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, 2011





OR





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





For the transition periodfrom ___________ 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 _________________________





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)





No. 2 Disheng Middle Road,


Beijing Economic-Technological Development Area,


Beijing, P. R. China 100176


(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 ordinary shares as of the close of the period covered by the annual report (June 30, 2011): [54,692,129] 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).  ̈ Yes  ̈ 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 x            Non-accelerated filer  ̈





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).   ̈Yes       x No









HOLLYSYS AUTOMATION TECHNOLOGIES LTD.





ANNUAL REPORT ON FORM 20-F


FOR THE FISCAL YEAR ENDED JUNE 30, 2011





TABLE OF CONTENTS





PagePART IITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

1ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE

1ITEM 3.
KEY INFORMATION

1ITEM 4.
INFORMATION ON THE COMPANY

19ITEM 4A.
UNRESOLVED STAFF COMMENTS

36ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS

36ITEM 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

58ITEM 7.
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

66ITEM 8.
FINANCIAL INFORMATION

68ITEM 9.
THE OFFER AND LISTING

69ITEM 10.
ADDITIONAL INFORMATION

71ITEM 11.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

84ITEM 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

84PART IIITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

85ITEM 14.
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITIES HOLDERS AND USE OF PROCEEDS

85ITEM 15T.
CONTROLS AND PROCEDURES

85ITEM 16A.
AUDIT COMMITTEE FINANCIAL EXPERT

88ITEM 16B.
CODE OF ETHICS

88ITEM 16C.
PRINCIPAL ACCOUNTANT FEES AND SERVICES

88ITEM 16D.
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

89ITEM 16E.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

89ITEM 16F.
CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

89ITEM 16G.
CORPORATE GOVERNANCE

89PART IIIITEM 17.
FINANCIAL STATEMENTS

89ITEM 18.
FINANCIAL STATEMENTS

89ITEM 19.
EXHIBITS

89




ii




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 Hollycon” are references to Beijing Hollycon Med. & Tech. Co., Ltd.;





·
“Beijing Hollysys” are references to Beijing Hollysys Co., Ltd.;





·
“Beijing Hollysys Electronics” are references to Beijing Hollysys Electronics Technology Co., Ltd.;





·
“Beijing Hollysys S&T” are references to Beijing Hollysys S&T Exploration Co., Ltd.;





·
“Beijing WoDeWeiye” are references to Beijing WoDeWeiye Technology 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;





·
“Concord” are references to a Singapore Group, including Concord Corporation Pte. Ltd., and Concord Electrical Pte. Ltd., and their subsidiaries Concord Electrical Sdn. Bhd. and Concord Corporation Pte. Ltd, Dubai Branch;





·
“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 BVI company, and its consolidated subsidiaries, Singapore Hollysys, Gifted Time, Clear Mind, World Hope, Beijing Helitong, Beijing Hollysys S&T, Hangzhou Hollysys, Hollysys Automation, Beijing Hollysys, Beijing Hollysys Electronics, Beijing Hollycon, Beijing Haotong, Beijing WoDeWeiye, Xi’an Hollysys and Hollysys Investments ;





·
“Hollysys Automation” are references to Beijing Hollysys Automation & Drive Co., Ltd.;





·
“HollysysInvestments” are references to Hollysys (Beijing) Investments 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;




iii




·
“Singapore Hollysys” are references to Hollysys (Asia Pacific) Pte. Limited, a Singapore company;





·
“World Hope” are references to World Hope Enterprises Limited, a Hong Kong company; and





·
“Xi’an Hollysys” are references to Xi’an Hollysys Co., Ltd.





iv




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, the volatility of 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 the underlying assumptions about our business and the commercial markets in which we operate 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.





v




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





A.  Selected Consolidated Financial Data





The following table presents selected financial data regarding our business.  It should be read in conjunction with our consolidated 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 operations data for the fiscal years ended June 30, 2009, 2010 and 2011 and the consolidated balance sheet data as of June 30, 2010 and 2011 have been derived from the audited consolidated financial statements of Hollysys that are included in this annual report beginning on page F-1.  The selected statement of operations data for the fiscal years ended June 30, 2007 and 2008, and balance sheet data as of June 30, 2007, 2008 and 2009 have been derived from our audited financial statements that are not included in this annual report.





The audited consolidated financial statements for the years ended June 30, 2009, 2010 and 2011 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.





1




Years Ended June 30,2007


2008


2009


2010


2011Statement of Operations DataRevenue


101,885,486



121,498,752



157,502,067



174,089,196



262,841,886Operating income (loss)


25,711,773



5,844,538



(5,550,479
)


32,547,400



44,690,766Income before income taxes


18,646,368



2,248,419



(5,603,121
)


35,219,424



47,909,081Income (loss)(1) attributable to Hollysys


13,084,751



(1,677,178
)


(13,851,064
)


25,704,538



41,469,998Add: Amortization of discount and interest on notes payable related to bridge loan


6,401,975



3,244,434



-



-



-Stock-based compensation cost for incentive shares


-



17,000,000



39,240,000



-



95,338Stock-based compensation cost for options


-



84,473



319,026



524,076



456,628Non-GAAP net income attributable to Hollysys


19,486,726



18,651,729



25,707,962



26,228,614



42,021,964Weighted average ordinary shares


22,200,000



37,658,437



44,950,883



51,243,667



54,564,842Weighted average number of diluted ordinary shares


22,883,836



37,658,437



44,950,883



51,838,294



54,949,280Basic earnings per share(1)


0.59



(0.04
)


(0.31
)


0.50



0.76Diluted earnings per share(1)


0.57



(0.04
)


(0.31
)


0.50



0.75Non-GAAP basic earnings per share


0.88



0.50



0.57



0.51



0.77Non-GAAP diluted earnings per share


0.85



0.48



0.51



0.51



0.76Cash dividends declared per share


0.03



-



-



-



-Balance Sheet DataTotal current assets


128,404,729



214,320,514



283,971,473



301,359,086



362,411,956Total assets


154,930,570



252,734,095



345,443,522



384,730,251



458,583,944Total current liabilities


101,419,000



71,028,772



101,121,574



135,917,248



161,038,804Total liabilities


104,703,288



87,794,820



149,424,388



171,258,661



192,715,669Non-controlling interest


13,200,169



17,645,377



22,479,241



774,865



810,618Stockholders’ equity


37,027,113



147,293,898



173,539,893



212,696,725



265,057,657





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





In evaluating our results, the non-GAAP measures of “Non-GAAP G&A Expenses”, “Non-GAAP Income (loss) from Operations”, and “Non-GAAP Net income (loss) and Earnings (loss) per share” serve as additional indicators of our operating performance and not as a replacement for other measures in accordance with U.S. GAAP. We believe these non-GAAP measures are useful to investors, as they exclude amortization of discount and interest on notes payable related to the bridge loan and stock-based compensation costs.  The amortization of discount and interest on notes payable related to bridge loan is non-recurrent and non-operation-related in nature. The stock-based compensation is calculated based on the number of shares granted and the stock price as of the grant date. It will not result in any cash inflows or outflows. We believe that using non-GAAP measures help our shareholders to have a better understanding of our operating results and growth prospects. In addition, given the business nature of Hollysys, it has been a common practice for investors and analysts to use such non-GAAP measures to evaluate the Company.





2




The following table provides a reconciliation of U.S. GAAP measures to the non-GAAP measures for the periods indicated:





Years ended June 30,2007


2008


2009


2010


2011G&A Expenses


7,135,221



26,588,771



48,981,078



13,914,091



16,671,448Minus: Stock-based compensation cost for incentive shares


-



17,000,000



39,240,000



-



95,338Minus: Stock-based compensation cost for options


-



84,473



319,026



524,076



456,628Non-GAAP G&A Expenses


7,135,221



9,504,298



9,422,052



13,390,015



16,119,482Net income (loss) attributable to Hollysys


13,084,751



(1,677,178
)


(13,851,064
)


25,704,538



41,469,998Add: Amortization of discount and interest on notes payable related to bridge loan


6,401,975



3,244,434



-



-



-Add: Stock-based compensation cost for incentive shares


-



17,000,000



39,240,000



-



95,338Add: Stock-based compensation cost for options


-



84,473



319,026



524,076



456,628Non-GAAP net income attributable to Hollysys


19,486,726



18,651,729



25,707,962



26,228,614



42,021,964Weighted average ordinary shares


22,200,000



37,658,437



44,950,883



51,243,667



54,564,842Weighted average number of diluted ordinary shares


22,883,836



38,664,032



50,015,536



51,838,294



54,949,280Non-GAAP basic earnings per share


0.88



0.50



0.57



0.51



0.77Non-GAAP diluted earnings per share


0.85



0.48



0.51



0.51



0.76





Exchange Rate Information





A majority of our business is conducted in China. We use U.S. dollars as our reporting currency in our financial statements and in this annual report. Monetary assets and liabilities denominated in Renminbi are translated into U.S. dollars at the rates of exchange as of the balance sheet date; equity accounts are translated at historical exchange rates and revenues, expenses, gains and losses are translated using the average rate for the year as published by the Federal Reserve Bank of New York. Translation adjustments are reported as cumulative translation adjustments and are shown as a separate component of other comprehensive income in the statement of changes in equity. Transactions and amounts in other parts of this annual report in Renminbi and other currencies are recorded at the rates of exchange prevailing when the transactions occurred. With respect to amounts not recorded in our consolidated financial statements included elsewhere in this annual report, all transactions from Renminbi into U.S. dollars and from U.S. dollars to Renminbi in this annual report on Form 20-F were made at a rate of RMB 6.4716 to $1.00, as set forth by the Federal Reserve Bank of New York. We make no representation that any Renminbi, U.S. dollar or other currency amounts could have been, or could be, converted into the other stated currencies at any particular rate, the rates stated below, or at all. The Chinese government imposes control over its foreign-currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On September 16, 2011, the closing buying rate was RMB 6.3833 to $1.00, as set forth by the Federal Reserve Bank of New York.





The following table sets forth information concerning exchange rates between the Renminbi 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 on Form 20-F or will use in the preparation of our periodic reports or any other information to be provided to you.





Exchange RatePeriod

Period End


Average


Low


High2006


7.8041



7.9579



8.0702



7.80412007


7.2946



7.5806



7.8127



7.29462008


6.8225



6.9193



7.2946



6.78002009


6.8259



6.8295



6.8470



6.81762010


6.6000



6.4356



6.7503



6.7861January 31, 2011


6.6017



6.5964



6.6364



6.5809February 28, 2011


6.5713



6.5761



6.5965



6.5520March 31, 2011


6.5483



6.5645



6.5743



6.5483April 29, 2011


6.5317



6.5382



6.5477



6.5310May 31, 2011


6.4786



6.4957



6.4786



6.5073June 30, 2011


6.4635



6.4746



6.4628



6.4830July 29, 2011


6.4360



6.4575



6.4360



6.4720August 29, 2011


6.3860



6.4072



6.3818



6.4401




3




B.  Capitalization and Indebtedness





Not applicable.





C.  Reasons for the Offer and Use of Proceeds





Not applicable.





D.  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, prospects, 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 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;


·
Expansion of manufacturing capacity; and


·
Acquiring technology through licensing and acquisitions.




4




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.





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 our 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, in part, on securing a steady stream of new customers.





Other than with our rail and nuclear plant customers, our average contract is worth approximately $150,000.  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.





Although we do not have a concentration of business with any customer at this time, recently our business has become more dependent on a few significant customers.





We have developed significant customer relationships with the subway providers of several locals and the Ministry of Railways in respect of the high speed train system in China. We expect that these relationships will continue to grow, and we will win more contracts with them over time. We also are expanding into the business of control systems for nuclear plants which may develop into a significant customer base in the future. To the extent that these customer groups or specific customers with a group represent an increasing proportion of our business, we will become more dependent on them for our revenues and business growth. In that case, our cash flow also will become more dependent on those customers’ payment practices and overall public funding policies, including the lengthening of collection times under performed contracts. Therefore, the loss of one or more of these customers or market groups as customers would have a material adverse impact on our revenues and our business operations and development.




5




We have a substantial backlog of contracts.





To date, our backlong has been a reflection of our ability to sell our products and services and increase our business.  This represents an amount of unrealized revenue to be earned from contracts secured by the Company.   Backlong, however, can also reflect our ability to perform our contracts on a timely basis.  Therefore, when evaluating our backlog, analysis should be made of whether or not it is a reflection of an expanding business, improving marketing and increasing acceptance of our products and services in the marketplace.





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





Among the competitive advantages and key business advantages that we enjoy are the plentiful supply of engineering talent in China and the comparatively lower cost of our engineering staff compared to those of our Western and Japan-based competitors. Recently, however, our costs of these persons has been subject to increased wage pressures due to the economic growth of China and certain inflationary pressures and additional employment related taxation.   If the available supply of engineers were to be absorbed by competing demands, or otherwise not as plentiful as we have experienced to date, 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.





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 88 PRC utility patents that relate to various product configurations and product components and 90 software copyrights and have 44 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.




6




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, subway  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 to industrial and manufacturing companies, our plans for growth include an increasing emphasis on railroad and subway 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 the 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 is unable to do so, our revenues and profits may not be as robust as anticipated, resulting in a decreased value of our stock.





To the extent that we devote more of our marketing and business capacities to these customers, our revenues and business development will be more dependent on our being able to service their needs.  To the extent that the nuclear industry and high speed railway in China may experience slowed growth, we would expect that there would be a slowing of our expansion into these business areas.




7




Although China is committed to expanding its energy production with nuclear power and building a high speed railway network, both these industries have experienced various setbacks due to higher than expected accidents due to natural disasters and operational error.  To the extent that the government slows their development and expansion within these two industries on which we are becoming more reliant, we may experience a slowing of our business growth due the inability to win contracts or our ability to win contracts for smaller amounts than previously experienced and anticipated.  If we are unable to generate the revenues that we seek and we are unable to replace the revenues in our traditional markets or other new markets, then we will likely experience slower growth or possibly even a reduction in revenues.





To the extent that our business is more dependent on large contracts and contracts from a few customers, our revenues, cash flow and profits will be influenced by this type of contracting and the timely payment for our products and services.





As we develop our business with the entities responsible for building municipal subway systems  and railroads we will be entering into contracts for larger sized projects than in the past for significantly greater value.  Therefore, our revenues, cash flow and profit will become increasingly dependent on our ability to perform these contracts and collect the payments due on a timely basis.  As many of the entities that are contracting with us are governmental authorities or ministries, our contracting and collections will become subject to these entities being able to adequately budget and have the revenues to timely pay for our products and services.  To some extent, we may become subject to delays and reductions in scope of project due to changes in the policies, objectives and budgeting of any of the public entities which control the projects on which we are contracting.





At this time, contracting with the entities that provide the subway and rail systems for which we provide control systems is similar to contracting with the customers we have sold to in the past.  Therefore, our contracts are written on a similar basis as before, and we expect that we will be operating under these contracts and accounting for their revenues in a similar manner as before.





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 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.




8




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 and Southeast Asia.  However, we have plans to further penetrate international markets in the near future, emphasizing Southeast Asia and the Middle East.  Our expansion is likely to use substantial resources, including substantial amounts of capital and equity and deploy 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 and market of surrounding countries, causing the operating results in our principal markets 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.”





Our control systems are used in infrastructure projects such as subway systems, surface railways and nuclear plants; to the extent that our systems do not perform as designed, we could be found responsible for the damage resulting from that failure.





We face potential responsibility for the failure of our control systems in performing the various functions for which they are designed and the damages resulting from any such problem.  To the extent that we contract to provide control systems in larger scale projects, the level of damages for which we may be held responsible is likely to increase.  To the extent that any of our installed control systems do not perform as designed for their intended purposes, and we are held responsible for the consequences of those performance failures and resulting damages, there may be an adverse impact on our business, business reputation, revenues and profits.  To date, we do not believe any of our control systems have not performed as designed and no claims to any significant degree have been asserted against us based on a non-performance event.  Notwithstanding our record, no assurance can be given that no claims will be sought in the future based on the design and performance of our control systems.




9




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





As directed by Section 404 of the Sarbanes-Oxley Act of 2002, 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 and the independent registered public accounting firm auditing a company’s financial statements to attest to and report on the operating effectiveness of such company’s internal controls.  Although our independent auditor has provided a positive attestation as of June 30, 2011, we can provide no assurance that we will comply with all of the requirements imposed thereby and we will receive a positive attestation from our independent auditors in the future.  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 initial 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, or the M&A Regulations, 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.




10




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 M&A 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.





We anticipate that the PRC will experience inflation in the near term, which may have an adverse effect on our cost of operations and profitability.





The PRC economy is experiencing  inflationary pressures in various ways due to a number of factors.  It is anticipated that all businesses within the PRC, including Hollysys, will experience increasing costs resulting from the pressure to increase wages, the imposition of new employment related taxation, the increase in interest rates, and the increase in the value of the Renmenbi, among other things.  If we are unable to increase the value of our contracts commensurate with increases in our operating expenses, we will experience a reduction in our profit margins.  If we raise our contract prices, we may not win the kind and amount of contracts that will permit us to operate profitably and grow our business.





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.




11




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 RMB 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 RMB. 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.





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.




12




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.





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 RMB.  The Chinese government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency out of China. RMB 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 RMB 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.




13




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 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.





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.




14




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





Almost all of our operations are conducted in China and most 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.





The implementation of the changes in the laws relating to PRC employment are likely to result in increased labor costs in China, which 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 time 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. On July 1. 2011, China promulgated the Social Insurance Law to unify pervious scattered laws relating to social insurance matters.  The new law clarifies that the social insurance system in China includes pension insurance, medical insurance, unemployment insurance, work-related injury insurance and maternity insurance, all of which are mandatory benefits for employees of companies operating in China.  Employers are required to make contributions under these insurance schemes, which although local in rates, are overall expected to increase employee expense over time. As a result of the new laws and regulations, our labor costs have increased and we anticipate that there will be increases these and similar costs in the future. There is no assurance that disputes, work stoppages or strikes will not arise in the future over these and other matters.  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.




15




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.





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 ordinary shares 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 ordinary shares 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;




16




·
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 automation and control 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.





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 ended June 30, 2011, 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.




17




We do not intend to pay dividends on our ordinary  shares for the foreseeable future.





We intend to retain any future earnings to fund the operation and expansion of our business and, therefore, we do not anticipate paying cash dividends on our ordinary shares in the foreseeable future.





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, our directors and officers are nationals and residents of countries other than the United States. The assets of these persons are located mostly 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.  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 BVI 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 ended June 30, 2011.  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, 2012 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.
 
 Our Shareholder Rights Plan and charter documents may hinder or prevent change of control transactions.
 
 Our shareholder rights plan and provisions contained in our Memorandum and Articles of Association may discourage transactions involving an actual or potential change in our ownership. In addition, our Memorandum and Articles of Association authorizes our board of directors to issue up to 90,000,000 shares of  preferred stock without any further action by the stockholders.  Please see Item 10, Additional Information for more information regarding our shareholder rights plan.  Such restrictions and issuances could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent our stockholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our ordinary shares, even if you or our other stockholders believe that such actions are in the best interests of us and our stockholders.
 
 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, a Delaware special purpose acquisition company, 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 ordinary shares 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 accounting and 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 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 focus on industrial automation and integrated solutions.
  19
 
 During the period from December 2007 to March 2008, we established a series of wholly owned subsidiaries, namely (i) Beijing Hollysys S&T, a Chinese domestic enterprise which acquired the original shareholders’ 74.11% equity interest in Beijing Hollysys; (ii) Beijing Helitong, a wholly foreign owned enterprise in China which acquired the original shareholders’ 100% equity interest in Beijing Hollysys S&T; (iii) World Hope, a Hong Kong company which acquired the original shareholders’ 100% equity interest in Beijing Helitong; (iv) Clear Mind, a BVI company which acquired the original shareholders’ 100% equity interest in World Hope.  Through this series of ownership arrangement, we 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 the 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 M&A Regulations.
 
 On July 1, 2009, the Company completed the acquisition of 1.78% equity interest in Beijing HollySys from the non-controlling interest holder for a consideration of RMB 18 million (approximately $2,638,793), and held 75.89% equity interest of Beijing HollySys upon the completion of the acquisition.
 
 On December 23, 2009, we entered into a share sale and purchase agreement, or the Share Purchase Agreement, with Unionway Resources Limited, a business company incorporated in the BVI, or the Seller, pursuant to which, among other things, the Company acquired 100% equity interest in Maypower Limited, a business company incorporated in the BVI and owned 24.11% of Beijing Hollysys.  As the consideration for the acquisition of the equity interest, we agreed to:
 
 1)         issue 4,413,948 ordinary shares, or the Shares, to the Seller, and
 
 2)         pay cash $9,917,062.5, or RMB 67,634,366.25 to the Seller.
 
 The Shares were issued to the Seller and its designeee on March 16, 2010.  As a result of the acquisition of the equity interest, we indirectly own 100% of Beijing Hollysys.
 
 On September 1, 2009, Beijing Hollysys entered into an agreement with two equity owners of Beijing WoDeWeiYe to acquire 51% equity interest in of Beijing WoDeWeiYe for a cash consideration of RMB 2 million (approximately $294,477).  Upon the acquisition, Beijing WoDeWeiYe became a subsidiary of the Company, and the operating result of Beijing WoDeWeiYe was included in the Hollysys’s consolidated financial statements effective from September 1, 2009.  We acquired Beijing WoDeWeiYe to engage in the intelligent electric meter business and to further build up our foothold in subway automation sector.
 
 On June 4, 2010, Beijing Hollysys S&T invested RMB 10 million (approximately $1,464,536) to establish a wholly owned subsidiary, Beijing Hollysys Electronics, which engages in the business of automation equipment manufacturing and assembly.
 
