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China Security & Surveillance Technology, Inc. Third Quarter 2009 Earnings Call Transcript 2 comments

October 28, 2009 | about: CSR

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China Security & Surveillance Technology, Inc. (CSR)

Q3 2009 Earnings Call Transcript

October 28, 2009 8:00 am ET

Executives

Michael Tieu – Managing Director, Integrated Corporate Relations

Terence Yap – Vice Chairman and Chief Financial Officer

Analysts

Jeffrey Kessler – Imperial Capital

[Adam Mel – OLT Global]

Kun Tao – Roth Capital Partners

Liang Hsu – Brean Murray

Michael Kim – Imperial Capital

Presentation

Operator

Greetings and welcome to the China Security & Surveillance Technology, Incorporated Third Quarter 2009 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Mr. Michael Tieu of ICR. Thank you, Mr. Tieu. You may begin.

Michael Tieu

Thank you everyone for joining us for the China Security & Surveillance Technology third 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 CSST'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 from the forward-looking statements depending on a 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. CSST undertakes no duty to revise or update any forward-looking statements, except as required by applicable law.

At this point, I would 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 U.S. and a very good evening to those participants in Asia. Welcome to our third quarter 2009 earnings conference call. Today, we will discuss our financial results, talk about our recent developments, and our strategic plan and conclude with our outlook for the remainder of 2009.

Additionally, as a complement to this call we have provided an accompanying slide presentation that is available for download from our website. If you haven't read it, we encourage you to download this presentation, because I'll be referencing the slides during my prepared discussion and Q&A session. I'd like to take this opportunity to thank the internal team for making this happen.

Before we discuss the details of our third quarter results further, I would like to review our recent successful restructuring of our balance sheet. As you can see from slide number three, beginning in late July of this year, we have restructured our two Guaranteed Senior Unsecured Convertible Notes to raise approximately $84 million through two registered direct equity offering and subsequently entered into agreement to repurchase $50 million of Tranche A portion of restructured notes.

We were encouraged by the strong interest and a strong solid participation of our shareholders in this offering. I'm very pleased to be able to retire the Tranche A Notes. As a result, our total debt due to Citadel in 2012 had been reduced to $84 million of non-convertible notes from $220 million of convertible notes. At the same time, we have also increased our cash position to more than $100 million by the end of Q3 2009.

In our view, the restructuring of our notes with Citadel has improved our capital structure, strengthened our financial position, and should lower our overall cost of capital. The combination of these transactions is consistent with our ongoing efforts to strengthen our balance sheet and further enhance our financial flexibility to help us support our ongoing growth in the surveillance and safety market and build long-term value for all of our shareholders. Although these efforts may not directly enhance our financial results in the third quarter of 2009, we believe that restructured notes will provide significant cost savings for CSST in a long-term.

In the future, we will no longer accrue non-cash interest expenses related to the original Citadel Notes. As such, we will not project pro forma earnings and we would quote our financials on a GAAP basis going forward without the need to include non-GAAP financial measures. However, we will continue to provide disclosure of other non-cash items as additional information for investors to understand our financial performance.

Well, let me turn our attention back to the third quarter financial results. Please turn to slide number four. During the third quarter of 2009, we continued to see strong organic revenue growth driven by robust demand for our products and services across our three core business segments.

Revenue for the third quarter of 2009 grew by $40.53 million or 34% to $159.82 million compared to $119.29 million in the third quarter of 2008, as we benefited from strong growth in the surveillance and safety market in China and a robust growth of the installation segment.

The Chinese government economic stimulus package, fast growing wealthy Chinese population and several governmental programs and regulations that require the installation of safety systems in public areas are the key drivers that generate strong demand for our integrated products and services. Our expanding distribution channels, strong brand recognition, reputable products and a better capitalization with enhanced working capital also accelerated our expansion this quarter.

Our installation revenue in the third quarter totaled $120.5 million or 70.5% of revenues, compared to $86.85 million or 72.8% of revenues in the third quarter of the prior year. Manufacturing revenues were $24.52 million or 15.3% of revenues, versus $21.43 million or 18% in the same period last year. Our distribution segment contributed $14.8 million or 9.3% of our overall revenue, compared to $11.01 million or 9.2% of the total revenue in the third quarter of 2008.

