China Security & Surveillance Technology, Inc. Q2 2009 Earnings Call Transcript

Jul.28.09 | About: China Security (CSR)

China Security & Surveillance Technology, Inc. (NYSE:CSR)

Q2 2009 Earnings Call Transcript

July 28, 2009 8:00 am ET

Executives

Michael Tieu - Managing Director, ICR

Terence Yap - Vice Chairman and CFO

Analysts

Kun Tao - Roth Capital Partners

Michael Kim - Imperial Capital

Charles [ph] -- Oppenheimer

Adele Mao - Susquehanna

Operator

Good day, everyone, and welcome to the China Security & Surveillance Technology Incorporated second quarter 2009 earnings conference call. Today's conference is being recorded.

At this time, I would like to turn the call over to Mr. Michael Tieu of ICR for opening remarks and introductions. Please go ahead, sir.

Michael Tieu

Thank you everyone for joining us for the China Security & Surveillance Technology's second quarter 2009 earnings call. With us today is Terence Yap, China Security's Vice Chairman and Chief Financial Officer.

Before we get started, I'm going to review the safe harbor statement regarding today's conference call. This conference call may contain forward-looking statements concerning China Security's business, which are intended to be covered by the Safe Harbor for forward-looking statements under the Private Securities Litigation Reform Act of 1995. The actual results may differ materially depending on the number of risk factors including, but not limited to, general economic and business conditions, new product developments, installations, market acceptance, additional competition from existing and new competitors, changes in technology, and various other factors beyond the company's control.

All forward-looking statements are expressly qualified in their entirety by the cautionary statement and risk factors detailed in the company's filings with the SEC. China Security undertakes no duty to revise or update any forward-looking statements, except as required by applicable law.

Additionally, during this conference call, the company will use non-GAAP financial measures to describe adjusted 2008 earnings per share, projected 2009 adjusted net income, and projected 2009 adjusted earnings per share. For reconciliation of this non-GAAP financial measures to the equivalent GAAP financial measure, and for an explanation of why the company (inaudible) that these non-GAAP measures are useful to investors, please the press release that the company issued this morning. A copy of which maybe obtained on the company’s Web site at www.csst.com.

At this point, I'd like to introduce Terence Yap, Vice Chairman and Chief Financial Officer. Terence?

Terence Yap

Thank you very much, Michael. Good morning to those in the US, and a very good evening to those participants in Asia. Welcome to our second quarter 2009 earnings conference call. Today, we will discuss our financial results, talk about recent developments and our strategic plans, and conclude with our outlook for the remainder of 2009.

Before we discuss the details of our second quarter results further, I would like to review with you our successful agreement with the restructure of the terms of our outstanding convertible notes with Citadel, which we have announced on a separate press release.

As many of you know, in early 2007, we raised a total of $110 million for two guaranteed senior unsecured convertible notes of $16 million and $15 million with Citadel Equity Fund Limited. These notes bear interests at a rate of 1% per annum and are due in 2012. Under the original term, the notes are to be redeemed by the company at a redemption price equal to a 100% of the principal amount, plus an additional amount of 15% per annum, which totals approximately $220 million and maturity in 2012. As of June 30th, 2009, the company accrued $44.3 million as a redemption amount payable under note.

Needless to say, we are excited of the proposed restructure and we expect to open a third quarter. At closing, we have both mentioned that these notes will be restructured in the two new tranches of notes consisting of Tranche A, senior unsecured convertible notes; and, Tranche B, senior unsecured non-convertible notes; maturing two years from a chosen date, and carrying zero coupon interest.

The covenants in our existing indentures will be modified as necessary. Indentures for the new notes in a way that is mutually agreeable to both Citadel and the company. China Security will make an initial cash payment and stock payment totaling approximately $25 million when definitive agreements are entered into.

We believed the restructured term will provide greater flexibility to our capital structure, and allow us greater agility to pursue additional strategic options. Both the required cash and stock payments may reduce our EPS in the near term. We believe the restructured notes provide significant cost savings of China Security in the long run.

We plan to provide you with the full financial details and eventual impact of the deal at the time of the closing. As such, I invite you to stay tuned for a full update at that time.