 On June 4, 2010, Beijing Hollysys S&T invested RMB 5.10 million (approximately $746,913) to establish a subsidiary, Beijing Hollycon, which engages in the medical automation equipment manufacturing business.
 
 On March 9, 2011, Beijing Hollysys invested RMB 10 million (approximately $1,520,751) to establish a subsidiary, Xi’an Hollysys Co., Ltd, which engages in the research and development business.
 
 On  April 15, 2011, Beijing Hollysys S&T invested RMB 10 million (approximately $1,528,585) to establish a subsidiary, Hollysys (Beijing) Investment Co., Ltd., which engages in the investment management and consulting business.
  20
 
 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. Kiam Fee Yau, an ex-director of ours, 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. Limited,” or Singapore Hollysys.  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.
 
 On May 18, 2011, we entered into a stock purchase agreement with Concord Corporation Pte. Ltd., or Concord, a Singapore headquartered electrification related service provider to rail and industrials in South-East Asia and the Middle East, to acquire a 100% interest of Concord Corporation Pte. Ltd., Concord Electrical Pte. Ltd., and Concord Electrical Sdn. Bhd. incorporated in Malasia (Concord Group), for a combination of cash and stock valued at approximately $43.2 million . The cash portion of purchase price was paid in two equal installments of 20.75 million Singaporean dollars (approximately $16.9 million) each in May 2011 and July 2011 respectively. The deal was closed on July 1, 2011, and approximately one million ordinary shares of Hollysys with a value of approximately $9.4 million were issued in September 2011. As a result of the transaction, Concord and its related companies became our wholly owned subsidiaries and the operation results will be included in our consolidated financial statements, effective from July 1, 2011.
 
 B.  Business Overview
 
 We are a leading provider of automation and control technologies and applications in China that enable our diversified industry and utility customers to improve operating safety, reliability, and efficiency. Founded in 1993, we have approximately 3,100 employees with nationwide presence in over 40 cities in China and   subsidiaries and offices in Singapore and the Middle East.  We serve over 2000 customers in the industrial, railway, subway and nuclear industries in China, and South-East Asia. Our proprietary technologies are applied in the industrial automation solution suite, including the Distributed Control System (DCS), Programmable Logic Controller (PLC), RMIS, HAMS, OTS, and other products, high-speed railway signaling system of the Train Control Center (TCC) and Automatic Train Protection (ATP), and other products for surface railway networks, subway supervisory and control platform (SCADA), and nuclear conventional island automation and control system.
 
 We have historically focused our efforts in the area of 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, that are mainly used to control continuous manufacturing processes. Our DCS have been widely used in the industries involving continuous flow of material handling, such as power generation, petro-chemical, chemical, cement manufacturing, paper mills, and waste water recycling. We have also entered the PLC market, which is mainly used in discreet control applied to a wide array of industries. PLCs are usually integrated together into machines providing control at the machinery level. With more of our proprietary products introduced into the market and the behavioral change of customers’ purchasing practice, we gradually have changed our market and sales positioning from being a single DCS/PLC product provider, to being a total solution provider encompassing third-party hardware-centric products such as instrumentation and actuators, our proprietary DCS/PLC products, and valued-added software packages such as AMS (asset management system), MES (manufacturing execution system), APC (advanced process control system), OTS Simulation, RPO Control Optimization, and Remote Monitoring. The safety system, currently in development, is expected to be certified under European safety standards and will be introduced to the market in 2012, to further round out our proprietary product suite in the industrial automation segment.
  21
 
 We also branched out from the industrial automation domain into the subway and surface rail businesses, leveraging on our core competency and strong research and development capabilities, and have already established a leading position in the high-speed rail signaling market and subway SCADA (Surveillance Control and Data Acquisition) market. We also command a position in China’s nuclear automation and control market as the only proven local automation and control product provider to the conventional island of nuclear stations. Through our 50/50 joint venture with China Guangdong Nuclear Power Holdings Co., Ltd., China Techenergy Co., Ltd., we have access to all the nuclear reactors being contracted to our joint venture partner, which is currently holding roughly 60% of China’s nuclear market share.  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 2,000 industrial enterprise customers and have undertaken over 10,000 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.
 
 Our revenue increased from approximately $121.5 million in fiscal year 2008, to approximately $262.8 million in fiscal year 2011, representing a compounded annual growth rate (CAGR) of approximately 29% for the past three years.  During the same period, our non-GAAP net income increased by CAGR of 31%. 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 products and improving our profit margin through new business areas such as railway control systems and nuclear power plant control, while exploring international market to fulfill our mission of sustainable and high-growth.
 
 Strategy
 
 Our goal is to become one of the world's leading automation and control technology and product providers.  To meet this goal we plan to enhance the core competencies that have made us a leading domestic automation and control technology and application provider in China, the only Chinese company qualified to design and manufacture control systems for conventional island of nuclear power stations, and a leader in the industrial automation and in the high-speed rail and subway sectors. The principal elements of our core business strategies are as follows:
 
 ·
To further establish our leadership position as a dominant automation and control technology and application provider across all the addressable market segments–  We seek to  be a potential industry consolidator in China as a dominant leading provider of industrial automation and control technology and application for clients in various industries, by presenting ourselves as a more total solution provider and expanded sales force and network across the country.  We seek to further penetrate the high-speed rail and subway business with more proprietary products to enhance our leading position and market share. Since the majority of our customers operate in a wide range of industries, especially in the high-speed rail, subway, and nuclear sectors, we stand to be a prime beneficiary of China’s drive for environment protection, clean energy, lower carbon emission, national economic development model transformation from export oriented to domestic consumption oriented, and the rising labor cost due to demographic change in China. We plan to aggressively expand our business to fully exploit the anticipated growing demand for automation and control in areas favored by government policy and the macro trend, 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.
  22
 
 ·
To continuously enhance our leadership position in technology– We have long been recognized as a pioneer in the development of industrial automation and control technology and applications in China.  We are continuously seeking ways to improve our existing product lines while being committed to the development of new applications, platforms, and products. In order to maintain our leadership in technology, we have devoted and will continue to devote significant resources to the research and development that is undertaken by a group of highly trained and skilled engineers.  We plan to concentrate our research and development resources on our addressable market related technologies and products, and international market, including the 5thgeneration of proprietary DCS platform, subway signaling system, safety system for industrial automation, and high-speed rail products to complement our existing high-speed product portfolio.
 
 ·
To actively explore and prepare for international market expansion– Management is pursuing a strategy for Hollysys to have meaningful revenue generated from the international market and to become one of the leading automation and control players in the world. We made significant progress in this business objective through the acquisition of the Concord Group, headquartered in Singapore, through which we obtained a well-established distribution channel and customer/partner base to cross-sell our products in the rail and industrial automation segments and a seasoned management team to form the core of our future international team. Because the Ministry of Railways of China employs its own administrative admission system to allow or disallow use  of products and entry of system providers to supply the China’s national rail industry, our high-speed rail signaling products that are currently deployed in China’s high-speed rail lines have not needed and have not European safety standard certification, which is a prerequisite for the rail market outside of China. To satisfy international requirements, we plan on redesigning the whole set of our signal systems, based wholly on our own proprietary technologies, with the goal of obtaining full certification  by European organizations for the SIL 4 certification (Safety Level IV). The signaling system set includes the onboard ATP (automatic train protection) system with SIL 4 certification for high-speed rail and subway that are used to protect the train from travelling at excessive speeds, the ground based TCC (train control center) with SIL 4 certification for ground safety control of trains, the CBI (computer based interlocking) system with SIL 4 certification for both high speed rail and subways, the ATS (automatic train supervision) system with SIL 2 certification for metro ATC systems, and  other auxiliary interfacing products. Based on our own technologies, we are able to customize our system platforms to meet every level of requirements from conventional rail signaling systems to the most state-of-the-art, high-speed rail applications, not only for the Chinese market but also for the international market. We already have our proprietary ATP and LEU (line side unit) certified under SIL4 standards. Our current schedule is that most of the platform will be certified by the calendar 2011 year-end, and ATP for metro systems with ATO (automatic train operation) will be certified by the end of calendar year 2012.
 
 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.
  23
 
 Industrial Automation: Our principal offering is a comprehensive suite of automation systems for a wide spectrum of industrial market clientele, ranging from petrochemical, thermal power industries, to cement production and paper making industries. Our comprehensive suite of automation solution consists of third-party hardware-centric products such as instrumentation and actuators, our proprietary software-centric DCS/PLC, and valued-added software packages such as AMS (asset management system), MES (manufacturing execution system), APC (advanced process control system), OTS Simulation, RPO Control Optimization, and Remote Monitoring. The safety system or emergency shut-down system, currently in development, is expected to be certified under European safety standards and be introduced to the market in 2012, to further round out our proprietary product suite in the industrial automation segment. The two mainstream products for this market segment are our DCS products and our PLC.  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, and logistic tools.  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 central computer (brain) processes information and generates commands, based on sophisticated algorithmic 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.
 
 High-speed Rail:  Over the years, Hollysys has successfully scaled its automation application from industrial manufacturing to rail and subway industry, with proprietary product lines including, TCC (Train Control Center) and ATP (Automation Train Protection).  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 that information 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 or equipment 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, or wireless.
 
 Nuclear Automation and Control:  As the only proven domestic automation control systems provider to the nuclear power industry in China, we provide our HOLLiAS NMS product to China’s nuclear power industry.    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, conventional energy power plants, with much more sophisticated software and hardware specifications, and more stringent production and quality assurance process. Our nuclear joint venture China Techenergy Co., Ltd. has already successfully completed developing its proprietary nuclear island automation and control system, which is expected to be commercialized in 2012 or 2013, when the total automation and control for nuclear power stations will be fully localized for China.
 
 Subway Automation:  We have provided our SCADA system to China’s subway market for many years, including 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.
  24
 
 We establish a project group for each potential customer, which has a team of systems engineers and managers to provide 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;
  25
 
 ·
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
 
 ·
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 $1,400 million by 2010.  The chart below shows the forecast of the DCS market size in China.
 
 
  26
 
 Source: ARC Advisory Group
 
 We agree with ARC’s assessment that, “China, in contrast to most other countries, provides robust growth prospects for the 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.”
 
 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); Emerson (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 in 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.
 
 From 2000 to 2008, the global automation industry grew, as measured by revenue, by about 4.5%, according to a research report by J.P.Morgan. We believe China’s industrial automation growth rate is far greater than this world average growth rate, in which we see PLC enjoying a more healthy growth rate than DCS given its relative lower penetration rate and the rising cost of labor.  In the 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. To date, we have implemented over 8,000 projects, with over 2,000 customers.  The client 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, as well as Supcon from China.  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 promising end-market for Hollysys is the high-speed rail market in China, where we command a leading position in providing high-speed rail signaling systems to ensure the safety of passenger train movement. High-speed rail is a relatively new development in China.  The Ministry of Railways of China developed China national high-speed rail signaling technological standard, the China Train Control System, or the CTCS. Under the CTCS, the standard governing 200-250km/hour speed category is called C2, while C3 is governing the 300-350km/hour category.  These standards are different from the international standards propounded by European organizations or Japan. There are more than 8,000km of high-speed rail tracks in operation in China, with more than 17,000 km high-speed rail tracks in construction, according to the Ministry of Railways. The majority of operational high-speed lines are in 200-250km/hour, with only a few operational lines in 300-350km/hour, which include Beijing-Shanghai line, Wuhan-Guangzhou line, Zhengzhou-Xian line, Shanghai-Nanjing line, and Shanghai-Hangzhou line, of which the Zhengzhou-Xian line was supplied by Hollysys. We have also entered into contracts to provide signaling systems for another line in C3 category, the Guangzhou-Shenzhen line, which is under construction.
  27
 
 According to the official announcement from the Ministry of Railways, China is planning to have 45,000 kilometers of high-speed railways in operation by the end of 2015, with an estimated capital budget of approximately 2.8 trillion RMB, far increasing the current capacity of total high-speed railway kilometers of 11,345 kilometers operating in 16 countries around the world.  According to China’s Ministry of Railways, the China’s high-speed rail network will consist of artery lines and inter-city lines.   The artery lines are “the Four Horizontals and the Four Verticals” referring to their positions on the map of China.  The Four Vertical lines include the Beijing-Guangzhou line, Beijing–Shanghai line, Harbin-Dalian-Shenyang-Beijing line, and Shanghai-Hangzhou-Shenzhen line.  The Four Horizontal lines include the Lanzhou-Xian-Zhengzhou-Lianyungang line, Shanghai-Wuhan-Chongqing-Chengdu line, Hangzhou-Changsha-Kunming line, and Taiyuan-Shijiazhuang-Qingdao line.  The inter-city high-speed lines are mainly planned for economically well-developed regions with high densities of population, such as  Zhu Jiang River Delta (Guangzhou-Shenzhen region), Yangtze River Delta (Shanghai-Hangzhou region), and Beijing-Tianjin-Tangshan region.   As one of the three high-speed rail signaling products providers admitted by the Ministry of Railways in the C2 category, and one of the only two high-speed rail signaling products providers to the C3 segment, we believe that Hollysys is well positioned to benefit from this unprecedented, world leading high-speed railway build-out.
 
 We also provide our proprietary software platform and solutions of SCADA to subway market. China subway market is expected to receive significant government investment due to urbanization and environmental concerns. According to China’s Ministry of Housing and Urban-Rural Development, the 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. Leveraging on our know-how from high-speed surface rail signaling technology and our well-recognized brand name, we are developing our proprietary signaling products for the subway market, and hoping to replace foreign platforms currently dominating the China’s subway signaling market. We believe it will present a better value positioning to our subway customers by bundling our proprietary subway SCADA system with our proprietary signaling system, when we will see our market share and margin expansion.
 
 Nuclear Market
 
 We are 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 approximately 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 China’s commitment of reducing its carbon emission by 45% per GDP unit by 2020, China’s installed nuclear power generating capacity is expected to reach 100 GW by 2020. Approximately, it is believed that one nuclear reactor generates 1GW electricity. During the fiscal year 2010, we formed a 50/50 joint venture, China Techenergy Co., Ltd., with China’s leading nuclear station operator, China Guangdong Nuclear Power Holdings Co., Ltd., to provide its proprietary non-safety automation and control products to the nuclear stations constructed by China Guangdong Nuclear Power Holdings Corporation.  We believe this strategic alliance position us to be the dominant nuclear automation system provider in China. China Guangdong Nuclear Power Holdings Co., Ltd. currently has approximately 60% of China’s nuclear market share.
 
 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, 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, which is in essence a recurring revenue stream to us, even though it is not in the form of multiple-year contract.
  28
 
 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:
 
 ·
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.
 
 ·
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.
 
 ·
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.
 
 ·
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.
 
 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.
  29
 
 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 we will be held responsible for this delay, in accordance with the terms specified in the respective integrated contracts.
 
 Competition
 
 We compete with various domestic and international corporations offering automation systems to the Chinese industrial automation 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 in competition with us. We believe that our primary competitors in the industrial automation market for our products are multi-national corporations, such as ABB, Honeywell, Emerson and Siemens, and the local company Supcon, a private company affiliated with Zhengjiang University.
 
 In the high-speed rail business, as China’s Ministry of Railways employs an administrative admission system and China establishes its national rail technology standard, the China Train Control Standard (CTCS), we believe that competition from multi-national companies will decrease or be eliminated. Currently, Hollysys is one of only three entities granted admission to supply signaling products to China’s 200-250km/h segment of the high-speed rail market. The other two are the China Rail Signal & Communication Corp. (CRSC) and the China Academy of Railway Science. Hollysys is one of the only two permitted signaling product providers to China’s 300-350km/h segment of the high-speed rail market. The other provider is CRSC. In subway business and the SCADA market, we mainly compete with Nanjing Automation Research Institute (NARI). In nuclear automation segment, we mainly compete with multi-national corporations such as Siemens, Areva, and Invensys.
 
 When compared to our competitors, apart from satisfying certain China based criteria, we believe that our key competitive edge is the provision of better value for money to our customers with the following distinctive attributes:
 
 ·
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 is the lower cost of engineers in China relative to those in the Western nations. 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 our 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 our 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.
  30
 
 ·
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 includes the 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. With engineers included in the sales process, we provide the ability to understand from the beginning the needs of the customer and how to address their issues 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.
  31
 
 ·
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, the complexity has increased and it has become more difficult 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 making 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 benefit 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 not only creates the opportunity to generate additional revenue, but enables us to troubleshoot installations effectively, helps 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.
 
 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. 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.
 
 Seasonality
 
 Like many other Chinese companies operating in China, our businesses tends to be slower in the quarter that includes the month of March and tends to be to be stronger in the quarter that includes December due to Chinese New Year factor and the budgeting practice that is on calendar basis adopted by government agencies and most of Chinese private enterprises.
 
 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.
  32
 
 ·
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%.
 
 ·
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 loans, advances or 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, once allocated, 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 are subject to a withholding tax of 5%, whereas those from Hangzhou Hollysys are 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 teams 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.
  33
 
 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.
 
 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 our 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:
 
 ·
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 their costs and improve their operating efficiency.
 
 As of June 30, 2011, we employed 957 direct sales personnel who were assigned to three business areas: industrial automation, high-speed rail, and subway. Sales activities are mainly centralized at our Beijing headquarter for high-speed rail and subway segments, whereas sales activities for industrial automation are widely distributed across China in 40 cities. All sales staffs are responsible for implementing the sales policies established at our headquarters.
 
 C. 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 mainly through our Chinese operating companies, Beijing Hollysys, Hangzhou Hollysys and Hollysys Automation.
  34
 
 
 
 Our corporate headquarters are located at No. 2 Disheng Middle Road, Beijing Economic-Technological Development Area, Beijing, 100176, 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.
 
 D. Property, Plant and Equipment
 
 Since, late in 2010, our principal executive offices have been located at No. 2 Disheng Middle Road, Beijing Economic-Technological Development Area, Beijing, 100176, China. We own the land use rights to the properties 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. MetersBeijing

90,000Hangzhou

25,000
 
 At the facilities in the Beijing Economic-Technological Development Area, we have our purpose built space into which we located our personnel that had been previously dispersed throughout Beijing. This facility permitted us to double our production capacity immediately, and we have sufficient additional space to quadruple our production capacity if the production demand warrants it.
 
 The manufacturing facilities at the above locations are used for the system integration production, including hardware testing instruments, auxiliary material processing, packaging and shipping, and for self-made product integration production, including inspection and testing.
  35
 
 After we relocated our headquarters to the new facility in the Beijing Economic-Technological Development Area in August 2010, we developed a plan to dispose of the old headquarters. In order to carry out the plan with the best earnings opportunity, we acquired two of the floors in the old headquarters to which we did not have rights. Therefore, in the balance sheet as of June 30, 2011, we reclassified the old headquarters from property, plant and equipment to assets held for sale with aggregated carrying value of approximately $8.9 million representing the then carrying value and the additional acquisition cost of the two additional floors.
 
 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 obtain our automation system business is the bidding process.  Customers seeking bids propose their requirements and specifications in legal bidding documents and companies that are interested in obtaining these contracts make a bid in a 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 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 consist 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 30,2009


2010


2011Number of new contracts won during the year


1,194



1,800



2,401Total amount of new contracts (mm)

$
201.66


$
267.17


$
330.96Average price per contract

$
168,892


$
148,428


$
137,841
  36
 
 Years Ended June 30,Backlog :

2009


2010


2011Contracts newly entered and unfinished (mm)

$
115.52


$
145.91


$
146.92Contracts started in the prior year and unfinished (mm)

$
73.42


$
106.95


$
149.48Total amount of backlog (mm)

$
188.94


$
252.86


$
296.40
 
 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, 2011 was approximately $262.8 million, compared to approximately $174.1 million for the prior fiscal year, representing an increase of 51.0%, followed by a growth of 10.5% from approximately $157.5 million in fiscal 2009.
 
 Recent Developments
 
 On May 18, 2011, Hollysys entered into a stock purchase agreement (the “SPA”) to acquire 100% ownership of Concord Group, which is engaged in the provision of electrical works and infrastructure engineering services in South-East Asia and the Middle East. The total consideration of the acquisition, of approximately $43.2 million consisted of cash consideration of SGD$41.5 million (approximately $33.8 million), and 1,006,788 ordinary shares of Hollysys, valued at approximately $9.4 million.
 
 In addition, Hollysys is obligated to issue an aggregate of 1,510,181 ordinary shares (“Incentive Shares”) to the management of the Concord Group if the Concord Group’s net income equals or exceeds $10 million and $11.5 million for the fiscal years ending June 30, 2012 and 2013, respectively (“Targeted Net Income Threshold”), in accordance with the SPA. Hollysys will issue 50% of Incentive Shares on an all or none basis per year after the Targeted Net Income Threshold is achieved.
 
 On May 30, 2011, Hollysys paid SGD$20.75 million (equivalent to approximately $16,856,148) as an advance of the purchase price consideration for the acquisition of the Concord Group.
 
 On July 1, 2011, the closing conditions were met, and the acquisition of the Concord Group was completed. Hollysys then made the final cash payment of SGD$20.75 million (equivalent to approximately $17,008,274) on July 11, 2011. On September 6, 2011, 1,006,788 ordinary shares were issued as the balance of the purchase consideration due for the Concord Group.
 
 Through the acquisition, the Company seeks to expand the existing distribution and marketing channels to cross sell the Company’s existing product lines in rail and industrial segments to fast growing South-East Asia and the Middle East markets. The operating results of Concord Group will be included in the Company consolidated financial statements for the year ending June 30, 2012, and thereafter.
 
