners of the Seven BVI companies, and these two notes would be
cancelled.





If the
default occurs with respect to the $200 million note after the $30 million note
has been paid, which means that the value of 22.2 million shares of Hollysys’
stock is lower than $200 million, APH will be obligated to return the 22.2
million shares of Hollysys through OSCAF to the individual owners of the Seven
BVI Companies.  By design, APH intended to use the proceeds of the
loan that it obtained from GTH (as discussed below under Bridge Loan
Transaction) to pay the $30 million note to OSCAF.  As a result, only
the $200 million note issued by APH would remain outstanding, which was
originally matured on September 15, 2007, and was then extended to October 20,
2007 in accordance with the terms contained in the $200 million
note.   As of October 19, 2007, the maturity of the
aforementioned $200 million note was further extended to April 19,
2008.  In March 2008, the $200 million note was terminated and
cancelled as a result of a dismissal agreement (the “ Dismissal Agreement”)
further described below.





As a
result of these transactions, APH became the sole stockholder of
GTH.  As agreed between Madame Qiao Li and Mr. Cheng Ka Wa prior to
the consummation of these transactions, GTH adopted board resolutions to
recapitalize GTH as follows: (i) the authorized common shares of GTH were
increased from 50,000 shares with par value of $1.00 per share to 33.5 million
shares with par value of $0.01 per share, (ii) preferred shares were created
with an authorization of 1.5 million shares at par value of $0.01 per share; and
(iii) all of the then outstanding common shares with par value of $1.00 per
share held by APH were split into 5 million shares with par value of $0.01 per
share and GTH issued an additional 17.2 million ordinary shares to APH,
resulting in a total of 22.2 million common shares issued and
outstanding.  GTH then issued 1.3 million preferred shares to 15
outside investors in connection with the $30 million Bridge Loan Transaction
described below.  On October 17, 2007, the holders of 1.3 million
GTH’s preferred shares exercised their rights to convert their 1.3 million
shares of GTH’s preferred shares into 1.3 million Hollysys’ common
shares.  After that conversion, GTH had a total of 23.5 million common
shares issued and outstanding as of October 17, 2007.


F-15





As a
result of the above series of transactions, APH, received the $30 million cash
consideration, 22.2 million common shares issued by Hollysys to acquire
GTH.





On March
19, 2008, APH and Dr. Wang Changli, individually and on behalf of the parties
which had previously been stockholders of GTH, entered into a Dismissal
Agreement.  The Dismissal Agreement resulted in (i) the dismissal and
termination of the agreement by which APH acquired the GTH shares from the
former stockholders of GTH; (ii) the assignment to the former stockholders of
GTH of the shares of Hollysys stock held by APH and the rights to earnout shares
issuable under the amended Stock Purchase Agreement between APH and Chardan in
the event specified after-tax profits goals are met; and (iii) the termination
and cancellation of the $200 million note issued by APH in connection with its
acquisition of the GTH shares.





Bridge
Loan Transaction





To
provide the funds required by GTH’s original stockholders, on December 20, 2006,
GTH issued 15 notes with an aggregate principal amount of $29.987 million to 15
outside investors.  Chardan Capital, a related party to Chardan,
assisted in identifying potential investors, but did not receive any
compensation for such services.  APH agreed to guarantee repayment of
these notes and pledged all of 22.2 million shares of GTH’s stock to secure that
guarantee.  As part of this transaction, GTH issued 1.3 million
preferred shares to these outside investors for $0.01 per share.  The
notes issued to the investors bear interest at 10% per annum.  The
repayment terms are: (i) an aggregate principal amount of $25 million, together
with any then unpaid and accrued interest thereon and other amounts payable
under the notes, is due and payable on the earlier to occur of (a) ten business
days following the closing of acquisition of the shares of GTH by Hollysys (the
“Business Combination”), (b) the Tranche B Maturity Date (as defined below), or
(c) when, upon or after the occurrence of an event of default under the note,
such amounts are declared due and payable to the investors or made automatically
due and payable in accordance with the terms of the notes; and (ii) the
remaining principal, plus all accrued and unpaid interest thereon and all other
amounts due under the notes, is due and payable on (a) the date (the “Tranche B
Maturity Date”) that is the earliest of (1) one year following the date that
Hollysys acquires all or substantially all of the shares of GTH; (2) 60 days
following the redemption (as provided in the warrant agreement) of the publicly
traded warrants to be assumed by Hollysys concurrently with the closing of the
Business Combination in substitution for the warrants issued by Chardan; or (3)
September 30, 2008, or (b) when, upon or after the occurrence of an event of
default, such amounts are declared due and payable by the investors or made
automatically due and payable in accordance with the terms of the
note.  If any payment of interest or any other amount under these
notes is not made within ten days after the due date, GTH is required to pay a
late payment fee equal to the lesser of 5% of the amount of such late payment or
the maximum amount permitted by the applicable law.  After the
occurrence and during the continuance of an event of default, the notes shall
bear interest at a rate equal 12% per annum.


F-16


GTH
loaned the $30 million of proceeds to APH on December 22, 2006 in return for a
note of $30 million payable to GTH. The note receivable from APH bears an
interest at 10% per annum. The repayment terms of this $30 million note issued
by APH are as follows: (i) upon the closing of a stock purchase transaction
between APH and Chardan (the “Chardan Transaction”), pursuant to which APH is to
receive a cash payment of $30 million, APH shall make an initial payment of not
less than $24 million. In the event that APH receives cash consideration upon
the closing of the Chardan transaction sufficient to repay more than $24
million, then, such larger amount will be due and payable in its
entirety.  The balance of the principal sum not covered by the initial
payment made by APH shall be repaid upon APH’s receipt of the balance of the
cash consideration due to APH in connection with the Chardan
transaction.  If the Chardan transaction occurs, all amounts are paid
to GTH, the obligation of repayment of the appropriate amount of principal and
accrued interest shall be discharged.  (ii) If Chardan transaction
does not close prior to the expiration of the agreements governing the
borrowing, and GTH enters into an agreement to effect another business
combination, pursuant to which APH will be entitled to receive cash
consideration in exchange for its ownership interest in GTH, the interest due on
the note will be forgiven in the same manner as if the Chardan transaction had
closed.  (iii) In the event that agreement governing the Chardan
transaction expires and the Chardan transaction has not closed prior to
September 30, 2008, then the entire principal sum then remaining unpaid,
together with all accrued but unpaid interest, shall be due and payable on that
date.  After receiving the proceeds of $30 million, APH in return paid
the note of $30 million payable to OSCAF discussed above.





If the
Share Exchange Transaction does not take place, the default provisions contained
in the $29.987 million notes payable to the 15 investors who are also the
holders of 1.3 million preferred shares of GTH will be triggered, which allows
the 15 investors to sell a portion or all the interest of GTH pledged by APH in
order for them to recover the outstanding principal and interest then due under
the notes payable.  If there is any remaining interest available after
selling by the 15 investors, the remaining interest will be returned to OSCAF,
which should return the remaining interest to the individual owners of the Seven
BVI Companies.  Among the original beneficial individual owners of the
Seven BVI Companies and Chardan, a consensus was reached that paying dividends
through Beijing HollySys and Hangzhou HollySys to satisfy the urgent capital
need was almost impractical because of Chinese government foreign exchange
regulations and individual income tax consequences related to these potential
dividends.  If the value of 22.2 million shares of Hollysys is lower
than $200 million, APH is obligated to return the 22.2 million shares of
Hollysys’ stock to the original beneficial individual owners of the Seven BVI
Companies.  The original beneficial individual owners of the Seven BVI
Companies believed that it was more likely than not that APH would return the
22.2 million shares of Hollysys’ common stock to them instead of the cash
proceeds of $200 million because it would be difficult for APH to generate the
necessary $200 million in cash within the time frame aforementioned. In March
2008, the return of 22.2 million shares of Hollysys common stock held by APH to
the former stockholders of GTH was made based on the above mentioned Dismissal
Agreement.





During
the year ended June 30, 2008, the 15 notes payable in aggregate of $29,987
million to 15 investors had been fully repaid. Details please refer to note 10
to the consolidated financial statements for more details.





NOTE
3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Principles
of Consolidation and Basis of Presentation





The
consolidated financial statements include the financial statements of the
Company and its subsidiaries.  All significant inter-company
transactions and balances are eliminated during the process of
consolidation.  Investments in investee companies in which the Company
does not have a controlling interest (interest holding by the Company from 20%
up to 50%), or in which the Company holds more than 51% interest, however, the
minority interest in that entity has participation rights defined in EITF 96-16,
are accounted for using the equity method.  The Company’s shares of
earnings (losses) of these investee companies are included in the accompanying
consolidated statement of income.  These consolidated financial
statements have been prepared in accordance with the accounting principles
generally accepted in the United States of America (“U.S. GAAP”).





Reclassifications





Certain
prior year amounts have been reclassified to conform to current year
classifications.





Foreign
Currency Translations and Transactions





The
Renminbi (“RMB”), the national currency of PRC, is the primary currency of the
economic environment in which the operations of the Company are conducted and is
determined the functional currency of all PRC subsidiaries.  The
Company uses the United States dollar for financial reporting
purposes.


F-17


The
Company translates the assets and liabilities into U.S. dollars using the rate
of exchange prevailing at the balance sheet date, and the statements of income
are translated at average rates during the reporting
period.  Adjustments resulting from the translation of financial
statements from RMB into U.S. dollars are recorded in stockholders’ equity as
part of accumulated comprehensive income - translation
adjustments.  Gains or losses resulting from transactions in
currencies other than RMB are reflected in consolidated statement of income for
the reporting period.





