China Security & Surveillance Technology: Roth Capital Conference Presentation Transcript

TRANSCRIPT SPONSOR

China Security & Surveillance Technology Inc (CSCT.OB)
Roth Capital Conference
February 21, 2007 2:30 pm ET

Executives

Terence Yap - CFO

Presentation

Moderator

Ladies and gentlemen, we are just about to get started with our next presentation. The next company presenting here in the China Track today is China Security & Surveillance Incorporation.

We are delighted to have members of the management team with us today. Mr. Tu, the company's CEO is here. We appreciate you being here Mr. Tu during the Chinese New Year. We appreciate you joining us.

Also Terence Yap is here, the company's CFO. And he is going to tell us the story. Go ahead, Terence Yap.

TRANSCRIPT SPONSOR

China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy. Read all investor conference presentation transcripts here. To sponsor an investor conference presentation transcript please contact us.

Terence Yap

Thank you very much. To start off, I apologize that you guys are going to be stuck in a room when there is such a fine weather outside. And to all the Chinese, [Foreign Language].

With your permission, I will not read the full forward-looking statements. I assume that you've read it many times before.

Some of the corporate highlights. We are domestic leader in a highly fragmented industry. We differentiate ourselves through a vertically integrated One-Stop-Shop business model. We have a security and surveillance pure-play with technological advantages. We've got solid growth and profitability. And we have got a strong management team with significant industry experience.

We provide security and surveillance solutions in China and we were actually established in April 2001. And we completed a reverse merger back in September '05. We are in the high growth industry. Currently, the China's security and surveillance market is growing about 45% CAGR over a five-year period and is estimated to be about $33.2 billion by the year 2009.

We have an extensive network, more than 200 sales representatives in all over 59 distribution points. These are actually our branch offices, all under our payroll.

Couple of growth drivers: First of all, the New Public Security Ordinances. The government is actually facilitating a lot of the regulatory drivers and growth in the market. And we've got a Beijing Olympics that's coming up in '08 and of course the Shanghai World's Fair that will happen in 2010. And of course, we are in a leading position to vertical and horizontal integration. And we have access to the US capital markets right now.

Financially, in '04, we had about $16.1 million in revenues, with a net income of $5.7 million. We grew to about $32.7 million, with a net income of $7.3 million. In the first nine months of last year we had about $66.1 million, with a net income of $16.3 million.

On the earnings per share front, in '04 we had about $0.34. We grew to about $0.39. In the first nine months of '06 we had about $0.70 a share. With approximately 34 million shares outstanding, the current share price is about $15 giving us about $0.5 billion or $509 million in market capitalization.

Corporate structure: CSST, we are listed under the symbol of CSCT. We own 100% of a BVI company called China Safetech Holdings, which in turn owns two separate entities. First of all, is a Golden Group Shenzhen, which was the company that we started back in '01. That has about more than 22 locations all over China. And of course, through our Hong Kong office, we recently closed an acquisition of Shanghai Chengfeng. So all together, we have more than 59 branch offices all over China.

We are very much focused on security and surveillance industry itself. First of all, we actually assemble our own Standalone Digital Video Recorder. Now, this is actually a video recorder box with a pre-installed software system. And this particular model is mainly for small and medium-sized enterprises. It supports 4 to 16 cameras.

The Embedded DVR system, which has similar features like the Standalone, except that this is actually mainly for industrial grade community wide installation. This supports 4 to 36 cameras. We also have In-Car DVR system. Once again, the features are similar except that this is actually for small installation, for buses, trains, cars etcetera. We also assemble our own Digital Cameras: The Sphere, Infra-red motion detectors, CCD etcetera.

And of course accessories. We manufacture our own VC cards, video compression cards. And we've recently started to assemble our own DLP monitors. This is mainly for the government projects.

We have a vertically integrated business model. First of all, we do design, and we manufacture and assemble our own products. We then distribute, and we have to set an installation on a One-Stop-Shop basis. And we provide post-sales service and maintenance. So, in China it's what we call [Foreign Language] "from a head of a dragon to the tail of a dragon we take out everything." So to a customer, it's responsibility. Right now, approximately 93% of our revenues come from solutions and about 7% is others.

Some of the projects that we have done: We have done Factory, Border Control, Banking, Campus, Transportation, City Wide, and Public Sector. Just to give you an idea. When we meet up with a management team of the factory, now here come the local guys. I want to monitor my factory line staff and make sure they are not stealing anything from the factory line. I want to monitor the trucks coming in and going out on a monitor at night.