Now, let me turn our attention back to the second quarter financial results. In the third same quarter of 2009, we continue our focus on expanding our market leadership in China through greater integration of our corporate strength and asset. I am pleased that ours is better than expected in growth in the second quarter, demonstrates our successful execution on our key objective as we continue to grow our company, our trend and our market leadership.

First of all, the financial results, during the second quarter of 2009, we continue to experience strong revenue growth driven by robust demands for our products and services by our core government and large corporate customers. Revenues for the second quarter of 2009 grew by $49.18 million or 53% to $141.92 million compared to $92.74 million in the second quarter of 2008. As we benefited from a steady growth in the civilian and Safe City markets in China, increased demand for our integrated products and services, our strong brand recognition.

Our installation revenue in the second quarter totaled $108.14 million or 76.2% of revenue compared to $62.15 million or 67% of revenues in the second quarter of the prior year. Manufacturing revenues was $20.49 million or 14.4% of revenues versus $20.36 million or 22% in the same period last year. Our distribution segment contributed $13.29 million or 9.4% to our overall revenue compared to $10.23 million or 9% of the total revenue in the second quarter of 2008.

We continue to view our installation segment as the main growth driver of the business. As we believe we perfectly leverage our sales expertise. During the quarter, we continue to see strong demands for our products and services, both from the government sector and the corporate sector. The Chinese government continued execution on its Safety programs and a well-publicized economic stimulus bank remained the key drivers for installation of electronic securities surveillance system, and safety products in China.

The government sector has a percentage of our total revenue was roughly 42%. Our corporate sector has always been a strong performer. Our projects on the second quarter include banks, airports, gasoline stations, community centers, shopping malls, business centers and entertainment venues. Corporate revenues as a percentage of our total revenues totaled roughly 58% for the quarter.

Organic revenues during the second quarter 2009 were approximately $127.32 million or 89.10% of total revenue, while revenue from acquired companies was approximately $14.6 million or 10.3% of total revenue. As a result, organic revenue grew during the quarter by $58.8 million or 85.8% year-over-year from $68.52 million in the second quarter of 2008.

In the second quarter of 2009, revenue contributions from Stone Sonic [ph], Gong Chang, Guang Ming, Gin Ling [ph], and BIT, were approximately $13.51 million. While revenue contributions from Ker Song [ph], the (inaudible), which closed in January 2009 was approximately $1.06 million.

We continue to drive cost synergies among all our business units and subsidiaries and leveraging our strong management expertise, marketing, distribution, and corporate lending. Second quarter gross profit grew approximately $0.56 million or 1.8% to $31.02 million from $30.46 million for the same period last year.

Gross margin for the second quarter was 21.9% as compared to 32.8% for the same period of 2008 due to a higher price competition in the corporate sector and lower margin from small scale projects. Gross margins for the installation segment, manufacturing segment, and distribution segment were approximately 21.5%, 27.8%, and 15.4% respectively compared to 34%, 35%, and 21.6% for the same period last year.

While our profit margins remained firm in the government sector, our effort in expanding our market share and customer base increased bales of small scale projects in our revenue mix.

Gross margins for the manufacturing sector decreased to 27.48% for three months ended June 30th of 2009 from 35% for the same period last year. This decrease was primarily driven by low return price.

Gross margins for distribution segment decreased 15.4% for the three months ended June 30th 2009 from 21.6% for the same period last year, also primarily due to lower selling price of third party products under current market environment.

Generally, we expect larger government contracts in our total revenue mix from third and fourth quarters. And as such, we anticipate the total gross margin will rebound in the second half of 2009. We are also confident that the gross margins can improve in each of our revenue segments in the second half of 2009.

Selling and marketing expenses was approximately $3.03 million in the second quarter of 2009 versus $2.99 million the prior year. As a percentage of revenues, our selling and marketing expenses decreased to 2.1% for the second quarter of 2009 from 3.2% for the same period in 2008. The percentage decrease benefitted from higher cost efficiencies and our focus on internal improvement.

General administrative expenses increased by $0.17 million or 2.1% to 8% or 15 million in the second quarter of 2009 from $10.98 million of the same period in 2008. As a percentage of revenues, general and administrative expenses decreased to 5.10% for the second quarter of 2009 from 8.6% for the same period in 2008. The percentage decreased was driven by higher operating scale. We believed that in lower SG&A expenses as a percentage of sale demonstrates all those which were actively managed our operating costs while sustaining our record revenue growth.