Cash
and Cash Equivalents





The
Company considers all highly liquid investments with maturity of three months or
less to be cash equivalents.





Revenue
Recognition





Revenues
generated from designing, building, and delivering customized integrated
industrial automation systems and providing relevant solutions are recognized
over the contractual terms based on the percentage of completion
method.  The contracts for designing, building, and delivering
customized integrated industrial automation systems are legally enforceable
binding agreements between the Company and customers.  Performance of
these contracts will often extend over long periods, and the Company’s right to
receive payments depends on its performance in accordance with these contractual
agreements.  The duration of contracts the Company performs is
depending on the contract size in terms of dollar amounts.  In
general, the bigger the contract size is, the longer the duration of that
contract is.  The duration of a small contract is less than one year
without including warranty period.  The duration of a large contract
is longer than one year without including warranty period.  Including
the warranty period, all of contracts have their duration longer than one year,
ranging from 16 months to 61 months.   The operating cycle of the
Company is determined by a composite of many individual contracts in various
stage of completion and is measured by the duration of the average time
intervening between the acquisition of materials or service entering the
construction process and the substantial completion of
contracts.  Based on the historical experience, the operating cycle of
the Company exceeds one year.





In
accordance with AICPA’s SOP 81-1, “Accounting for Construction Contracts and
Certain Production-Type Contracts,” revenue recognition is based on an estimate
of the income earned to date, less income recognized in earlier
periods.  Estimates of the degree of completion are based on the costs
incurred to date comparing to the expected total costs for the
contracts.  Revisions in the estimated profits are made in the period
in which the circumstances requiring the revision become
known.  Provisions, if any, are made currently for anticipated loss on
the uncompleted contracts.  Revenue in excess of billings on the
contracts is recorded as costs and estimated earnings in excess of
billings.  Billings in excess of revenues recognized on the contracts
are recorded as deferred revenue until the above revenue recognition criteria
are met.  Billings are rendered based on agreed milestones included in
the contracts with customers.  There are different milestones among
the contracts the Company has won.  In general, there are four
milestones: 1) system manufacturing, 2) system delivery, 3) installation,
trial-run, and customer acceptance, and 4) expiration of a warranty
period.  The amount to be billed when each of the specified milestones
is reached has been specified in a contract.  All contracts have the
first milestone, but not all contracts have a prepayment.


F-18


The
Company recognizes 100% of the contractual revenue at the end of customer
acceptance stage as the Company estimates that no further major costs will incur
under a contract, a signed customer acceptance document has been obtained, and a
warranty period starts to count.  Revenues are presented net of taxes
collected on behalf of government.





Revenue
generated from sales of electronic equipment is recognized when persuasive
evidence of an arrangement exists, delivery of the products has occurred,
customer acceptance has been obtained, which means the significant risks and
rewards of the ownership have been transferred to the customer, the price is
fixed or determinable and collectability is reasonably assured.





Inventories





Inventories
are composed of raw materials and low value consumables, work in progress, and
purchased and manufactured finished goods.  Inventories are stated at
the lower of cost or the market value.





On
January 1, 2009, the Company elected to change the “costing method” for
purchased inventories previously accounted for on the “weighted average basis”
to the “first-in, first-out basis”.  The percentage of purchased
inventories accounted for under the weighted average method shared approximately
64% of the closing inventories at December 31, 2008.  The Company
believe that purchased inventories measured based on first-in first-out basis
can better reflect the current value of purchased inventories on the
Consolidated Balance Sheet and enhances the matching of future cost of sales
with revenues. Since the change of the inventories costing method did not result
in a material cumulative difference or a material difference in any one
reporting period, and consequently the prior periods figures have not been
restated.  The cumulative effect of the accounting change, which was
immaterial, was reflected in the results of operations in the year ended June
30, 2009.





The
Company makes provisions for estimated excess and obsolete inventory based on
its regular reviews of inventory quantities on hand and the latest forecasts of
product demand and production requirements from its customers.  The
Company writes down inventories for not saleable, excess or obsolete raw
materials, work-in-process and finished goods by charging such write-downs to
cost of sales.  In addition to write-downs based on newly introduced
parts, statistics and judgments are used for assessing a provision on the
remaining inventory based on salability and obsolescence.





Warranty





Warranty
is a major term under an integrated contract, which will last, in general, for
twelve months or be specified under a contract. The Company estimates a warranty
liability under a contract using a percentage of revenue recognized, which is
derived from its historical experience, in order to recognize a warranty cost
for a contract in the proper period of time.  In addition, at the end
of each reporting period, the Company estimates whether or not the accrued
warranty liabilities are adequate based on 1) the outstanding warranty time
period of a contract which has entered into the warranty period, 2) the total
revenue has recognized on a contract which has been under the warranty period,
and 3) all contracts which have been under the warranty period.  The
Company adjusts the accrued warranty liabilities in line with the result of its
assessment.


F-19


Accounts
Receivable and Cost and estimated earnings in excess of billings





Performance
of the contracts often will extend over long periods and the Company’s right to
receive payments depends on its performance in accordance with these contractual
agreements.  The Company bills a customer in accordance with the
amount specified under the contract from the cost and estimated earnings in
excess of billings when the Company’s performance has reached a
milestone.  In general, among four milestones, each interval of two
contiguous billings under a contract is within one year (under certain railway
control system contracts, the interval of two contiguous billings is longer than
one year) and the last billing to be issued for a contract is at the end of the
warranty period.  When a customer makes a prepayment at the start of a
contract, the amount received will be recorded as deferred
revenue.  The deferred revenue would be recognized as revenue under
the percentage of completion method along with the progress of a
contract.  If no prepayment is received by the Company, revenue would
be recognized through cost and estimated earnings in excess of
billings.  Accordingly, when a particular milestone is reached, a
particular amount of cost and estimated earnings in excess of billings will be
transferred into accounts receivable.  Cost and estimated earnings in
excess of billings are usually billed within one year.  The Company
does not specify credit terms in its invoices and expect that its customers will
make their payments upon receipt even though the contract terms say that a
specific amount is due when a milestone is reached.  The Company does
not require collateral from its customers.  Based on the prevailing
collection practice in China, it is a reasonable expectation for the enterprises
in automation industry to take over one year to collect accounts
receivable.





As of
June 30, 2008 and 2009, balance of $7,780,192  and $6,772,812 were
related to contracts which have been completed but are still within the warranty
period respectively.





The
Company issues invoices to its customers without specifying credit terms and
consequential interests charge for late payments by its
customers.  The Company reviews the status of contracts periodically
and decided how much allowance for doubtful accounts should be made based on
factors surrounding the credit risk of customers, as well as its historical
experience.  The Company set up bad debt allowance for an individual
customer if there is a deterioration of the customer’s creditability and the
assessed probability of default is higher than the historical
experience.





Based on
the information available to management, the Company believes that its allowance
for doubtful accounts as of June 30, 2008 and 2009 were adequate,
respectively.


The
allowance for doubtful debts for the years ended June 30, 2007, 2008 and 2009
were $1,118,903 and $3,439,486 and $1,145,770
respectively.





Property,
Plant and Equipment





Property,
plant and equipment are recorded at cost and are stated net of accumulated
depreciation.  Depreciation expense is determined using the
straight-line method over the estimated useful lives of the assets as
follows:





Land
      use right
                49
      yearsBuildings
                30
      yearsMachinery
                5 - 10 yearsSoftware
                5
      yearsVehicles
      and other equipment
                5
      years





Construction
in progress represents construction of certain facilities which construction
work has not been completed and which, upon completion, management intends to
hold for production purpose. In addition to costs under construction contracts,
external costs directly related to the construction of such facilities,
including duty and tariff, equipment installation and shipping costs, and
borrowing costs are capitalized. Depreciation is recorded at the time assets are
placed in service.


F-20


Maintenance
and repairs are charged directly to expense as incurred, whereas betterment and
renewals are capitalized in their respective property accounts.  When
an item is retired or otherwise disposed of, the cost and applicable accumulated
depreciation are removed and the resulting gain or loss is recognized for the
reporting period.





Impairment
of Long-Lived Assets





The
Company adopts the provisions of SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets”, which requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable through the
estimated undiscounted cash flows expected to result from the use and eventual
disposition of the assets.  Whenever any such impairment exists, an
impairment loss will be recognized for the amount by which the carrying value
exceeds the fair value.  Losses on long-lived assets to be disposed of
are determined in a similar manner, except that fair market values are reduced
for the cost to dispose.





There was
no impairment of long-lived assets for the year ended June 30, 2007, 2008 and
2009, respectively.





Shipping
and Handling Cost





The
Company adopted EITF 00-10, “Accounting for Shipping and Handling Fees and
Costs”.  All shipping and handling fees charged to customers are
included in net revenue, and shipping and handling costs for goods shipped by
the Company to customers are included in cost of integrated contract and/or cost
of goods sold.





Goodwill
and Impairment Test





Goodwill
resulting from an acquisition is measured at the excess of the cost of the
business combination over the fair value of the assets acquired and liabilities
assumed.  Goodwill will not be amortized, instead be tested for
impairment at least annually as prescribed by SFAS No. 142.  When
impairment occurs, the carrying value of goodwill is written down and a charge
is recorded against net income.  For the year ended June 30, 2007,
2008 and 2009, there was an impairment loss of nil, $99,439 and nil,
respectively. The carrying value of goodwill was written down to $0 as of June
30, 2008 and 2009.





