China Security & Surveillance Technology Management Discusses Q4 2010 Results - Earnings Call Transcript

Feb.28.11 | About: China Security (CSR)

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

Q4 2010 Earnings Call

February 28, 2011 08:00 AM ET

Executives

Patrick Yu – IR, Fleishman-Hillard

Stacy Yan – Director, IR

Terence Yap – Vice Chairman and CFO

Operator

Greetings and welcome to the China Security & Surveillance Technology Incorporated Fourth Quarter 2010 Earnings Conference Call. At this time, all participants are in a listen-only mode. The 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, Patrick Yu, from Fleishman-Hillard, the Investor Relations agency for China Security & Surveillance Technology. Thank you, Mr. Yu, you may begin.

Patrick Yu

Thank you, Diego. Good morning and welcome to CSST Fourth Quarter and Full Year 2010 Earnings Conference Call. Here with me today our CSST’s Vice Chairman and CFO, Terence Yap and also Investor Relations Director, Stacy Yan.

Before we get underway, let me remind you that the press release, supplementary information and presentation slides used for this call are all available on the Investor Relations page of CSST, which is irpage.net/csct/index.html.

I’d also like to take a minute to review the company’s Safe Harbor statements, which can found on Slide 2, which says that 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 statements and risk factors detailed in the company’s filing with the SEC. CSST undertakes no duty to revise or update any forward-looking statements except as required by the applicable law.

Before we get started, I also want to point out that all available information pertaining to Mr. Tu’s recent letter to Board of Directors and the company’s actions on it have been filed with the SEC. We’ll not have the Q&A session today for the conference call and we urge you to refer to www.sec.gov or the governance website at csst.com for further information.

Without further ado, I’ll now turn the call over to CSST’s IR Director, Stacy Yan. Stacy, please.

Stacy Yan

Thank you, Patrick. Good morning. Well, I guess good evening for those of you in Asia Pacific time zone. Before Terence covers our results, I’d like to take just a few minutes to offer our view of the business and what you’d expect from us in 2011.

As you’ve seen in our presentation materials on slide number 3, we had a very productive 2010. Our revenues and net income grew. Margins expanded robustly. We’ve closed the year well. And we expect another solid year in 2011, with continued execution our long term strategies and focus on our key growth initiatives.

As we look into the future, our confidence in the industry and our business in government sector and security services continued to be promising.

We have invested heavily over the past few years and those investments are beginning to pay off, and it’s driving our revenue growth and margin improvement. So, these are all large and scalable opportunities and we’re early in their growth cycles.

As you can see, our government sector takes up 56% of our total revenues in 2010 and security services business has started to establish its presence in China. As the demand for surveillance and the safety products and services continues to grow, we will be well-positioned to drive industry’s next wave of innovation and growth. So, that is just a real quick review.

Again, 2010 was a very productive year for us. We are executing well. We expect another strong year in 2011 in our key growth drivers, which are large scale government contracts and security services business.

We believe we are going to engineer our growth in the years ahead. So with that Terence, I’ll now turn the call over to you.

Terence Yap

Thank you, Stacy and good morning and good evening to everyone. I’d like to start by providing an update on our Q4 results. Please turn to slide number four.

In the fourth quarter of 2010, we have reported revenues of $214.01 million, up 17.1% year-over-year, from $182.71 million in the fourth quarter of 2009, driven by the strong demand from both the government and the corporate sectors.

Fourth quarter gross profit grew 18.8%, to $61.15 million, up from $51.48 million for the same period last year. Gross margin for the fourth quarter increased to 28.6%, from 28.2% for the same period in 2009.

Let me continue on the fourth quarter with a look at net income. Fourth quarter GAAP net income attributable to the company increased 11.4%, to $29.04 million, up from $26.07 million for the same period in 2009. Net margin decreased to 13.6%, from 14.3% for the same period in 2009, mainly due to higher taxes paid in the fourth quarter of 2010. GAAP earnings per diluted share was $0.33 in the fourth quarter of 2010, as compared to $0.38 in the fourth quarter of 2009.

For the full year 2010 results, please refer to slide number five. Total revenues topped $684.7 million, that was up 17.9% versus last year. These revenue trends showed a number of things. First, the growth of Safe City and E-city businesses remained robust, which was reflected by heavy backlogs in government projects in the pipeline.