Income from operation decreased by approximately $1.68 million or 11.8% to $12.57 million for the second quarter of 2009 as compared to $14.25 million for the same period in 2008. Accordingly, operating margins decreased to 8.9% in the second quarter of 2009 or 15.4% for the same period in 2008 primarily due to lower gross margin and a higher non-cash employee compensation.

Our effective tax rate for the second quarter was 7.8% compared to 21.8% in the same period last year. As we benefited from the tax exemptions stated about of two years of DSSTTRC, Longhorn and Jin Lin, and (inaudible) back status of Shenzhen Hongtianzhi, Ningji, Tsingvision, Golden, Coson, and DIT.

Though we continue to optimize tax planning for our various subsidiaries, we expect to see fluctuations for effective tax rates over the next few quarters due to non-tax deductible expenses.

Second quarter 2009 debt net income decreased $1.24 million or 16% to $6.5 million from $7.74 million for the same period in 2008. And the percentage of revenues, net income decreased to 4.6% in the second quarter of 2009, from 8.3% for the same period in 2008. Our diluted share account increased 11.4% in second quarter of 2009 to 15 million shares from $44.9 million in prior year. Consequently, debt earnings per diluted share was $0.13 versus $0.17 in the second quarter of 2008.

On non-cash expenses, during the second quarter, we recognized $5.58 million or $0.11 per value to share after redemption accretion on convertible loans. We also incurred $3.15 million or $0.06 per diluted share in the second quarter for depreciation and amortization of long-lived assets. Lastly, we incurred approximately $4.36 million or $0.09 for diluted share on a non-cash basis or employee compensation.

Adjusting for our non-cash item, net income grew 11.7% to $19.59 million versus $17.54 million in the second quarter of 2008. Adjusted earnings per diluted share were $0.39, same as $0.39 per diluted share in the second quarter of 2008.

Backlog, at the end of that second quarter, our total backlog was $24.25 million, less than a previous backlog of $86.87 million at the end of the first quarter of 2009. As a growing portion of our cost savings consist of large payment agreement are not included in our net backlog calculation.

We also have not included market intents in various out agreements and they are subjected to final binding individual agreements to be entered at later date. We expect the majority of these total backlogs to realize in 2009. The annualized and a firmer agreement provide us with the confidence in our 2009 guidance.

Balance sheet, because the balance sheet is a snatch short at a moment in time, I like to address specifically other line items that have significantly changed, or that I believe can have a true impact on ongoing operation.

Cash, as of June 30th, 2009, our cash balance grew by nearly $17 million to $89.47 million, up from $72.4 million at the end of the first quarter of 2009. During the quarter, we continuously benefited from the support of the Chinese local bank in addressing our working capital requirement and successfully raised nearly $28 million from bank borrowing in China at an annual interest rate of between 5% to 6%.

Net cash provided by operating activities was $17.76 million in the first half of 2009, an increase of $6.7 million from the $11.06 million of net cash provided by operating activities for the same period in 2008, which can be attributed to the solid growth of adjusted earnings excluding non-cash expenses in the first half of 2009.

DSOs, though our accounts receivables increased sequentially by $46.35 million to $179.15 million, compared with $132.8 million at the end of the first quarter, our DSOs, or days-of-bills-outstanding, improved on higher still to 115 days versus 124 days in the previous quarter.

On the other hand, as we stated on our previous conference calls, our fulfillment of safety contracts commissioned by the government entities tend to have longer payment cycles and therefore, as the government cycle continues to grow, we expect DSOs to increase accordingly. Nevertheless, without these financing facilities, we believe we are sufficiently capitalized to sustain this collection cycle. It is worth speaking again, that although, we would prefer to have smaller account receivables on our books, we believe that a credit willingness of our local and national customers, as long as our government customer is reliable. And these accounts receivables are collectible, and because the majority of our revenue has a base from the government contracts, we do not see this as credit outfit, but rather a typical timing of payment for receivables from government entities in China.