 Rights Plan
 
 On August 27, 2010, our Board of Directors adopted a Rights Plan, or the 2010 Rights Plan. In connection with the 2010 Rights Plan, the Board of Directors declared a dividend distribution of one “Right” for each outstanding ordinary share to shareholders of record at the close of business on August 27, 2010, effective as of September 27, 2010. Each Right entitles the shareholder to buy one share of the our Class A Preferred Stock at a price of $160.
  37
 
 The Rights will become exercisable if a person or group announces an acquisition of 20% or more of our outstanding ordinary shares, or announces commencement of a tender offer for 20% or more of the ordinary shares. In that event, the Rights permit shareholders, other than the acquiring person, to purchase our ordinary shares having a market value of twice the exercise price of the Rights, in lieu of the Class A Preferred Stock. In addition, in the event of certain business combinations, the Rights permit the purchase of the ordinary shares of an acquiring person at a 50% discount. Rights held by the acquiring person become null and void in each case. Unless terminated earlier by our Board of Directors, the 2010 Rights Plan will expire on September 27, 2020.
 
 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, 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.
 
 ·
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.
  38
 
 ·
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 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
 
 Our consolidated financial statements are impacted by the accounting policies used and the estimates, judgments, and assumptions made by management during their preparation. We base our estimates and judgments on our experience, our current knowledge (including terms of existing contracts), our beliefs of what could occur in the future, our observation of trends in the industry, information provided by our customers and information available from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
 We have identified the following accounting policies and estimates as those that we believe are most critical to our financial condition and results of operations and that require management’s most subjective and complex judgments in estimating the effect of inherent uncertainties: revenue recognition, warranty, allowance for doubtful accounts, impairment of long-lived assets, goodwill and impairment test, income taxes and share-based compensation expense.
 
 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.
  39
 
 In accordance with Accounting Standards Codification (“ASC”) 605-305 Revenue Recognition - Construction-Type and Production-Type Contracts 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.
 
 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.
 
 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.
 
 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 and subway 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.
  40
 
 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, 2010 and 2011, the balances of $7,065,816 and $11,351,985, respectively, 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 interest charge for late payments by its customers. The Company reviews the status of contracts periodically and decides 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 will set up a bad debt allowance for an individual customer if there is a deterioration of the customer’s credit worthiness 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, 2010 and 2011 were adequate.
 
 The allowance for doubtful debts for the years ended June 30, 2009, 2010 and 2011 were $1,145,770, $2,790,078, and $2,816,320, respectively.
 
 Impairment of Long-Lived Assets
 
 The Company adopts the provisions of ASC Topic 360 Property, Plant and Equipment, 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.
 
 The impairment loss on long-lived assets for the years ended June 30, 2009, 2010 and 2011 were nil, $715,246, and $23,711, respectively, which represented impairment loss on property, plant and equipment.
 
 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 ASC Topic 350 Intangibles - Goodwill and Other. If the fair value is less than its carrying value, an indication of goodwill impairment exists, then the carrying value of goodwill is written down, and an impairment loss is recognized for any excess of the carrying amount over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Fair value of the reporting unit is determined using a discounted cash flow analysis. For the years ended June 30, 2009, 2010 and 2011, there was an impairment loss of nil, $286,610, and nil, respectively. The carrying value of goodwill was nil as of June 30, 2010 and 2011.
  41
 
 Income Taxes
 
 The Company accounts for income taxes in accordance with ASC Topic 740 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 “Accounting for Uncertainty in Income Taxes” which included in ASC Topic 740 Income Taxes. It clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. It 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. It 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.
 
 Share-based Compensation
 
 The Company adopted ASC Topic 718 Compensation - Stock Compensation, which requires that share-based payment transactions with employees, such as share options and restricted shares, 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 January 2010, the FASB issued ASU No. 2010-06 Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements (“ASU No. 2010-06”). This pronouncement is an authoritative guidance to improve disclosures about fair value measurements. This guidance amends previous guidance on fair value measurements to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurement on a gross basis rather than on a net basis as currently required. This guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. ASU No. 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, which the Company adopted this statement as of July 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early adoption is permitted. ASU No. 2010-06 does not require disclosures for earlier periods presented for comparative purposes at initial adoption. Since ASU No. 2010-06 only requires additional disclosures, it will not have an impact on our financial position or results of operations.
 
 In December 2010, the FASB issued ASU No.2010-28, “Intangible-Goodwill and Other” (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts . This ASU requires that reporting units with zero or negative carrying amounts perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Management does not believe the adoption of this update will materially impact the Company's financial condition, results of operations and disclosures.
  42
 
 In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations. This ASU specifies that when financial statements are presented, the revenue and earnings of the combined entity should be disclosed as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 is effective for business combinations with acquisition dates on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. Adoption of ASU 2010-29 will affect our disclosures of material business combinations in future periods.
 
 In May 2011, the FASB issued ASU 2011-04 “Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. This pronouncement is an authoritative guidance to amend certain measurement and disclosure requirements related to fair value measurements to improve consistency with international reporting standards. This guidance is effective prospectively for public entities for interim and annual reporting periods beginning after December 15, 2011, with early adoption by public entities prohibited. The Company is currently evaluating this guidance, but does not expect its adoption will have a material effect on its consolidated financial statements.
 
 In June 2011, the FASB issued ASU 2011-05 “Comprehensive Income (Topic 220) Presentation of Comprehensive Income”. This pronouncement is an authoritative guidance on the presentation of comprehensive income that will require a company to present components of net income and other comprehensive income in one continuous statement or in two separate, but consecutive statements. There are no changes to the components that are recognized in net income or other comprehensive income under current GAAP. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, with early adoption permitted. The Company has elected to adopt this ASU 2011-05 early.
 
 Financial Position
 
 The following are some financial highlights for the fiscal year ended June 30, 2011:
 
 ·
Total assets increased by approximately $73.85 million, from approximately $384.73 million as of June 30, 2010, to approximately $458.58 million as of June 30, 2011.  The increase was mainly due to an increase of approximately $42.59 million in cost and estimated earnings in excess of billings and an increase of approximately $33.62 million in accounts receivable.
 
 ·
Accounts receivable at June 30, 2011, were approximately $98.0 million, an increase of approximately $33.62 million, or 52.2%, compared to approximately $64.38 million at June 30, 2010.  The increase was mainly due to our increased revenues.
 
 ·
Cost and estimated earnings in excess of billings as of June 30, 2011, were approximately $103.52 million compared to approximately $60.93 million as of June 30, 2010, representing an increase of approximately $42.59 million, or 69.9%. The increase was mainly attributable to the increase in total revenues.
  ·
Inventory increased by approximately $4.41 million, from approximately $23.55million as of June 30, 2010, to approximately $27.97 million as of June 30, 2011.  The increase was mainly due to an increase of approximately $1.95 million in raw materials, and an increase of approximately $1.95 million in finished goods.
  43







·
Property, plant and equipment decreased by approximately $5.59 million, from approximately $65.35 million as of June 30, 2010, to approximately $59.75 million as of June 30, 2011.  The decrease was mainly due to the reclassification of $8.95 million from property, plant and equipment to assets held for sale,  discussed below.





·
Assets held for sale increased by approximately $8.95 million, from nil as of June 30, 2010, to approximately $8.95 million as of June 30, 2011.  Upon the completion of the new facility in Beijing Yizhuang BDA, the Company relocated its headquarters to this new facility in August 2010, and intends to dispose the old headquarters in Beijing Xisanqi, which was comprised of a land use right and buildings, with an aggregate carrying amount of $8.95 million as of June 30, 2011.





·
Long-term investment increased by approximately $1.22 million, from 17.35 million as of June 30, 2010, to approximately $18.57 million as of June 30, 2011.  The increase was mainly due to the share of net gains the Company picked up from equity investee.





·
Total liabilities at June 30, 2011, were approximately $192.72 million, increasing by approximately $21.46 million, or 12.5%, compared to approximately $171.26 million at June 30, 2010. The increase in liabilities was mainly due to an increase of approximately $10.06 million in short-term bank loans, an increase of approximately $21.92 million in accounts payable, an increase of approximately $9.65 million in deferred revenues, a decrease of approximately $11.78 million in bond payable, and a decrease of approximately $10.68 million in construction cost payable.





·
Short-term loan increased by approximately $10.06 million, or 682.9%, from approximately $1.47 million at June 30, 2010, to approximately $11.53 million at June 30, 2011, mainly due to increased financing activities with local bank during fiscal 2011.





·
Deferred revenue increased by approximately $9.65 million, or 28.8%, from approximately $33.55 million at June 30, 2010, to approximately $43.20 million at June 30, 2011, mainly due to the increased advances received related to our industrial automation contracts we signed during fiscal 2011.





·
Bond payable decreased by approximately $11.78 million, or 100.0%, from approximately $11.78 million at June 30, 2010, to nil at June 30, 2011, as the outstanding long term bonds were fully repaid in December, 2010.





·
Construction cost payable decreased by approximately $10.68 million, or 85%, from approximately $12.56 million at June 30, 2010, to $1.88 million at June 30, 2011, mainly due to the Company successively making cash payments after the Yizhuang facility construction completion in August 2010.





A.
Operating Results





Comparison of Fiscal Years Ended June 30, 2011 and 2010





Operating Revenues:  For the fiscal year ended June 30, 2011, total revenues amounted to approximately $262.84 million, an increase of approximately $88.75 million, compared to approximately $174.09 million for the prior fiscal year, representing a significant increase of 51.0%.


44





Integrated contract revenue accounted for approximately $248.58 million of total revenues, an increase of approximately $84.46 million, or 51.5%, compared to approximately $164.12 million for the prior fiscal year.  The increase in revenues was mainly attributable to an increase of approximately $34.93 million in industrial automation projects and $55.25 million of revenues generated from rail automation & control business.





Approximately $14.27 million of total revenues related to product revenue, an increase of approximately $4.29 million, or 43.1%, compared to approximately $9.97 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 2011 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, 2011, amounted to approximately $296.40 million, representing an increase of approximately $43.5 million, or 17.2%, compared to approximately $252.86 million as of June 30, 2010.





Of the total backlog as of June 30, 2011, the unrecognized revenue associated with new contracts signed in the fiscal 2011 period was approximately $146.92 million and the carry forward amount of the outstanding contracts from the prior year was approximately $149.48 million.  The total backlog as of June 30, 2010 comprised of approximately $145.91 million from new contracts signed in fiscal year 2010, and approximately $106.95 million from contracts carried forward from prior year.





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 fiscal year ended June 30, 2011, the total cost of revenues amounted to approximately $171.71 million, an increase of approximately $57.78 million, or 50.7%, compared to approximately $113.94 million for the prior fiscal year.  The increase was due to an approximately $55.09 million increase in the cost of integrated contracts, and an approximately $2.69 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 approximately $165.35 million for the fiscal year ended June 30, 2011, compared to approximately $110.27 million for the prior fiscal year, representing an increase of approximately $55.09 million, or 50.0%.  The increase was primarily due to an increase of approximately $51.03 million in the cost of equipment and materials, and approximately $3.13 million in labor cost.  Of the total cost of integrated contract revenue, labor cost accounted for 5.3% for the fiscal 2011 period, compared to 5.1% for the prior fiscal year; cost of equipment and materials accounted for 81.5%, compared to 76.0% for the prior fiscal year; and other manufacturing expenses accounted for 13.2%, compared to 18.9% for the prior fiscal year.  Of the total integrated contract revenue, labor cost accounted for 3.5% for the 2011 period, compared to 3.8% for the prior fiscal year; cost of equipment and materials accounted for 53.8%, compared to 56.1% for the prior fiscal year; and other manufacturing expenses accounted for 8.7%, compared to 14.0% for the prior 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, 2011 was approximately $6.36 million, an increase of approximately $2.69 million, compared to approximately $3.67 million for the prior fiscal year.


45





Gross Margin:  For the fiscal year ended June 30, 2011, as a percentage of total revenues, the overall gross margin was 34.7%, compared 34.6% for the prior fiscal year.  The gross margin for integrated contracts was 33.5% for the year ended June 30, 2011, compared to 32.8% for the prior year.  The increase in gross margin for integrated contracts was due mainly to our different sales mix during the fiscal 2011 period.  The gross margin for products sold was 55.4% for the fiscal year ended June 30, 2011, compared to 63.2% 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 departments.  Selling expenses were approximately $20.45 million for the fiscal year ended June 30, 2011, an increase of 68.3%, or approximately $8.29 million, compared to approximately $12.15 million for the prior fiscal year, mainly due tothe Company’s expanded sales network and increased selling staffs.  As a percentage of total revenues, selling expenses accounted for 7.8% and 7.0% for the fiscal year ended June 30, 2011 and 2010, 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 approximately $16.67 million for the fiscal year ended June 30, 2011, representing an increase of approximately $2.78 million, or 19.8%, compared to approximately $13.91 million for the prior fiscal year, mainly due to increased labor cost. As a percentage of total revenues, G&A expenses were 6.1% and 7.7% for the fiscal year 2011 and 2010, respectively.




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, 2011, research and development expenses were approximately $20.1 million, compared to approximately $13.07 million for the prior fiscal year. The approximately $7.10million, or 54.0%, increase was mainly due to increased research and development activities during the 2011 period.  As a percentage of total revenues, research and development expenses were 7.7% and 7.5% for the fiscal years ended June 30, 2011 and 2010, respectively.





VAT Refunds and Government Subsidies:  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, 2011, VAT refunds were approximately $8.99 million, compared to approximately $8.97 million for the prior fiscal year, increased by approximately $0.02 million, or 0.2%.  As a percentage of total revenues, VAT refunds were 3.4% and 5.2% for the fiscal years ended June 30, 2011 and 2010, respectively.





The local governments in Beijing and Hangzhou also 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 approximately $1.82 million and approximately $2.56 million for the fiscal year ended June 30, 2011 and 2010, respectively, a decrease of approximately $0.74 million, or 28.9%.


46





Income from Operations:  Income from operations increased by approximately $12.14 million, from approximately $32.55 million for the fiscal year ended June 30, 2010, to approximately $ 44.69 million for the fiscal year ended June 30, 2011.  The increase in income from operations was primarily due to the increased revenue.





Gains on disposal of long term investments:  The gains on disposal of long term investment amounted to $1.4 million for fiscal year 2011, which was mainly contributed by the gain on disposal of 29% interest in Hollysys Information Technology Co. Ltd. which Hollysys will continue to own 20% after the transaction.





Dilution gain on share of an equity investee: The dilution gain on share of an equity investeewas $0.8 million for the year ended June 30, 2011, which was from a dilution of the equity interest in IPE Biotechnology Co., Ltd (hereafter “IPE”). In April 2011, a third party company injected $4.5 million to IPE, of which $0.9 million was recognized as the paid in capital, and the remaining $3.6 million was recognized as capital premium. As a result of this capital increment, Hollysys’ equity interest in IPE was diluted from 28.04% to 23.39%, and recognized a gain of $0.8 million from this dilution.





Interest Expenses, Net:  For the year ended June 30, 2011, net interest expenses increased by approximately $0.51 million, or 47.4%, from approximately $1.07 million for the prior year, to approximately $1.58 million for the current period.  As a percentage of total revenue, net interest expense accounted for 0.6% and 0.6% for the fiscal years ended June 30, 2011 and 2010, respectively.





Income Tax Expenses:  For the year ended June 30, 2011, the Company’s income tax expense was approximately $6.44 million for financial reporting purposes, a decrease of approximately $1.22 million, as compared to $7.66 million for the prior year.  In fiscal 2011, Hangzhou Hollysys declared a cash dividend of $26.9 million, of which $10. 8million was to be paid to Gifted Time Holdings Limited, a BVI company. According to the tax treaty between China and the BVI, the Company recognized a 10% withholding tax of $1.1 million. Excluding the withholding tax related to the dividends declaration for fiscal 2011, and a one-time tax expense of $4.45 million related to Hollysys group re-organization recorded in the prior year, the effective tax rate was 11.2% and 9.1% for the year ended June 30, 2011 and 2010, respectively.





Net income attributable to non-controlling interest:  The non-controlling interest of the Company includes other parties’ interests in each subsidiary.  For fiscal 2011 and 2010, the non-controlling interest is ownership interests of 49% in Beijing WodeWeiYe and Hollycon, respectively. The net loss attributable to non-controlling interest for the fiscal year ended June 30, 2011 was $5 thousand, a decrease of $1.86 million, from a net income of $1.85 million for the prior year, primarily due to the decrease in non-controlling interests after the acquisition of the remaining 24.11% interest of Beijing Hollysys by the Company during fiscal 2010.





Net income and Earnings per share attributable to Hollysys:  For the fiscal year ended June 30, 2011, net income attributable to Hollysys amounted to approximately $41.47 million or $0.75 per diluted share, an increase of approximately $15.77 million, or $0.25 per diluted share, as compared to approximately $25.70 million, or $0.50 per diluted share, for the prior year. Such increase was primarily due to an increase of approximately $30.97 million in gross profit.





Comparison of Fiscal Years Ended June 30, 2010 and 2009





Operating Revenues:  For the fiscal year ended June 30, 2010, total revenues amounted to approximately $174.09 million, an increase of approximately $16.59 million, compared to approximately $157.50 million for the prior fiscal year, representing a significant increase of 10.5%.


47





Integrated contract revenue accounted for approximately $164.12 million of total revenues, an increase of approximately $14.81 million, or 9.9%, compared to approximately $149.30 million for the prior fiscal year.  The increase in revenues was mainly attributable to an increase of approximately $12.71 million of revenues generated from the sale of our industrial automation products.





Approximately $9.97 million of total revenues related to product revenue, an increase of approximately $1.77 million, or 21.6%, compared to approximately $8.20 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 2010 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, 2010, amounted to approximately $252.86 million, representing an increase of approximately $63.92 million, or 33.83%, compared to approximately $188.94 million as of June 30, 2009.





Of the total backlog as of June 30, 2010, the unrecognized revenue associated with new contracts signed in the fiscal 2010 period was approximately $145.91 million and the carry forward amount of the outstanding contracts from the prior year was approximately $106.95 million.  The total backlog as of June 30, 2009 comprised of approximately $115.52 million from new contracts signed in fiscal year 2009, and approximately $73.42 million from contracts carried forward from prior year.





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 fiscal year ended June 30, 2010, the total cost of revenues amounted to approximately $113.94 million, an increase of approximately $11.01 million, or 10.70%, compared to approximately $102.92 million for the prior fiscal year.  The increase was due to an approximately $10.84 million increase in the cost of integrated contracts, and an approximately $0.17 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 approximately $110.27 million for the fiscal year ended June 30, 2010, compared to approximately $99.42 million for the prior fiscal year, representing an increase of approximately $10.84 million, or 10.9%.  The increase was primarily due to an increase of approximately $5.50 million in the cost of equipment and materials, and approximately $4.94 million in other manufacturing expenses. Labor cost accounted for 5.1% of the cost of integrated contract revenue for the fiscal 2010 period, compared to 4.8% for the prior fiscal year; cost of equipment and materials accounted for 76.0%, compared to 78.7% for the prior fiscal year; and other manufacturing expenses accounted for 18.9%, compared to 16.4% for the prior fiscal year. Labor cost accounted for 3.4%of the integrated contract revenue for the 2010 period, compared to 3.2% for the prior fiscal year.Cost of equipment and materials accounted for 51.0%, compared to 52.4% for the prior fiscal year.  Other manufacturing expenses accounted for 12.7%, compared to 10.9% for the prior 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, 2010 was approximately $3.67 million, an increase of approximately $0.17 million, compared to approximately $3.50 million for the prior fiscal year.


48





Gross Margin:  For the fiscal year ended June 30, 2010, as a percentage of total revenues, the overall gross margin was 34.6%, compared 34.7% for the prior fiscal year.  The gross margin for integrated contracts was 32.8% for the year ended June 30, 2010, compared to 33.4% for the prior year.  The decrease in gross margin for integrated contracts was due mainly to our different sales mix during the fiscal 2010 period.  The gross margin for products sold was 63.2% for the fiscal year ended June 30, 2010, compared to 57.3% 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 $12.15 million for the fiscal year ended June 30, 2010, an increase of 21.3%, or approximately $2.13 million, compared to approximately $10.02 million for the prior fiscal year, mainly due to the Company’s increased marketing activities.  As a percentage of total revenues, selling expenses accounted for 7.0% and 6.4% for the fiscal year ended June 30, 2010 and 2009, 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 approximately $13.91 million for the fiscal year ended June 30, 2010, representing an decrease of approximately $35.07 million, or 71.6%, compared to approximately $48.98 million for the prior fiscal year.  The decrease in general and administrative expenses was mainly due to a decrease of approximately $39.03 million in the stock compensation expense on the modification of earn-out shares and granted options, an increase of approximately $1.6 million in bad debt allowance, an increase of approximately $1.2 million in staff salaries and bonus, and an increase of approximately $0.7 million in provision for fixed assets. Excluding stock compensation expenses and option expenses, general and administrative expenses should be approximately $13.39 million and approximately $9.42 million, or 7.7% and 6.0% as a percentage to total revenues, for the fiscal years ended June 30, 2010 and 2009, respectively.





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 achieves or exceeds 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 ordinary shares 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 operations. 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 approximately $22.24 million was recorded in the statement of operations for the fiscal years ended June 30, 2009.





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, 2010, research and development expenses were approximately $13.07 million, compared to approximately $8.83 million for the prior fiscal year. The approximately $4.24 million, or 48.0%, increase was mainly due to increased research and development activities during the 2010 period.  As a percentage of total revenues, research and development expenses were 7.5% and 5.6% for the fiscal years ended June 30, 2010 and 2009, respectively.


49





VAT Refunds and Government Subsidies:  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, 2010, VAT refunds were approximately $8.97 million, compared to approximately $5.94 million for the prior fiscal year, increased by approximately $3.03 million, or 51.0%.  As a percentage of total revenues, VAT refunds were 5.2% and 3.8% for the fiscal years ended June 30, 2010 and 2009, respectively.