We continue to view our installation segment as the main growth driver of our business. The segment posted 38.7% year-over-year revenue growth in the third quarter of 2009. The strong growth of our installation business was in line with the robust growth of the industry as we continued to deploy our total surveillance and safety solution by expanding government and corporate customers, [inaudible] business opportunity. At the same time, with our recent acquisitions we expect to expand our service offerings to be added to our cost system integration solution to drive revenue growth.

During the quarter, we continued to see strong demand for our products and services both from the government sector and the corporate sector. As you can see from slide number five, the government sector, as a percentage of our total revenues was roughly 55%. We continue to see strong growth potential of the government sector driven by a number of government initiatives and expect to soon realize benefits from a recently signed government contract.

Our corporate sector has also been a strong performer. Our projects in the third quarter included airport, hotels, real estate, banks, mines, railways, supermarkets, and entertainment venues all over China. Corporate revenues as a percentage of our total revenues totaled roughly 45% for the quarter.

As you can see from slide number six, our organic revenue during the third quarter of 2009 was approximately $152.77 million or 95.6% of total revenues, while revenue from acquired companies was approximately $7.05 million or 4.4% of total revenues. As a result, organic revenues grew during the quarter by $46.56 million or 43.8% year-over-year from $106.21 million or 89% of total revenues in the third quarter of 2008.

In the third quarter of 2009 Jin Lin, DIT, and Coson respectively contributed approximately $0.52 million, $5.18 million, and $1.35 million in non-organic revenues, as these companies had not clear past the one-year anniversary yet.

Our organic revenues grew solid during the third quarter, and we continue to expand our acquisition strategy by driving cost synergies among all of our business units and subsidiaries to grow the market share competitively.

Please turn to slide seven, as you can see, the third quarter gross profits grew approximately $3.3 million or 10.4% to $35.34 million from $32.01 million for the same period last year. Gross margins for the third quarter was 22.1% as compared to 26.8% for the same period of 2008, while our profit margins remain same in the government sector; we continued to experience margin crises in the corporate sector as a result of our efforts to expand our market share, and increased sales of smaller scale project. Gross margins for the Installation Segment, Manufacturing Segment and the Distribution Segment were approximately 21.6%, 30.3% and 12.5% respectively, compared to 25.7%, 32.2% and 25.1% respectively for the same period last year.

However, on a quarter-over-quarter basis, the gross margin for the Manufacturing Segment has improved to 30.3% in the third quarter, from 27.8% in the second quarter of 2009. The gross margin for the Installation Segment has also improved by 10 basis points for the last quarter.

On the other hand, the decrease in gross margins from distribution segment was primarily driven by market competition, buying pressure, until [ph] pricing. Overall, although our business is due materially impacted by macroeconomic environment, the margin trend has began to stabilize on an annualized basis.

Moving to operating expenses depicted in slide number eight. Selling and marketing expenses decreased $0.28 million or 8.2% to $3.1 million in the third quarter of 2009 from $3.3 million in the same period of the prior year. As a percentage of revenues, our selling and marketing expenses decreased to 1.9% for the third quarter 2009, from 2.8% for the same period in 2008.

General and administrative expenses decreased $0.09 million or 1.2% to $7.33 million for the third quarter of 2009, from $7.42 million of the same period in 2008. As a percentage of revenues, general and administrative expenses decreased to 4.5% for the third quarter of 2009, from 6.2% for the same period in 2008.

The improvement in G&A as a percentage of revenue was driven by proactive management of operating costs enhancing internal controls. This marks two consecutive quarters that we have been able to simultaneously lower our SG&A expenses, while continuing to rapidly grow our revenues.