So we are going. We do a site survey. We will put our engineers who will go and say, okay, this is where you put the night vision and this is where you put the motion detectors, etcetera. Then we build the whole system for them. We pull all the lines to a single location. Now, this may be within the factory or remotely, depending on telecoms infrastructure. We set up the network control center for them. We then teach them how to record the system and we leave the data management to them.

Some of the industry dynamics: The key factors driving the security market in China. As everyone knows, China is a huge market opportunity. First of all, China's increasing urbanization. We have a lot of major international events happening in China. Due to a lot of content, there is a lot of demand for surveillance systems. We also have more importantly favorable regulatory environment, State Ordinance 458, the 3111 initiative. And of course, we have got a robust real estate growth excluding a lot of demand for surveillance within the real estate business.

It is a large established growing industry. This is especially taken from the China Public Security Guide. As you can see, the market has just started to grow in about '03, '04. In a dark blue market segment is the security market demand. This actually relates to the whole security market, which includes security personnel, manufacturing of small firearms, the police camp etcetera. Where we are dealing with, is really like the blue market which is actually the surveillance market demand. And as you can see, in '04 it was about $4.93 billion. It will grow to about $33.18 in the year 2009. So we're still in a very infancy stage of the whole industry.

Some of the key drivers and opportunities for us: Currently, on top of all lists in terms of management's strategy is the 660 cities, City Safety surveillance systems. Now, this is where the government is trying to be a big brother. They want to know what you are doing, where you are doing and when you are doing it? So, just be careful.

Now, we also have the State Ordinance 458, which requires all entertainment venues in China, cybercafés, pubs, discos, ordered karaoke to install electronic eyes. I am not sure how many of you have been to ordered karaoke clubs in China and cybercafés for that matter. A lot of them offer other value-added services besides singing. So when you go to China this time just be careful of our electronic eye. So, this is actually a law right now. It's not a guideline, and it is actually a law by the government.

We also have the Intelligent Community homes. We also have railways stations, traffic control, toll Road, educational institutions and home surveillance. The top current market opportunity is actually where we have contracts already, where we have the customers.

The bottom part is where we think the opportunity is, but we are not only focusing. Those are just added bonuses for us.

First on the list is actually Beijing Olympics which will happen obviously in '08. From our point of view, the lights of GE and Honeywell have already got major part of the contract ready. Now Honeywell and GE are paying about $600 million to sponsor Olympic. So basically, we have the right folks. We actually get more of such contracts. We do not mind being a subcontractor providing some of the inflation, some of the accessories. But once again, we think that at the top of our list is 660 cities will continue to grow even beyond the Olympics.

Coal mines: I am not sure whether you are aware. There are about 24,000 coal mines in China. Recently, they announced about 6,000 non-fertility rate. That's just an official number. Unofficial number is a lot higher because a lot of villages in my own opinion is just [game off]. So we think that's an opportunity to provide safety surveillance systems within the coal mines down the road. And of course, Shanghai World's Fair that will happen in 2010.

Why we think that the Safe City project is such an important agenda for us? First of all, in a recent 11th planetary 5-year meeting in China, the government has stated that secured and stable society has become a number one priority for the central government.

Why? Because global incidence have fueled a lot of concerns. What's happen in US, what's in UK has given a lot of concerns for the central government. Right now, the government is trying to put in place surveillance systems within public areas, traffic junctions, government buildings. Cities have their budgets in terms of determining the size and extent of the inflations. Our initial projects have already started in '06. Now, major installations will begin in '07, '08 and '09.

From our point of view, once the network or once the camera systems has reached a certain critical mark, there will be other relative opportunities.

First of all, unless it's actually a service operating division. I guess it's similar to what we have here in the US called the ADT. Whereby, it becomes the first level of filtering. Whereby, we will then do a network control, filtering all the phone calls coming in and the videos coming. So, that is a recurring revenue model. But, we think that it will probably happen in about two years down the road, '08 and '09. And of course, there is a city-wide fire alarm industry opportunity there as well.

Estimated size: Possible contract value, we average about $30 million in some of the major cities; we think that approximately 660 cities. There are also about another 2,300 smaller cities. So, the addressable market size is about $25 billion. They include installation of street cameras at traffic junctions, main public government areas, all linked back to the local police stations.

Now, the government knows that providing a monitoring and surveillance project all over China is going to be a huge headache. So, what they've come out last year was a 3111 initiative.

What is the 3111 initiative? First of all, it is actually a testing phase for monitoring and reporting. 3 meaning province, city, county or municipals, and 111 meaning each province will select a city, each city will select a county, and each county will select a small district for testing of pilot projects. Last year about 22 cities were selected. We actually got about 13 of them and once successful the government will actually conduct a nation-wide roll-out plan.