The local governments in Beijing and Hangzhou also 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 approximately $2.56 million and approximately $1.76 million for the fiscal year ended June 30, 2010 and 2009, respectively, an increase of approximately $0.80 million, or 45.3%.





Income (loss) from Operations:  Income from operations increased by approximately $38.10 million, from a loss of approximately $5.55 million for the fiscal year ended June 30, 2009, to an income of approximately $27.60 million for the fiscal year ended June 30, 2010.  The increase in income from operations was primarily due to the decrease in stock compensation expenses related to 2009 incentive share issuance and option grants.  Excluding stock compensation expenses, operating income as a percentage of total revenues for the fiscal year ended June 30, 2010 was approximately $33.07 million, or 19.0%, as compared to approximately $34.01 million, or 21.6% as a percentage of total revenues for the prior year, a decrease that was mainly due to the increase in research and development expenses.





Interest Expenses, Net:  For the year ended June 30, 2010, net interest expenses increased by approximately $0.12 million, or 12.2%, from approximately $0.95 million for the prior year, to approximately $1.07 million for the current period.  As a percentage of total revenue, net interest expense accounted for 0.6% and 0.6% for the fiscal years ended June 30, 2010 and 2009, respectively.





Income Tax Expenses:  For the year ended June 30, 2010, the Company’s income tax expense was approximately $7.66 million for financial reporting purposes, an increase of approximately $4.60 million, as compared to an income tax expense of approximately $3.06 million for the prior year.  The increase was mainly due to a one-time tax expense of $4.45 million related to Hollysys group re-organization as the follows:





·
In February 2010, Hollysys re-organized the group structure of its wholly owned PRC subsidiaries, or the Reorganization.  Before the Reorganization, Hangzhou Hollysys was 60% owned by Gifted Time and 40% by Beijing Hollysys. To minimize the tax expenses arising from the Reorganization, Hangzhou Hollysys declared dividends pay-out for all the retained earnings of Hangzhou Hollysys as of December 31, 2009 to reduce its fair market value, and then conducted the ownership transfer within Hollysys group, as illustrated in the diagram below. The one-time re-organization related tax expense of $4.45 million is consisted of $3.08 million of dividend pay-out withholding tax and $1.37 million of investment income tax;


50





·
On February 1, 2010, the board of directors of Hangzhou Hollysys adopted a resolution of declaring dividends of $75.25 million, among which $30.10 million was to be paid to Beijing Hollysys, and the remaining $45.15 million to Gifted Time.  Pursuant to China’s Corporate Income Tax Laws, domestic companies are required to withhold income tax on dividends pay-out to non-resident companies based on the earnings after January 1, 2008, $30.82 million out of $45.15 million dividends to Gifted Time falls into this category. According to the tax treaty between China and the BVI, 10% of $30.82 million was withheld by Hangzhou Hollysys;





·
On February 3, 2010, Beijing Hollysys S&T entered into a stock purchase agreement to purchase 20% and 40% ownership of Hangzhou Hollysys from Gifted Time and Beijing Hollysys, for RMB 24 million and RMB 48 million, respectively.  Hangzhou Hollysys’ fair market value was appraised at US$109.99 million by Hangzhou Lixin Assets Appraisal Company, which rendered investment taxable income of $3.43 million and $6.86 million for Gifted Time and Beijing Hollysys, respectively, among which $0.34 million was withheld as investment income tax for Gifted Time, and $1.03 million was accrued as investment income tax by Beijing Hollysys based on a 15% tax rate.  After the Reorganization, Hangzhou Hollysys has been 60% owned by Beijing Hollysys S&T and 40% owned by Gifted Time.











Net income attributable to non-controlling interest:  The non-controlling interest of the Company includes other parties’ interests in each subsidiary.  For fiscal 2010, the non-controlling interest is ownership interests of 49% in Beijing WodeWeiYe and Hollycon, respectively, as compared to 25.89%, 10.36% and 31.45% in Beijing Hollysys, Hangzhou Hollysys, and Beijing Haotong, respectively, for fiscal 2009. The decrease in non-controlling interest was mainly due to the acquisition of the remaining 24.11% interest of Beijing HollySys by the Company during the year. The net income attributable to non-controlling interest for the fiscal year ended June 30, 2010 was $1.85 million, a decrease of $3.34 million, or 64.3%, from $5.19 million for the prior year, primarily due to the decrease in non-controlling interests.





Net income (loss) and Earnings (loss) per share attributable to Hollysys:  For the fiscal year ended June 30, 2010, net income attributable to Hollysys amounted to approximately $25.70 million or $0.50 per diluted share, an increase of approximately $39.56 million, or $0.80 per diluted share, as compared to a net loss of approximately $13.85 million, or $(0.31) per diluted share, for the prior year.  Such increase was primarily due to an increase of approximately $5.60 million in gross profit, a decrease of approximately $39.56 million in stock compensation expenses related to incentive shares and granted options, and an increase of $4.60 million in income tax expenses..


51





B.  Liquidity and Capital Resources





We believe our working capital is sufficient to meet our present requirements. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. In the long-term, we intend to rely primarily on cash flow from operations and additional borrowings from banks to meet our anticipated cash needs. If our anticipated cash flow is insufficient to meet our requirements, we may also seek to sell additional equity, debt or equity-linked securities. We cannot assure you that any financing will be available in the amounts we need or on terms acceptable to us, if at all.





In line with the industry practice, we typically have a long receivable collection cycle. As a result, our cash provided by our operation in any given year may not be sufficient to fully meet our operating cash requirements in that year. We will use available financing means, including bank loans, to provide sufficient cash inflows to balance such timing differences in our cash flows





We estimate our liquidity needs for 2012 will be approximately $30 million, which will be primarily related to the repayment of bank borrowings and the cash payments for acquisition of Concord Group. Our future working capital requirements will depend on many factors, including, among others, the rate of our revenue growth, the timing and extent of expansion of our sales and marketing activities, the timing of introductions of new products and/or enhancements to existing products, and the timing and extent of expansion of our manufacturing capacity.





Our long-term liquidity needs will relate primarily to working capital to pay our suppliers, and third-party manufacturers, as well as any increases in manufacturing capacity or acquisitions of third party businesses that we may seek in the future. We expect to meet these requirements primarily through our current cash holdings, revolving short-term bank borrowings, as well as our cash flow from operations. We currently do not have any plan to incur significant capital expenditures in 2012 and for the foreseeable future beyond 2012.





Cash Flow and Working Capital





As of June 30, 2009, 2010 and 2011, we had approximately $128.89 million, $119.50 million and $90.67 million, respectively, in cash and cash equivalents. As of June 30, 2011, we had total assets of $458.58 million, of which cash amounted to $90.67 million, accounts receivable amounted to $98.0 million and inventories amounted to $27.97 million. While working capital was approximately $201.37 million, equity amounted to $265.87 million and our current ratio was approximately 2.25.





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, 2009, 2010 and 2011:





Cash Flow Item

Fiscal Years Ended June 30,2009


2010


2011Net cash (used in) provided by Operating activities

$
40,127,458


$
30,145,816


$
(1,793,491
)Net cash used in investing activities

$
(11,940,293
)

$
(21,478,441
)

$
(29,071,216
)Net cash provided by (used in) financing activities

$
35,882,189


$
(19,184,238
)

$
(2,760,031
)Effect of exchange rate changes on cash and cash  equivalents

$
562,754


$
1,136,142


$
4,791,852Net increase (decrease) in cash and cash equivalents

$
64,632,108


$
(9,380,721
)

$
(28,832,886
)Cash and cash equivalents,  beginning of year

$
64,250,558


$
128,882,666


$
119,501,945Cash and cash equivalents, end of year

$
128,882,666


$
119,501,945


$
90,669,059


52





Operating Activities





For the fiscal year ended June 30, 2011, net cash used in operating activities was approximately $1.79 million, compared to a net cash inflow of approximately $30.15 million for prior fiscal year 2010.





The net cash outflow of operating activities in fiscal year 2011 was primarily due to an increase in cost and estimated earnings in excess of billings of approximately $42.59 million, an increase in accounts receivable of approximately $30.23 million, and an increase of inventories of approximately $3.47 million, all of which were partially offset by the net income of approximately $41.47 million, an increase in deferred revenue of approximately $7.99 million, an increase in accruals and other payables of approximately $2.11 million, an increase of accounts payable of approximately $18.48 million. The company accounts receivable, together with the account of costs and estimated earnings in excess of billings, was adversely affected by MOR’s change of payment practice and payment process cycle, which was largely alleviated by company’s more aggressive cash collection from other customers. Overall, the company still demonstrated the trend of improvement in accounts receivable collection, evidenced by continuously shortened annual DSO during the past three years.





For the fiscal year ended June 30, 2010, net cash provided by operating activities was approximately $30.15 million, compared to approximately $40.13 million for prior fiscal year 2009.  The net cash inflow from operating activities in fiscal year 2010 was primarily due to the net income of approximately $27.56 million, an increase in deferred revenue of approximately $12.48 million, an increase in accruals and other payables of approximately $5.95 million, an increase of accounts payable of approximately $5.03 million, and an increase of $4.97 million in income tax payable, all of which were partially offset by an increase in cost and estimated earnings in excess of billings of approximately $10.19 million, an increase in accounts receivable of approximately $10.13 million, and an increase of inventories of approximately $6.0 million.





For the fiscal year ended June 30, 2009, net cash provided by operating activities was approximately $40.13 million, compared to net cash used in operating activities of approximately $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 approximately $5.31 million, an increase in accounts payable of approximately $13.06 million, an increase in tax payable of approximately $3.02 million, and the reconciling item in net income of approximately $39.56 million in stock compensation expenses, all of which were partially offset by an increase in cost and estimated earnings in excess of billings of approximately $8.3 million, an increase in amount due from related parties of approximately $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 the increase in revenues.





Investing Activities





For the fiscal years ended June 30, 2011 and 2010, net cash used in investing activities was approximately $29.07 million and approximately $21.48 million, respectively.





The net cash used in investing activities for the fiscal year 2011 consisted mainly of a cash outflow of approximately $16.86 million for prepayment for acquisition of Concord Group, a cash outflow of approximately $16.05 million for capital expenditure.


53





The net cash used in investing activities for the fiscal year 2010 consisted mainly of a cash outflow of approximately $20.92 million for the construction of our new facility.





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





Financing Activities





For fiscal year ended June 30, 2011, net cash used in financing activities was approximately $2.76 million, as compared to approximately $19.18 million for the prior year.





The net cash outflow for fiscal year 2011 is composed of a repayment of bonds payable of approximately $12.07 million, a repayment of short-term bank loans of approximately $5.9 million, a repayment of long-term bank loans of approximately $1.51 million, the proceeds of short-term loans of approximately $15.67 million, and proceeds from the exercise of options of approximately $1.07 million.





For fiscal year ended June 30, 2010, net cash used in financing activities was approximately $19.18 million, as compared to approximately $35.88 million cash provided by financing activities for the prior year. The net cash outflow for fiscal year 2010 is composed of a cash outflow of $10.37 million in the acquisition of equity interest from non-controlling interest, a repayment of short-term bank loans of approximately $4.40 million, a repayment of long-term bank loans of approximately $5.13 million, and a capital injection from non-controlling interest of $0.72 million.





For fiscal year ended June 30, 2009, the net cash inflow from financing activities primarily comprised proceeds of $36.81 million from a long-term bank loan relating to the then ongoing construction of our new headquarters facility.





In December 2007, Beijing Hollysys and three independent third parties entered into an agreement with the underwriters to issue bonds to institutional and public investors in the PRC with an aggregate principal amount of RMB 305 million. Pursuant to the agreements, Beijing Hollysys issued RMB 80 million (equivalent to $11.7 million) of bonds (collectively, the “Bond”) for the purpose of technology improvement and industrial implementation of certain technology. The Bond carried interest at a rate of 6.68% per annum, which was payable semi-annually and matured in December 2010. Related to the Bond, Beijing Zhongguancun Science and Technology Guaranty Co., Ltd.  undertook joint and several guarantee liabilities in full in favour of Beijing Hollysys. Concurrently, the China Development Bank  authorized its business department to undertake general guarantee liability in respect of the guarantee liabilities of Beijing Zhongguancun Science and Technology Guaranty Co., Ltd. The long term bond was fully repaid in December 2010.





On March 31, 2009, the Company entered into a seven-year bank loan for RMB 250 million from Industrial and Commercial Bank of China, which is due on March 30, 2016, with an annual interest rate of 6.44%. The borrowing was secured by a pledge of the new headquarters facility in Beijing, comprised of land and buildings with the aggregate carrying value of $39,302,147 and $37,789,950 as of June 30, 2010 and 2011, respectively. Principal amount of $1.5 million was due and repaid before June 30, 2011, and the scheduled principal payments for the outstanding balance on June 30, 2011 are as follows:





Year Ending June 30,2012

$
5,408,2452013


7,726,0652014


7,726,0652015


7,726,0652016


8,498,670$
37,085,110


54





C.  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 660 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;





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. Because part of our research and development efforts are paid for by government subsidies that aim to encourage research and development efforts of certain enterprises, the amount of our research and development spending shown on our financial statements (the total amount of spending less the amount of these subsidies) is only a portion of our total spending on research and development.  Our recent major research and development focuses include:


55





·
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, 2011, we held 90 software copyrights, 88 authorized patents, 44 patent applications and 26 registered trademarks.  Our earliest software copyrights will expire in 2048.  Our invention patents have terms of 20 years (with the first and the next issued patent expiring in 2020), and our utility patents and design patents have terms of 10 years (with the first and the next issued utility patent expiring in 2011 and the first and the next issued design patent due to expire in 2011 and 2016 respectively.)





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).





D.  Trend Information





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 fiscal year 2011 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.


56





E.  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.





F.  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, 2011.





Total


Less than 1 year


1-3 years


3-5 yearsShort-Term Bank Loans


11,809,804



11,809,804



-



-Long-Term Bank Loans


43,764,834



7,703,234



18,661,382



17,400,218Operating Lease Obligations


1,577,037



793,314



767,138



16,585Purchase Obligations


150,019,177



114,365,499



26,313,215



9,340,463Construction cost payable


1,882,872



1,882,872



-



-Amount due for acquisition of Concord


17,008,274



17,008,274



-



-Total


226,061,998



153,562,997



45,741,735



26,757,266





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, 2011.





Operating Lease Commitment





The Company leases premises under various operating leases.  Rental expenses under operating leases included in the consolidated statement of operations were $1,105,473, $1,002,666 and $1,053,907 for the years ended June 30, 2009, 2010 and 2011, respectively.





At June 30, 2011, the Company was obligated under operating leases requiring minimum rentals as follows:





Years Ending June 30,2012

$
793,3142013


681,8552014


85,2832015


13,2182016


3,367Total minimum lease payments

$
1,577,037





Purchase Commitment





As of June 30, 2011, the Company had approximately $150.0 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 obligations 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.


57





G.  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

PositionChangli Wang

48

Chief Executive Officer and ChairmanPeter Li

47

Chief Financial OfficerColin Sung

45

DirectorJerry Zhang

39

DirectorJianyun Chai

49

DirectorQingtai Chen

73

Director





Dr. Changli Wang has been our director and Chief Executive Officer since September 2007 and has been our Chairman since May 2010.  Since 1999, Dr. Wang has also been the Chief Executive Officer and Vice Chairman of our subsidiary, Beijing Hollysys.  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 served since November 2008, as an independent director and audit committee chairman for China Valves Technology, Inc. (NASDAQ: CVVT), a NASDAQ 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., a NASDAQ listed company (NASDAQ: YUII.PK) in the day-old broiler breeding business in China.  Prior to joining us, Mr. Li served as a Senior Advisor to Yucheng Technologies Ltd. ("Yucheng") (NASDAQ: YTEC), a leading IT service provider to banking industry in China, 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.





Mr. Colin Sung has been our director and the Chair of our Audit Committee since February 2008.  Mr. Sung became the CFO of Lighting the Box in  March 2011 in which position he is currently employed. He was the Deputy Chief Executive Officer and Chief Financial Officer of Linktone Ltd., the leading provider of wireless media, entertainment and communications services in China, between June 2009 and February 2011. Mr. Sung served as the President and CFO of China Cablecom, a U.S. public company that provides provider cable television services in China, between April 2008 and May 2009.  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.


58





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.





Dr. JianyunChaihas 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. QingtaiChenhas 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.





10b5-1 Trading Plans





Our Insider Trading Policy allows directors, officers and other employees covered under the policy to establish, under limited circumstances contemplated by Rule 10b5-1 under the Securities Exchange Act of 1934, written programs that permit automatic trading of our stock or trading of our stock by an independent person (such as an investment bank) who is not aware of material inside information at the time of the trade. From time to time, certain of our directors, executive officers and employees have adopted Rule 10b5-1 trading plans.  Currently, three of our officers and directors have entered into purchase plans under Rule 10b5-1.


59





B.  Compensation





Executive Compensation





The aggregate cash compensation paid to our executive officers as a group was $496,330 for the fiscal year ended June 30, 2011.  We did not grant 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 the fiscal year ended June 30, 2011.





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 granted to each of the independent directors an option to purchase a certain amount of shares of the Company’s ordinary shares, 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 ordinary shares, Jerry Zhang for the purchase of 36,000 shares of our ordinary shares and each of Dr. Jianyun Chai and Mr. Qingtai Chen for the purchase of 30,000 shares of our ordinary shares. Besides, we grant to each of the independent director restricted shares, which vest in equal installments on a quarterly basis over a three-year period beginning on the grant date.  Specifically, we granted 22,500 restricted shares to Colin Sun, and 15,000 to each of Jerry Zhang, Jianyun Chai and Qingtai Chen.





For the fiscal year ended June 30, 2011, the aggregate cash compensation paid to our directors as a group was approximately $132,000.





2006 Stock Plan





On September 7, 2007, our stockholders approved the 2006 Stock Plan, or the Plan.  The Plan was assumed by us as of the closing of the merger of Chardan with and into us.  The Plan reserves 3,000,000 ordinary shares for issuance in accordance with the Plan’s terms.  A description of the  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.  The table below sets forth the options and the restricted shares granted to our current and former directors and executive officers pursuant to the Plan:





Options:


Name

Number of Ordinary Shares

Issuable upon Exercise of

Options


Exercise Price

per Ordinary Share

Date of Grant

Date of

ExpirationJerry Zhang


3,000


$
7.9

1/1/2008

1/1/2018Yau Kiam Fee


30,000


$
7.9

1/1/2008

1/1/2018Colin Sung


45,000


$
7.9

1/1/2008

1/1/2018Jianyun Chai


30,000


$
5.85

6/2/2008

6/2/2018Qingtai Chen


30,000


$
5.85

6/2/2008

6/2/2018Peter Li


300,000


$
2.24

1/20/2009

1/20/2019




The options vest quarterly over a period of 3 years from their respective grant date.


60




Restricted shares:


Name

Number of Restricted

Shares Issued

Date of GrantJerry Zhang


15,000

1/1/2011Colin Sung


22,500

2/1/2011Jianyun Chai


15,000

6/2/2011Qingtai Chen


15,000

6/2/2011





The restricted shares vest quarterly over a period of 3 years from their respective grant date.





Employment Agreements





We entered into a three-year employment agreement with our Chief Executive Officer, Dr. Changli Wang on June 6, 2010.  Dr. Wang is entitled to insurance benefits, five weeks vacation, a car and reimbursement of business expenses and, if necessary, relocation expenses.  The agreement is terminable by us for death, disability and cause.  Dr. Wang may terminate the employment agreement for good reason, which includes our 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 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.





C.  Board Practices





Terms of Directors and Executive Officers





Our board consists of five 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, 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.


61





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


62





·
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:





·
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.


63


D.  Employees





We had 3,106, 2,185 and 1,736 employees as of June 30, 2011, 2010 and 2009, respectively.  Substantially all of our employees are located in China.  The following table sets forth our employees as of June 30, 2011 based on their functional area within the Company:





Category

Number of EmployeesSales & Marketing


957Research and development


807Engineering


637Production


349Management


356Total


3,106





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.





E.  Share Ownership





The following table sets forth information, as of September 16, 2011, 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 table does not include any preferred shares or ordinary shares that may be issued under the rights plan of the company. The address of each of the persons set forth below is in care of Hollysys Automation Technologies Ltd., No. 2 Disheng Middle Road, Beijing Economic-Technological Development Area, Beijing, P. R. China 100176.





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 Chairman

Ordinary Shares


8,935,840
(3)


16.44
%Peter Li

Chief Financial Officer

Ordinary Shares


300,000
(4)


*Colin Sung

Director

Ordinary Shares


45,000
(5)


*Jerry Zhang

Director

Ordinary Shares


36,000
(6)


*Qingtai Chen

Director

Ordinary Shares


30,000
(7)


*Jianyun Chai

Director

Ordinary Shares


30,000
(8)


*An Luo

Vice President

Ordinary Shares


6,057,303
(9)


11.14
%All officers and directors as a group (6 persons named above)



Ordinary Shares


15,424,143



28.38
%(12)5% Securities HolderChangli Wang

CEO and Chairman

Ordinary Shares


8,935,840
(3)


16.44
%Plus View Investments Limited



Ordinary Shares


6,057,303
(9)


11.14
%Li Qiao



Ordinary Shares


3,807,516
(10)


7.00
%Unionway Resources Limited



Ordinary Shares


4,113,948
(11)


7.57
%Wenfu Wang



Ordinary Shares


4,113,948
(11)


7.57
%All persons named above as a group



Ordinary Shares


27,210,483



50,04
%


64





* 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 55,698,917 shares of our ordinary shares as of September 16, 2011 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 4,144,223 shares of our ordinary shares held indirectly through Ace Lead Profits Limited, 681,471 shares held indirectly through Billion Bright International Limited, 1,362,942 shares held indirectly through Excellent Link Enterprises Limited, 681,471 held indirectly through Golden Result Enterprises Limited, 1,000,000 held indirectly through Long Result Limited and 1,063,733 held indirectly through Sure Grow Profits Limited.  The foregoing entities are all BVI 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 Mr. Li include options to purchase 300,000 ordinary shares that are vested or are to be vested within 60 days from the date hereof.