Allow me to move to slide number nine. Income from operations increased by approximately $1.88 million or 12.3% to $17.21 million for the third quarter of 2009, as compared to $15.33 million for the same period in 2008. Our operating margins decreased to 10.8% in the third quarter of 2009 from 12.8% for the same period in 2008, primarily due to lower gross margins. However, we have seen a sequential stabilization of our operating margin. The third quarter 2009 operating margins expanded 190 basis points sequentially from 8.9% in the second quarter of 2009.

Our effective tax rate for the third quarter was negative 0.7% compared to 7.8% in the same period last year as we benefited from the tax exemptions status of our subsidiaries DSSTTRC, Longhorn and Jin Lin, and a [favorable] tax status of Shenzhen, Hangzhou, Minking, Tsingvision, Golden, Coson, and Zhuhai DIT Digital. Though we continue to optimize tax planning for our various subsidiaries, we expect to see fluctuations of effective tax rates over the next few quarters due to non-tax deductible expenses.

Moving on to slide 10, the third quarter 2009 GAAP net income attributable to the company increased $12.85 million or 140.4% to $22 million from $9.15 million for the same period in 2008. As a percentage of revenues, net income increased significantly to 13.8% in the third quarter of 2009 from 7.7% for the same period in 2008. The increase in net income was primarily due to improved sales and one-time non-cash gain of $9.32 million.

Our diluted share count increased 15.8% in the third quarter of 2009 to 53.5 million shares from 46.2 million shares in the prior year. Consequently, GAAP earnings per diluted share also increased 105% to $0.41 in the third quarter of 2009, as compared to $0.20 in the third quarter of 2008.

On slide 11, during the second quarter we recognized $3.9 million or $0.07 per diluted share as a redemption accretion on convertible notes. We incurred $3.22 million or $0.06 per diluted share in the third quarter of depreciation and amortization of long-lived assets due to the acquisition of subsidiaries.

We also incurred approximately $4.74 million or $0.09 per diluted share for non-cash employee compensation. Lastly, we incurred a non-cash gain on a modification of convertible notes of $9.32 million, or $0.17 per diluted share in the third quarter of 2009.

Moving on to our backlog, as you can see from slide number 12. At the end of the third quarter, our total backlog was $73.26 million, slightly less than the previous backlog of $74.25 million at the end of the second quarter of 2009, as a growing portion of our contract wins consist of large agreements, but are not included in our backlog calculations.

We also have not included letters of intent and various other agreements as they are subject to final binding individual agreements to be entered at later dates. Additionally, it is important to note that we typically also have large number of contracts signed and completed during the same quarter that are not included in the previous backlog.

On a balance sheet front, because the balance sheet is a snapshot at a moment in time, I'd like to address specifically only line items that have significantly changed, or that I believe that have material impact on our ongoing operation.

As you can see on slide 13, as of the end of the third quarter, our total debt was $181.66 million and our debt ratio was 26.1% compared to 30.8% as of the end of the second quarter. This change is benefited from a restructuring of convertible notes as we discussed earlier.

Next, please refer to slide 14. As of September 30, 2009 our cash balance grew by nearly $11.51 million to $100.98 million, up from $89.47 million at the end of the second quarter of 2009. Net cash provided by operating activities was $15.95 million for the nine months of 2009, compared to $30.55 million net cash used in operating activities for the same period of 2008, which is mainly attributed to those decreases in inventories and increases in advances from our customers.

Our DSOs, moving to slide 15, our accounts receivables increased sequentially by $48.01 million to $227.16 million, compared with $179.15 million at the end of the second quarter. Our DSOs, or the days of sales outstanding was approximately 127 days verses 113 days in previous quarter. The increase of accounts receivable is in-line with our revenue growth.

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 sector continues to grow, we expect DSOs to increase accordingly. Nevertheless, without distinct financing facilities, we believe we are sufficiently capitalized to sustain these collection cycles.

It is worth speaking once again, that although, we prefer to have smaller account receivable balance in our books, we believe that credit worthiness of our local and national customers, as well as government customers is reliable and these accounts receivables are collectible, because the majority of our revenues have a base from government contracts, we do not see this credit as a credit crunch [ph], but rather as a typical timing of payment for receivables from government entities in China.