Inventory, our inventory decreased by $6.63 million to $120.48 million versus $127.11 million at the end of the first quarter of 2009. As a result, our continuous expert of proactively monitoring and controlling inventory build-up, our inventory level was necessary to fulfill our future obligations. We both mentioned vital contract as we are confident we will generate revenue in next several quarters.

Working capital, lastly, our working capital at the end of the second quarter increased to $258.92 million versus $241.9 million at the end of the first quarter of 2009, reflecting our higher cash balance.

With regards to our recent developments and strategic plans, as I mentioned earlier, we continue to see strong demands for our products and services from our core corporate and government customers. We believe the Chinese government is still our strength, has provided large government organizations and corporations with the additional capital for infrastructure spending, and therefore, for the remainder of 2009, we remain steadfast on expanding our market leadership and achieving greater internal efficiency.

We will continue to capture new business opportunities driven by Robert Demay of our integrated exchange solutions in China and abroad, and at the same time proactively manage our core structure. We will also continue to expand our scope along our natural evolutionary path as a recent strategic acquisitions further agreement are recurring revenue base.

In June 2009, we signed three separate letter of intent require higher percent ownership of Shanghai Forever Security Company Limited or SFSC, AG Securities Service Center for maintenance and repair of DESC and Santachi Video Technology Company Limited.

As ways to these letters of intent, if the acquisitions are closed, we’ll pay a total consideration of up to $17 million in (inaudible), which is approximately $2.5 million, 3 million RMB, which is approximately $0.4 million and 150 million RMB, which is approximately $21.9 million, exchange for higher percent ownership of SFCS, DESC, and Santachi, respectively.

SFSC is a civilian and safety services company. With SFSC’s dedicated call center facility, digital facility, and blog, and the speed of guard dispatch and patrol vehicles, it provides surveillance and safety monitoring and (inaudible) responses. DESC, the Surveillance and Safety Emergency Maintenance Service provider in Nevada engaged in emergency maintenance, Kuching Maintenance and Consulting Services. Santachi is a leading security solutions provider for highways and railways in China, with strong execution capabilities for large-scale based projects as well.

In July of 2009, we signed a letter of intent to acquire 5% ownership of Dejiang Loyal Company Limited and Ang Huy Xanxeng Technology. Dejiang Loyal is engaged primarily in the design and installation of safety auto alarm systems. They also provide spy monitoring and management services with networks to customers. Anhuei focuses on providing total solutions and application to intelligent transportation district.

Referring to the letters, if the acquisitions are closed in exchange for a higher percent ownership of Dejiang Loyal and Anhuei, we will pay a total consolation of up to RMB110 million ,which is approximately $16.4 million and RMB20 million, approximately $2.9 million respectively. These acquisitions will set our long-term strategy to evolve from a beginning of a put up manufacture to a recently increasing shift to a total solution provider with emphasis on security systems installation to a main -- to our aim of substantially growing our recurring revenue base of monitoring and services.

Lastly, for the outlook for the rest of the 2009, in light of our strong second quarter revenue, we believe we will continue to see strong growth from manufacturing and systems relations associated with our base in government and from the corporate sector. We intend to sustain our current momentum for the remainder of 2009 and aim to achieve greatest energies because our portfolio of technologies, quota and subsidiaries, as focusing on greater cost selling and cost development throughout our organization. We believe that our integrated strength will allow us to expand our market share within our core market and help us to capture opportunities in a new market.

In summary, we remain confident about our business and the growth of the security industry. For the 2009 fiscal year, we are reaffirming our revenue projection of between $600 to $630 million excluding non-cash charges, we expect net income to be between $108 and $130 million. We expect adjusted EPS excluding non-cash charges to be the range of $2.16 to $2.26.

In closing, it is worth repeating that we continue to work diligently to optimize shareholder value by focusing on our growing business strategy and by capitalizing on greater opportunities, committing results to be profitable base to the project and integrating our organizational strength to achieve greater internal efficiencies. We continue to be delighted with our growth and we plan to continue to generate strong growth in our business across all operating outlets [ph].

This concludes my prepared remarks for the second quarter of 2009. Operator, I am now ready to take some questions, please. 

 
Question-and-Answer Session

Operator

Thank you. (Operator instructions) Okay, and we will take our first question from Kun Tao of Roth Capital Partners.