(5)
The securities reported as held by Mr. Sung include options to purchase 45,000 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. Zhang include options to purchase 36,000 ordinary shares that are vested or are to be vested within 60 days from the date hereof.





(7)
The securities reported as held by Mr. Chen include options to purchase 25,000 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. Chai include options to purchase 25,000 ordinary shares that are vested or are to be vested within 60 days from the date hereof.





(9)
The securities reported as held by An Luo represent 6,057,303 ordinary shares held by Plus View Investments Limited, 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.





(10)
The securities reported as held by Ms. Qiao represent 935,844 ordinary shares held by Faith Best Profits Limited, 717,918 shares held by OSCAF International Company Limited, 717,918 shares held by Glory Pearl International Limited, 717,918 shares held by Jumbo Growth International Limited, and 717,918 shares held by Pearl Success Investments Limited.  The foregoing entities are all BVI entities that are wholly-owned and controlled by Ms. Qiao. Therefore Ms. Qiao may be deemed to be the beneficial owner of the ordinary shares held by them.





(11)
Unionway Resources Limited is controlled by Mr. Wenfu Wang and therefore, Mr. Wang may be deemed to be the beneficial owner of the ordinary shares held by Unionway Resources 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.


65





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





Related Party Relationships





Name of Related Parties

Relationship with the CompanyHollysys Information

20% owned by Beijing HollySysNew Huake Electronic Technology Co., Ltd. (“New Huake”)

37.5% owned by Beijing HollySysChina Techenergy Co., Ltd. (“China Techenergy”)

50% owned by Beijing HollySysIPE

23.39%owned by Beijing HollySysHollysys Electric Tech Co., Ltd. (“Hollysys Electric Tech”)

40% owned by Beijing HollySysHollysys Equipment Technology Co., Ltd. (“Hollysys Equipment”)

20% owned by Beijing HollySysZhejiang Sanxin  Engineering Co., Ltd (“Zhejiang Sanxin”)

6% owned by Hangzhou HollySys





Due from Related Parties


June 30,2010


2011Hollysys Information

$
998,113


$
1,333,534China Techenergy


9,749,715



10,837,123Hollysys Electric Tech


9,234



-Hollysys Equipment


4,565



4,790Zhejiang Sanxin


3,201



-$
10,764,828


$
12,175,447





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 30,2010


2011Hollysys Information


1,853,162



2,725,059New Huake


73,191



58,203Hollysys Equipment Technology Co. Ltd.


1,696



1,780Beijing Techenergy Co., Ltd


673,966



536,125Hollysys Electric Tech Co., Ltd


8,584



17,396$
2,610,599


$
3,338,563


66





Purchases and Sales with Related Parties





Purchases of goods and servicesYear Ended June 30,2009


2010


2011Hollysys Electric Tech

$
24,709


$
41,757


$
34,085Beijing Techenergy


1,531,058



70,368



-Hollysys Information


728,897



4,857,416



2,151,391New Huake


431,693



493,203



879,111$
2,716,357


$
5,462,744


$
3,064,587


Purchase of buildingsYear Ended June 30,2009


2010


2011Hollysys Information

$
-


$
-


$
3,608,675
 
 Lease ExpensesYear Ended June 30,2009


2010


2011Hollysys Information

$
-


$
32,069


$
-





Sales


Year Ended June 30,2009


2010


2011HollySys Electric Tech

$
13,865


$
11,038


$
13,478Beijing Techenergy


5,721,797



4,189,366



3,557,125Hollysys Information


920,333



2,184,844



727,460Zhejiang Sanxin


-



8,337



-Hollysys Equipment


30,794



1,385



-$
6,686,789


$
6,394,970


$
4,298,063





Lease IncomeYear Ended June 30,2009


2010


2011Beijing Techenergy

$
27,835


$
-


$
-Hollysys Equipment


3,351



-



-$
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.





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.


67





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.





Notwithstanding the understanding that earnings will be accumulated, our ability to pay dividends depends substantially on the receipt of dividends to us by our PRC subsidiaries. Each of our PRC subsidiaries may pay dividends only out of its accumulated distributable profits, if any, determined in accordance with its articles of association and the accounting standards and regulations in China.  Pursuant to applicable PRC laws and regulations, 10% of after-tax profits of each of our consolidated PRC entities is required to be set aside in a statutory surplus reserve fund annually until the reserve balance reaches 50% of such PRC entity’s registered capital. Allocations from these statutory surplus reserves may only be used for specific purposes and are not distributable to us in the form of loans, advances, or cash dividends.





Under the New EIT Law and its implementation rules issued by the PRC State Council, both of which became effective on January 1, 2008, dividends from our PRC subsidiaries to us may be subject to a withholding tax at the rate of 10% if the dividend is derived from profits generated after January 1, 2008. If we are deemed to be a PRC resident enterprise, the withholding tax may be exempted, but in such a case we will be subject to a 25% tax on our global income, and our non-PRC investors may be subject to PRC income tax withholding.  For a more detailed discussion of the New EIT Law, see Item 10- Additional Information, Subpart E, Taxation in China of this Form 20-F Report.





Because we do not anticipate that dividends will be paid in the future, the above limitations and taxes are not considered to have any current effect on the company.





B. Significant Changes





On May 18, 2011, the Company entered into a stock purchase agreement (the “SPA”) to acquire 100% ownership of the Concord Group which is engaged in the provision of electrical works and infrastructure engineering services in South-East Asia and the Middle East. The total consideration of the acquisition consisted of cash consideration of SGD$41.5 million (approximately $33,864,422), and 1,006,788 ordinary shares  of the Company.


68


In addition, the Company is obligated to issue an aggregate of 1,510,181 ordinary shares  of the Company (“Incentive Shares”) to the management of the Concord Group  if the Concord Group’s net income equals or exceeds $10 million and $11.5 million for the fiscal years ending June 30, 2012 and 2013, respectively (“Targeted Net Income Threshold”), in accordance with the SPA. The Company shall issue 50% of Incentive Shares to the management of the Concord Group on an all or none basis per year when the Targeted Net Income Threshold was achieved.





On May 30, 2011, the Company paid SGD$20.75 million (equivalent to approximately $16,856,148) as an advance of purchase price consideration for the acquisition of the Concord Group.





On July 1, 2011, the closing conditions were met, and the acquisition of the Concord Group was completed. The Company made the final cash payment of SGD$20.75 million (equivalent to approximately $17,008,274) on July 11, 2011. On September 6, 2011, 1,006,788 ordinary shares were issued as the balance of the purchase consideration due for the Concord Group.





Through the acquisition, the Company seeks to expand the existing distribution and marketing channels to cross sell the Company’s existing product lines in rail and industrial segments to fast growing South-East Asia and the Middle East markets. The operating results of Concord Group will be included in the Company consolidated financial statement for the year ending June 30, 2012, and thereafter.





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/ordinary shares, 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 Prices(3)Year 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 3June 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


$
2.03Year 2010


N/A



N/A



N/A



N/A



N/A



N/A


$
13.09


$
5.52Year 2011


N/A



N/A



N/A



N/A



N/A



N/A


$Quarterly Market PricesFirst Quarter 2010 ended September 30, 2009


N/A



N/A



N/A



N/A



N/A



N/A


$
9.97


$
5.52Second Quarter 2010 ended December 31, 2009


N/A



N/A



N/A



N/A



N/A



N/A


$
13.09


$
8.62Third Quarter 2010 ended March 31, 2010


N/A



N/A



N/A



N/A



N/A



N/A


$
12.54


$
9.69Fourth Quarter 2010 ended June 30, 2010


N/A



N/A



N/A



N/A



N/A



N/A


$
12.62


$
8.43First Quarter 2011 ended September 30, 2010


N/A



N/A



N/A



N/A



N/A



N/A


$
11.19


$
8.33Second Quarter 2011 ended December 31, 2010


N/A



N/A



N/A



N/A



N/A



N/A


$
15.99


$
11.03Third Quarter 2011 ended March 31, 2011


N/A



N/A



N/A



N/A



N/A



N/A


$
18.15


$
11.56Fourth Quarter 2011 ended June 30, 2011


N/A



N/A



N/A



N/A



N/A



N/A


$
14.41


$
7.59First Quarter 2012 ended September 30, 2011


N/A



N/A



N/A



N/A



N/A



N/A


$



$Monthly Market PricesMarch 2011


N/A



N/A



N/A



N/A



N/A



N/A


$
15.23


$
11.56April 2011


N/A



N/A



N/A



N/A



N/A



N/A


$
14.41


$
11.25May 2011


N/A



N/A



N/A



N/A



N/A



N/A


$
10.06


$
7.68June 2011


N/A



N/A



N/A



N/A



N/A



N/A


$
11.30


$
7.59July 2011


N/A



N/A



N/A



N/A



N/A



N/A


$
11.54


$
6.93August 2011


N/A



N/A



N/A



N/A



N/A



N/A


$
7.22


$
4.54September 2011(through September 20, 2011)


N/A



N/A



N/A



N/A



N/A



N/A


$
7.50


$
5.39


69








(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.  The above table sets forth the range of high and low closing prices per share of our ordinary shares as reported by www.quotemedia.com for the periods indicated.





(3) All periods end June 30 of the stated year, unless otherwise noted.





There were  11,500,000 public warrants issued in connection with our August 2005 initial public offering.  Each warrant entitled the holder to purchase one ordinary share 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.





In addition, in connection with the initial public offering, we issued a unit purchase option to the representative of the underwriters, or the UPO.  The UPO was exercisable for 250,000 units, comprised of 250,000 of our ordinary shares and 500,000 warrants, each warrant to purchase one ordinary share.  The part of the UPO relating to the underlying warrants expired in 2009 pursuant to the terms of the UPO.  In April 2010, the holders of the UPO exercised the UPO, on a cashless basis, and we issued an aggregate of 92,567 ordinary shares to them, in full satisfaction of the UPO.





During the period from December 2010 to February 2011, a total of 243,000 options were exercised by the option holders, of which 150,000 and 93,000 options were exercised at a price of $2.24 and $7.90, respectively. The company issued an aggregate of 243,000 ordinary shares.





B. Plan of Distribution





Not applicable





C. Markets





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





D. Selling Shareholders





Not Applicable





E. Dilution





Not Applicable


70





F. Expenses of Issue





Not Applicable





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 filed a Certificate of Change of Name to change its name from HLS Systems International, Inc. to Hollysys Automation Technologies Ltd. on July 17, 2009.  The Company’s memorandum of association authorizes the issuance of up to 100,000,000 ordinary shares of $0.001 par value, and (ii) 90,000,000 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.





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.





Directors may only be removed for cause by the shareholders.


71





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.





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.


72





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.





Change in Control of Company





While directors of the Company may be appointed by the members or directors for such terms as may be determined at the time of such appointment, and may be removed by resolution of directors with or without cause, directors may not be removed by the members except for cause.





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.


73





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.





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.


74





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





On August 27, 2010, our Board of Directors adopted the 2010 Rights Plan.  In connection with the 2010 Rights Plan, the Board of Directors declared a dividend distribution of one “Right” for each outstanding ordinary share to shareholders of record at the close of business on August 27, 2010, effective as of September 27, 2010.  Each Right entitles the shareholder to buy one share of the our Class A Preferred Stock at a price of $160.  Unless terminated earlier by our Board of Directors, the 2010 Rights Plan will expire on September 27, 2020.





Initially, the Rights will be attached to all certificates representing ordinary shares then outstanding, and no separate Rights certificates or stock statements will be distributed or provided.  The Rights will separate from the ordinary shares and become exercisable if a person or group announces an acquisition of 20% or more of our outstanding ordinary shares, or announces commencement of a tender offer for 20% or more of the ordinary shares.  In that event, the Rights permit shareholders, other than the acquiring person, to purchase our ordinary shares having a market value of twice the exercise price of the Rights, in lieu of the Class A Preferred Stock.  In addition, in the event of certain business combinations, the Rights permit the purchase of the ordinary shares of an acquiring person at a 50% discount.  Rights held by the acquiring person become null and void in each case.





The 2010 Rights Plan is designed to ensure that all of our shareholders receive fair and equal treatment in the event of any proposed takeover of us and to guard against partial tender offers, open market accumulations and other abusive or coercive tactics to gain control of us without paying all shareholders a control premium.  The Rights will cause substantial dilution to a person or group that acquires 20% or more of our stock on terms not approved by the our Board of Directors, but the Rights should not interfere with any merger or other business combination approved by the Board of Directors at any time prior to the first date that a person or group has become an acquiring person.





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.


75





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.





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.


76





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.





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.


77





C. Material Contracts





Except for the following, 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 elsewhere in this annual report.





On December 23, 2009, we entered into the Share Purchase Agreement with Unionway Resources Limited, a business company incorporated in the BVI, or the Seller, pursuant to which, among other things, we acquired 100% equity interest in Maypower Limited, a business company incorporated in the BVI and owned 24.11% of Beijing Hollysys, from the Seller.  As the consideration for the acquisition of the equity interest, we agreed to:





1)
issue 4,413,948 ordinary shares, or the Shares, to the Seller, and





2)
pay cash US$9,917,062.5, or RMB 67,634,366.25 to the Seller.





The Shares were issued to the Seller and its designeee on March 16, 2010.  As a result of the acquisition of the equity interest, we indirectly own 100% of Beijing Hollysys.





On May 18, 2011, the Company entered into a stock purchase agreement (the “SPA”) to acquire 100% ownership of Concord Group which is engaged in the provision of electrical works and infrastructure engineering services in South East Asia and the Middle East. The total consideration of the acquisition consisted of cash consideration of SGD$41.5 million (approximately $33,864,422), and 1,006,788 ordinary shares of the Company.


78





In addition, the Company is obligated to issue an aggregate of 1,510,181 ordinary shares  of the Company (“Incentive Shares”) to the management of the Concord Group, if the Concord Group’s net income equals or exceeds $10 million and $11.5 million for the fiscal years ending June 30, 2012 and 2013, respectively (“Targeted Net Income Threshold”), in accordance with the SPA. The Company shall issue 50% of Incentive Shares to the management of the Concord Group on an all or none basis per year when the Targeted Net Income Threshold is achieved.





On May 30, 2011, the Company paid SGD$20.75 million (equivalent to approximately $16,856,148) as an advance of purchase price consideration for the acquisition of the Concord Group.





On July 1, 2011, the closing conditions were met and the acquisition of the Concord Group was completed. The Company made the final cash payment of SGD$20.75 million (equivalent to approximately $17,008,274) on July 11, 2011. On September 6, 2011, 1,006,788 ordinary shares were issued as the balance of the purchase consideration due for the Concord Group.





Through the acquisition, the Company seeks to expand the existing distribution and marketing channels to cross sell the Company’s existing product lines in rail and industrial segments to fast growing South-East Asia and the Middle East markets. The operating results of Concord Group will be included in the Company consolidated financial statement for the year ending June 30, 2012 and thereafter.





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.





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.


79





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 aresubject 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.


80





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.


81





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, 2011.  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.


82





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.


83





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, 2011.





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, 2011, would decrease net income before provision for income taxes by approximately $0.49 million for the fiscal year ended June 30, 2011.  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.





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 $1.28 million based on our outstanding revenues, costs and expenses, assets, and liabilities denominated in RMB as of June 30, 2011.





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





Inflation





Inflationary factors such as increases in the cost of our out-sourced components for our products and overhead costs, including wages and employment taxes, 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, the inflationary environment in China has changed during the last 12 to 18 months, and we have experienced some increases in costs in various aspects of our business, notably in the areas of wages and other employee expenses and financing costs.  If there is persistent inflation over time or a period of inflation at high or accelerated rates in the future, we belive that, then, inflation would 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.


84





PART II





ITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES





None.





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





In August 2010 our Board of Directors adopted the 2010 Rights Plan. The 2010 Rights Plan provides for a dividend distribution of one preferred share purchase Right, for each outstanding ordinary share.  Each Right entitles the shareholder to buy 1 share of our Class A Preferred Stock at an exercise price of $160.  The Rights will become exercisable if a person or group announces an acquisition of 20% or more of our outstanding ordinary shares, or announces commencement of a tender offer for 20% or more of the ordinary shares. In that event, the Rights permit shareholders, other than the acquiring person, to purchase our ordinary shares having a market value of twice the exercise price of the Rights, in lieu of the Class A Preferred Stock. In addition, in the event of certain business combinations, the Rights permit the purchase of the ordinary shares of an acquiring person at a 50% discount.  Rights held by the acquiring person become null and void in each case.  Unless terminated earlier by our Board of Directors, the 2010 Rights Plan will expire on September 27, 2020.





In connection with the adoption of the 2010 Rights Plan, we amended our Memorandum and Articles of Association to increase our authorized shares of Class A Preferred Stock from 10,000,000 shares to 90,000,000 shares, and to provide that directors may only be removed by shareholders for cause.





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, 2011.





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 as of June 30, 2011.


85





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.





Our management assessed the effectiveness of our internal control over financial reporting as of June 30, 2011. In making this assessment, our 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, 2011, our internal control over financial reporting was effective based on those criteria.





Our independent registered public accounting firm has audited our internal control over financial reporting as of June 30, 2011 and has issued an attestation report set forth below.


86


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the Board of Directors and Stockholders of


Hollysys Automation Technologies Ltd.





We have audited the internal control over financial reporting of Hollysys Automation Technologies Ltd. and its subsidiaries (the “Company”) as of June 30, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 15, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.





We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.





A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting 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 the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.





Because of its inherent limitations, internal control over financial reporting 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 or procedures may deteriorate.





In our opinion, Hollysys Automation Technologies Ltd. and its subsidiaries maintained, in all material respects, effective internal control over financial reporting as of June 30, 2011, based on the COSO criteria.





We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Hollysys Automation Technologies Ltd. and its subsidiaries as of June 30, 2010 and 2011, and the related consolidated statements of operations and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended June 30, 2011 and our report dated September 20, 2011 expressed an unqualified opinion thereon.





/S/  BDO Limited





Hong Kong





September 20, 2011


87


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, 2011, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.





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 BDO Limited, our independent registered public accounting firm, for the fiscal years ended June 30, 2011 and 2010:





2010


2011Audit fees(1)

$
581,000


$
550,000Audit-related fees






-Tax fees


-



-All other fees


-



-Total


581,000



550,000








(1)
Consists of the aggregate fees billed for each of the fiscal years ended June 30, 2010 and 2011 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, 2010 and 2011 were $450,000 and $470,000, 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, 2010 and 2011 were $131,000 and $80,000, respectively.





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).


88





ITEM 16D.
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES





We have applied and granted for following our corporate home country rule of British Virgin Islands with respect to shareholder meeting’s time and interval with NASDAQ. Under our home country rule, we are not required to hold annual shareholder meeting unless there are issues requiring approval of general shareholder meeting.





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





None.





ITEM 16G.
CORPORATE GOVERNANCE





Our 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.





ITEM18.
FINANCIAL STATEMENTS





Our Audited Financial Statements for the Years Ended June 30, 2011, 2010 and 2009 are included in this annual report.





ITEM19.
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 Name (Incorporated by reference to Exhibit 1.3 of the Form 20-F filed with the Securities and Exchange Commission on September 30, 2009).1.4

Amendment to Memorandum and Articles of Association of Hollysys Automation Technologies Ltd. (Incorporated by reference to Exhibit 1.1 of the Form 6-K filed with the Securities and Exchange Commission on September 21, 2010).


89





2.1

Rights Agreement, dated as of August 27, 2010, between Hollysys Automation Technologies Ltd. and Continental Stock Transfer & Trust Company, which includes the Form of Right Certificate as Exhibit A and the Summary of Rights to Purchase Preferred Shares as Exhibit B (Incorporated by reference to Exhibit 2.1 of the Form 6-K filed with the Securities and Exchange Commission on September 21, 2010).4.1

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).4.3

Chardan North China Acquisition Corporation 2006 Stock Plan (Incorporated by reference to Exhibit 4.1 of the Registration Statement on Form S-8 (file no. 333-170811) filed with the Securities and Exchange Commission on November 24, 2010).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

Share Sale and Purchase Agreement, by Unionway Resources Limited and the Company, dated December 23, 2009. ((Incorporated by reference to Exhibit 4.20 of the Report on Form 20-F for the fiscal year ended June 30, 2010 filed with the Securities and Exchange Commission on December 22, 2010)4.6*

Stock Purchase Agreement, by Concord Corporation Pte. Ltd and the Company, dated March 18, 2011.4.7*

Form of Joint Venture Agreement regarding China Techenergy Co., Ltd., the 50/50 joint venture between China Guangdong Nuclear Power Holdings Co., Ltd., and the Registrant.4.8

Director engagement letter with Ms. Jerry Zhang, dated October 30, 2010.4.9

Director engagement letter with Mr. Colin Sung, dated December 18, 2010.4.10

Director engagement letter with Mr. Jianyun Chai, dated June 2, 2011.4.11

Director engagement letter with Mr. Qingtai Chen, dated June 2, 2011.8.1*

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))


90





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

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

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

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).15.4

Consent of BDO Limited, relating to Form S-8 registration statement 333-170811*








* Filed with this annual report on Form 20-F





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 20, 2011
Chief Executive Officer


91





HOLLYSYS AUTOMATION TECHNOLOGIES LTD.