On the inventory front, our inventory decreased by $24.97 million to $95.51 million versus $120.48 million at the end of the second quarter 2009, as a result of our continuous effort to proactively monitor and control inventory build-up.

Lastly, our working capital at the end of the third quarter decreased to $217.2 million versus $258.92 million at the end of the second quarter 2009. We are confident that working capital is sufficient for our market expansion and revenue growth in the China market.

Moving on to our recent developments and strategic plans. As I mentioned earlier, we continue to see strong demand for our products and services from all our corporate and government customers. As you can see in slide 16, in September 2009, we signed a RMB944 million or approximately $138 million contract, E-city agreement for Nanjing New Town Science and Technology Park, the local government representatives of Nanjing City.

Nanjing is the capital of Jiangsu Province. It was one of the largest industrial cities in Southeast China. This E-city project for Nanjing New Town Science and Technology Park is customized to service fast growing companies headquartered in this area and to capitalize regional economic growth.

In the same month, we also signed an E-city project framework agreement valued approximately RMB1 billion or approximately $146.2 million U.S. with the local government of Haimen City in the southeast of Jiangsu Province. Haimen City project involves the build out of fully integrated Safe City platform, Emergency Response System and Digital City Network, as well as digitization of the Binjiang Industrial and Trade Zone to support the development of Haimen City.

The project features the combination of broadband communications infrastructure, flexible and service-oriented computer systems, and multi-media and mass storage platform, as well as the integration of innovative GIS, GPS, remote sensing and various other technologies to meet the needs of government, citizens, and businesses.

These E-City projects highlight the expansion of CSST solution to include not only surveillance and safety offerings, but also other broader digital infrastructure offerings, which paddle out CSST's strategic development. We are also confident that our expanding customer portfolio of this large scale E-City projects will drive additional wings in all major cities throughout China.

In August 2009 we signed a letter of intent to acquire 100% ownership of Shanghai Nanxiao Fire Protection Engineering Equipment Company Ltd., one of the largest fire protection systems installation companies in China for approximately RMB100 million or approximately $14.6 million. The intended acquisition marks CSST's strategic expansion into the fire safety industry, further leveraging the company's established brand, broad distribution network, and scalable project management expertise.

Shanghai Nanxiao is a professional fire safety solution provider and equipment manufacturer, engaging primarily in the development, installation, inspection and maintenance of a number of building fire safety auto-alarm and extinguishing systems. It also markets and sells various fire safety products and offers technical consultation for fire safety projects.

Shanghai Nanxiao owns a First Degree Certificate of Fire Safety System Installation and Project Construction enacted by the Ministry of Construction and complies with several international and national standards. It has 15 well-established branches all over China, and regularly undertakes key national fire safety projects, such as the 2010 World Expo Shanghai.

The contemporary acquisition of Shanghai Nanxiao enhances our long-term strategy to expand into the Fire Safety market and to further strengthen our presence and execution capabilities in Tier 1 cities. We continuously focus on integrated total safety solutions to meet our customers' needs and provide our premium edge that we strive to create value for our customers.

Moving on to the next slide number 17, allow me to provide you with a brief overview of selective macroeconomic trends that led us to believe that the Chinese economy has strengthened in an upward trend for the last several months. China's GDP increased by 7.7% year-over-year in the first nine months of 2009, while the national industrial production output accelerated to 12.4% year-over-year in the third quarter of 2009. Additionally, we continue to benefit from the Chinese government's relatively relaxed monetary policy and enjoy low interest rates on our existing financing facilities with domestic banks.

As illustrated by the chart on slide 17, the uptick in the right side provides us with a high confidence for our business for the remainder of 2009 and for the full-year of 2010. The remaining outlook of 2009, with an improving Chinese economy as a driver, we believe we will continue to see strong from system integrations installations associated with Safe City and E-City programs and remain confident about our business and growth of the security industry.

Looking at slide 18, for the 2009 fiscal year, we are reaffirming our revenue projections of between $600 million to $630 million of revenue and we project for 2009 GAAP diluted EPS of about $0.95 to $0.98. For the full-year of 2010, we forecast revenue of $800 million to $820 million and a GAAP diluted EPS of $1.15 to $1.20.