Income
Taxes





The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes”, which requires an entity to recognize deferred tax
liabilities and assets.  Deferred tax assets and liabilities are
recognized for the future tax consequence attributable to the difference between
the tax bases of assets and liabilities and their reported amounts in the
financial statements.  Deferred tax assets and liabilities are
measured using the enacted tax rate expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that included the
enactment date.  Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be realized. Current
income taxes are provided for in accordance with the laws of the relevant tax
authorities.


F-21


The
Company adopted the FASB’s Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (FIN 48). FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in an enterprise’s financial statements in accordance
with SFAS No. 109. FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on de-recognition of tax benefits, classification on the balance sheet,
interest and penalties, accounting in interim periods, disclosure, and
transition. The Company’s policy on classification of all interest and penalties
related to unrecognized tax benefits, if any, as a component of income tax
provisions.





Value
Added Tax





All the
PRC subsidiaries of the Company are subject to value added tax (“VAT”) imposed
by PRC government on its domestic product sales.  The output VAT is
charged to customers who purchase goods from the Company and the input VAT is
paid when the Company purchases goods from its vendors.  VAT rate is
17%, in general, depending on the types of product purchased and
sold.  The input VAT can be offset against the output
VAT.  VAT payable or receivable balance presented on the Company’s
balance sheets represents either the input VAT less than or larger than the
output VAT.  The debit balance represents a credit against future
collection of output VAT instead of a receivable.





Pursuant
to the laws and regulations of the PRC, the Company is entitled to a refund of
the 14% VAT for software expenses. The Company recognizes the VAT refunds upon
completion of government approval. VAT refunds are included as a credit in the
operating expense in the consolidated statement of income.





Research
and Development





Research
and development costs consist primarily of staff costs, which include salaries,
bonuses and benefits for research and development personnel.  Research
and development costs also include travel expenses of our research and
development personnel as well as depreciation of hardware equipment and software
tools and other materials used in our research and development activities.
Research and development costs are expensed as incurred.





Government
Subsidies





Certain
subsidiaries of the Company located in PRC have, respectively, received certain
government subsidies from local PRC government agencies.  Government
subsidies are recognized when all the conditions for their receipt have been
met. The Company presents the government subsidies received as part of other
income.





Appropriations
to Statutory Reserve





Under the
corporate law and relevant regulations in PRC, all of the subsidiaries of the
Company located in PRC are required to appropriate a portion of its retained
earnings to statutory reserve.  All subsidiaries located in PRC are
required to appropriate 10% of its annual after-tax income each year to the
statutory reserve until the statutory reserve balance reaches 50% of the
registered capital.  In general, the statutory reserve shall not be
used for dividend distribution purpose.





Use
of Estimates





The
preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period.  Actual results could differ
materially from those estimates.


F-22


Comprehensive
Income





The
Company adopted SFAS No. 130, “Reporting Comprehensive Income”, which
establishes standards for reporting and presentation of comprehensive income and
its components in a full set of general-purpose financial
statements.  The Company has chosen to report comprehensive income in
the statements of income and comprehensive income.  Comprehensive
income is comprised of net income and all changes to stockholders’ equity except
those due to investments by owners and distributions to owners.





Long-Term
Investments





The
Company accounted for its long-term investments under either equity method or
cost method in accordance with equity interest holding percentage. Equity method
also applies to the investment in investee company with equity interest more
than 50% when the minority interest in that investee company has the
participation rights defined in EITF 96-16.





Earnings
(Loss) Per Share





The
Company presents earnings per share in accordance with the SFAS No. 128,
“Earnings per Share”, which defines that basic earnings (loss) per share include
no dilution and are computed by dividing income (loss) available to common
stockholders by the weighted average number of common shares outstanding during
the period whereas diluted earnings (loss) per share reflect the potential
dilution of securities that could share in the earnings of an
entity.





Share-based
compensation





The
Company adopted SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), ‘‘Share-based
Payment’’, which requires that share-based payment transactions with employees,
such as share options, be measured based on the grant-date fair value of the
equity instrument issued and recognized as compensation expense over the
requisite service period, with a corresponding addition to equity. Under this
method, compensation cost related to employee share options or similar equity
instruments is measured at the grant date based on the fair value of the award
and is recognized over the period during which an employee is required to
provide service in exchange for the award, which is generally the vesting
period.





Fair
Value of Financial Instruments





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
No. 157”). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosure about such fair value measurements.
In October 2008, the FASB issued FASB Staff Position (“FSP”) 157-3 “Determining
the Fair Value of a Financial Asset When the Market for That Asset is Not
Active”. FSP SFAS 157-3 clarifies the application of SFAS in a market that is
not active, and provides guidance on the key considerations in determining the
fair value of a financial asset when the market for the financial asset is not
active. Effective July 1, 2008, the Company adopted the measurement and
disclosure requirements related to financial assets and financial liabilities.
The adoption of SFAS 157 for the financial assets and financial liabilities did
not have a material impact on the Company’s results of operation or the fair
values of its financial assets and liabilities. FSP SFAS 157-2, “Effective Date
of FASB Statement No. 157” delayed the effective date of SFAS 157 for
non-financial assets and liabilities that are recognized or disclosed at fair
value in the consolidated financial statements on a non-recurring basis, until
the fiscal year beginning after November 15, 2008.  The Company is
currently assessing the impact of SFAS No. 157 for non-financial assets and
liabilities that are recognized or disclosed on a non-recurring basis on its
results of operation and financial position.


F-23


Recent
Accounting Pronouncements





In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business
Combinations” (“SFAS No. 141(R)”).  SFAS No. 141(R) changes accounting
for acquisitions that close beginning in 2009.  SFAS No. 141R broadens
the guidance of SFAS No. 141, extending its applicability to all transactions
and other events in which one entity obtains control over one or more other
businesses.  It broadens the fair value measurement and recognition of
assets acquired, liabilities assumed, and interests transferred as a result of
business combinations.  SFAS No. 141R expands on required disclosures
to improve the statement users’ abilities to evaluate the nature and financial
effects of business combinations.  SFAS No. 141R is effective for
fiscal years beginning on or after December 15, 2008. The Company is currently
evaluating the potential impact on the adoption of SFAS No. 141(R) that may have
on its financial position, result of operations and cash flow.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, An Amendment of ARB No. 51” (“SFAS No.
160”).  SFAS No. 160 requires that a noncontrolling interest in a
subsidiary be reported as equity and the amount of consolidated net income
specifically attributable to the noncontrolling interest be identified in the
consolidated financial statements.  It also calls for consistency in
the manner of reporting changes in the parent’s ownership interest and requires
fair value measurement of any non-controlling equity investment retained in a
deconsolidation.  SFAS No. 160 requires retroactive adoption of the
presentation and disclosure requirements for existing minority interests. SFAS
160 is effective for fiscal years beginning after December 15, 2008. The Company
does not anticipate that the adoption of SFAS No. 160 will have significant
impact on the Company’s financial disclosures.





In March
2008, FASB released SFAS No. 161, “Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133” (“SFAS No. 161”).
SFAS No. 161 is intended to improve financial reporting about derivative
instruments and hedging activities by requiring enhanced disclosures to enable
investors to better understand their effects on an entity’s financial position,
financial performance, and cash flows. It is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008,
with early application encouraged and is required to be adopted by the Company
in the first quarter of fiscal year 2010. The Company does not anticipate that
the adoption of SFAS No. 161 will have significant impact on the Company’s
financial disclosures.





In
April 2009, the FASB issued FSP 157-4, “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 157-4”). FSP
157-4 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. FSP 157-4 also includes guidance on identifying
circumstances that indicate a transaction is not orderly. FSP 157-4 is effective
for interim and annual reporting periods ending after June 15, 2009, with
early adoption permitted for periods ending after March 15, 2009. FSP 157-4 does
not require disclosures for earlier periods presented for comparative purposes
at initial adoption. In periods after initial adoption, FSP 157-4 requires
comparative disclosures only for periods ending after initial adoption. The
adoption of FSP 157-4 in the fourth quarter of fiscal 2009 did not have a
material impact on the Company’s financial position or results of
operations.





In May
2009, the FASB issued SFAS No. 165 “Subsequent Events” (“SFAS No. 165”), 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. SFAS No. 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. This
disclosure should alert all users of financial statements that an entity has not
evaluated subsequent events after that date in the set of financial statements
being presented. SFAS No. 165 is effective for interim and annual periods ending
after June 15, 2009. The adoption of SFAS No. 165 in the fourth quarter of
fiscal 2009 did not have a material impact on the Company’s financial position
or results of operations.


F-24


In June
2009, the FASB issued SFAS No. 166 “Accounting for Transfers of Financial
Assets” (“SFAS No. 166”). This statement is intended to improve the relevance,
representational faithfulness, and comparability of the information that a
reporting entity provides in its financial reports about a transfer of financial
assets; the effects of a transfer on its financial position, financial
performance, and cash flows; and a transferor’s continuing involvement in
transferred financial assets. This Statement must be applied as of the beginning
of each reporting entity’s first annual reporting period that begins after
November 15, 2009. Earlier application is prohibited. This Statement must be
applied to transfers occurring on or after the effective date. The Company is
currently evaluating the potential impact on the adoption of SFAS No. 166 may
have on the Company’s financial position, result of operations and cash
flow.