Why we think we are in a competitive position? As I mentioned, we have very secured initial phase projects in several cities. We've been approved by the 3111 initiative. Now, the government will not allow any vendor, that's not been approved to start installation. Our camera systems and our DVR systems have been approved by the government.

More importantly, I guess typical of any government, they will not pay you immediately upon completion of the contracts. What they typically do is that they will pay you in installments of three to five years. From our point of view, that will hit us in terms of the working capital and AR.

So with this in mind, last year we actually went ahead and we did a deal with the China Construction Bank, whereby it's like a banking facility. If you bring $10, the China Construction Bank will give us 10 times higher to our credit limit.

Now, what do we do with the credit limit? First of all, there are three options when we deal with the government. First of all, the government can either borrow the full amount from the bank and it clears off total once we complete the projects. Or when the AR kicks us, we sell it to the bank. The bank will then give us 85% of request. The remaining 15% is collected from the government. They will pay us back minus of the interest. Or the third option is whereby we then borrow from the bank and then the government will pay us on an installment basis.

Right now, we are still the only security and surveillance company in China to have such a facility. And this is actually quite an important facility when we go and bid for government projects.

This is just a newspaper cutting from the Hong Kong Standard Bank on February 15, electronic eyes for discos in campaign against vice. So Beijing has ordered karaoke clubs, discos, etcetera, which are widely popular fronts for prostitution and drugs to install electronic eyes. So this has become a lot since last year.

3111 Recognition: Unfortunately, this is in Chinese. This was actually taken from the China Police Daily, which is a police newspaper. This highlights all the companies that have vendors that have been approved by the 3111 initiative. And on top of the list is, especially Golden Group and also the Shanghai Chengfeng, the company that we acquired last year. So this gives you an idea of ranking in the industry.

Facilities, we have a manufacturing facility out in the Shenzhen's special industrial zone, currently about 50% of capacity, approximately 6,000 square feet. We also have a R&D center, a joint R&D lab with the Beijing University at Shenzhen.

On a competitive landscape front, the market is actually segmented into three different areas. First of all, there are the manufacturers. They are the ones, who have a strong technical know-how. But I promise that they don't have the sales network to rely on the distributors to buy the products from them and distribute it locally.

The local distributors are within specific cities. They are small. They don't have any manufacturing capabilities. And they also rely on local contractor's office and system integrators who actually sell the product to them. Now, the local contractors and system integrators, they buy the camera from one person, the DVR from another person, the cables, and they package it and sell it as a full solution to the end customers as well.

Couple of points to take note. None of them are vertically integrated. If you are a manufacturer, you stay as a manufacturer. You don't go to become a local distributor. Local distributors and local contractors are only operating within specific cities, mainly because of their size. Most of them are actually five to ten people. And because of the size as well, they cannot participate in government and large projects.

CSST compete effectively in all three segments. First of all, we have a technology. We have the sales network, wider sales network right now. We have the necessary relationships with the business community and the government. They allow us to get the permits and approvals to bid on the large projects.

So to summarize, we have a diversified products portfolio, with a world class R&D team. With an excellent logistic support, the wide sales network, approvals and permits, and what I mentioned about was the One-Stop-Shop solution.

Some of the certificates: We've got the ISO, some of this you need to manufacture, some of this you need to do construction and maintenance. And the China Famous Brand right in the middle down below is actually issued to us by the China Public Security Association recognizing our Golden Group brand in China. We also recently issued with the top 50 enterprise in the security business. And the one on the right hand side is actually a (inaudible). It's the 3111 certificate for our product.

Revenue breakdown: Approximately 50% our customers are corporate. Government currently represents for 40%. 10% others means non-government organizations, non profit organization, schools, hospitals, etcetera. And because over 90% of our business is actually solutions, we don't actually breakdown as to how much each component will cost. But in a typical contract, let's say for example the $100,000, about 40% is equipments, engineering represents for 30%, software accounts for about 20%, and maintenance about 10%.

In terms of distribution by region, in '05 because of our wide sales network although we are headquartered in Shenzhen, our revenues come from almost every where, all over China.

Financially, in '03 of our $11.78 million revenues we grew to about $16 million, in '05 about $32.7 million. Our net income was about $2.7, growing to about $7.3. Earnings per share of $0.16 has grown to $0.39. You noticed that the gross margins fell between '04 and '05.

Now very simply in '03 and '04, as you know, the market grew and actually as one of the first movers in the market, we were able to enjoy economical prices. In '04 and '05, we started to seeing smaller players coming in. But we also started to bid for larger projects. So therefore, we gave some of the preference to some of those coming up.