In closing, we are very pleased with our successful restructuring of convertible notes as we have improved our capital structure, strengthened our financial position and lowered our overall cost of capital. We continue to generate strong growth in our business across all our operating segments.

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

Question-and-Answer Session

Operator

Thank you, sir. We will now be conducing the question-and-answer session. (Operator Instructions) Our first question comes from Jeff Kessler with Imperial Capital. Please take your question.

Jeffrey Kessler – Imperial Capital

Good morning, Terence.

Terence Yap

Good morning, Jeff.

Jeffrey Kessler – Imperial Capital

A couple of questions, first, with new wins like Nanjing and Haimen City, how long does it take and what is the process for you to go from installation to servicing these projects and what types of services are you going to be able to provide to these projects as they build up?

Terence Yap

As part of our overflow strategy most of these projects are really still one installation businesses. But as we indicated in the call, when we complete the installation project, we actually have our foot in the door for future recurring revenue businesses such as maintenance of equipment and even providing upgrading of software and equipment as the City expands. In terms of the timeline itself, the project will actually last about two years, but right now at this point in time, we are splitting into different phases, but as we complete Phase 1 we can recognize revenue from Phase 1 and financing with the local bank. So we anticipate that the revenues will start coming in 2010, especially for the Nanjing and also the Haimen City.

Jeffrey Kessler – Imperial Capital

Okay. Second question is, can you get a little bit more specific on your programs to rebound or reinvigorate several of the gross margins in the couple of your sectors that have slowed down a little bit?

Terence Yap

Well we are continuing to monitor the overall situation, as I mentioned, the biggest challenge that we have seen so far is really the corporate side of selling product or selling system installations to the corporate sector. We have seen that the margins are still being pressured in the corporate sector, but we are somewhat happy and somewhat satisfied that the margins on a overall basis has stabilized, and began to increase a little bit. Moving forward, we will continue to focus more on larger government contracts, which the margins are much more further, even the less competitive debt, and also given that the government is also paying a lot more pension, and ensuring the safety of the whole cities, but it does not mean that we will forego the corporate sector, because for every single corporate client that we get, it builds the customer base for us for future recurring revenue on the services business side. So hopefully, we see the beginning of the recovery in the gross margin, this quarter was kind of a [inaudible] in terms of a good result in terms of the margin stabilizing. We will continue to work on this, and we will continue to focus on largest government contracts at the same time building the customer base for a future recurring service business.

Jeffrey Kessler – Imperial Capital

Final question on your fire business that you acquired. Do you intend to keep that separate in terms of both bidding and operations from the security business or will there be some type of integration? Let’s say conjunctive bidding on projects for both fire and security in the future.

Terence Yap

Right now we are integrating all within the manufacturing prices, for the manufacturing sites and also the (Inaudible) business, whether or not we will separate out in a separate division will depend on how the integration will come out eventually, and how the business trends will go within the 550, but certainly, a lot of the system installation projects, we do see a high complementary application, as a lot of our clients, if anybody has a [inaudible] almost on a same network for safety and also for [inaudible], so at this point in time, I cannot disclose whether we will be separating as a separate division, but we are making efforts to integrate it as part of the CSST group once we complete the acquisition.

Jeffrey Kessler – Imperial Capital

Okay, thank you very much.

Terence Yap

Thank you.

Operator

Our next question comes from [Adam Mel with OLT Global]. Please state your question.

Unidentified Analyst

Hi Terence, my first question is related to your guidance, for 2009 revenue guidance of $600 million to $630 million, have you included that addition you announced over the former?

Terence Yap

No, no because that close sooner.

Unidentified Analyst

I see okay, could you give us just a little more color in terms of what assumption that went into your, $0.95 to $0.98 GAAP EPS guidance, specifically sort of your gross margin expectation for the year, and tax rate as well as share count that you are using?