Kun Tao - Roth Capital Partners

Hey, good morning everyone, congratulations on the quarter. My first question is regarding what you have announced. What’s the status with the term seed with Citadel? So you have signed the total amount of payments, or you have -- you don’t know at the current stage and what’s the $25 million including percentage of cash or equities? And how much are you valuing those equities right now?

Terence Yap

At this point in time, it’s really a ten feet level. Nevertheless, it’s actually a common on both sides to work towards a real position to actually resolve the Citadel notes. We have committed ourselves to conquer an agreement sometime this quarter. And that’s our position right now. We are looking at stocking acquisition, that’s all.

There’d be zero coupon and a note will actually be extended or to tend to a series of installment payments within three years. By this point in time, I will not be able to provide any further details, and until we finally have finally defended the agreement. And after which we are going to provide full details in terms of the impact et cetera.

Kun Tao - Roth Capital Partners

So when do you expect probably when you can sign the agreement?

Terence Yap

We hope to complete everything within Q3.

Kun Tao - Roth Capital Partners

Within Q3?

Terence Yap

Yes.

Kun Tao - Roth Capital Partners

Okay, thanks. My second question regarding your financing vehicles. You signed roughly based on your backlog and your commission. That seems like pretty large contracts. Have you ever assigned any accounts receivable to any bank in the quarter and what’s your status with other financing vehicles like IBM, et cetera?

Terence Yap

We’re still getting a lot of support especially from a local Chinese bank, given that we are dealing a lot with the government sector and we’re a new specialist in this company and we do get lots of support. And in manufacturing, we have not sold anything in Q2 though we sold one in Q1 mainly because a lot of large projects have not been completed. Q3, Q4, and that’s when most of the large projects do kick in and finish off as well. From our perspective, we are always mindful of our cash flow position and that’s why we are tapping the bank and facilities in China.

IBM, we are working closely with them on a product financing side. So from our perspective, we are getting a lot of support. We are trying to leverage a lot more on our balance sheet refund, the working capital requirement in China.

Kun Tao - Roth Capital Partners

Okay. So is that why your accounts receivable actually increased over $40 million in the quarter, mostly because you have not filed your factory agreement?

Terence Yap

Right. Correct. That’s right. But if you look at it, our vehicles have also reduced from 124 days to 115 days. So that’s also the year’s also one of our chief height in terms of managing the cash flow.

Kun Tao - Roth Capital Partners

Okay. My last question is how much you signed in the quarter for large safety projects? I know you’re starting Q2 you haven’t announced anything of the large contracts you signed. But do you have a total dollar amount that you signed in the quarter?

Terence Yap

Well, we have not disclosed that part. Certainly from our exclusive ownership right now. I mean, we don’t disclose all the agreements that we signed. We have definitely signed medium-sized contracts now. How we define large hundred over million dollars, well, we have not disclosed any of them. But definitely we have signed medium-sized contracts within the quarter. Unfortunately, we don’t disclose the individual contracts at this point in time but I should say, it doesn’t mean we don’t put out a PR, doesn’t mean that we don’t sign contracts anymore. We are still signing contracts.

Given the situation in China, as we all know what’s happening. And also the 60th Communist Party anniversary, we see as well so we continually see a lot of catalyst that drive the demand that’s happening widely that’s actually reason for the government to actually improve the city standards within the city.

Kun Tao - Roth Capital Partners

Okay, just help me on that. Just look at your backlog, you say you have $74.3 million of backlogs this quarter and you have $86.8 million of backlogs last quarter. And then assuming these backlogs are all you projects, right? So --

Terence Yap

Correct.

Kun Tao - Roth Capital Partners

And then you recognize installations based on the project basis, as $118.4 million of this quarter. So you pretty much -- you have to sign approximately about $122 million and $130 million of safety projects or some other projects in order for you to have this revenue recognized and that much of backlog remaining. Is that right?

Terence Yap

Correct. As I mentioned before, this does not include the letter of intent or frame of agreement that we signed for this year as well. Internally, we have our own pipeline that is visible for our next 12 to 18 months. Therefore, by this point in time, we are not even looking at 2009 traditionally. We are going beyond that, we’re looking at 2010. So we are still remaining confident in the numbers in terms of meeting the top line figure of meeting $600 million to $630 million.