On the summary of balance sheet as of the end of the September last year, we had about $23.5 million in cash. Long-term debt was only about $2.7 million. Total assets were $92 million and shareholders' equity about $48.9 million.

When we did the first PIPE, we were very confident in terms of our business. So much that we actually make good provisions.

In '06 we commented a net income of $17.49 million and in '07 we commented a net income of $34.1. Now since we have issued a guidance for September last year with the net income of about $15 million, I think our shareholders knew that we are not going to issue any shares to them.

In that Mr. Tu actually placed 15% of his own personal shares in an escrow account. If we do not meet '06 and '07 numbers about a million of shares to be given away, another million will be given for '07 numbers. So, given the guidance and results that we have been giving out so far, I think '06 is definitely not going to be an issue. And we are also very confident that '07 definitely is not going to be an issue.

Two or three highlights: We signed about 51 new contracts worth about $32 million. Revenues were $43.4 million. Our gross profit was about $12.9 million. Our net income was about $10.2 million.

On our recent transaction, I think most of you may know that we have completed a financing with Citadel. We also have about $60 million in convertible notes. Initial conversion price is about $18 with a coupon of 1%. Maturity is five years.

Some of the growth drivers: First of all, as I mentioned, we only did a reverse merger back in '05 September and we did a first round of financing back in April. So, it's only in '06 and '07 early this year that we have done any fund rising. So, we are very much better capitalized right now.

We've got a growing market. The Safe City projects were only issued last year. The State Ordinance 458 was also only issued last year. And of course, we've been approved by the government for 3111 project. And of course, we have acquired Shanghai Chengfeng, which has increased our management team, technology and customer base as well.

Management: Mr. Tu, he holds the Masters in Philosophy from Zhejiang University. He has been an entrepreneur since 1992 and received numerous awards from the State.

Myself, I am Vice Chairman and CFO. I hold an MBA from a Chinese University of Hong Kong. I lead finance and accounting and basically look after the corporate strategy, the investor relations and executive spokesperson in US as well.

Mr. Yang Shufang, our COO. He is a good example of our acquisition. Now, whenever we do an acquisition we also look at the management team. We don't want to change the management team rather we want the management team to join us as group. Mr. Yang has since joined us as a Group Operating Officer. The day-to-day operations he is now looking after thereby now limiting Mr. Tu's time in terms of going through the daily operations. So, Mr. Yang has been helping us a lot in terms of improving the internal operations.

Dr. Zhao, unfortunately he is not here. He is our CTO. He holds the PhD in engineering and he used to work for Honeywell. And so, he heads our R&D Center with the Beijing University.

So to conclude, we have strong regulatory drivers in place that will help facilitate the growth. Significant revenues and earnings growth as well as diversified business model. Security Surveillance has dynamic growth characteristics, clear domestic leader in a highly fragmented industry. And we are the first Chinese security company to be listed in the US.

So, with that, I thank you. I hope everything was short and sharp.

Question-and-Answer Session

Moderator

Yeah, we have time for a couple of questions.

Unidentified Audience Member

Terence, what is the size of the Safe City project 3111 in the opportunity?

Terence Yap

We think the market size is about $20 billion to $25 billion given that there are some of the cities that may have a pricing about $30 million to $50 million depending on the size, as I mentioned. We have approximately 660 major cities. We have another 2,300 smaller cities. Now all of them need to install the big brother system. So, next year the government has given this a priority in terms of spending itself. So, our own internal budget is about $25 billion.

Moderator

Yeah, we have time for a couple of questions.

Unidentified Audience Member

When we see around finance and there needs to be the private place going forward, in other words, the share count has not been as [free] going forward in the rate it has. Can you talk about where that financing will be used towards the [council]?

Terence Yap

Right. The reason why we have raised the $69 for working capital, the market is growing about 45%. From '05 to '06, we grew by almost 200%. Given the growth and given the opportunities, and new government regulatory there is a need for working capital. What we think that there is a need for us to raise any further funding? Well, I should have hope not because every time we come to market, it's very tiring event.

That's the reason why, this time we are raising about $60 million, so that we don't have to come back again. And the event that we do, some proceeds we will use for acquisitions. As I mentioned, we have about 15,000 vendors there. The market is right for consolidation. So right now, we are well capitalized to pull the trigger, if and when required.

Unidentified Audience Member

Thank you.

Terence Yap

Thank you. Thank you very much.

TRANSCRIPT SPONSOR China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy. Read all investor conference presentation transcripts here. To sponsor an investor conference presentation transcript please contact us.

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