Terence Yap

Well unfortunately, we don’t provide the gross margin guidance for the full year. The tax rate, fortunately for us on Q3 basis we actually got a tax refund what our subsidiaries spent. At the national, 25%. I can safely say that our tax rate for this year was definitely a lot lower than that, but revenue being in a low, low 20s or high teens, I cannot say at this point in time, because there may be some more expenditures that really may enjoy Q4. And the remaining of the year, if you look carefully, 600 to 630, even our own internal visibility for a pipe line, and given historically as well. If you look at ’08, ’07 as well Q4, ’08, the Q4 revenues represented about 34% of our revenues, ’07 Q4 revenues represented about 35% of a full year. So we are talking about along the same ridge being 35% to 38% of revenues coming in on a fourth quarter.

And that historically is what has been happening and so therefore as seasonality we’re too confident that the last quarter is going to be another strong quarter for us this year and that’s why we’re reaffirming our 600 to $630 million top line guidance. On a EPS level, right now we’re providing a debt EPS, this is really the first time we’re providing a debt EPS on our guidance that will come off a lot of non-cash items, which I’ve mentioned in my conference call. The biggest ticket that changes, naturally the non-cash expense attributed to the convertible notes. We too have taken into count the D&A and also the employee compensation. Given the incentive fee and given the share count EPS as well and given the cost savings that we continue to derive on the operating side we are comfortable right now with a debt EPS of $0.95 to $0.98 for the full year of 2010.

Unidentified Analyst

Okay if we could move on to our 2010 guidance, I assume that the 800 to 820 is 100% organic growth, correct?

Terence Yap

Close to 100% organic growth, some of the acquisitions may be closing in Q1 of 2010. So it may be closed, but if you look at our history, more than 90% of our revenues are organic, so that will continue to be a track.

Unidentified Analyst

Okay. So does the $800 million to $820 million include plenty of acquisitions that you announced?

Terence Yap

No, not at this point in time because we’ve still not closed them yet but we are factoring about less than 10% of all revenues that would be represented in 2009. Naturally, once we close the acquisitions, we may revise the numbers again.

Unidentified Analyst

Okay. That’s helpful. In terms of your backlog right now standing at $73.26 million, slightly decreased from the previous quarter, with a number of large Framework Agreements in place, could just give us a total amount in terms of how much more Framework Agreement and LOIs that are outstanding that you currently have not included in the reported backlog number?

Terence Yap

Allow me to explain it. The backlog itself as mentioned in the past is really not a good indicator of the business that you are seeing mainly because we do sign and complete a significant number of contracts within the same quarter. For example, in Q3 of 2009 we actually signed and completed about $32.09 million of contracts, so moving forward we’ll continue to see strong growth in the contract signed and completed. Now, we don’t actually provide a pipeline, but as I mentioned before, the internal visibility of between 12 to 18-months. Now, we have recently announced almost RMB2 billion worth of contracts, and of course internally we are also recently signed a few more contracts that we haven’t announced yet. So all I can say is that hanging there we’ll continue to deliberately contract on a larger scale and that will probably show you why we are confident in meeting the 2010 revenue growth.

Unidentified Analyst

Okay. That’s fair and my last question is on your balance sheet, I guess your sequential revenue growth is about $18 million, but your accounts receivable balance went up about $48 million. Could you elaborate a little bit on that in terms of what’s behind the meaningful increase in accounts receivable?

Terence Yap

Well some of the projects that we specially complete in a quarter, as you know, accounts receivable is really a accounting time as well. For example, if we complete the project one week before the end of the quarter, there is no way for a client to give us the cash straightaway, so therefore we moved to the next quarter. Now, Q3 has been a strong quarter, stronger than Q2, so naturally there is also an increase in the accounts receivables on our books. From my financial division side, monitoring the AR is definitely a key performance index we’ll continue to monitor closely to ensure that our cash flow management is inline with our expectations.

Unidentified Analyst

Okay. I think which is just related to the, what’s the split between corporate versus government on your accounts receivable balance?

Terence Yap

We have not disclosed that figure, but you can assume 55% to 45% on a government and corporate.