Kun Tao - Roth Capital Partners

Okay. So every quarter it seems like you have to find new contracts or finish contracts in about $110 million to $120 million?

Terence Yap

That’s right.

Kun Tao - Roth Capital Partners

Okay. All right. That’s all for my questions, thank you very much.

Terence Yap

Okay.

Operator

We move now to Michael Kim of Imperial Capital.

Michael Kim - Imperial Capital

Hi, Terence. A couple of questions, first on the government side, I know you haven’t announced a new safety awards but your progress to date on letter intent and framework agreement, are you seeing the same level of confidence -- do you have the same level of confidence or visibility carrying on 2010 that you were looking into 2009, around this time last year or can you give us a sense of your progress on the safety this side? Thanks.

Terence Yap

Absolutely. We still remain confident in terms of the number of projects coming here at CSR mainly because of the number of projects coming here at CSR. Mainly because of the part of and the state of the statements they have achieved in the government sector right now. Given the current situation that’s happening in China, Shin Jiang, et cetera, we are seeing that a lot of spending will come to the point.

On top of it, we are also seeing an increasing amount of local municipals and cities looking at expanding the safety program to also include traffic management systems, which is a rather profitable business for the government at this point in time, and it could be able to issue fines and collect fines and therefore some of our rise are really, really very short.

So we are seeing an increase in the demand, not only for surveillance cameras, but also expanding beyond that to include traffic management, to include visualization of the information, to also include site action emergency response, and even disaster and conflict. So we have the confidence in this coming year.

Michael Kim - Imperial Capital

If you were to look down in 2010, is it your sense that your growth, I don’t know if you can break out the growth between new project awards versus expansion of current customers or current projects?

Terence Yap

We definitely do see a mixed probably leading towards new customers mainly because -- you remember the penetration rates right now for the safety program this year only about 28% or 28.5%. So we still get a lot of new customers and we have a lot of customers out trying to retrofit everything all over again because some of them wouldn’t have done that well in the past so we treat them as customers from our perspective. So, yes, we do see a lot of new customers, new projects coming in.

Michael Kim - Imperial Capital

Okay and then switching gears to the corporate sector. It sounds like that, at least on the smaller projects, there’s more aggressive pricing on the part of your competitor. Do you have any thoughts on the level of focus on smaller projects versus larger projects?

Terence Yap

Well, at this point in time we assumed doing business on the small projects mainly because it is our price. I mean, we cannot tell them that we won’t want to serve you anymore. We don’t do that.

As part of our effort in terms of expanding our customer base, because if you do remember, for every inclination we do right now, it provides a future customer base for us on a recurring level of business in the future. So as long as we can still provide industry so that’s what we tried right now, we will do it. The larger contracts mainly come from a young manufacturer, so most of the corporate projects are smaller projects at this point in time.

Michael Kim - Imperial Capital

And how much is your sense on the corporate sector be driven, I guess, by increased penetration versus having a head one on the macro side? How do you see that playing out for the rest of the year?

Terence Yap

Well, the corporate sector is not essentially governed by the rules and regulations by the government, except for the entertainment venues and you have to (inaudible) in 2004, 2005, et cetera. But essentially, the demand there is driven by the need to help management to manage, protect and mitigate asset risk.

We are seeing a lot of factories installing ccTVs to have a monitor at the start, even a lot of the managers or the owners actually live in Hong Kong. They actually would like to have a system they happen to manage and look at site -- off-site remotely over the weekend, et cetera. And so a lot of it is also demand from the corporations due to natural requirement of protecting the asset -- shopping malls, banks especially, train stations they’re all gearing towards trying to use crime -- or having something that “event analysis” will help them to analyze data.

Michael Kim - Imperial Capital

Okay. And then just lastly on SG&A, can you give a sense of if we should continue to expect continued sales on the SG&A sense or is it your sense that your company will be a little and more aggressive on the second half until the 2010?

Terence Yap

Well, last year I’ve indicated to the public that now we are looking at ways to manage the cost because last year we have seen our costs, we’re really escalating especially SG&A. And we then send in place a second mechanism within the company job controlling. We are really encouraged by our ability to actually capitally manage costs while focusing on the growth and rental point and providing the best to what the customers would like.