Our efforts to build the brand awareness and distribution channels also paid off to reinforce our market leadership position in China. While our full year revenue is slightly lower than our previous guidance, we believe that we are still in a very good position to maintain our healthy growth in the years ahead.

In 2010, we had seen stronger demand for government contracts in Safe City and E-city projects. These contracts are usually huge and complex projects, with long implementation periods and involving multiple vendors, which impacted the progress of the project.

In line with our company accounting policy, which is in compliance with U.S. GAAP, we only recognize revenues when the project has been completed. All business segments in 2010 maintained healthy growth. Our revenue mix in 2010 remained heavily weighted towards our system installation business.

In 2010 $527.97 million or 77.1% of our revenues, came from installation segment, compared to $442.37 million or 76.1% of revenues in 2009. Installation segment revenues grew 19.4% year-over-year. The increase would affected a broader industry demand in China, due to various government policies and our aggressive stance, that helped us, secure key contracts in areas such as Safe City and E-city.

There’s every reason to expect the installation segment to continue as the revenue driver for the next few years. Revenues from our manufacturing segment were $92 million or 13.4% of revenues in 2010, versus $87.55 million or 15.1% last year. Our distribution segment contributes at a healthy $54.53 million or 8% of our overall revenues in 2010, versus $50.95 million or 8.8% of the total revenues in 2009. We remain upbeat regarding growth across our three businesses segments.

On the other hand, we’ve started reporting also these revenues since Q2 of 2010. We reported revenues of $10.2 million or 1.5% of revenues for full year of 2010. Service segment provides a full range of surveillance and safety services, such as maintenance services, wholesale services, consulting services, software upgrade services, network alarm response services and security guard services. The third part of our long-term strategy is to create opportunities for higher value security service business, with recurring revenue potentials and we remain upbeat for the growth outlook in this area.

Analysts

Referring to slide number six – the government sector as a percentage of our total revenues was approximately 56% for 2010. We continue to see robust growth potential here and we believe the revenues from government customers with strong growth in last year projects in Safe City and E-city will continue to outpace revenues from corporate customers in the coming quarters.

Corporate customer’s revenues accounted for 44% in 2010. Corporate customer base expanded healthily in 2010. Our key projects included airports, hotels, real estate, banks, mines, railways, supermarkets and entertainment venues.

In terms of organic growth, we continue to generate revenues with internal resources very nicely and achieved greater synergies across all subsidiaries. Our full-year organic revenues were $683.88 million in 2010, compared to $543.89 million, or 93.6% of total revenues in 2009.

Non-organic revenues mainly contributed from Coson, were approximately $0.82 million, which only represented 0.1% of total revenues in 2010. Since Q2, 2010, all our revenues have been organic.

Gross profit, please refer to slide number seven. Gross profit for the full year of 2010 was approximately $189.42 million, up 32.6% from $142.87 million in 2009. Gross margin for the full year 2010 was 27.7%, up 310 basis points from 24.6% last year. This was due to relatively higher margins from large-scale government projects.

As shown on slide number eight, gross margin for the Installation, manufacturing and distribution segments were approximately 29.3%, 25.9% and 15.9% respectively, compared to 25.2%, 27.7%, and 13.7% in 2009. Service segment reported gross margin of 21.9% in 2010.

Operating expenses. Please refer to slide number nine. We continue to improve our cost structure, cautiously monitoring operating expenses, while continuing to raise brand awareness, expanding market penetration and the hiring of additional staff.

Selling and marketing expenses decreased $0.68 million or 5.4% to $11.82 million in 2010, from $12.5 million for 2009. As a percentage of revenues, selling and marketing expenses decreased to 1.7% for 2010 from 2.2% for 2009. The percentage decrease was mainly due to our increased efforts in cost savings.

Excluding non-cash employee compensation, our general and administrative expenses increased 6.3% to $36.78 million in 2010, from $34.59 million in 2009. As a percentage of revenues, general and administrative expenses decreased to 5.4% in 2010, from 6% in 2009 as a result of our improved operational efficiencies.

Non-cash employee stock compensation expenses totaled $24.74 million in 2010, up from $18.09 million last year. The increase was due to more shares granted to our employees and consultants in 2010. As mentioned before, we will continue with a thorough review of our executive compensation packages.

In 2010, we granted an aggregate of 4.572 million shares of a restricted stocks to our Directors and employees, which we will be vested over a period of four to five years.