Index to Consolidated Financial Statements





PageReports of Independent Registered Public Accounting Firms

F-2Consolidated Balance Sheets as of June 30, 2010 and 2011

F-3Consolidated Statements of Operations and Comprehensive Income for years ended June 30, 2009, 2010 and 2011

F-5Consolidated Statements of Cash Flows for years ended June 30, 2009, 2010 and 2011

F-6Consolidated Statement of Stockholders’ Equity for years ended June 30, 2009, 2010 and 2011

F-8Notes to Consolidated Financial Statements

F-10


F-1




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




F-2


HOLLYSYS AUTOMATION TECHNOLOGIES LTD.
 CONSOLIDATED BALANCE SHEETS
 (In US Dollars)
 June 30,2010


2011ASSETSCurrent AssetsCash and cash equivalents

$
119,501,945


$
90,669,059Contract commitment deposit in banks


4,383,684



4,115,733Accounts receivable, net of allowance for doubtful accounts of $8,408,318 and $10,691,810 (note 4)


64,384,519



98,002,235Cost and estimated earnings in excess of billings, net of allowance for doubtful accounts of $1,102,016 and  $1,232,813 (note 5)


60,928,056



103,515,659Other receivables, net of allowance for doubtful accounts of $214,789 and $249,052


4,102,136



5,057,899Advances to suppliers


10,676,175



7,818,493Amount due from related parties (note 17)


10,764,828



12,175,447Inventories, net of provision of $2,393,546 and $1,738,184 (note 3)


23,554,331



27,972,600Prepaid expenses


1,022,803



1,018,841Income tax recoverable


1,083,640



1,098,806Deferred tax assets (note 15)


956,969



2,021,466Assets held-for-sale (note 6)


-



8,945,718Total current assets


301,359,086



362,411,956Advance payment for acquisition of a subsidiary (note 21)


-



16,856,148Property, plant and equipment, net (note 6)


65,345,618



59,753,192Long term investments (note 7)


17,348,159



18,571,152Deferred tax assets (note 15)


677,388



991,496Total assets

$
384,730,251


$
458,583,944LIABILITIES AND EQUITYCurrent liabilitiesShort-term bank loans (note 9)

$
1,472,559


$
11,528,465Current portion of long-term bank loans (note 11)


1,472,559



5,408,245Current portion of long-term bond payable (note 10)


11,780,471



-Accounts payable


41,479,662



63,397,616Construction cost payable


12,562,565



1,882,872Deferred revenue


33,552,968



43,202,760Accrued payroll and related expense


4,386,681



6,181,626Income tax payable


5,971,136



5,060,131Warranty liabilities (note 8)


1,916,654



2,798,800Other tax payables


10,632,611



12,547,517Accrued liabilities


8,078,783



5,692,209Amounts due to related parties (note 17)


2,610,599



3,338,563Total current liabilities


135,917,248



161,038,804Long-term bank loans (note 11)


35,341,413



31,676,865Total liabilities

$
171,258,661


$
192,715,669
  F-3
 
 HOLLYSYS AUTOMATION TECHNOLOGIES LTD.
 CONSOLIDATED BALANCE SHEETS – Continued
 (In US Dollars)
 June 30,2010


2011Commitments and contingencies (note 20)


-



-EquityOrdinary shares, par value $0.001 per share, 100,000,000 shares authorized, 54,449,129 and 54,692,129  shares issued and outstanding (note 12)

$
54,450


$
54,693Additional paid-in capital


138,751,162



140,373,585Appropriated earnings


17,396,777



23,061,779Retained earnings


38,936,792



74,741,788Accumulated comprehensive income - translation adjustments


17,557,544



26,825,812Total Hollysys Automation Technologies Ltd. stockholders’ equity


212,696,725



265,057,657Non-controlling interests


774,865



810,618Total equity


213,471,590



265,868,275Total liabilities and equity

$
384,730,251


$
458,583,944
 
 See accompanying notes to consolidated financial statements
  F-4
 
 HOLLYSYS AUTOMATION TECHNOLOGIES LTD.
 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
 (In US Dollars)
 
 Year Ended June 30,2009


2010


2011RevenuesIntegrated contract revenue

$
149,303,309


$
164,118,183


$
248,576,098Products sales


8,198,758



9,971,013



14,265,788Total revenues


157,502,067



174,089,196



262,841,886Cost of integrated contracts


99,423,487



110,268,475



165,354,157Cost of products sold


3,500,471



3,668,899



6,359,013Gross profit


54,578,109



60,151,822



91,128,716Operating expensesSelling expenses


10,021,832



12,152,019



20,445,846General and administrative expenses


48,981,078



13,914,091



16,671,448Research and development expenses


8,829,402



13,071,318



20,132,575VAT refunds and government subsidies


(7,703,724
)


(11,533,006
)


(10,811,919
)Total operating expenses


60,128,588



27,604,422



46,437,950Income (loss) from operations


(5,550,479
)


32,547,400



44,690,766Other income (expense), net


322,713



(215,277
)


(208,093
)Gains on disposal of long term investments (note 7)


400,556



-



1,400,533Dilution gain on share of an equity investee (note 7)


-



-



756,619Share of net income of equity investees


178,167



3,958,073



2,847,866Interest expense, net


(954,078
)


(1,070,772
)


(1,578,610
)Income (loss) before income taxes


(5,603,121
)


35,219,424



47,909,081Income taxes expenses (note 15)


3,061,141



7,663,433



6,443,967Net income (loss)


(8,664,262
)


27,555,991



41,465,114Less: Net income (loss) attributable to non-controlling interests


5,186,802



1,851,453



(4,884
)Net income (loss) attributable to Hollysys Automation Technologies Ltd.

$
(13,851,064
)

$
25,704,538


$
41,469,998Other comprehensive income (loss)Net income (loss)

$
(8,664,262
)

$
27,555,991


$
41,465,114Translation adjustments


605,582



1,219,809



9,308,905Comprehensive income (loss)


(8,058,680
)


28,775,800



50,774,019Less: Comprehensive income attributable to non-controlling interests


5,254,351



1,876,297



35,753Comprehensive income (loss) attributable to Hollysys Automation Technologies Ltd.

$
(13,313,031
)

$
26,899,503


$
50,738,266Net income (loss) per share (note 16)Weighted average number of ordinary shares


44,950,833



51,243,667



54,564,842Weighted average number of diluted ordinary shares


44,950,833



51,838,294



54,949,280Basic earnings (loss) per share attributable to Hollysys Automation Technologies Ltd.

$
(0.31
)

$
0.50


$
0.76Diluted earnings (loss) per share attributable to Hollysys Automation Technologies Ltd.

$
(0.31
)

$
0.50


$
0.75
 
 See accompanying notes to consolidated financial statements
  F-5
 
 HOLLYSYS AUTOMATION TECHNOLOGIES LTD.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In US Dollars)
 
 Year ended June 30,2009


2010


2011Cash flows from operating activities:Net income (loss)

$
(8,664,262
)

$
27,555,991


$
41,465,114Adjustments to reconcile net income to net cash provided by (used in) operating activities:Depreciation and amortization


2,241,344



2,683,042



4,468,592Allowance for doubtful accounts


1,145,770



2,790,078



2,816,320Provision for inventories


517,694



1,279,406



211,919Loss (gain) on disposal of property, plant and equipment


58,133



14,112



(166,177
)Impairment loss on goodwill


-



286,610



-Impairment loss on property, plant and equipment


-



715,246



23,711Impairment loss on long-term investments


-



152,732



165,948Share of net income from equity investees


(178,167
)


(3,958,073
)


(2,847,866
)Gains on disposal of long-term investments


(400,556
)


-



(1,400,533
)Dilution gain on share of an equity investee


-



-



(756,619
)Amortization of expenses accrued for bond payable


61,222



61,281



31,531Stock-based compensation


39,559,026



524,076



551,966Deferred tax assets (liabilities), net


530,229



(885,014
)


(1,297,968
)Loss on deemed acquisition of a subsidiary


18,962



-



-Changes in operating assets and liabilities:Accounts receivable


2,517,399



(10,131,840
)


(30,227,617
)Cost and estimated earnings in excess of billings


(8,301,687
)


(10,191,299
)


(42,587,603
)Inventories


5,311,489



(5,996,365
)


(3,468,049
)Advance to suppliers


(861,429
)


(2,598,327
)


3,384,430Other receivables


(573,733
)


(93,051
)


(685,398
)Deposits and other assets


(1,975,917
)


1,497,584



506,365Due from related parties


(4,581,972
)


(3,143,615
)


(336,128
)Accounts payable


13,056,177



5,032,941



18,481,215Deferred revenue


397,735



12,480,428



7,994,334Accruals and other payable


(2,748,314
)


5,953,753



2,113,829Due to related parties


(17,671
)


1,145,916



(457,800
)Tax payable


3,015,986



4,970,204



222,993Net cash provided by (used in) operating activities


40,127,458



30,145,816



(1,793,491
)Cash flows from investing activities:Purchase of property, plant and equipment


(8,728,334
)


(20,918,968
)


(16,045,183
)Proceeds from disposal of property, plant and equipment


13,271



9,251



12,574Repayment from related parties


1,134,090



653,325



27Acquisition of long term investments


(3,895,781
)


(1,001,569
)


-Proceeds from disposal of long-term investments


2,103,136



-



3,726,997Dividends from long-term investments


69,568



58,640



90,517Acquisition of a subsidiary, net of cash acquired


(439,374
)


(279,120
)


-Cash prepaid for acquisition of a subsidiary


-



-



(16,856,148
)Deposit for acquisition of equity interest from  non-controlling interest


(2,196,869
)


-



-Net cash used in investing activities

$
(11,940,293
)

$
(21,478,441
)

$
(29,071,216
)
  F-6
 
 HOLLYSYS AUTOMATION TECHNOLOGIES LTD.
 CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
 (In US Dollars)
 
 Year ended June 30,2009


2010


2011Cash flows from financing activities:Repayments of bonds payable

$
-


$
-


$
(12,068,913
)Proceeds from short-term bank loans


5,858,317



-



15,671,580Repayments of short-term bank loans


(4,393,738
)


(4,397,989
)


(5,924,784
)Proceeds from long-term bank loans


36,614,479



-



-Repayments of long-term bank loans


(2,196,869
)


(5,130,987
)


(1,508,614
)Cash injected by non-controlling interest


-



718,338



-Acquisition of equity interest from non-controlling interest


-



(10,373,600
)


-Proceeds from exercise of share options


-



-



1,070,700Net cash provided by (used in) financing activities


35,882,189



(19,184,238
)


(2,760,031
)Effect of foreign exchange rate changes


562,754



1,136,142



4,791,852Net increase (decrease) in cash and cash equivalents

$
64,632,108


$
(9,380,721
)

$
(28,832,886
)Cash and cash equivalents, beginning of year


64,250,558



128,882,666



119,501,945Cash and cash equivalents, end of year

$
128,882,666


$
119,501,945


$
90,669,059Supplementary disclosures of cash flow information:Cash paid during the year for:Interest, net of capitalized interest cost

$
2,576,444


$
2,227,667


$
2,680,141Income tax

$
2,758,695


$
5,074,938


$
7,109,057Supplementary disclosures of significant non-cash transactions:Issuance of ordinary shares in connection with acquisition of equity interest in a subsidiary from  non-controlling interest

$
-


$
53,011,515


$
-Issuance of additional ordinary shares upon exercise of Unit Purchase Option

$
-


$
93


$
-
 
 See accompanying notes to consolidated financial statements.
  F-7
 
 HOLLYSYS AUTOMATION TECHNOLOGIES LTD.
 CONSOLIDATED STATEMENTS OF EQUITY
 (In US Dollars)
 Ordinary Shares


Additional

Paid-in

Capital


Appropriat-

ed Earnings


Retained

Earnings


Accumulat
ed

Comprehen

-sive

Income


Total

Hollysys

Automation

Technologies

Ltd.

Stockholders’

Equity


Non-

controlling

Interests


Total EquityShares


AmountBalance at July 1, 2008


43,942,614


$
43,943


$
91,667,183


$
11,676,276


$
30,542,484


$
13,364,012


$
147,293,898


$
17,645,377


$
164,939,275Incentive stock compensation


6,000,000



6,000



39,553,026



-



-



-



39,559,026



-



39,559,026Acquisition of additional equity interest in a subsidiary from  non-controlling interest


-



-



-



-



-



-



-



(420,487
)


(420,487
)Net loss for the year


-



-



-



-



(13,851,064
)


-



(13,851,064
)


5,186,802



(8,664,262
)Appropriation


-



-



-



3,459,166



(3,459,166
)


-



-



-



-Translation adjustments


-



-



-



-



-



538,033



538,033



67,549



605,582Balance at June 30, 2009


49,942,614


$
49,943


$
131,220,209


$
15,135,442


$
13,232,254


$
13,902,045


$
173,539,893


$
22,479,241


$
196,019,134Incentive stock compensation


-



-



524,076



-



-



-



524,076



-



524,076Acquisition of additional equity interest in a subsidiary from  non-controlling interest


4,413,948



4,414



7,006,970



2,261,335



-



2,460,534



11,733,253



(24,305,847
)


(12,572,594
)Acquisition of a subsidiary


-



-



-



-



-



-



-



7,548



7,548Capital contribution from non-controlling interest


-



-



-



-



-



-



-



717,626



717,626Issuance of ordinary shares upon exercise of UPO


92,567



93



(93
)


-



-



-



-



-



-Net Income for the year


-



-



-



-



25,704,538



-



25,704,538



1,851,453



27,555,991Translation adjustments


-



-



-



-



-



1,194,965



1,194,965



24,844



1,219,809Balance at June 30, 2010


54,449,129


$
54,450


$
138,751,162


$
17,396,777


$
38,936,792


$
17,557,544


$
212,696,725


$
774,865


$
213,471,590
  F-8
  HOLLYSYS AUTOMATION TECHNOLOGIES LTD.
 CONSOLIDATED STATEMENTS OF EQUITY - Continued
 (In US Dollars)
 
 Ordinary Shares


Additional

Paid-in

Capital


Appropriat

-ed

Earnings


Retained

Earnings


Accumulat-

ed

Comprehen

-sive

Income


Total

Hollysys

Automation

Technologies

Ltd.

Stockholders’

Equity


Non-

controlling

Interests


Total EquityShares


AmountBalance at June 30, 2010


54,449,129


$
54,450


$
138,751,162


$
17,396,777


$
38,936,792


$
17,557,544


$
212,696,725


$
774,865


$
213,471,590Incentive stock compensation


-



-



551,966



-



-



-



551,966



-



551,966Issuance of ordinary shares upon exercise of share options


243,000



243



1,070,457



-



-



-



1,070,700



-



1,070,700Net Income for the year


-



-



-



-



41,469,998



-



41,469,998



(4,884
)


41,465,114Appropriation


-



-



-



5,665,002



(5,665,002
)


-



-



-



-Translation adjustments


-



-



-



-



-



9,268,268



9,268,268



40,637



9,308,905Balance at June 30, 2011


54,692,129


$
54,693


$
140,373,585


$
23,061,779


$
74,741,788


$
26,825,812


$
265,057,657


$
810,618


$
265,868,275
  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 of merging 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”) on September 7, 2007.
 
 As of June 30, 2011, 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

September 21, 2005


100
%


-

Investment holdingHollySys (Asia Pacific) Pte. Limited (“HAP”)

Singapore

October 23, 1997


100
%


-

Sale of integrated automation productsClear Mind Limited  (“Clear Mind”)

BVI

November 29, 2007


-



100
%
Investment holdingWorld Hope Enterprises Limited (“World Hope”)

Hong Kong

September 17, 2007


-



100
%
Investment holdingBeijing He Li Tong S&T Exploration Co., Ltd. (“BJHLT”)

People’s  Republic of China (“PRC”)

January 25, 2008


-



100
%
Investment holdingBeijing Hollysys S&T Exploration Co., Ltd. (“Hollysys S&T”)

PRC

December 17, 2007


-



100
%
Investment holdingBeijing Hollysys Automation & Drive Co., Ltd. (“Hollysys Automation”)

PRC

May 13, 2008


-



100
%
Manufacture and sale of integrated automation productsHangzhou Hollysys Automation Co., Ltd. (“Hangzhou Hollysys”)

PRC

September 24, 2003


-



100
%
Provision of integrated industrial automation products and servicesBeijing Hollysys Electronics Technology Co., Ltd. (“Hollysys Electronics”)

PRC

June 4, 2010


-



100
%
Manufacture and sale of automation equipment
  F-10
 
 Name of company

Place of

incorporation

Date of

incorporation

Percentage of

ownership interest

attributable to the

Company

Principal activitiesDirectly


IndirectlyBeijing Hollycon Med. & Tech. Co., Ltd. (“Hollycon”)

PRC

June 4, 2010


-



51
%
Manufacture and sale of medical automation equipmentHollysys (Beijing) Investment Co., Ltd. (“Hollysys Investment ”)

PRC

April 15, 2011


-



100
%
Investment management and consultingBeijing Hollysys Co., Ltd. (“Beijing Hollysys”)

PRC

September 25, 1996


-



100
%
Provision of integrated automation systems and servicesBeijing Haotong Science and Technology Development Co., Ltd. (“Haotong”)

PRC

October 26, 2000


-



100
%
DormantBeijing WoDeWeiYe Technology Exploration Co., Ltd. (“WoDeWeiYe”)

PRC

December 31, 1997


-



51
%
Manufacture and sale of electric componentsXi’an Hollysys  Co., Ltd. (“Xi’an Hollysys”)

PRC

March 9, 2011


-



100
%
Research and development of automation
 
 The Company is principally engaged in manufacture, sale and provision of integrated automation systems and services in the PRC mainly through the PRC operating subsidiaries.
 
 On September 1, 2009, Beijing Hollysys acquired 51% equity interest of Beijing WoDe WeiYe Technology Limited (WoDeWeiYe”), which was principally engaged in intelligent electric meter business, at a cash consideration of RMB2 million (equivalent to $294,422), to further build up its foothold in the subway automation sector. The identifiable net assets of the acquiree was insignificant and goodwill of $286,610, comprised of the value of expected synergy arising from acquisition, was recognized and impaired during the year. The total net cash paid in this acquisition was $279,120. The amounts of WoDeWeiYe’s revenue and earnings included in the Company’s consolidated statement of operations for the year ended June 30, 2010, and the revenue and earnings of WoDeWeiYe had the acquisition date been July 1, 2008, or July 1, 2009, are insignificant to the Company’s result of operations.
 
 On May 18, 2011, the Company entered into a stock purchase agreement (the “SPA”) to acquire  100% interest of Concord Corporation Pte. Ltd., which is incorporated in Singapore, and its affiliates including Concord Electrical Pte. Ltd. and Concord Electrical Sdn. Bhd. (“collectively referred to as the “Concord Group”), for a combination of cash and stock with a total value equivalent to approximately US $43.2 million.  This acquisition was completed subsequent to the balance sheet date as of June 30, 2010, please refer to note 21 to the financial statements for further details.
  F-11
  NOTE 2 - 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. The consolidated financial statements have been prepared in accordance with the accounting principles generally accepted in the United States of America (“U.S. GAAP”).
 
 Non-controlling interests
 
 Effective July 1, 2009 the Company adopted an authoritative pronouncement issued by the Financial Accounting Standards Board (the “FASB”) regarding non-controlling interests in consolidated financial statements. The pronouncement requires non-controlling interests to be separately presented as a component of equity in the consolidated financial statements.
 
 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.
 
 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 operations 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 operations 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 the contracts have a duration of 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.
  F-12
 
 In accordance with Accounting Standards Codification (“ASC”) 605-305 Revenue Recognition - Construction-Type and Production-Type Contracts 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.
 
 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 believes 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 non-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 otherwise be specified in the terms of the contract. The Company estimates warranty liability under a contract using a percentage of revenue recognized, which is derived from its historical experience, in order to recognize the warranty cost for a contract in the proper period of time.  In addition, the Company estimates whether or not the accrued warranty liabilities are adequate by considering specific conditions that may arise and the number of contracts under warranty period at each financial year-end.  The Company adjusts the accrued warranty liabilities in line with the result of its assessment.
  F-13
 
 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 and subway 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 and will be due upon reaching the billing milestone.  Cost and estimated earnings in excess of billings are usually billed within one year.
 
 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 interest charges for late payments by its customers.  The Company reviews the status of contracts periodically and decides how much of an allowance for doubtful accounts should be made based on factors surrounding the credit risk of customers and its historical experience.  The Company sets up a bad debt allowance for an individual customer if there is a deterioration of the customer’s credit worthiness and the assessed probability of default is higher than historical experience.
 
 Based on the information available to management, the Company believes that its allowance for doubtful accounts as of June 30, 2010 and 2011 were adequate.
 
 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
5 yearsElectronic and other equipments
5 years
 
 Construction in progress represents uncompleted construction work of certain facilities 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.
 
 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.
  F-14
  Impairment of Long-Lived Assets
 
 The Company adopts the provisions of ASC Topic 360 Property, Plant and Equipment, 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.
 
 The impairment loss on long-lived assets for the years ended June 30, 2009, 2010 and 2011 were nil, $715,246, and $23,711 respectively, which represented impairment loss on property, plant and equipment.
 
 Shipping and Handling Cost
 
 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 ASC Topic 350 Intangibles -  Goodwill and Other.  If the fair value is less than its carrying value, an indication of goodwill impairment exists, then the carrying value of goodwill is written down, and an impairment loss is recognized for any excess of the carrying amount over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Fair value of the reporting unit is determined using a discounted cash flow analysis. For the year ended June 30, 2009, 2010 and 2011, there was an impairment loss of nil, $286,610, and nil respectively, included in general and administratively expenses. The carrying value of goodwill was nil as of June 30, 2010 and 2011.
 
 Income Taxes
 
 The Company accounts for income taxes in accordance with ASC Topic 740 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 “Accounting for Uncertainty in Income Taxes” which included in ASC Topic 740 Income Taxes. It clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. It 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. It 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.
  F-15
  Value Added Tax
 
 All the PRC subsidiaries of the Company are subject to value added tax (“VAT”) imposed by the 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.
 