So although we have been able to control the cost, I think at this state, we will continue to try to manage this cost during a certain percentage. We look forward to 2010. I don’t want to provide any data at this point in time, but all I can say is that we will not see the same levels of loss in 2008. One of our key -- one of the KPIs for us is really managing our SG&A report. So, you don’t see the same growth in equity. The growth in SG&A will definitely be slower than the growth in our revenues.

Michael Kim - Imperial Capital

Okay, great. And, I’m sorry, one more thing with the effective tax rate. You said that you changed the tax policy to impact the effective tax rate through the remainder of the year?

Terence Yap

No I don’t think so. I think we’ll probably have -- we’ll probably see and enjoy the same benefits. The only thing that’s really still within the realms of uncertainty is the non-taxable -- non-tax deductible of our expenses. That’s something that we are still trying to figure out and hopefully we can also review that as well. But at this point in time, I don’t want to provide any guidance for the tax rate or the seasonal -- due to the last year's -- due to their tax spending, and usually maintaining such a (inaudible) tax spending.

Michael Kim - Imperial Capital

Okay, great. Thank you very much.

Terence Yap

Thank you, Michael.

Operator

And we will now take the question of Oppenheimer.

Charles -- Oppenheimer

Hey, Terence. This is Charles [ph] calling in for Paul. Just a question on --

Terence Yap

Hey.

Charles -- Oppenheimer

Hey, a question on your acquisition projects. If we’d look at a couple of them are actually thought this is continuous. So can you just help us understand whether, on the customer mix, are they mostly -- do they mostly serve government of corporate and how do you intend to grow this second quarter forward?

Terence Yap

Okay. Well, as I’ve mentioned in the past, in our free-state approach, we’ve had it going from manufacturing and then going to system operation and now we’re moving into product scope, so the acquisition that we have announced, thus far, are all nothing new. That’s still based on our strategy of building a recurring revenue business. Now, majority of the clients that some of the companies are requiring are actually (inaudible). Some of them -- one of them is actually doing maintenance for the government project. So at this point in time, most of them have actually covered the law (inaudible).

Charles -- Oppenheimer

And then can you help us understand how you are going to go on this business segment?

Terence Yap

Well, we thought we are probably looking at further acquisitions in this sector in terms of the services sector. If you’d look at the experiences in the U.S. market or the European market, et cetera. They have all gone through the same phase as well.

Of course, we also need to look at which market, whether we grow organically for the solutions business or we continue to look at possible acquisition targets because right now, services business in China is still very young, but it’s also very friendly. We have a lot of small players that may have a few small new clients here, a few small new clients there. There’s not one single, nationwide regional provider was able to provide professional on a nationwide basis. So we still look at – we may still be looking at opportunities that can (inaudible) along the way.

Charles -- Oppenheimer

Okay. Thank you.

Terence Yap

Thank you.

Operator

(inaudible) Adele Mao of Susquehanna.

Adele Mao - Susquehanna

Hello, Terence. I have several questions. First of all, I was wondering if you could elaborate a little bit on the decline in gross margin this quarter. I would like to understand is this because of the revenue mixed towards the corporate, towards smaller projects or the overall margin in the industry has just been reset lower?

Terence Yap

It’s actually a combination of both. Actually, the fact that the corporate and smaller projects are all -- the (inaudible) overall economic situation in China that’s why, I would see a decline in the gross margins. As decline, is now asking for cheaper prices, et cetera.

On the overall side, the index -- the market may result a lot better (inaudible) when you look at the market rebounding shortly, but I’d like to remain conservative at this point and time. So the overall economic situation is bouncing back on the business, especially on the corporate sector.

Adele Mao - Susquehanna

Okay. Where do you see gross margin stabilize?

Terence Yap

We have been stabilizing in the government -- the larger government contracts, whereby we are able to provide large one-stop-shop solutions to the government sector. So that’s why in my conferences now, I've indicated that we are still confident that you’ll see gross margins improving in Q3, Q4, the second half of 2009.