In June
2009, the FASB issued SFAS No. 167 “Amendments to FASB Interpretation No. 46(R)”
(“SFAS No. 167”). SFAS 167 seeks to improve financial reporting by enterprises
involved with variable interest entities. SFAS No. 167 is applicable for annual
periods after November 15, 2009 and interim periods therein and
thereafter. The Company is currently evaluating the potential impact on the
adoption of SFAS No. 167 may have on the Company’s financial position, result of
operations and cash flow.





In June
2009, the FASB issued SFAS No. 168 “The FASB Accounting Standards CodificationTM
and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS No.
168”).  The FASB approved the FASB Accounting Standards Codification
(the “Codification”) as the single source of authoritative non-governmental U.S.
GAAP to be launched on July 1, 2009. 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. All existing accounting standard documents will be superseded and
all other accounting literature not included in the Codification will be
considered nonauthoritative. The Codification is effective for interim and
annual periods ending after September 15, 2009. The Company does not anticipate
that the adoption of SFAS No. 168 will have significant impact on the Company’s
financial position, result of operations and cash flow.





NOTE
4 - INVENTORIES





Components
of inventories are as follows:





June 30,2008
                  
                  
                  2009Raw
      materials
                  
                  $
                  11,369,296
                  
                  
                  $
                  8,048,588Work
      in progress
                  
                  
                  4,189,594
                  
                  
                  
                  3,851,689Finished
      goods
                  
                  
                  9,653,925
                  
                  
                  
                  8,025,219Low
      value consumables
                  
                  
                  50,084
                  
                  
                  
                  25,914Less:
      Provision
                  
                  
                  (596,446
                  )
                  
                  
                  (1,114,140
                  )$
                  24,666,453
                  
                  
                  $
                  18,837,270





NOTE
5 – COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS





June 30,2008
                  
                  
                  2009Contracts
      costs incurred plus estimated earnings
                  
                  $
                  249,440,721
                  
                  
                  $
                  311,865,312Less:
      Progress billings
                  
                  
                  (206,788,298
                  )
                  
                  
                  (260,770,652
                  )Cost
      and estimated earnings in excess of billings, net
                  
                  $
                  42,652,423
                  
                  
                  $
                  51,094,660


F-25


NOTE
6 - PROPERTY, PLANT AND EQUIPMENT





A summary
of property, plant and equipment at cost is as follows:





June 30,2008
                  
                  
                  2009Land
      use right
                  
                  $
                  6,223,545
                  
                  
                  $
                  7,238,446Buildings
                  
                  
                  14,422,530
                  
                  
                  
                  13,520,841Machinery
                  
                  
                  3,765,048
                  
                  
                  
                  2,873,789Software
                  
                  
                  569,312
                  
                  
                  
                  797,327Vehicles
      and other equipment
                  
                  
                  6,204,204
                  
                  
                  
                  8,008,915Construction
      in progress
                  
                  
                  3,419,457
                  
                  
                  
                  23,343,595$
                  34,604,096
                  
                  
                  $
                  55,782,913Less:
      Accumulated depreciation and amortization
                  
                  
                  (6,821,182
                  )
                  
                  
                  (8,680,164
                  )$
                  27,782,914
                  
                  
                  $
                  47,102,749





Construction
in progress consists of capital expenditures and capitalized interest charges
relating to the construction of facilities and assembly lines projects. Interest
of nil, nil and $206,595 during the period of construction for the years ended
June 30, 2007, 2008 and 2009 respectively have been capitalized.





During
the year ended June 30, 2009, the Company commenced the construction of a new
facility with building area of about 150,000 square meters.  As of June 30,
2009, the construction in progress of the new facility was $20 million.
 The Company estimated that the whole construction budget would amount to
approximately $51 million including the cost of land use right of $5 million
which had been acquired during the year ended June 30, 2008.  The Company
expects to complete this new facility and related construction project by the
end of fiscal year ending June 30, 2010.





The
depreciation and amortization for the years ended June 30, 2007, 2008 and 2009
were, $1,566,876, $1,817,657, and $2,241,344 respectively.


F-26


NOTE
7 - LONG-TERM INVESTMENTS





The
following long-term investments were accounted for under either equity method or
cost method.





June30,2008
                    
                    Interest
                      held
                    
                    
                    Long-term
                      investment,
                      atCost
                    
                    
                    Shareof
                      undistributed
                      profits
                    
                    
                    Advanceto
                      investee
                      company
                    
                    
                    TotalEquity
      MethodHollySys
      Information Technology Co., Ltd
                    
                    
                    49.00
                    %
                    
                    $
                    2,968,216
                    
                    
                    $
                    21,163
                    
                    
                    $
                    244,177
                    
                    
                    $
                    3,233,556HollySys
      Electric Machinery Co., Ltd
                    
                    
                    40.00
                    %
                    
                    
                    772,134
                    
                    
                    
                    1,087,491
                    
                    
                    
                    -
                    
                    
                    
                    1,859,625New
      Huake Electric Technology Co., Ltd
                    
                    
                    37.50
                    %
                    
                    
                    218,688
                    
                    
                    
                    9,997
                    
                    
                    
                    -
                    
                    
                    
                    228,685Beijing
      Techenergy Co., Ltd.
                    
                    
                    50.00
                    %
                    
                    
                    1,457,917
                    
                    
                    
                    745,573
                    
                    
                    
                    15,015
                    
                    
                    
                    2,218,505IPE
      Biotechnology Co., Ltd
                    
                    
                    31.15
                    %
                    
                    
                    1,749,501
                    
                    
                    
                    (24,396
                    )
                    
                    
                    -
                    
                    
                    
                    1,725,105$
                    7,166,456
                    
                    
                    $
                    1,839,828
                    
                    
                    $
                    259,192
                    
                    
                    $
                    9,265,476Cost
      MethodBeijing
      HollySys Equipment Technology Co., Ltd
                    
                    
                    20.00
                    %
                    
                    
                    58,317
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    58,317Zhongjijing
      Investment Consulting Co., Ltd
                    
                    
                    5.00
                    %
                    
                    
                    437,375
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    437,375$
                    7,662,148
                    
                    
                    $
                    1,839,828
                    
                    
                    $
                    259,192
                    
                    
                    $
                    9,761,168


F-27





June30,2009
                    
                    Interest
                      held
                    
                    
                    Long-term
                      investment,
                      atCost
                    
                    
                    Shareof
                      undistributed
                      profits
                    
                    
                    Advance
                      toinvestee
                      company
                    
                    
                    TotalEquity
      MethodHollySys
      Information Technology Co., Ltd
                    
                    
                    49.00
                    %
                    
                    $
                    3,012,508
                    
                    
                    $
                    38,650
                    
                    
                    $
                    649,423
                    
                    
                    $
                    3,700,581HollySys
      Electric Machinery Co., Ltd
                    
                    
                    40.00
                    %
                    
                    
                    775,208
                    
                    
                    
                    1,199,076
                    
                    
                    
                    -
                    
                    
                    
                    1,974,284New
      Huake Electric Technology Co., Ltd
                    
                    
                    37.50
                    %
                    
                    
                    219,558
                    
                    
                    
                    (21,329
                    )
                    
                    
                    -
                    
                    
                    
                    198,229Beijing
      Techenergy Co., Ltd.
                    
                    
                    50.00
                    %
                    
                    
                    6,586,747
                    
                    
                    
                    (1,260,619
                    )
                    
                    
                    43,152
                    
                    
                    
                    5,369,280IPE
      Biotechnology Co., Ltd
                    
                    
                    31.15
                    %
                    
                    
                    1,756,466
                    
                    
                    
                    (160,122
                    )
                    
                    
                    -
                    
                    
                    
                    1,596,344$
                    12,350,487
                    
                    
                    $
                    (204,344
                    )
                    
                    $
                    692,575
                    
                    
                    $
                    12,838,718Cost
      MethodBeijing
      HollySys Equipment Technology Co., Ltd
                    
                    
                    20.00
                    %
                    
                    
                    58,549
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    58,549Zhongjijing
      Investment Consulting Co., Ltd
                    
                    
                    5.00
                    %
                    
                    
                    439,116
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    439,116Zhejiang
      Sanxing Technology Co., Ltd
                    
                    
                    10.00
                    %
                    
                    
                    146,372
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    146,372Zhejiang
      Sanxing Engineering Co., Ltd
                    
                    
                    6.00
                    %
                    
                    
                    87,823
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    87,823$
                    13,082,347
                    
                    
                    $
                    (204,344
                    )
                    
                    $
                    692,575
                    
                    
                    $
                    13,570,578





In
January 2008, the Company acquired an additional 9% of equity interest of
HollySys Information Technology Co., Ltd with the respective interest held in
the investment of 40%, 49% and 49% as of June 30, 2007, 2008 and
2009.





In May
2008, the Company approved to dispose the equity interest of Beijing Best Power
Electrical Technology Co., Ltd. (the “Best Power”).  In accordance
with FAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”,
investment in Best Power is reclassified as assets held for sale under current
assets as of June 30, 2008 and measured at lower of carrying value or fair value
less selling cost . The Company disposed Best Power with a consideration of RMB
13,980,000 (equivalent to $2,047,782) in July 2008. A gain on disposal of
$400,556 was recorded in the consolidated statement of income for the year ended
June 30, 2009





In July
2008, the Company acquired 6% of equity interest of Zhejiang Sanxing Engineering
Co., Ltd, and in October 2008, the Company acquired 10% of equity interest of
Zhejiang Sanxing Technology Co., Ltd, The Company adopted cost method to account
for investments in the two investee companies.