 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.
 
 VAT Refunds and Government Subsidies
 
 Pursuant to the laws and regulations of the PRC, the Company remits 17% of its sales as VAT to the government, and then is entitled to a refund of the 14% VAT levied on all sales containing internally developed software products. The Company recognizes the VAT refunds upon the completion of government approval process. Certain subsidiaries of the Company located in the PRC have, respectively, received certain government subsidies from local PRC government agencies.  Government subsidies are recognized when received and the conditions prescribed by the government have been fulfilled. VAT refunds and government subsidies are included as a credit in the operating expense in the consolidated statement of operations, which is largely research and development tax credit in essence.
 
 Appropriations to Statutory Reserve
 
 Under the corporate law and relevant regulations in the PRC, all of the subsidiaries of the Company located in the PRC are required to appropriate a portion of its retained earnings to statutory reserve.  All subsidiaries located in the 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.
 
 Comprehensive Income
 
 The Company adopted ASC Topic 220 Comprehensive Income, which establishes standards for reporting and presentation of comprehensive income and its components in a full set of general-purpose financial statements.  Accumulated other comprehensive income represents foreign currency translation adjustments and is included in the consolidated statement of operations and comprehensive income.
  F-16
  Long Term Investments
 
 The Company accounted for its long-term investments under either an equity method or a cost method in accordance with its equity interest holding percentage. Long-term investments under cost method are periodically evaluated to determine if there have been any other than temporary declines below carrying value. A variety of factors are considered when determining if a decline in fair value below carrying value is other than temporary, including, among others, the financial condition and prospects of the investee, as well as the Company’ s investment intent. The investments in entities over which the Company has the ability to exercise significant influence are accounted for using the equity method. Significant influence is generally considered to exist when the Company has an ownership interest in the voting stock of the investee between 20% and 50%. Other factors, such as representation on the investee’s Board of Directors and the impact of commercial arrangements, are also considered in determining whether the equity method of accounting is appropriate.
 
 Under the equity method, original investments are recorded at cost and adjusted by the Company's share of undistributed earnings or losses of these entities, by the amortization of any difference between the amount of the Company's investment and its share of the net assets of the investee, and by dividend distributions or subsequent investments. All unrealized inter-company profits and losses are eliminated under the equity method. When the estimated amount to be realized from the investments falls below its carrying value, an impairment charge is recognized in the consolidated statements of operations when the decline in value is considered other than temporary.
 
 The impairment loss on long term investments for the years ended June 30, 2009, 2010 and 2011 were nil, $152,732, and $165,948 respectively.
 
 Capitalization of Interest
 
 Interest incurred on borrowings used to construct the Company’s construction of facilities and assembly lines projects during the active construction period are capitalized. The capitalization of interest ceases once a project is substantially complete. The amount to be capitalized is determined by applying the weighted-average interest rate of the Company’s outstanding borrowings to the average amount of accumulated capital expenditures for assets under construction during the year and is added to the cost of the underlying assets and amortized over their respective useful lives.
 
 Earnings (Loss) Per Share
 
 The Company presents earnings per share in accordance with the ASC Topic 260 Earnings Per Share, which defines that basic earnings (loss) per share include no dilution and are computed by dividing income (loss) available to the ordinary shares by the weighted average number of ordinary 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 ASC Topic 718 Compensation - Stock Compensation, which requires that share-based payment transactions with employees, such as share options and restricted shares, 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.
  F-17
  Fair Value Measurements
 
 The Company has adopted ASC Topic 820  Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. It does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. It establishes a three-level valuation hierarchy of valuation techniques based on observable and unobservable inputs, which may be used to measure fair value and include the following:
 
 Level 1  -
Quoted prices in active markets for identical assets or liabilities.
 Level 2  -
Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 Level 3  -
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
 Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement.
 
 Reclassifications
 
 The consolidated financial statements for prior years reflect certain reclassifications, which have no effect on previously reported results, to conform to the current year presentation.
  F-18
 
 Recent Accounting Pronouncements
 
 In January 2010, the FASB issued ASU No. 2010-06 Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements (“ASU No. 2010-06”). This pronouncement is an authoritative guidance to improve disclosures about fair value measurements. This guidance amends previous guidance on fair value measurements to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurement on a gross basis rather than on a net basis as currently required. This guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. ASU No. 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, which the Company adopted this statement as of July 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early adoption is permitted. ASU No. 2010-06 does not require disclosures for earlier periods presented for comparative purposes at initial adoption. Since ASU No. 2010-06 only requires additional disclosures, it will not have an impact on our financial position or results of operations.
 
 In December 2010, the FASB issued ASU No.2010-28, “Intangible-Goodwill and Other” (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. This ASU requires that reporting units with zero or negative carrying amounts perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Management does not believe the adoption of this update will materially impact the Company's financial condition, results of operations and disclosures.
 
 In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations. This ASU specifies that when financial statements are presented, the revenue and earnings of the combined entity should be disclosed as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 is effective for business combinations with acquisition dates on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. Adoption of ASU 2010-29 will affect our disclosures of material business combinations in future periods.
  In May 2011, the FASB issued ASU 2011-04 “Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. This pronouncement is an authoritative guidance to amend certain measurement and disclosure requirements related to fair value measurements to improve consistency with international reporting standards. This guidance is effective prospectively for public entities for interim and annual reporting periods beginning after December 15, 2011, with early adoption by public entities prohibited. The Company is currently evaluating this guidance, but does not expect its adoption will have a material effect on its consolidated financial statements.
 
 In June 2011, the FASB issued ASU 2011-05 “Comprehensive Income (Topic 220) Presentation of Comprehensive Income”. This pronouncement is an authoritative guidance on the presentation of comprehensive income that will require a company to present components of net income and other comprehensive income in one continuous statement or in two separate, but consecutive statements. There are no changes to the components that are recognized in net income or other comprehensive income under current GAAP. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, with early adoption permitted. The Company has elected to adopt this ASU 2011-05 early.
  F-19
 
 NOTE 3 - INVENTORIES
 
 Components of inventories are as follows:
 
 June 30,2010


2011Raw materials

$
7,126,042


$
9,078,780Work in progress


5,491,687



5,338,130Finished goods


13,274,854



15,228,823Low value consumables


55,294



65,051Less: Provision


(2,393,546
)


(1,738,184
)$
23,554,331


$
27,972,600
 
 Provision for inventories is as follows:
 
 June 30,2009


2010


2011Balance at beginning of year

$
596,446


$
1,114,140


$
2,393,546Additions


517,694



1,279,406



211,919Written off


(2,071
)


(191
)


(985,404
)Exchange difference


2,071



191



118,123$
1,114,140


$
2,393,546


$
1,738,184
 
 NOTE 4 – ACCOUNTS RECEIVABLE
 
 Allowance for doubtful debts for accounts receivable is as follows:
 
 June 30,2009


2010


2011Balance at beginning of year

$
5,285,529


$
6,276,670


$
8,408,318Additions


1,116,346



2,438,328



2,731,820Written off


(154,527
)


(341,917
)


(903,768
)Exchange difference


29,322



35,237



455,440$
6,276,670


$
8,408,318


$
10,691,810
  F-20
 
 NOTE 5 – COST AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS
 
 June 30,2010


2011Contract costs incurred plus estimated earnings

$
320,014,935


$
389,676,454Less: Progress billings


(259,086,879
)


(286,160,795
)Cost and estimated earnings in excess of billings, net

$
60,928,056


$
103,515,659
 
 As of June 30, 2010 and 2011, balances of $7,065,816 and $11,351,985, respectively, were related to contracts which are completed but are still within the warranty period.
 
 Allowance for doubtful accounts is as follows:
 
 June 30,2009


2010


2011Balance at beginning of year

$
884,663


$
744,113


$
1,102,016Additions


50,444



353,412



76,423Written off


(194,516
)


-



-Exchange difference


3,522



4,491



54,374$
744,113


$
1,102,016


$
1,232,813
 
 NOTE 6 - PROPERTY, PLANT AND EQUIPMENT
 
 A summary of property, plant and equipment at cost is as follows:
 
 June 30,2010


2011Land use right

$
7,282,148


$
6,734,503Buildings


13,608,227



41,388,443Machinery


3,118,451



4,434,365Software


1,206,719



2,798,335Vehicles


1,234,259



1,282,623Electronic equipments and other equipments


10,770,860



16,218,118Construction in progress


39,329,699



757,39076,550,363



73,613,777Less: Accumulated depreciation and amortization


(11,204,745
)


(13,860,585
)$
65,345,618


$
59,753,192
 
 Land use rights represent rights to use state-owned lands in the PRC with lease terms of 50 years expiring in 2057.
  F-21
 
 Construction in progress consists of capital expenditures and capitalized interest charges relating to the construction of facilities and assembly lines projects. Interest of $206,595, $1,102,772 and $310,551 during the period of construction for the years ended June 30, 2009, 2010 and 2011, respectively, have been capitalized.
  F-22
 
 The Company commenced the construction of a new facility in Beijing, the PRC, during the year ended June 30, 2009, and the  construction project was completed in August 2010.
 
 Upon the completion of the new facility, the Company relocated its headquarters to this new facility in August 2010. At that time, the management of the Company developed a plan to dispose of the old headquarters. The old headquarters comprised a piece of land and several buildings which the Company owned, except for the fourth and fifth floors of the main building which were owned by Hollysys Information Technology Co., Ltd (“Hollysys Information”), an unconsolidated investee of the Company. In order to carry out the disposal of buildings with the best earnings opportunity through selling the whole complex, the Company purchased the fourth and fifth floors of the main building from Hollysys Information for a cash consideration of RMB 23,353,900 (equivalent to $3,608,675), plus transaction costs of $108,260. After the acquisition of the fourth and fifth floors of the main building and the relocation of headquarters, the Company initiated a plan to sell the whole complex of buildings of the old headquarters, which comprised  land and building with a carrying value of $5,228,783, and the acquired floors with a carrying value of $3,716,935, and reclassified them to assets held for sale with an aggregate carrying value of $8,945,718 as of June 30, 2011. The old headquarters, recognized as assets held for sale, are no longer depreciated as they are being held at the lower of cost or fair value less cost to sell.
 
 A long-lived asset shall not be depreciated (amortized) while it is classified as held for sale.
 
 The depreciation and amortization for the years ended June 30, 2009, 2010 and 2011 were $2,241,344, $2,683,042  and $4,468,592, respectively.
  F-23
 
 NOTE 7 - LONG-TERM INVESTMENTS
 
 The following long-term investments were accounted for under either equity method or cost method.
 
 June 30, 2010

Interest

held


Long-term

investment,

at cost, less

impairment


Share of

undistributed

results


Advance

to investee

company


TotalEquity Method InvestmentHollysys Information  Technology Co., Ltd.


49.00
%

$
3,063,366


$
371,738


$
27


$
3,435,131Hollysys Electric Machinery Co., Ltd


40.00
%


779,888



1,571,979



-



2,351,867New Huake Electric Technology Co., Ltd


37.50
%


220,884



(153,428
)


-



67,456China Techenergy Co., Ltd.


50.00
%


6,626,515



1,201,756



43,412



7,871,683IPE Biotechnology Co., Ltd


31.15
%


1,613,655



266,035



-



1,879,690$
12,304,308


$
3,258,080


$
43,439


$
15,605,827Cost Method InvestmentBeijing Hollysys Equipment Technology Co., Ltd


20.00
%


58,902



-



-



58,902Zhongjijing Investment Consulting Co., Ltd


5.00
%


441,768



-



-



441,768Zhejiang Sanxin Technology Co., Ltd


10.00
%


147,256



-



-



147,256Zhejiang Sanxin Engineering Co., Ltd


6.00
%


88,354



-



-



88,354Heilongjiang Ruixing Technology Co., Ltd


8.31
%


1,006,052



-



-



1,006,052$
1,742,332


$
-


$
-


$
1,742,332$
14,046,640


$
3,258,080


$
43,439


$
17,348,159
 
 F-24
 
 June 30, 2011

Interest

held


Long-term

investment,

at cost, less

impairment


Share of

undistributed

results


Advance

to

investee

company


TotalEquity Method InvestmentHollysys Electric Machinery Co., Ltd


40.00
%


818,367



2,020,888



-



2,839,255New Huake Electric Technology Co., Ltd


37.50
%


231,782



(92,350
)


-



139,432China Techenergy Co., Ltd.


50.00
%


6,953,458



2,994,512



45,554



9,993,524IPE Biotechnology Co., Ltd


23.39
%


1,523,944



1,099,935



-



2,623,879$
9,527,551


$
6,022,985


$
45,554


$
15,596,090Cost Method InvestmentHollysys Information


20.00
%


1,471,261



-



-



1,471,261Beijing Hollysys Equipment Technology Co., Ltd


20.00
%


46,356



-



-



46,356Zhongjijing Investment Consulting Co., Ltd


5.00
%


309,043



-



-



309,043Zhejiang Sanxin Engineering Co., Ltd


6.00
%


92,713



-



-



92,713Heilongjiang Ruixing Technology Co., Ltd


8.31
%


1,055,689



-



-



1,055,689$
2,975,062


$
-


$
-


$
2,975,062$
12,502,613


$
6,022,985


$
45,554


$
18,571,152
 
 In July 2010, the Company entered into an agreement to dispose of 29%  of its 49% equity interest in Hollysys Information to the other equity interest owner, for a cash consideration of RMB 23,377,700 (equivalent to $3,526,793), and a gain of $1,443,994 was recognized in the consolidated statement of operations during the year ended June 30, 2011. Upon the disposal, the Company held a 20% equity interest of Hollysys Information, and lost the ability to exercise significant influence in Hollysys Information. The Company discontinued accruing its share of the earnings or losses of Hollysys Information and adopted the cost method to account for the remaining 20% equity interest of Hollysys Information upon the disposal as the Company is only able to nominate 1 director out of 5 directors in the board of Hollysys Information and lost significant influence in Hollysys Information in accordance with the revised Memorandum and Article of Association of Hollysys Information.
  F-25
 
 In December 2010, the Company disposed of all its investment in Zhejiang Sanxin Technology Co., Ltd at cost.
 
 In November 2010, the Company entered into an agreement to dispose of 3.115%  of its 31.15% equity interest in IPE Biotechnology Co., Ltd (“IPE”) to a third party, for a cash consideration of RMB 934,500 (equivalent to $140,980), and a loss of $43,461 was recognized in the consolidated statement of operations during the year ended June 30, 2011. The Company continued to hold a 28.035% equity interest in IPE after the disposal.
 
 In April 2011, a third party injected RMB 30 million (equivalent to $4,525,843) capital into IPE, of which RMB 5.95 million (equivalent to $897,626) was recognized as the paid-in capital, and the remaining balance was recognized as capital surplus. Upon the injection of paid in capital, the Company’s equity interest in IPE was diluted from 28.035% to 23.39%, while the share of net assets from IPE increased by $756,619. This increase in share of net assets from IPE was recognized as dilution gain on share of an equity investee in the consolidated statement of operations during the year ended June 30, 2011.
 
 NOTE 8 - WARRANTY LIABILITY
 
 June 30,2009


2010


2011Beginning balance

$
2,051,397


$
1,631,407


$
1,916,654Expense accrued


522,640



949,111



1,912,880Expense incurred


(951,048
)


(674,939
)


(1,143,953
)Exchange difference


8,418



11,075



113,219$
1,631,407


$
1,916,654


$
2,798,800
 
 NOTE 9 - SHORT-TERM BANK LOANS
 
 On June 30, 2010 and 2011, the Company’s short-term bank borrowings consisted of revolving bank loans of $1,472,559 and $11,528,465, respectively, from several banks.
 
 As of June 30, 2010, the short-term borrowings of $1,472,559 was subject to an annual interest rate of 4.779%, without any guarantee or pledge of assets.
 
 As of June 30, 2011, the short-term borrowings of $11,528,465 was subject to annual interest rates from 5.85% to 8.13%, with weighted average interest rate of 7.37%, of which $6,767,705 are subject to a pledge of certain accounts receivable, amounted to $6,767,705. The remaining borrowings are without any guarantee or pledge of assets.
 
 NOTE 10 - LONG TERM BOND PAYABLE
 
 In December 2007, Beijing Hollysys and three independent third parties entered into an agreement with the underwriters to issue bonds to institutional and public investors in the PRC with an aggregate principal amount of RMB 305 million. Pursuant to the agreements, Beijing Hollysys issued RMB 80 million (equivalent to $11.7 million) of bonds (collectively, the “Bond”) for the purpose of technology improvement and industrial implementation of certain technology. The Bond carried interest at a rate of 6.68% per annum, which was payable semi-annually and matured in December 2010. Related to the Bond, Beijing Zhongguancun Science and Technology Guaranty Co., Ltd.  undertook joint and several guarantee liabilities in full in favour of Beijing Hollysys. Concurrently, the China Development Bank  authorized its business department to undertake general guarantee liability in respect of the guarantee liabilities of Beijing Zhongguancun Science and Technology Guaranty Co., Ltd. The Bond issuing costs were RMB 1,254,054 (equivalent to $183,559).  Such issuing costs were amortized during the three-year term of the Bond and any unamortized issuing cost was presented as long-term deferred expenses on the balance sheet.
  F-26
 
 For the year ended June 30, 2009, 2010, and 2011,  interest of $782,671, $792,510 and $342,684, respectively, was charged to interest expenses.
 
 The long term bond was fully repaid in December 2010.
 
 NOTE 11 - LONG-TERM BANK LOANS
 
 June 30,2010


2011RMB-denominated loan from Industrial and Commercial Bank of China

$
36,813,972


$
37,085,110Less: Current portion


(1,472,559
)


(5,408,245
)$
35,341,413


$
31,676,865
 
 The loan from Industrial and Commercial Bank of China is effective from March 31, 2009 to March 30, 2016, with an annual effective interest rate of 6.44%. The borrowing was secured by a pledge of the new headquarters facility in Beijing, comprised of land and buildings with the aggregate carrying value of $39,302,147 and $37,789,950 as of June 30, 2010 and 2011, respectively.
 
 Scheduled principal payments for all outstanding borrowings on June 30, 2011 are as follows:
 
 Year Ending June 30,2012

$
5,408,2452013


7,726,0652014


7,726,0652015


7,726,0652016


8,498,670$
37,085,110
 
 For the years ended June 30, 2009, 2010, and 2011, loan interest including short-term and long-term bank loans of $1,192,485, $2,537,929 and $2,648,008 was incurred and $985,890, $1,435,157 and $2,337,457 were charged to interest expenses, respectively.
 
 NOTE 12 – STOCKHOLDERS’ EQUITY
 
 In accordance with the Share Exchange Transaction, the original shareholders of GTH and their designees were entitled to receive, on an all or none basis per year, an aggregate of 11 million ordinary shares of Hollysys (2 million shares each year for the first four years and 3 million shares for the fifth year), if the Company’s profit for any respective twelve months period ending December 31, 2007 to 2011 exceeds certain profit targets (the “Future Annual Incentive Share Plan”).
 
 During the years ended June 30, 2008 and 2009, the Company determined that the after-tax profit (in terms of comprehensive income concept) target for the 12-months ended December 31, 2007 and 2008 was met respectively. Accordingly, 4 million incentive shares were issued on July 25, 2009.
  F-27





On June 15, 2009, the Company agreed to immediately issue 4 million ordinary shares 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 ASC Topic 718 Compensation - Stock Compensation, the modification of the incentive stock compensation resulted in an incremental incentive stock compensation of $22 million, which was charged to the consolidated statement of operations for the year ended June 30, 2009. These incentives shares were issued on February 29, 2010.




On July 1, 2009, Hollysys S&T acquired a 1.78% equity interest of Beijing Hollysys from the non-controlling interest holder, for  cash consideration of RMB 18 million (equivalent to $2,638,793).





On December 23, 2009, the Company entered into the Share Purchase Agreement with the non-controlling interest holder, Unionway Resources Limited, to acquire a 24.11% equity interest of Beijing Hollysys, by issuing 4,413,948 ordinary shares of the Company with a fair value of $53,011,515 and a cash payment of RMB 67.63 million (equivalent to $9,936,203). The 4,413,948 shares were issued on March 16, 2010.





According to ASC Topic 810-10 Consolidation, these non-controlling interest acquisitions were recognized as equity transactions, and the difference between the consideration paid and the carrying amount of the 1.78% and 24.11% equity interest in Beijing Hollysys amounted approximately to $1,414,108, and $44,586,023 was recognized as additional paid in capital during the year ended June 30, 2010.





In April 2010, the holders of the Unit Purchase Option (“UPO”) exercised 250,000 of the UPO on a cashless basis, and 92,567 ordinary shares were issued to the UPO holders on June 3, 2010. As of June 30, 2010 and 2011, none of the UPO was outstanding.





NOTE 13 – STOCK COMPENSATION EXPENSES





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.





Share options





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 June 30, 2009


681,000


$
3.98Options granted


-



-Options exercised


-



-Options cancelled/forfeited/expired


-



-Options outstanding at June 30, 2010


681,000


$
3.98Options granted


-



-Options exercised


(243,000
)


4.41Options cancelled/forfeited/expired


-



-Options outstanding at June 30, 2011


438,000


$
3.74Options vested and exercisableAt June 30, 2010


412,500


$
4.59At June 30, 2011


388,000


$
3.94




F-28





During the year ended June 30, 2011, a total of 243,000 options were exercised by the share option holders, of which 150,000 and 93,000 share options were exercised at a price of $2.24 and $7.9, respectively, with total of cash receipt of $1,070,700 for the share options exercised. The total intrinsic value of the options exercised during the year ended June 30, 2011 was $2,640,820.