Adele Mao - Susquehanna

Will we see gross margin improve in the next few quarters to the high 20s or --

Terence Yap

Well, that is something we are aiming for. At this point and time, please allow me to refrain from providing a guidance, except that we are now working towards the achieving of these targets (inaudible), that's because of the economic situation right now, we’re still -- I would like to remain conservative. But I would like to reaffirm our guidance in (inaudible) adjusted income, and also adjusted EPS.

Adele Mao - Susquehanna

Right, so it’s your reiterated guidance. What gross margin assumption have you factored in?

Terence Yap

Once again, I cannot disclose that. The only thing that I can see is we’re also looking at private managed costs as well.

Adele Mao - Susquehanna

Okay. And I understand that on the pricing front, customers are asking for more discounts. Are there any areas that CSR can save on the cost front to sort of help offset some of the margin pressure?

Terence Yap

Well, we are already seeing some benefits from moving all the manufacturing assets from the industrial park. Definitely, we’ll continue to benefit from economies of scale, and this is something that we'll continue to work on in order to improve the cost of (inaudible) product base.

As you’ve seen in our SG&A and operating expenses, we had been pretty successful in our ability to actually have to manage the cost. So as a product of our management and a couple of other key common index, we will continue to do that, than monitoring actual.

Adele Mao - Susquehanna

Okay. With respect to your guidance, have you included any of the five acquisitions--

Terence Yap

No.

Adele Mao - Susquehanna

announced?

Terence Yap

No.

Adele Mao - Susquehanna

Okay. Is there any way you can quantify the revenue potential or current revenue streams for the five acquisitions together?

Terence Yap

Well, if you look at -- at this point and time, I do not provide any, especially because we’ve been going through due diligence. But if you look halfway, we do close them at Q3, that means you only get and exclude the revenues in one quarter in 2009.

Moreover, both of the companies up high are not that thick anyway, so the revenue impact from these companies will not be that significant. Organically, the company is still going strong, although we do (inaudible) one year anniversary again. But once again, I do not (inaudible) a significant contribution to the client (inaudible).

Adele Mao - Susquehanna

Okay. I’d like to go back to that backlog question a little bit more. So as of Q2, you had some $74 million. Is there a backlog number that you can share with us as of today, given that we are already one month into the third quarter?

Terence Yap

Okay. Obviously, that’s not disclosed.

Adele Mao – Susquehanna

Okay. All right. Any sort of--

Terence Yap

But once again, if you remember last year -- end of last year was about $300 million worth of (inaudible) tests. Part of it has been recognizing the first half of the year. One half we’ll probably be recognizing in the second half of the year.

Given our historical performance for Q1, Q2, I think we managed to -- we have surpassed the analysts’ expectations in terms of the revenue growth. We are still confident in the growth perspective from the business commune mainly because once again, currently, we have an internal pipeline that's about 12 to 18 months down the road. Once again, at this point and time, I’m not even looking at 2009, I’m looking at 2010.

So that’s our ability and confidence in reaffirming our members for the full year 2009.

Adele Mao - Susquehanna

Okay. Just one last question on the other income line this quarter, it’s about a million. Is there anything left in our recurring or one time? It seems a little bit higher than the previous quarters.

Terence Yap

Rentals, et cetera, there is nothing that is coming there.

Adele Mao - Susquehanna

Rental? Rental income?

Terence Yap

Yes, rental income. About a $1 million, if I remember correctly. Yes. There is nothing substantial there.

Adele Mao - Susquehanna

Okay. So it’s recurring every quarter?

Terence Yap

Yes. We do get other income coming in, which may also include some (inaudible) maintenance, (inaudible) program. Yes.

Adele Mao - Susquehanna

I see. Okay, that’s all the questions I have.

Terence Yap

Okay.

Adele Mao - Susquehanna

Thank you.

Operator

And at this point, we have no further questions. Mr. Yap, I’d like to turn the conference back to you for any additional or closing remarks.

Terence Yap

Thank you. Well, ladies and gentlemen, thank you for joining me once again for the second quarter of 2009. Please allow me to represent the management team and the directors of the company, which we affirm our diligence in terms of (inaudible) shareholders’ value and building a business to be the leading security company in China. I look forward to speaking to you once again in Q3 this year. Thank you very much once again.

Operator

That concludes this conference. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!