In May
2009, the Company made further capital injection of RMB 35 million (equivalent
to $5,126,027) into Beijing Techenergy Co., Ltd,. The injection was contributed
by cash consideration of RMB 25 million (equivalent to $3,661,448) and
re-investment of retained earnings of RMB 10 million (equivalent to $1,464,579).
As the other equity interest owner also made the same amount of capital
injection, the equity interest in Beijing Techenergy Co., Ltd, remained 50% as
of June 30, 2009.


F-28


NOTE
8 - WARRANTY LIABILITY





June 30,2008
                  
                  
                  2009Beginning
      balance
                  
                  $
                  2,126,569
                  
                  
                  $
                  2,051,397Expense
      accrued
                  
                  
                  246,325
                  
                  
                  
                  522,640Expense
      incurred
                  
                  
                  (538,120
                  )
                  
                  
                  (951,048
                  )Exchange
      difference
                  
                  
                  216,623
                  
                  
                  
                  8,418$
                  2,051,397
                  
                  
                  $
                  1,631,407





NOTE
9 - SHORT-TERM BANK LOANS





On June
30, 2008 and 2009, the Company’s short-term bank borrowings consisted of
revolving bank loans of $4,373,752 and $5,854,887 respectively from several
banks.





As of
June 30, 2008, the short-term borrowing of $4,373,752 is subject to an annual
interest rate ranging from 5.83% to 6.56%, without any guarantee or pledge of
assets; and such borrowing has been fully repaid as of June 30,
2009.





As of
June 30, 2009, the short-term borrowing of $5,854,887 is subject to an annual
interest rate ranging from 5.31% to 7.20%, without any guarantee or pledge of
assets.





NOTE
10 - NOTES PAYABLE





As
mentioned in Note 2, GTH and the initial beneficial owners of Beijing HollySys
and Hangzhou HollySys entered into a series of agreements with Chardan, APH and
15 investors who provided a bridge loan and purchased 1.3 million preferred
shares in the aggregate amount of $30 million in order to satisfy the urgent
needs from the original Chinese owners of GTH.





On
December 20, 2006, GTH issued 15 notes in aggregate of $29.987 million payable
to 15 investors and 1.3 million preferred shares with a par value of $0.01 per
share in exchange for the proceeds of $30 million.  The detailed terms
of the notes issued to the 15 investors has been mentioned in Note 2 under
Bridge Loan Transaction.





As part
of the Bridge Loan Transaction, the 15 investors who were issued with 1.3
million shares of GTH’s preferred stock are fully informed of the Share Exchange
Transaction between GTH and Chardan and have the rights to accept the Exchange
Offer tendered by Chardan to convert each outstanding share of preferred stock
into one common share of the successor company of Chardan, which is
Hollysys.





GTH
identified the fact that the closing price of Chardan’s common share was $7.34
per share on December 20, 2006 and believed that this price was the most
objective indicator of the fair value of these 1.3 million preferred
shares.  GTH allocated the entire $30 million proceeds between the
$29.987 million notes payable and 1.3 million preferred shares, resulting in a
discount of $7,239,390 to the $29.987 million notes payable.  GTH
estimated that the life of these notes payable will be about nine months with
the expectation that the Share Exchange Transaction would be consummated before
September 20, 2007.  With such estimated life of the bridge loan, GTH
adopted the effective interest method to amortize the discount of $7,239,390
over the nine-month period.





During
the year ended June 30, 2008, the notes payable had been fully repaid and the
outstanding balance is nil.


F-29


The notes
interest charged for the years ended June 30, 2007, 2008 and 2009 were
$1,582,649, $824,370, and nil respectively.  The amortization of
discount on notes payable which charged to interest expenses were $4,819,326,
$2,420,064, and nil for the years ended June 30, 2007, 2008 and 2009
respectively.





NOTE
11 - LONG TERM BONDS PAYABLE





In
December 2007, Beijing HollySys and three independent third parties entered into
an agreement with the underwriters to issue a bond to institutional and public
investors in PRC with an aggregate principal amount of RMB 305 million. Pursuant
to the agreement, the Group issued a RMB 80 million (equivalent to $11.7
million) bond (the“Bond”) for the purpose of technology improvement and
industrial implementation of certain technology. The Bond carries interest at a
rate of 6.68% per annum, which is payable semiannually and will mature in
December 2010. For the purpose of the Bond, Beijing Zhongguancun Science and
Technology Guaranty Co., Ltd. has undertaken joint and several guarantee
liabilities in full in favour of Beijing HollySys. Concurrently, the China
Development Bank has authorized its business department to undertake general
guarantee liability in respect of the guarantee liabilities of Beijing
Zhongguancun Science and Technology Guaranty Co., Ltd.. Beijing HollySys also
pledged its property located in Beijing with a net book value of $5.1million as
at June 30, 2009 to Beijing Zhongguancun Science and Technology Guaranty Co.,
Ltd. as a collateral.





Bond
issuing costs was RMB 1,254,054 (equivalent to $183,559).  Such
issuing costs will be amortized during the three-year term of the bonds and any
unamortized issuing cost is presented as long-term deferred expenses on the
balance sheet.





For the
year ended June 30, 2008 and 2009, bond interest of $378,575 and $782,671 were
charged to interest expenses, respectively.





NOTE
12 - LONG-TERM BANK LOANS





June 30,2008
                      
                      
                      2009RMB-denominated
      loan from China Development Bank
                      
                      (i)
                      
                      
                      2,186,876
                      
                      
                      
                      -RMB-denominated
      loan from Bank of China
                      
                      (ii)
                      
                      
                      5,102,710
                      
                      
                      
                      5,123,026RMB-denominated
      loan from Industrial and Commercial Bank of China
                      
                      (iii)
                      
                      
                      -
                      
                      
                      
                      36,593,0417,289,586
                      
                      
                      
                      41,716,067Less:
      Current portion
                      
                      
                      
                      
                      (2,186,876
                      )
                      
                      
                      (5,123,026
                      )$
                      5,102,710
                      
                      
                      $
                      36,593,041





(i)
            The
      borrowing of $4,373,753 is effective from June 29, 2006 to June 28, 2009,
      with an annual interest of 6.03% to 6.75% throughout the loan
      period.  Principal payments of $728,959, $1,457,917 and
      $2,186,876 were due and settled on June 28, 2007, 2008, and 2009
      respectively. Such borrowing was full repaid as of June 30,
      2009.





(ii)
            The
      borrowing of $5,123,026 is effective from August 29, 2007 to August 28,
      2009, with an annual interest of 6.48%. Principal payments of $5,123,026
      are due on August 28, 2009. The borrowing is without any guarantee or
      pledge of assets. Such borrowing was subsequently repaid on August 28,
      2009


F-30


(iii)
            The
      borrowing of $36,593,041 is effective from March 31, 2009 to March 30,
      2016, with an annual interest rate of 6.44%. The borrowing are pledged
      with the new facility in construction, with building area of about 150,000
      square meters, amounted to $20,043,222 as of June 30,
  2009.





Scheduled
principal payments for all outstanding borrowings on June 30, 2009 are as
follows:





Year Ending June 30,2010
                    
                    $
                    5,123,0262011
                    
                    
                    1,463,7222012
                    
                    
                    5,123,0262013
                    
                    
                    7,318,6082014
      and onward
                    
                    
                    22,687,685$
                    41,716,067





For the
years ended June 30, 2007, 2008, and 2009, loans interest including short-term
and long-term bank loans of $1,261,731, $1,342,407 and $1,192,485 was incurred
and $1,261,731, $1,342,407 and $985,890 was charged to interest expenses
respectively.





NOTE
13 – COMMON STOCK





As of
September 20, 2007, the net assets of Chardan were $28,156,361 representing by
the outstanding 7,000,000 common shares, which were presented in the
stockholders equity under the line item of recapitalization in connection with
Share Exchange Transaction.





In
accordance with the terms of the Future Annual Incentive Share Plan described in
Note 2, the original shareholders of GTH and their designees would entitle to
receive additional shares of 2 million shares of common stock for each 12-month
periods if the Company’s profit for twelve months periods ended December 31,
2007 and 2008 met the US$23,000,000 and US$32,000,000 threshold
respectively.





During
the year ended June 30, 2008 and 2009, the Company determined the after-tax
profit (in terms of comprehensive income concept) target for the 12-month ended
December 31, 2007 and 2008 was met respectively.





The
Company accounted for the transactions of issuing these incentive stock based on
the fair value on the grant date, which is the date when the shareholders of
Chardan held a special meeting to vote for the Share Exchange Transaction on
September 7, 2007 when the common stock of Hollysys was at $8.5
each.





Therefore,
the fair value of incentive stock compensation of $17 million and $17 million
was recorded in the consolidated statement of income for the year ended June 30,
2008 and 2009. As of June 30, 2009, these incentives shares have not yet been
issued.





On June
15, 2009, the Company agreed to immediate issue 4 million shares of common stock
to the original shareholders of GTH and their designees for the cancellation of
the Future Annual Incentive Share Plan for the 12-month periods ending December
31, 2009, 2010 and 2011. In accordance with SFAS No. 123(R), the modification of
the incentive stock compensation resulted in an incremental incentive stock
compensation of $22 million which is charged to the consolidated statement of
income for the year ended June 30, 2009. As of June 30, 2009, these incentives
shares have not yet been issued.