The following table summarizes information with respect to options outstanding at June 30, 2011:





Options outstanding and exercisableNumber

outstanding


Weighted average

remaining

contractual life years


Weighted average

fair value as of

the grant dateExercise price:US$7.90


78,000



1.5


$
2.34US$5.85


60,000



1.9



2.21US$2.24


300,000



7.6



2.31Total


438,000



5.7


$
2.30





The aggregate intrinsic value as of June 30, 2010 and 2011 is $3,425,910 and $2,442,960 respectively .





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





Year Ended June 30,2009


2010


2011Options granted (weighted average)Average risk-free rate of return


1.85
%


-



-Expected option life

6 years



-



-Volatility rate


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 ASC Topic 718 Compensation - Stock Compensation 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 $319,026, $524,076 and $456,628, included in general and administrative expenses, for the years ended June 30, 2009, 2010 and 2011. As of June 30, 2010 and 2011, there were $658,765 and $115,500, respectively, of total unrecognized compensation expense related to the share options. The unrecognized compensation expense related to the share options is expected to be recognized over a weighted-average vesting period of 0.5 year.




F-29





Restricted shares





During June 30, 2011, the Company granted 67,500 restricted ordinary shares to certain directors under the Plan, vesting over a period of 3 years, with the vesting period starting from the grant date. Fair value of the restricted shares was determined with reference to the market closing price at grant date.





A summary of the restricted shares is as follows:





Number of

restricted

shares


Weighted

average grant

date fair valueRestricted shares outstanding at July 1, 2010


-


$
-Granted


67,500



12.57Cancelled/forfeited


-



-Restricted shares outstanding at June 30, 2011


67,500


$
12.57Restricted shares vestedAt June 30, 2011


6,459


$
14.76





The Company recorded restricted share compensation expense of $95,338, included in general and administrative expenses, for the year ended June 30, 2011. As of June 30, 2011, there was $753,440 of total unrecognized compensation expense related to the restricted shares. The unrecognized compensation expense related to the restricted shares is expected to be recognized over a weighted-average vesting period of 2.71 years.





NOTE 14 - 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 $4,467,855,  $6,378,917  and $8,661,442 for the years ended June 30, 2009, 2010 and 2011, respectively.





NOTE 15 - INCOME TAX





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





The standard statutory tax rate of PRC Enterprise Income tax (“EIT”) is 25% effective from calendar year ended December 31, 2008. All PRC subsidiaries applied the standard statutory tax rate except the following subsidiaries.





Beijing Hollysys





In 2008, Beijing Hollysys was certified as a High-tech Enterprise for three years commencing January 1, 2008. Pursuant to PRC EIT law, an enterprise certified as a High-tech Enterprise enjoys a preferential EIT rate of 15%. Therefore, the EIT tax rate applicable to Beijing Hollysys was 15% for the calendar years ended December 31, 2008, 2009 and 2010. As of June 30, 2011, Beijing Hollysys was in the process of renewing its High-tech Enterprise status. According to the State Administration of Taxation Notice [2011] No. 4 – Provisional tax implementation for High-tech Enterprise subject to renewal process, a High-tech Enterprise can apply a provisional EIT rate of 15% when the High-tech Enterprise status expired but is in the process of renewal. The management expects that Beijing Hollysys will be certified again as a High-tech Enterprise during the calendar year ending December 31, 2011. Accordingly, the applicable EIT rate for Beijing Hollysys is 15% for the period from January 1 to June 30, 2011.




F-30


Hangzhou Hollysys





In 2008, Hangzhou Hollysys was certified as a High-tech Enterprise for the three years commencing  January 1, 2008. In addition, Hangzhou Hollysys also was certified as a “Major Software Enterprise” for the calendar years ended December 31, 2008, 2009 and 2010, and was entitled to a concessionary EIT rate of 10% which was granted by relevant authorities discretionarily on an annual basis. In accordance with the new EIT law, the EIT tax rate applicable to Hangzhou Hollysys for the calendar years ended December 31, 2008, 2009, and 2010 was 10%. For the calendar year ending December 31, 2011, concessionary EIT has not yet been granted by relevant authorities as Hangzhou Hollysys is still in the process of obtaining the certification as Major Software Enterprise.





As mentioned above, Hangzhou Hollysys is in the process of renewing its High-tech Enterprise status as of June 30, 2011. According to the State Administration of Taxation Notice [2011] No. 4 – Provisional tax implementation for High-tech Enterprise subject to renewal process, a High-tech Enterprise can apply the provisional EIT rate of 15% when the High-tech Enterprise status expired but is in the process of renewal. The management expects that Hangzhou Hollysys will be certified as a High-tech Enterprise during the calendar year ending December 31, 2011. Accordingly, the applicable EIT rate for Hangzhou Hollysys is 15% for period from January 1 to June 30, 2011.





Hollysys Automation





Hollysys Automation is registered in a high-tech zone located in Beijing and was certified as a “Software Enterprise” for the calendar years ended/ending December 31, 2009, 2010 and 2011, 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 after the first profitable calendar year, which was the calendar year ended December 31, 2010. In accordance with the new EIT law, the EIT tax rate applicable to HollySys Automation for the calendar years ended/ending December 31, 2009, 2010, and 2011 is therefore 25%, 0%, and 0%  respectively.




F-31


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





Year Ended June 30,2009


2010


2011Current income tax expense

$
2,525,416


$
8,540,774


$
7,634,494Deferred income tax expense (benefit)


535,725



(877,341
)


(1,190,527
)$
3,061,141


$
7,663,433


$
6,443,967





Reconciliation between the provisions for income taxes computed by applying the statutory tax rate in PRC of 25% for the fiscal years ended June 30, 2009, 2010, and 2011 for the income before income taxes and the actual provision for income taxes is as follows:





Year Ended June 30,2009


2010


2011Income (loss) before income taxes

$
(5,603,121
)

$
35,219,424


$
47,909,081Expected income tax expense at statutory tax rate in PRC


(1,400,780
)


8,804,856



11,977,270Effect of different tax rates in various jurisdictions


32,590



15,555



15,070Effect of preferential tax treatment


(4,004,659
)


(4,989,382
)


(5,768,020
)Effect of income for which no income tax is chargeable


(1,447,910
)


(1,394,901
)


(1,792,868
)Effect of additional deductible research and development expense


(770,383
)


(197,472
)


(860,736
)Effect of non-deductible expenses


10,585,029



883,415



882,370Under/(over) provision of income tax in previous years


(34,818
)


(86,171
)


792,662Change in valuation allowance


113,096



63,397



149,420Utilization of tax loss previously not recognized


-



-



(40,019
)Effect of deemed profit arisen in re-organization


-



1,372,299



-Withholding tax on capital repayment


-



3,082,100



1,077,377Others


(11,024
)


109,737



11,441Effective income tax expense

$
3,061,141


$
7,663,433


$
6,443,967





Had the all above tax holidays and concessions not been available, the tax charge would have been higher by $4,004,659, $4,989,382 and $5,768,020 and the basic net income per share would have been lower by $0.09, $0.10 and $0.11 for the years ended June 30, 2009, 2010 and 2011 respectively, and diluted net income per share for the years ended June 30, 2009, 2010 and 2011 would have been lower by $0.09 , $0.10 and  $0.10, respectively.





In February 2010, Hollysys re-organized the group structure of its PRC wholly owned subsidiaries (the “Group Re-organization”). GTH and Beijing Hollysys, each held 60% and 40% equity interest of Hangzhou Hollysys respectively, transferred the equity interest of 20% and 40% equity interest of  Hangzhou Hollysys, respectively to Hollysys S&T at cost on February 3, 2010.  As a result, GTH and Beijing S&T held 40% and 60% equity interest of Hangzhou, without any change in the effective interest held by the Company before and after the equity transfer.




F-32





Prior to the equity transfer, on February 1, 2010, the board of directors of Hangzhou Hollysys approved the resolution of dividend declaration amounted to RMB 513.27 million (equivalent to $75.25 million), on a one-off basis, among which RMB 205.31 million (equivalent to $30.10 million) was distributable to Beijing Hollysys, and RMB 307.96 million (equivalent to $45.15 million) distributable to GTH.





Pursuant to PRC Enterprise Income Tax Law, Hangzhou Hollysys, a foreign investment enterprise, is obligated to withhold income tax on dividends paid-out to GTH, a foreign enterprise and non-resident, for the earnings retained after January 1, 2008. Out of the total dividends of RMB 307.96 million (equivalent to $45.15 million) distributable to GTH, RMB 210.24 million (equivalent to $30.82 million) was retained after January 1, 2008. As a result, Hangzhou Hollysys withheld RMB 21.04 million (equivalent to $3.08 million) of income tax for the dividends distributable to GTH based on the tax rate of 10% in accordance with the PRC tax law during the year ended June 30, 2010.





Hangzhou Hollysys  is also obligated to withhold the income tax for the gain on disposal of equity interest. Pursuant to PRC Enterprise Income Tax Law, the consideration of equity transfer shall be adjusted to fair value for taxation purpose. The Company engaged a third party value, to value the equity interest of Hangzhou Hollysys as of February 3, 2010, the date of transfer. The fair value of the equity interest in Hangzhou for tax purpose was approximately $34.85 million.





As a result, Hangzhou Hollysys withheld RMB 2.34 million (equivalent to $0.34 million) of income tax for GTH in respect of the gain on disposal of equity interest based on the tax rate of 10% in accordance with the PRC tax law. Beijing Hollysys accrued RMB 7.02 million (equivalent to $1.03 million) of income tax in respect of the gain on disposal of equity interest based on Beijing Hollysys’ applicable enterprise income tax rate. Total of income tax expense for the deemed profit arising from the Group Re-organization of $1.37 million was incurred during the year ended June 30, 2010.





In January 2011, the Company determined to carry out another group re-structuring, where Beijing S&T transferred the equity interest of 60% equity interest of Hangzhou Hollysys, at cost, to Beijing Hollysys. Before the execution of the equity transfer, the board of directors of Hangzhou Hollysys approved a resolution to declare a  dividend  of RMB 178.54 million (equivalent to $26.93 million), on a one-time basis, of which RMB 107.12 million (equivalent to $16.16 million) was distributable to Beijing S&T, and RMB 71.42 million (equivalent to $10.77 million) was distributable to GTH. As a result, Hangzhou Hollysys withheld RMB 7.14 million (equivalent to $1.08 million) in income tax for the dividends distributable to GTH based on the tax rate of 10% in accordance with the PRC tax law during the year ended June 30, 2011.




F-33





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





June 30,2010


2011Deferred tax assetsDoubtful debt allowance

$
1,449,386


$
1,811,353Inventory provision


309,047



242,891Long-term assets


129,955



457,206Deferred revenue


1,804,203



4,049,695Warranty liability


285,800



416,429Recognition of intangible assets


628,215



714,693Accrued payroll


406,988



802,344Net operating loss carry forward


519,683



684,0855,533,277



9,178,696Less: Valuation allowances


(519,683
)


(631,775
)$
5,013,594


$
8,546,921Deferred tax liabilitiesCost and estimated earnings in excess of billings

$
(3,379,237
)

$
(5,533,959
)Deferred tax assets, net

$
1,634,357



3,012,962Deferred tax assets - current

$
956,969


$
2,021,466Deferred tax assets – non-current


677,388



991,496$
1,634,357


$
3,012,962





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 foreign holding company are subject to a withholding tax at a rate of 10% unless reduced by tax treaty. At June 30, 2010 and 2011, aggregate undistributed earnings of the Company’s subsidiaries located in the PRC that are available for distribution to the Company of approximately RMB583.45 million (equivalent to $85.92 million) and RMB862.11 million (equivalent to $133.21 million) are intended to be reinvested, and accordingly, no deferred taxation has been made for the PRC dividend withholding taxes that would be payable upon the distribution of those amounts to the Company. Distributions made out of pre January 1, 2008 retained earnings will not be subject to the withholding tax.





In accordance with ASC Topic 704 Income Taxes, 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.





Determining income tax provisions involves judgement on the future tax treatment of certain transactions. The Company performed a self-assessment and concluded that there was no significant uncertain tax position requiring recognition in its financial statements. The tax treatment of such transactions is reconsidered periodically to take into account all changes in tax legislations. Where the final tax outcome of these transactions is different from the amounts that were initially recorded, such difference will impact the income tax and deferred tax provisions in the year in which such determination is made.





There were no material interest or penalties incurred for the years ended June 30, 2009, 2010 and 2011.




F-34





NOTE 16 – EARNINGS (LOSS) PER SHARE





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





Year Ended June 30,2009


2010


2011Net income (loss) attributable to Hollysys - numeratorBasic and diluted

$
(13,851,064
)

$
25,704,538


$
41,469,998Shares - denominator:Weighted average ordinary sharesoutstanding used in computing basicnet earnings (loss) per share attributable to Hollysys


44,950,833



51,243,667



54,564,842OptionEffect of dilutive securitiesShare options


-



251,062



382,070UPO


-



343,565



-Restricted shares


-



-



2,368Weighted average ordinary sharesoutstanding used in computingdiluted net earnings per share attributable to Hollysys


44,950,833



51,838,294



54,949,280Net earnings (loss) per share attributable to Hollysys  - basic

$
(0.31
)

$
0.50


$
0.76Net earnings (loss) per share attributable to Hollysys - diluted

$
(0.31
)

$
0.50


$
0.75





For the year ended June 30, 2009, potential ordinary shares of 681,000 shares related to stock options granted under the terms of the Plan, 750,000 shares related to UPO and 4,991,781 shares related to contingent issuance of ordinary shares 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.




F-35





NOTE 17 - RELATED PARTY TRANSACTIONS





Related Party Relationships





Name of Related Parties

Relationship with the CompanyHollysys Information

20% owned by Beijing HollySysNew Huake Electronic Technology Co., Ltd. (“New Huake”)

37.5% owned by Beijing HollySysChina Techenergy Co., Ltd. (“China Techenergy”)

50% owned by Beijing HollySysIPE

23.39%owned by Beijing HollySysHollysys Electric Tech Co., Ltd. (“Hollysys Electric Tech”)

40% owned by Beijing HollySysHollysys Equipment Technology Co., Ltd. (“Hollysys Equipment”)

20% owned by Beijing HollySysZhejiang Sanxin  Engineering Co., Ltd (“Zhejiang Sanxin”)

6% owned by Hangzhou HollySys





Due from Related Parties


June 30,2010


2011Hollysys Information

$
998,113


$
1,333,534China Techenergy


9,749,715



10,837,123Hollysys Electric Tech


9,234



-Hollysys Equipment


4,565



4,790Zhejiang Sanxin


3,201



-$
10,764,828


$
12,175,447





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 30,2010


2011Hollysys Information


1,853,162



2,725,059New Huake


73,191



58,203Hollysys Equipment Technology Co. Ltd.


1,696



1,780Beijing Techenergy Co., Ltd


673,966



536,125Hollysys Electric Tech Co., Ltd


8,584



17,396$
2,610,599


$
3,338,563




F-36





Purchases and Sales with Related Parties





Purchases of goods and services


Year Ended June 30,2009


2010


2011Hollysys Electric Tech

$
24,709


$
41,757


$
34,085Beijing Techenergy


1,531,058



70,368



-Hollysys Information


728,897



4,857,416



2,151,391New Huake


431,693



493,203



879,111$
2,716,357


$
5,462,744


$
3,064,587





Purchase of buildings


Year Ended June 30,2009


2010


2011Hollysys Information

$
-


$
-


$
3,608,675





Lease Expenses


Year Ended June 30,2009


2010


2011Hollysys Information

$
-


$
32,069


$
-





Sales


Year Ended June 30,2009


2010


2011HollySys Electric Tech

$
13,865


$
11,038


$
13,478Beijing Techenergy


5,721,797



4,189,366



3,557,125Hollysys Information


920,333



2,184,844



727,460Zhejiang Sanxin


-



8,337



-Hollysys Equipment


30,794



1,385



-$
6,686,789


$
6,394,970


$
4,298,063





Lease Income


Year Ended June 30,2009


2010


2011Beijing Techenergy

$
27,835


$
-


$
-Hollysys Equipment


3,351



-



-$
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.




F-37





NOTE 18 - OPERATING RISK





The Company has significant investments in the PRC.  The operating results of the Company may be adversely affected by changes in the political and social conditions in the PRC, 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, 2009, 2010 and 2011.





The Company has no customer that individually comprised 10% or more of the outstanding balance as of June 30, 2010 and 2011.





NOTE 19 – FAIR VALUE OF FINANCIAL INSTRUMENTS





The carrying amount of cash and cash equivalents, contract commitment deposit in banks, 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 their fair value due to the interest rates on the debts approximating at current rates.





NOTE 20 - COMMITMENT





The Company leases premises under various operating leases.  Rental expenses under operating leases included in the consolidated statement of operations were $1,105,473, $1,002,666 and $1,053,907 for the years ended June 30, 2009, 2010 and 2011, respectively.





At June 30, 2011, the Company was obligated under operating leases requiring minimum rentals as follows:





Years Ending June 30,2012


793,3142013


681,8552014


85,2832015


13,2182016


3,367Total minimum lease payments

$
1,577,037





There was no significant capital commitment as of June 30, 2011.





NOTE 21 - SUBSEQUENT EVENTS





On May 18, 2011, the Company entered into the SPA to acquire the 100% interest of Concord Group, which is engaged in the provision of electrical works and infrastructure engineering services in South-East Asia and the Middle East. The total consideration of the acquisition, of approximately $43.2 million, consisted of cash consideration of SGD$41.5 million (approximately $33.8 million), and 1,006,788 ordinary shares of Hollysys, valued at approximately $9.4 million.




F-38





In addition, the Company is obligated to issue an aggregate of 1,510,181 ordinary shares of the Company (“Incentive Shares”) to the management of the Concord Group if the Concord Group’s net income equals or exceeds $10 million and $11.5 million for the fiscal years ending June 30, 2012 and 2013, respectively (“Targeted Net Income Threshold”), in accordance with the SPA. The Company will issue 50% of Incentive Shares to the management of the Concord Group on an all or none basis per year when the Targeted Net Income Threshold is achieved. The Company will account for the transactions of issuing these Incentive Shares as compensation stock expenses in the consolidated statements of operation in accordance with ASC Topic 805-10 Business Combinations.





On May 30, 2011, the Company paid SGD$20.75 million (equivalent to approximately $16,856,148) as an advance of the  purchase price consideration for the acquisition of the Concord Group.





On July 1, 2011, the closing conditions were met and the acquisition of the Concord Group was completed. The Company made the final cash payment of SGD$20.75 million (equivalent to approximately $17,008,274) on July 11, 2011. On September 6, 2011, 1,006,788 ordinary shares were issued as the balance of the purchase consideration due for the Concord Group.





Through the acquisition, the Company seeks to expand the existing distribution and marketing channels to cross sell the Company’s existing product lines in the rail and industrial segments to the fast growing South-East Asia and the Middle East markets. The operating results of Concord Group will be included in the Company’s consolidated financial statement for the year ending June 30, 2012, and thereafter. Due to insufficient preparation time, the initial accounting treatment for this business combination is incomplete at the issuance of the Company’s 2011 consolidated financial statements. As a result, the Company is unable to disclose the financial effect of this business combination, including information regarding fair value of assets acquired and liabilities assumed, until the Company has a more in-depth review.




F-39





NOTE 22 – CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY





The condensed financial statements of Hollysys Automation Technologies (“the parent company”) have been prepared in accordance with accounting principles generally accepted in the United States of America. Under the PRC laws and regulations, the Company’s PRC subsidiaries are restricted in their ability to transfer certain of their net assets to the parent company in the form of dividend payments, loans or advances. The amounts restricted include paid-in capital, capital surplus and statutory reserves, as determined pursuant to PRC generally accepted accounting principles, totaling RMB1,244.91 million (equivalent to $183.32 million) and RMB1,292.47 million (equivalent to $199.71 million) as of June 30, 2010, and 2011, respectively.





The following represents condensed unconsolidated financial information of the Parent Company only:





CONDENSED BALANCE SHEET


(In US Dollars)





June 30,2010


2011ASSETSCurrent assetsAmounts due from subsidiaries

$
71,105,607


$
55,146,317Prepaid expenses


42,497



50,712Total current assets


71,148,104



55,197,029Advance payment for acquisition of a subsidiary


-



16,856,148Investments in unconsolidated subsidiaries


142,216,219



193,809,983Total assets

$
213,364,323


$
265,863,160LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilitiesAccrued payroll and related expense

$
42,382


$
43,984Accrued liabilities


625,216



761,519Total current liabilities


667,598



805,503Total stockholders' equity


212,696,725



265,057,657Total liabilities and stockholders' equity

$
213,364,323


$
265,863,160





CONDENSED STATEMENTS OF OPERATIONS


(In US Dollars)





Year Ended June 30,2009


2010


2011Equity in earnings of unconsolidated subsidiaries

$
27,609,431


$
27,994,479


$
43,432,493General and administrative expenses


(41,495,313
)


(2,289,941
)


(1,962,495
)Income (loss) before income taxes


(13,885,882
)


25,704,538



41,469,998Income taxes credit


(34,818
)


-



-Net income (loss)

$
(13,851,064
)

$
25,704,538


$
41,469,998




F-40





CONDENSED STATEMENTS OF CASH FLOW


(In US Dollars)





Year ended June 30,2009


2010


2011Net cash used in operating activities

$
(126,698
)

$
(70,942
)

$
-Net cash provided by (used in) investing activities


-



-



-Net cash provided by (used in) financing activities


-



-



-Net decrease in cash and cash equivalents


(126,698
)


(70,942
)


-Cash and cash equivalents, beginning of year


197,640



70,942



-Cash and cash equivalents, end of year

$
70,942


$
-


$
-





Basis of presentation





The condensed financial information has been prepared using the same accounting policies as set out in the Company’s consolidated financial statements except that the parent company has used equity method to account for its investments in subsidiaries.




F-41