Income from operations, slide number 10. Income from operations and operating margins both recorded healthy growth in 2010. Income from operation increased $37.9 million or 57.6% to $103.94 million in 2010, compared to $65.96 million in 2009. Such increase was mainly due to high demand for total one-stop shop installation from customers.

Our operating margin was 15.2% in 2010 compared to 11.3% in 2009. The increment was again due to higher margin of large-scale government contracts and our concerted efforts on internal cost efficiencies. Interest expense, slide number 11. Interest expense increased from $4.8 million last year to $13.52 million for 2010, due to the increase in the outstanding balances of the company’s bank loans.

Income tax, our income tax increased $13.4 million to $15.14 million of 2010, from $1.73 million in 2009. Our 2010 effective tax rate was 16.4% compared to 3% during the same period of last year. Continue to fully utilize the tax benefit status of various subsidiaries.

Slide number 12, net income. Full year 2010 GAAP net income attributable to the Company was $77.39 million, representing a year-over-year increase of 36.8% from $56.58 million in 2009. Net margins increased 11.3% in 2010 compared to 9.7% in 2009. The increase of net income was mainly attributable to the gross margin expansion and continuous improvement of operational efficiencies.

Fully diluted GAAP earnings per share, was $0.96 in 2010, as compared to $1.01 in 2009. The decrease in our GAAP EPS was mainly due to the increase in number of shares outstanding. Weighted average diluted share count increased from 56.17 million shares in 2009 to 80.52 million shares in 2010.

Non-cash expenses, please refer to slide 13. For the full year of 2010, non-cash expenses were approximately $37.88 million, up $1.52 million or 4.2% from $36.36 million in 2009. This included a non-cash gain of approximately $9.32 million on a modification of convertible notes. Non-cash expenses in 2010 included depreciation of $13.14 million and non-cash employee compensation expense of approximately $24.74 million.

Backlog, please refer to slide number 14. As discussed earlier, government contracts remained strong in the fourth quarter and the full year of 2010. As of December 31st, 2010, our total backlog was $325.5 million, down $87.06 million from $412.56 million at the end of the third quarter of 2010. We continue to execute on our existing book order and expect the majority of the total backlog to be realized within the next few quarters.

On a year-over-year basis, our backlog increased significantly from $192.85 million as of December 31st, 2009. This increase in the year-over-year backlog results of our continuous efforts in pursuing large-scale government projects, which usually take a relatively longer time for completion.

Once again, we have not included Letters of Intent, framework agreements and various other agreements in our backlogs, as they are subject to final binding individual agreements to be handed into at (inaudible). These projects in our pipelines provide us extra confidence in our outlook for the years ahead.

Balance sheet, our balance sheet remained solid because it’s a snapshot at any given point in time. I’d like to address specifically only line items that significantly changed or that I believe have a material impact on our ongoing operations.

Please refer to slide number 15. Debt ratio, as of December 31st, 2010, our total debt was $314.05 million, up from $260.59 million in the last quarter. Our debt ratio was approximately 28.3% compared to 24.4% at the end of the third quarter of 2010. We continue to incur domestic borrowings, which supported our large-scale government projects.

DSOs, as of December 31st, 2010, our accounts receivables increased sequentially to $433.99 million, up from $388.58 million at the end of the third quarter of 2010. The increase in accounts receivables is in line with our healthy quarter-on-quarter growth in revenues. Our DSOs or days of sales outstanding have decreased to 182 days versus 192 days in the previous quarter.

Allow me to point out that we are a safety solutions provider and system integrator and we recognize project revenues and corresponding accounts receivables only upon project completion. Therefore, we expect to see fluctuations in accounts receivable and DSO. At the current stage, we remain comfortable with our DSO and we’ll continue to monitor AR closely, while capitalizing on our existing banking facilities with Chinese banks.

Inventory, as of December 31st, 2010 our inventories decreased to $59.37 million versus $90.55 million at the end of the third quarter of 2010. The decrease was mainly due to our efficient execution and delivery on previously signed contracts.

Working capital, our working capital as of the end of December 31st, 2010 was approximately $377.78 million versus $349.89 million at the end of the third quarter of 2010. The increase was due in part to the increase of AR and advance to suppliers.

Cash, please refer to slide 16. At the end of December 31st, 2010 we had cash balances of $65.63 million, which is down, $185.7 million as of the end of September 30th, 2010. Net cash used in operating activities was $176.77 in 2010 as compared with $52.6 million of net cash provided by operating activities in 2009.