F-31


In August
2005, Chardan issued 11.5 million warrants to the investors who purchased
Chardan’s common stock.  In accordance with the terms of these
warrants, all warrants should be exercised or redeemed on or before June 30,
2008.  The exercise price of these warrants was $5 per share and the
redemption price was $0.01 per share.  During the period from October
to December 2007, a total of 11,442,614 warrants were exercised while 57,386
warrants were redeemed.  Consequently, Hollysys received cash proceeds
of $57.21 million from the exercise of warrant and paid $574 to the holders of
57,386 warrants for redemption purpose.





For the
years ended June 30, 2008 and 2009, none of the 250,000 UPO has been exercised
respectively. The UPO will be expired on August 2, 2010.





NOTE
14 - SHARE OPTION PLAN





On
September 20, 2007, the Company adopted the “2006 Stock Plan” (the “Plan”) which
allows the Company to offer a variety of incentive awards to employees,
officers, directors and consultants. Options to purchase 3,000,000 ordinary
shares are authorized under the Plan.





On
February 1, 2008 and June 2, 2008, options to purchase 186,000 and 60,000
ordinary shares were granted under the terms of the Plan. 186,000 and 60,000
options were priced at $7.9 and $5.85 per share respectively, in which 231,000
options with expiry period of 5 years from the date of grant and vest over a
period of 3 years, and 15,000 options with expiry period of 1 year from the date
of grant with immediate vesting. The 15,000 options were not exercised and have
been expired as of June 30, 2009.





On
January 20, 2009, options to purchase 450,000 ordinary shares were granted under
the terms of the Plan. They were priced at $2.24 per share, with expiry period
of 10 years from the date of grant and vest over a period of 3
years.





A summary
of the share option activity under the Plan is as follows:


Options
                              outstanding
                            
                            
                            
                            Weighted
                              average
                              exercise
      priceOptions
      outstanding at July 1, 2007
                            
                            
                            -
                            
                            
                            
                            
                            -Options
      granted
                            
                            
                            246,000
                            
                            
                            
                            $
                            7.40Options
      exercised
                            
                            
                            -
                            
                            
                            
                            
                            -Options
      cancelled/forfeited/expired
                            
                            
                            -
                            
                            
                            
                            
                            -Options
      outstanding  at June 30, 2008
                            
                            
                            246,000
                            
                            
                            
                            
                            7.40Options
      granted
                            
                            
                            450,000
                            
                            
                            
                            
                            2.24Options
      exercised
                            
                            
                            -
                            
                            
                            
                            
                            -Options
      cancelled/forfeited/expired
                            
                            
                            (15,000
                            )
                            
                            
                            
                            7.90Options
      outstanding at June 30, 2009
                            
                            
                            681,000
                            
                            
                            
                            
                            3.98Options
      vested and exercisableAt
      June 30, 2008
                            
                            
                            45,167
                            
                            
                            
                            
                            7.82At
      June 30, 2009
                            
                            185,500
                            
                            
                            
                            5.34


F-32


The
following table summarizes information with respect to options outstanding at
June 30, 2009:





Options outstanding and
      exercisableNumber
                    outstanding
                  
                  
                  Weighted average
                    remaining
                    contractual life years
                  
                  
                  Weighted average
                    fair value as of
                    the grant dateExercise
      price:US$7.90
                  
                  
                  171,000
                  
                  
                  
                  3.5
                  
                  
                  $
                  2.34US$5.85
                  
                  
                  60,000
                  
                  
                  
                  3.9
                  
                  
                  
                  2.21US$2.24
                  
                  
                  450,000
                  
                  
                  
                  9.6
                  
                  
                  
                  2.31Total
                  
                  
                  681,000
                  
                  
                  
                  7.6
                  
                  
                  $
                  2.31





The
aggregate intrinsic value as of June 30, 2008 and 2009 is nil and $1,602,000
respectively . No options have been exercised during the year ended June 30,
2007, 2008, and 2009.





The fair
value of each option granted is estimated on the date of grant using the
Black-Scholes Option Pricing Model.





Year Ended June 30,2007
                    
                    
                    2008
                    
                    
                    2009Options
      granted (weighted average)Average
      risk-free rate of return
                    
                    
                    -
                    
                    
                    
                    2.77% - 3.24%
                    
                    
                    
                    1.85
                    %Expected
      option life
                    
                    
                    -
                    
                    
                    3
      years
                    
                    
                    6
      yearsVolatility
      rate
                    
                    
                    -
                    
                    
                    
                    37% - 40%
                    
                    
                    
                    116
                    %Dividend
      yield
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -





Average
risk-free rate of return for periods within the contractual life of the option
is based on the U.S. Treasury yield curve in effect at the time of grant.
Expected option life is derived from the simplified method in accordance to
Staff Accounting Bulletin No. 110 of the Securities and Exchange Commission of
the United States as no historical exercise pattern could be studied for
reference, Volatility rate is based on historical volatility of the Company’s
stock. Dividend yield is estimated by the Company at zero for the expected
option life.





The
Company recorded share option compensation expense of nil, $84,473, and $319,026
for the year ended June 30, 2007, 2008, and 2009. As of June 30, 2008 and 2009,
there were $462,367 and $1,182,841 of total unrecognized compensation expense
related to non-vested share-based compensation arrangement under the Plan. The
unrecognized compensation expense is expected to be recognized over a
weighted-average vesting period of 2.3 years.





NOTE
15 - EMPLOYEE BENEFITS





The
Company contributes to a state pension scheme run by the Chinese government in
respect of its employees in China.  The expense related to this plan was
$1,992,113, $3,136,409 and $4,467,855 for the years ended June 30, 2007, 2008
and 2009, respectively.


F-33


NOTE
16 - INCOME TAX





Hollysys,
and its subsidiary, GTH, are incorporated in the BVI and are not subject to
income tax under the relevant jurisdiction. Its major operating subsidiaries are
incorporated in the PRC and are subject to income taxes as described
below.





Prior to
December 31, 2007, the statutory tax rate of PRC Enterprise Income tax (“EIT”)
was 33% (30% of national income tax plus 3% local income tax).





On March
16, 2007, the National People’s Congress passed the new Enterprise Income Tax
law (the “new EIT law”) which imposes a single income tax rate of 25% for most
domestic enterprises and foreign investment enterprise. The new EIT law was
effective as of January 1, 2008. The new EIT law provides a five-year transition
period from its effective date for those enterprises which were established
before March 16, 2007 and which were entitled to a preferential lower tax rate
under the then effective tax laws or regulations, as well as grandfathering tax
holidays. Further, according to the new EIT law, entities that qualify as
“High-tech Enterprises” are entitled to the preferential EIT rate of
15%.





Beijing
HollySys is registered in a high-tech zone located in Beijing and was deemed as
a High-tech Enterprise by Beijing Commission of Science and
Technology.  According to the preferential regulations specified by
State Council, Beijing HollySys had entitled to a favorable EIT rate of 15% from
October 1, 2002 to December 31, 2007. During the calendar year ended December
31, 2008, Beijing HollySys was certified as a High-tech Enterprise for three
years commencing from January 1, 2008. Therefore, the EIT tax rate applicable to
Beijing HollySys is 15% for the fiscal years ended June 30, 2007, 2008 and
2009.





Hangzhou
HollySys is registered as a foreign investment enterprise in China and was
entitled to tax holidays of 100% exemption of income tax for two years followed
by 50% exemption of income tax for the next three years since the first
profitable calendar year ended December 31, 2004. During the calendar year ended
December 31, 2006, Hangzhou HollySys enjoyed preferential EIT rate of 16.5%
(i.e. 15% of national income tax plus 1.5% local income tax) in accordance with
relevant regulations regarding Hangzhou HollySys located in a development zone
recognized by the Ministry of Land and Resource in China. This preferential EIT
rate benefit, together with the 50% exemption of income tax holiday, entitled
Hangzhou HollySys with applicable EIT rate of 8.25% for the calendar years ended
December 31, 2006 and 2007. During the calendar year ended December 31, 2008,
Hangzhou HollySys was certified as a High-tech Enterprise for three years
commencing from January 1, 2008. In addition, Hangzhou HollySys was also
certified as “Major Software Enterprises for the calendar year ended December
31, 2008 and is entitled to a concessionary tax rate of 10%. In accordance with
the new EIT law, the EIT tax rate applicable to Hangzhou HollySys for the
calendar year ended December 31, 2008 and 2009 is therefore 10% and 15%
respectively.





Beijing
HollySys Haotong (Haotong) is registered in a high-tech zone located in Beijing
and was deemed as a High-Tech Enterprise by Beijing Commission of Science and
Technology.  According to the preferential regulations specified by
State Council, Haotong had entitled to a favorable EIT rate at
15%.  Under the preferential regulations, Haotong also enjoyed a 100%
exemption of income tax for three years from January 1, 2001 to December 31,
2003 and a 50% exemption of income tax for three years from January 1, 2004 to
December 31, 2006. The EIT rate applicable to Haotong was 33% for the calendar
year ended December 31, 2007. As of June 30, 2009, Haotong has not yet applied
for the status as a High-Tech Enterprises. The management does not expect
Haotong will qualify as a High-tech Enterprise under the new EIT law. As a
result, the applicable tax rate for Haotong is 25% starting from January 1,
2008.





For other
PRC operating subsidiaries, the applicable tax rate is 25% starting from January
1, 2008.