Unidentified Analyst

Okay. All right, that’s helpful. Thank you, Terence.

Terence Yap

Thank you.

Operator

Thank you. Our next question comes from Kun Tao with Roth Capital Partners. Please state your question.

Kun Tao – Roth Capital Partners

Good morning, everyone. Any project you are factoring this quarter?

Terence Yap

No. Not this quarter. Bear in mind, the large project has not been completed yet. We have been completing small government projects. So therefore we have not sold anything in Q3 yet. But we are definitely working with banks and the banks are willing to skew, are willing to provide the facilities if we choose to.

Kun Tao – Roth Capital Partners

Okay. Can you provide us some color of your recent two very large E-city projects? For instance, how long you think the government, the duration the government will pay and you mentioned that you’ve finished this two projects in two years, but when do you think, you would transfer the title to the government and what do you think of – how do you finance this project?

Terence Yap

Well, as I mentioned that before as well. The projects we will be contributing to the period. However, I believe the information in press release that we are actually working with the local bank for this project for the financing and the bank will actually provide the working capital plus the receivable financing facility. Now, the key for us is that we are not going to wait until the project ends in two to three years before we sell it. We are now working with the government to actually split into phases whereby every quarter, we can actually recognize the phase the government signs and we sell off straight to the bank. Therefore as last indicated that we will start recognizing the revenues in 2010 for these two projects.

Kun Tao – Roth Capital Partners

Okay. For instance Nanjing City project, is that constructions or what do you mean of E-city on Nanjing, the technology?

Terence Yap

Sure. E-city project is now a new concept in China which not only encompasses the E-city project, but in the past looking at - along with street along with traffic junctions along [inaudible] where there are typically a lot of robberies, now we are seeing it because of the snow storming, earth quake that happened last year, the government is trying to include emergency response systems, traffic management systems – pollution detection even within a small, well I wouldn’t say small, even within a small area such as the industrial pop which we [inaudible] size of a city, they want to build up a whole infrastructure that will allow different government officers to communicate effectively in case of any emergency. So The E-city really includes Haimen City project, they include the infrastructure for emergency response system GPS, GIS and even modification of the medical services, the fire services, FHR within the area.

Kun Tao – Roth Capital Partners

Okay, you mentioned about tax rather, you don’t know exactly for Q4 but what is your expectation for 2010, you are thinking the 7% to 10% range or you think you can get tax benefits or you probably go to 25%?

Terence Yap

As mentioned we don’t provide guidance but I can safely say that you will be not at 25% for the remaining of 2009. Some of the companies that we have as subsidiaries, some of them are now in the second year of the tax free status, CSST PRC is now on a second year of the two year free program. Subsequently, after three years, it’s going to be 50%. Some of them are still enjoying 10.5%, some of them are enjoying 15% et cetera depending on high tax status.. So, as mentioned, we will not see 25% as the effective tax rate. We will definitely - significantly be lower by 8.5, please allow me to refrain from providing exact guidance, all I can say is that it’s definitely not be 25%, it’ll be much lower.

Kun Tao – Roth Capital Partners

All right, that’s helpful. that’s all my questions. Thank you.

Terence Yap

Thank you.

Operator

Our next question comes from Liang Y. Hsu with Brean Murray, Carret & Co. please state you question.

Liang Y. Hsu – Brean Murray, Carret & Co.

Hi Terence

Terence Yap

Hi.

Liang Y. Hsu – Brean Murray, Carret & Co.

Hi. Actually a part of my question has been answered. But I’m just wondering would you be able to maintain such efficient working capital without having to factor your account receivable and still keep your day sales outstanding under the controllable fashion. Does that mean in Q3, your DSO increased a little bit but it seems like you would still be able to manage your working capital because we were talking about 8 to 10% financing cost associated with the AR factor. I am just wondering, would you be able to use something like, draw the bank facility and draw the sufficient to deliver phase I in relation to the E-city project?