The increase in net cash used in operating activities in 2010 was primarily due to increase in accounts receivables and advances to suppliers. Net cash used in investing activities in 2010 was approximately $142.45 million, which is an increase of approximately $122.96 million from net cash used in investing activities of $19.49 million in 2009.

The decrease was primarily due to deposits made for acquisitions of subsidiaries in 2010. Net cash provided by financing activities in 2010 totaled $222.93 million, increased from net cash provided by financing activities of $75.54 million in 2009.

The net cash provided by financing activities was mainly attributable to proceeds from our public offering and additional bank loan obtained in fiscal year 2010. We completed a public offering of 17,250,000 shares of common stock in May 2010 and received net proceeds of approximately $64.57 million.

Allow me to move on to corporate developments in 2010. Please refer to slide number 17. As mentioned previously, we had a productive year. We delivered what we outlined for you, that we – when the year commenced. We extended our leadership well in the government sector with the Safe City and E-city initiatives.

We saw tremendous growth in large-scale government contracts. Growth in all our three segments continued to be encouraging. And our security service business started to establish its presence in China.

We have made good headway on margins and costs. Our business development into large scale Safe City project and E-city projects is parallel with our strengthening working relationships with the Chinese banks.

We continue to work with various banks who provide us with sufficient working capital to support our large scale government projects. For example, we entered into a term loan facility agreement in an aggregate principal amount of up to $50 million with the China Development Bank Corporation Hong Kong branch on October 28th, 2010, subject to the terms and conditions of the Loan Agreement.

On January 28, 2011 our Board of Directors received a preliminary non-binding letter from Chairman and Chief Executive Officer Mr. Guoshen Tu, which stated that Mr. Tu is considering the feasibility of developing a proposal to acquire all of the outstanding shares of common stock of the CSST, not currently owned by Mr. Tu in a going private transaction.

We have already formed a special committee of independent directors to consider Mr. Tu’s interest on any proposal made by him. The special committee is composed of the company’s three Independent Directors. Just to keep a neck, Mr. Runsen Li and Mr. Robert Shiver, with Mr. Peter Mak being the Chairman of the special committee.

The special committee retained Nomura International Hong Kong Limited as the financial adviser, and Shearman & Sterling as its legal adviser to assist the special committee in its work.

No assurance can be given or any definitive offer will be made, that any agreement will be executed or that a transaction with Mr. Tu or any other transactions will be approved or consummated. The company does not intend to disclose developments regarding these matters unless and until the Board of Directors determines there is need to update the market.

With regards to the outlook for 2007, sorry 2011 please refer to slide number 18. Looking back at the last two years or the three years, we’ve executed a lot of this place to engineer our growth. We have marketing growth, there’s large-scale government contracts and geared up our security service business. I believe we have worked very hard to improve the efficiencies.

As we look ahead, the most important thing we have done over the past few years is that we have built and scaled some nice growth platforms for the future. Installation business for large-scale government contracts with particular focus on Safe City and E-city and also the service business. And we’ve invested aggressively in all these areas.

So as we look forward to 2011, we plan to continue growing revenues and earnings. We do expect the trends for heavy backlog and accounts receivables likely to continue in 2011. Obviously this is going to make things a little bit harder to predict early on in the year.

But with our prudent control on costs and accounts receivables as well as our solid relationship with local banks to provide financing facilities, we believe our business will continue to be very strong. And this is consistent with what we saw in the fourth quarter of 2010. We are still confident on our strategic direction embracing opportunities of large-scale government projects as they can new sustainable higher margins.

On slide number 19, given what you have seen in 2010 and the first two months in 2011, we reiterate our 2011 guidance of revenues in the range of $870 million to $890 million, net income in the range of $104 million to $106 million, and GAAP diluted EPS in the range of $1.13 to $1.15.

We have had a very productive 2010. We are confident 2011 is going to be strong as well. Patrick that concludes what I’ve prepared for this conference call.

Patrick Yu

Thank you, Terence. Thanks for everyone for attending CSST’s fourth quarter and full year 2010 earnings call. I’d like to remind you that we won’t have Q&A session this time. We appreciate your understanding. Have a good day and good night. Thanks everyone.

Operator

Ladies and gentlemen, all parties may disconnect. Thank you.

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