F-34


Income
tax expense, which is all incurred in the PRC, consists of:





Year Ended June 30,2007
                  
                  
                  2008
                  
                  
                  2009Current
      income tax expense
                  
                  $
                  2,338,686
                  
                  
                  $
                  2,798,920
                  
                  
                  $
                  2,525,416Deferred
      income tax expense (benefit)
                  
                  
                  162,418
                  
                  
                  
                  (1,706,443
                  )
                  
                  
                  535,725$
                  2,501,104
                  
                  
                  $
                  1,092,477
                  
                  
                  $
                  3,061,141





A
reconciliation between the provisions for income taxes computed by applying the
statutory tax rate in PRC of 33% for the calendar year ended December 31, 2007
and 25% for the calendar years ended December 31, 2008 and 2009 for the income
before income taxes and the actual provision for income taxes is as
follows:





Year Ended June 30,2007
                    
                    
                    2008
                    
                    
                    2009Income
      (loss) before income taxes
                    
                    $
                    18,646,368
                    
                    
                    $
                    2,248,419
                    
                    
                    $
                    (5,603,121
                    )Expected
      income tax expense at statutory tax rate in PRC
                    
                    
                    6,153,301
                    
                    
                    
                    562,104
                    
                    
                    
                    (1,400,780
                    )Effect
      of different tax rate in variousjurisdictions
                    
                    
                    -
                    
                    
                    
                    141,756
                    
                    
                    
                    32,590Effect
      of preferential tax treatment
                    
                    
                    (4,623,896
                    )
                    
                    
                    (4,237,165
                    )
                    
                    
                    (4,004,659
                    )Effect
      of income for which no incometax
      is chargeable
                    
                    
                    (435,483
                    )
                    
                    
                    (742,063
                    )
                    
                    
                    (1,447,910
                    )Effect
      of additional deductible researchand
      development expense
                    
                    
                    (31,172
                    )
                    
                    
                    (346,788
                    )
                    
                    
                    (770,383
                    )Effect
      of non-deductible expenses
                    
                    
                    1,025,965
                    
                    
                    
                    5,694,332
                    
                    
                    
                    10,585,029Under/(over)
      provision of income taxin
      previous years
                    
                    
                    530,983
                    
                    
                    
                    (348,399
                    )
                    
                    
                    (34,818
                    )Change
      in valuation allowance
                    
                    
                    -
                    
                    
                    
                    348,936
                    
                    
                    
                    113,096Others
                    
                    
                    (118,594
                    )
                    
                    
                    19,764
                    
                    
                    
                    (11,024
                    )Effective
      income tax expense
                    
                    $
                    2,501,104
                    
                    
                    $
                    1,092,477
                    
                    
                    $
                    3,061,141





Had the
all above tax holidays and concessions not been available, the tax charge would
have been higher by $4,623,896, $4,237,165 and $4,004,659 and the basic net
income per share would have been lower by $0.21, $0.11 and $0.09 for the years
ended June 30, 2007, 2008 and 2009 respectively, and diluted net income per
share for the years ended June 30, 2007, 2008 and 2009 would have been lower by
$0.20, $0.11 and $0.09, respectively.





The
temporary differences that have given rise to the deferred tax liabilities
consist of the following:




F-35





June 30,2008
                      
                      
                      2009Deferred
      tax assetsDoubtful
      debt provision
                      
                      $
                      979,042
                      
                      
                      $
                      1,076,484Inventory
      provision
                      
                      
                      89,467
                      
                      
                      
                      182,993Deferred
      revenue
                      
                      
                      730,957
                      
                      
                      
                      1,151,302Warranty
      provision
                      
                      
                      307,710
                      
                      
                      
                      247,981Recognition
      of intangible assets
                      
                      
                      839,416
                      
                      
                      
                      719,996Accrued
      payroll
                      
                      
                      288,451
                      
                      
                      
                      227,896Net
      operating loss carry forward
                      
                      
                      348,936
                      
                      
                      
                      524,2343,583,979
                      
                      
                      
                      4,130,886Less:
      Valuation allowances
                      
                      
                      (348,936
                      )
                      
                      
                      (462,032
                      )$
                      3,235,043
                      
                      
                      $
                      3,668,854Deferred
      tax liabilitiesCosts
      and estimated earnings in excess of billings
                      
                      $
                      (1,955,471
                      )
                      
                      $
                      (2,919,511
                      )Deferred
      tax assets (liabilities), net
                      
                      $
                      1,279,572
                      
                      
                      
                      749,343Deferred
      tax assets - current
                      
                      $
                      980,345
                      
                      
                      $
                      319,737Deferred
      tax assets – non-current
                      
                      
                      717,140
                      
                      
                      
                      706,943Deferred
      tax liabilities – current
                      
                      
                      (417,913
                      )
                      
                      
                      (277,337
                      )$
                      1,279,572
                      
                      
                      $
                      749,343





The
Company operates through the PRC subsidiaries and the valuation allowance is
considered on each individual basis. Where a valuation allowance was not
recorded, the Company expects to generate sufficient taxable income in the
future.





Under the
New EIT Law and the implementation rules, profits of the PRC subsidiaries earned
on or after January 1, 2008 and distributed by the PRC subsidiaries to Hollsys
are subject to a withholding tax at a rate of 10% unless reduced by tax treaty.
Since the Company intends to reinvest the earnings of the PRC subsidiaries in
business expansion in mainland China, the PRC subsidiaries do not intend to
declare dividends to their immediate non-PRC established holding companies in
the foreseeable future. Accordingly, no deferred taxation on undistributed
earnings of the PRC subsidiaries has been recognized as of June 30, 2008 and
2009.





The net
operating loss attributable to those PRC subsidiaries can only be carried
forward for a maximum period of five years. The expiration periods of unused tax
losses are as follows:





Years Ending June 30,2010
                              
                              $
                              -2011
                              
                              
                              -2012
                              
                              
                              -2013
                              
                              
                              348,9362014
      and onward
                              
                              
                              175,298$
                              524,234





As a
result of the Share Exchange Transaction, pursuant to the Internal Revenue Code
Section 367 (“§367”), the merger portion of the transaction may not be
considered a tax-free exchange and thus the Company would be taxed on the gain
of its assets at the time of the merger. The management of the Company
consulted independent tax experts regarding the tax effect on the
re-domestication merger and assessed that the Company should undertake a tax
liability of $1,699,915. As of completion date of Share Exchange Transaction on
September 20, 2007, tax on re-domestication amounted to $1,699,915 was charged
against equity because the assumption of such tax is part of the
recapitalization in connection with the Stock Exchange Transaction. In June
2008, Hollysys filed 2007 tax returns and made payment of $1,636,154. The
Company does not expect to incur further material tax liabilities in this
connection.


F-36


In
accordance with FIN 48, the Company’s liability for income taxes includes the
liability for unrecognized tax benefits, interest and penalties which relate to
tax years still subject to review by taxing authorities. The Company performed a
self-assessment and concluded that there was no significant uncertain tax
position requiring recognition in its financial statements. There were no
material interest or penalties incurred for the years ended June 30, 2007, 2008
and 2009.





NOTE
17 – EARNINGS (LOSS) PER SHARE





The
following table sets forth the computation of basic and diluted net earnings
(loss) per share for the years indicated:





Year Ended
      June 30,2007
                              
                              
                              2008
                              
                              
                              2009Net
      income (loss)  - numeratorBasic
      and diluted
                              
                              $
                              13,084,751
                              
                              
                              $
                              (1,677,178
                              )
                              
                              $
                              (13,851,064
                              )Shares
      - denominator:Weighted
      average ordinary sharesoutstanding
      used in computing basicnet
      earnings (loss) per share
                              
                              
                              22,200,000
                              
                              
                              
                              37,658,437
                              
                              
                              
                              44,950,833Incremental
      weighted averagePreferred
      shares of GTH before conversion
                              
                              
                              683,836
                              
                              
                              
                              -
                              
                              
                              
                              -Weighted
      average ordinary sharesoutstanding
      used in computingdiluted
      net earnings per share
                              
                              
                              22,883,836
                              
                              
                              
                              37,658,437
                              
                              
                              
                              44,950,833Net
      earnings (loss) per share - basic
                              
                              $
                              0.59
                              
                              
                              $
                              (0.04
                              )
                              
                              $
                              (0.31
                              )Net
      earnings (loss) per share - diluted
                              
                              $
                              0.57
                              
                              
                              $
                              (0.04
                              )
                              
                              $
                              (0.31
                              )





For the
year ended June 30, 2007, potential common shares of 750,000 shares related to
UPO are excluded from the computation of diluted net income per share as their
exercise prices were higher than the average market price.





For the
year ended June 30, 2008, potential common shares of 246,000 shares related to
stock options granted under the terms of the Plan, 750,000 shares related to UPO
and 1,002,740 shares related to contingent issuance of common stock in
accordance with the Share Exchange Transaction were excluded from the
computation of diluted net loss per share as they had an anti-dilutive
effect.





For the
years ended June 30, 2009, potential common shares of 681,000 shares related to
stock options granted under the terms of the Plan, 750,000 related to UPO and
4,991,781 shares related to contingent issuance of common stock related in
accordance with the Share Exchange Transaction were excluded from the
computation of diluted net loss per share as they had an anti-dilutive
effect.





NOTE
18 - RELATED PARTY TRANSACTIONS





Related
Party Relationships





Name
      of Related Parties
                  
                  Relationship
      with the CompanyHollySys
      Information Technology Co., Ltd.
                  