Terence Yap

Very good question –and that’s the reason we are not selling everything to the bank. We need to cut the [inaudible] lot of cost from the local bank for line of working capital. Some of the interest rates are actually about 5.5% or if you look at our Q some of interest rate - has been below 5% with the local Chinese bank. That have actually helped us in terms of reaching on working capital and that’s why I’ve indicated in the past that we do not see the need to go to the capital markets to raise funds to fund our working capital because of the fact that we are able to tap the local domestic banks for relatively cheap, cost of financing to finance this project. Now, whether or not we’ll sell will depend on a type of project and depend upon the collection of the local government. We still see a lot of support from local banks in terms of asking us to sell them the projects and you are right. If we sell them, we may have to share a little bit of percentage. So therefore, we also need to bet it. If we sell that, then our margin will be better. Sell more [inaudible] our cash will be better. So we are trying to balance that ourselves. But from our perspective, within the group, we are managing this process to ensure sufficient working capital from local Chinese bank to meet our ongoing meets with the large project.

Liang Y. Hsu – Brean Murray, Carret & Co.

Okay, thank you. And my second question is that, you had mentioned that normally your gross margins from the government projects usually is around high 20s or low 30s, and as to your corporate is going to around low 20s or high-teen. Just to look at Q3 realized gross margin of 22%, it seems to me your government projects, the gross margins from the government projects, from this quarter stand, still or below, they only just around the mid 20, is that, because you don’t –

Terence Yap

No. Well, if you look carefully, the gross margins are really for the installation cost of 21%, manufacturing 30%, this recent [inaudible], but installation includes corporate installation as well, that has really been the main challenge for us. Although we see the improvements in the government sector, we still see continuos pressure from the corporate sector side of it.

Liang Y. Hsu – Brean Murray, Carret & Co.

I see. Okay, so there is a drag on the corporate side still?

Terence Yap

Yeah. Unfortunately, at this point in time, but fortunately, we are able to see on a overall basis - we see a stabilization as we also continue to gain more on the government sector as well. As we look at this quarter we managed to up the government sector a little bit, so then it helped a little bit.

Liang Y. Hsu – Brean Murray, Carret & Co.

And you also see the continued increase on the revenue contributions on the government side as we go into 2010, that’s what we have had given the large project?

Terence Yap

Correct.

Liang Hsu – Brean Murray, Carret & Co.

Okay.

Terence Yap

Correct.

Liang Hsu – Brean Murray, Carret & Co.

Were you talking about 65?

Terence Yap

Unfortunately, I have not provided the guidance but I can safely say that it would probably be more than 50% which is where it is right now. But forgive me, I am unable to provide you with further clarity on that. Allow us to continue and deliver more government projects and hopefully we’ll see the gradual improvement in gross margins. Having said that, allow me to also reiterate that we are not giving up on the corporate sector as well. Naming the cost once again for every single corporate client that we do for the system installation project, once again it’s a national customer base for our future business opportunity in the services business.

Liang Hsu – Brean Murray, Carret & Co.

Okay. And then my last question is regarding your E-city project. I am just wondering, how many missing links in terms of components of the service that is required by the project that you have to outsource or you have to continue to acquire new companies in order to be able to make the delivery?

Terence Yap

Well, we have always focussed on providing security and safety solutions. We are expanding into traffic management; we are always expanding through the fire. The E-City encompasses a new lot of things like bomb detection, chemical detective et cetera. At this point in time, I cannot say that we will continue to do acquisitions or we stop acquisitions et cetera, all I can say is that if it makes for us to acquire, we will, if not we will prefer to outsource the particular segment or the particular area of the product to a partner to deliver together with us. So at this point in time, our acquisitions have been strategic only if we feel that there is further growth potential within that area, also within the security and safety solutions.

Liang Hsu – Brean Murray, Carret & Co.

Okay. And so in terms of percentage, how many percentage is going to be, if not already covered by your current product mix?

Terence Yap

Well, I would say more than 50% is right now not covered by us.

Liang Hsu – Brean Murray, Carret & Co.

Okay. All right. Thank you very much.

Terence Yap

Welcome.

Operator

Our next question comes from Michael Kim with Imperial Capital. Please state your question.