                  49%
      owned by Beijing HollySysNew
      Huake Electronic Technology Co., Ltd.
                  
                  37.5%
      owned by Beijing HollySysBeijing
      Techenergy Co., Ltd.
                  
                  50%owned
      by Beijing HollySysHollySys
      Electric Tech Co., Ltd.
                  
                  40%
      owned by Beijing HollySysHollySys
      Equipment Technology Co., Ltd.
                  
                  20%
      owned by Beijing HollySysIPE
      Biotechnology Co., Ltd.
                  
                  31.15%
      owned by Beijing HollySysBeijing
      Best Power Electrical Technology Co., Ltd.
                  
                  18.49%
      previously owned by Beijing HollySysRilin
      Construction Group Co., Ltd
                  
                  One
      of the owner in Beijing HollySysSixth
      Institute of Information Industry
                  
                  One
      of the ex-owners in Beijing
HollySys


F-37


Due
from Related Parties


June 30,2008
                  
                  
                  2009HollySys
      Information Technology Co., Ltd.
                  
                  $
                  30,540
                  
                  
                  $
                  618,785Beijing
      Techenergy Co., Ltd.
                  
                  
                  1,903,883
                  
                  
                  
                  6,562,318HollySys
      Electric Tech Co., Ltd.
                  
                  
                  2,095
                  
                  
                  
                  13,857HollySys
      Equipment Technology Co. Ltd.
                  
                  
                  42,393
                  
                  
                  
                  8,098Beijing
      Best Power Electrical Technology Co., Ltd.
                  
                  
                  103,512
                  
                  
                  
                  -IPE
      Biotechnology Co., Ltd.
                  
                  
                  2,478,459
                  
                  
                  
                  -$
                  4,560,882
                  
                  
                  $
                  7,203,058





The
Company’s management believed that the collection of amounts due from related
parties were reasonably assured and accordingly, no provision had been made for
these balances of due from related parties.





Due
to Related Parties


June 30,2008
                  
                  
                  2009HollySys
      Information Technology Co., Ltd
                  
                  
                  679,447
                  
                  
                  
                  827,573New
      Huake Electronic Technology Co., Ltd.
                  
                  
                  -
                  
                  
                  
                  35,142HollySys
      Equipment Technology Co. Ltd.
                  
                  
                  -
                  
                  
                  
                  1,978Beijing
      Techenergy Co., Ltd
                  
                  
                  759,502
                  
                  
                  
                  588,383HollySys
      Electric Tech Co., Ltd
                  
                  
                  19,836
                  
                  
                  
                  11,607Sixth
      Institute of Information Industry
                  
                  
                  23,569
                  
                  
                  
                  -$
                  1,482,354
                  
                  
                  $
                  1,464,683





Purchases
and Sales with Related Parties





PurchasesYear Ended June 30,2007
                            
                            
                            2008
                            
                            
                            2009HollySys
      Electric Tech Co., Ltd.
                            
                            $
                            2,370
                            
                            
                            $
                            71,019
                            
                            
                            $
                            24,709Beijing
      Techenergy Co., Ltd.
                            
                            
                            891,655
                            
                            
                            
                            1,075,530
                            
                            
                            
                            1,531,058HollySys
      Information Technology Co., Ltd.
                            
                            
                            -
                            
                            
                            
                            1,630,574
                            
                            
                            
                            728,897New
      Huake Electronic Technology Co., Ltd.
                            
                            
                            45,090
                            
                            
                            
                            842,824
                            
                            
                            
                            431,693$
                            939,115
                            
                            
                            $
                            3,619,947
                            
                            
                            $
                            2,716,357





Lease ExpensesYear Ended June 30,2007
                    
                    
                    2008
                    
                    
                    2009HollySys
      Information Technology Co., Ltd.
                    
                    $
                    81,005
                    
                    
                    $
                    731
                    
                    
                    $
                    -$
                    81,005
                    
                    
                    $
                    731
                    
                    
                    $
                    -


F-38





SalesYear Ended June 30,2007
                    
                    
                    2008
                    
                    
                    2009HollySys
      Electric Tech Co., Ltd.
                    
                    $
                    -
                    
                    
                    $
                    4,995
                    
                    
                    $
                    13,865Beijing
      Techenergy Co., Ltd.
                    
                    
                    86,504
                    
                    
                    
                    1,535,446
                    
                    
                    
                    5,721,797HollySys
      Information Technology Co., Ltd
                    
                    
                    864
                    
                    
                    
                    37,496
                    
                    
                    
                    920,333Beijing
      HollySys EquipmentTechnology
      Co., Ltd
                    
                    
                    34,371
                    
                    
                    
                    -
                    
                    
                    
                    30,794$
                    121,739
                    
                    
                    $
                    1,577,937
                    
                    
                    $
                    6,686,789





Lease IncomeYear Ended June 30,2007
                    
                    
                    2008
                    
                    
                    2009Beijing
      Techenergy Co., Ltd.
                    
                    $
                    83,868
                    
                    
                    $
                    77,583
                    
                    
                    $
                    27,835HollySys
      Information Technology Co., Ltd.
                    
                    
                    30,976
                    
                    
                    
                    52,832
                    
                    
                    
                    -HollySys
      Equipment Technology Co., Ltd.
                    
                    
                    6,766
                    
                    
                    
                    2,974
                    
                    
                    
                    3,351$
                    121,610
                    
                    
                    $
                    133,389
                    
                    
                    $
                    31,186





Amounts
due from and due to the related parties relating to the above transactions are
unsecured, non-interest bearing and repayable on demand.





Note
Receivable from the stockholder





GTH
raised $30 million cash by using the Bridge Loan Transaction mentioned in Note
2, GTH then loaned the $30 million cash to APH, in order for it to pay off its
first $30 million note payable to OSCAF, in exchange for a note receivable of
$30 million from APH.  On December 22, 2006, the entire proceeds of
$30 million were wired to the original Chinese owners’ bank accounts through
Chardan Capital, Inc.  The note receivable bears an interest at 10%
per annum.  The repayment terms of this note receivable was disclosed
in Note 2.  Because APH, being the sole stockholder, was only a
holding company with no stand-alone operations and no material assets available
to repay the note, the note receivable from APH was presented in the
stockholder’s equity section on the balance sheet as of June 30,
2007.  Based on the deemed distribution of $30 million derived from
the Share Transfer Transaction between GTH and Chardan, the balance of the note
receivable from the stockholder has been reduced to zero after a deemed
collection of $30 million from this note receivable.





Acquisition
of HAP from a Related Party





On
November 19, 2007, Hollysys entered into a Stock Purchase Agreement with Fulbond
Systems Pte Ltd, which is a Singapore based company and partially owned by Mr.
Yau Kiam Fee, who is a member of Board of Directors of Hollysys, to acquire 100%
interest of Fulbond Systems for a total consideration of SGD$1,066,234
(equivalent to $744,596). After the ownership transfer, Fulbond System changed
its name to HollySys (Asia Pacific) Pte Ltd. The purchase price of $744,596 was
paid in cash on December 11, 2007.





NOTE
19 - OPERATING RISK





The
Company has significant investments in China.  The operating results
of the Company may be adversely affected by changes in the political and social
conditions in China, and by changes in Chinese government policies with respect
to laws and regulations, anti-inflationary measures, currency conversion and
remittance abroad, and rates and methods taxation, among other
things.  There can be no assurance, however, those changes in
political and other conditions will not result in any adverse
impact.





Most of
the Company’s customers are located in the PRC. The Company had no customer that
individually comprised 10% or more of revenue for the years ended June 30, 2007,
2008 and 2009.





The
Company has no customer that individually comprised 10% or more of the
outstanding balance as of June 30, 2008 and 2009.


F-39


NOTE
20 – FAIR VALUE OF FINANCIAL INSTRUMENTS





The
carrying amount of cash, accounts receivable, other receivables, amount due to
or from related parties, accounts payable and accrued liabilities are reasonable
estimates of their fair value because of the short maturity of these items. The
carrying amount of the Company’s long term debts approximates at their fair
value due to the interest rates on the debts approximating at current
rates.





NOTE
21 - COMMITMENT





The
Company leases premises under various operating leases.  Rental
expenses under operating leases included in the consolidated statement of income
were $345,715 $545,796 and $1,105,473 for the years ended June 30, 2007, 2008
and 2009, respectively.





At June 30, 2009, the Company was
obligated under operating leases requiring minimum rentals as
follows:





Years Ending June 30,$2010
                        
                        
                        522,9962011
                        
                        
                        345,4292012
                        
                        
                        55,9272013
                        
                        
                        22,913Total
      minimum lease payments
                        
                        $
                        947,265





Other
than the details set out in the note 6 to the consolidated financial statements,
there was no significant capital commitment as of June 30, 2009.





NOTE
22 - SUBSEQUENT EVENTS





On July
1, 2009, the Company completed the acquisition of 1.78% equity interest on
Beijing HollySys from the minority interest holder and held 75.89% equity
interest of Beijing HollySys upon the completion of the acquisition. Total
consideration made was RMB 18,000,0000 (equivalent to $2,643,969), of which RMB
15,000,000 (equivalent to $2,195,582) was paid in June 2009 and RMB 3,000,000
(equivalent to $448,387) was paid in July 2009.





The
Company has evaluated material subsequent events through September 30, 2009, the
date these financial statements were issued.


F-40