China Security & Surveillance Tech's CEO Discusses Q2 2011 Results - Earnings Call Transcript

| About: China Security (CSR)

China Security & Surveillance Tech. Inc. (NYSE:CSR)

Q2 2011 Earnings Call

July 25, 2011 8:00 AM ET

Executives

Patrick Yu – IR, Fleishman-Hillard

Kevin Chen – IR

Terence Yap – Vice Chairman and CFO

Operator

Good morning, everyone. Welcome to the China Security & Surveillance Technology Second Quarter 2011 Earnings Conference Call. Today’s conference is being recorded. At this time I’d like to turn the call over to Mr. Patrick Yu of Fleishman-Hillard, CSST Investor Relations Consultancy. Mr. Yu please begin.

Patrick Yu

Hi, thank you, Bobby. Good morning and welcome to the CSST’s Second Quarter 2011 Earnings Conference Call. Here with me today are CSST’s Vice Chairman and CSST Investor Relations team, Kevin Chen.

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 website, which is irpage.net/csct/index.html.

I’d also like to take few minutes to review the company’s Safe Harbor statement which is found on slide two, which says that the conference call may contain forward-looking statements concerning CSST’s business, which are not 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, 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 recent privatization plan and the company’s actions on this have been filed with the SEC. We’ll not conduct Q&A session during today’s conference call and we urge you to refer to www.sec.gov or the company website at csst.com for further information.

Without further ado, I’ll now turn the call over to CSST’s Investor Relations team Kevin Chen, please.

Kevin Chen

Thanks, Patrick. Good morning and good evening everyone. Welcome to our second quarter 2011 earnings conference call. Before Terence covers (ph) to you our results, I just want to give you an overview of our business in the second quarter of 2011 and what you should expect from us this year.

Please refer to slide three in the company’s financial slides. We just completed our quarter with meaningful improvements in our gross margin despite a sliding revenues and the net income. The decrease was mainly due to structural change in our customer mix to include more large-scale government installation projects which require a longer installation time to complete and consequently fewer projects were completed during the quarter. Since we recognize revenue upon project completion, we expect our revenue upturn in the rest of the year.

With the benefit of our strong pricing power and economics of scale products – scale projects, our gross margin improved (inaudible) in the second quarter as compared with 25.8% for the same time last year. Our operating margin fell to 9.4% mainly due to the increase of professional expenses related to the proposed merger transaction and the increased advertising expenses to support the company’s business expansion efforts and hiring of additional staff.

We were encouraged to report a positive net cash flow of 78.39 million over the first six months of 2011 as compared with 53.59 million over the first six months of 2010. This was mainly due to additional financing activities to support a large-scale installation projects and the business expansion. Despite all these challenges we were also encouraged by continued favorable cost control initiatives as well as growth opportunities in suburban China with particular focus on large-scale government projects and the service operations which continue to be our growth platforms as we persist (ph) to cement our marketing leadership in China.

So Terence, I’ll turn it over to you.

Terence Yap

Thank you very much, Kevin. A good morning and a good evening to everyone. I’d like to start by providing an update on our Q2 results. Please refer to slide number four.

In the second quarter of 2011, we have reported revenues of 153 – $156.34 million, down 7.1% as compared to $168.35 million in the second quarter of 2010. The decrease was mainly due to structural change in our customer mix. During 38% of total revenues were generated from government projects which required a longer time for completion. Recognition of revenues from large-scale government installation projects was affected by government policies and payment practices which would likely result in a considerable revenue growth in the second half of 2011.

Second-quarter revenue mix in 2011 continued to be heavily weighted towards our system installation business. For the quarter ended June 30, 2011 $118.05 million or 75.5% of revenues came from the installation segment compared to $129.35 million or 76.8% of revenues in the second quarter of 2010.

Revenues from the manufacturing segment improved with $30.34 million or 19.4% of revenues in the second quarter of 2011 versus $21.98 million or 13.1% in the second quarter of last year. We see the continuous upward trend in the manufacturing segment as we continue to consolidate our businesses and strive to achieve greater synergies across all subsidiaries.

Our distribution segment (inaudible) $7.15 million or 4.6% of the total revenues in the second quarter of 2011 versus 13 point or 8.1% of the total revenues in the second quarter of 2010. The decrease was mainly affected by increase of certain prices due to increased market competition.

Revenues from all service segments were $0.8 million or 0.5% of revenues in the second quarter of 2011 compared to $3.35 million or 2% in the second quarter of 2010. Our service segment is still at a development stage and we expect to see revenue fluctuations before consolidating our expanding customer base in China.

We remain positive regarding business opportunities across our four business segments and we believe the revenues from installation projects will continue to be the major revenue source over the next few years.

Turning over to slide number five, in the second quarter of 2011 we have seen a meaningful structural change of our customer base. Approximately 88% of revenues came from the government sector as compared to approximately 55% in the same quarter of 2010. We will continue to look for opportunities in the higher margin large-scale government installation projects.

Gross profit, please refer to slide number six. 2011 second quarter gross profits fell slightly by 3.1% to $42.01 million from 43.36 million for the same period last year. Gross margin for the second quarter increased 26.9% from 25.8% for the same period in 2010. The increase was mainly driven by improved gross margin installation segment over the second quarter as well as disciplined execution of cost control initiatives.

Moving over to slide number seven. Gross margin for installation, manufacturing, distribution and service segments were 29.7%, 18.9%, 14.9% and 25.9% in the second quarter of 2011 respectively compared to 27.8%, and 27.3%, 6.3% and 16.7% for the same quarter of 2010. Two quarters of 2011 was primarily affected by reduction in selling prices to sustain and expand our customer base. The increase in gross margin from distribution and service segment was due to cost deficiencies.

Operating expenses, please refer to slide number eight. We continue to improve our cost structure instituting cost-control initiatives and prudently monitoring operating expenses while continuing to promote our brand, expand our market penetration and hiring of additional staff.

Selling and marketing expenses decreased $0.02 million or 0.6%, $3.11 million in the second quarter of 2011 from $3.13 million in the second quarter of 2010. As a percentage of revenues selling and marketing expenses increased 2% in the second quarter of 2011 from 1.8% in the second quarter of 2010. The percentage increase was mainly due to the decrease in revenues.

Our general and administrative expenses increased 113.7% to $ 16.26 million in the second quarter of 2011 from $ 7.61 million in the second quarter of 2010. As a percentage of revenues general and administrative expenses increased 10.4% in the second quarter of 2011 as compared to 4.6% in the same period of 2010.

The dollar and percentage increase was mainly due to professional expenses related to the proposed merger transaction and increased advertising expenses to support the company’s business development efforts and hiring of additional staff.

Income from operations, please refer to slide number nine. Income from operations and margin – an operating margin both sort of fall in the second quarter of 2011. Income from operation decreased $9.91 million, a 40.4% to $40.65 million in the second quarter of 2011, compared to $24.56 million for the second quarter of 2010, decreased to 9.4% in the second quarter of 2011 from 14.6% in the second quarter of 2010. The decrease was mainly due to the impact of rising in hidden costs and expenses on an underlying operating income.

Interest expense, on slide number 10. Interest expense increased to $6.44 million in the second quarter of 2011, as compared to $3.06 million in the second quarter of 2010. The dollar increase in interest expense was primarily due to the increase in outstanding balance of our bank loans to support our last year installation projects and business expansions in China.

Income taxes, our income taxes decreased to $3.18 million in the second quarter of 2011 from $4.13 million in the same quarter of 2010. Effected income tax rate increased to 34.8% from 18.8% at the same time last year. Such increase was primarily due to non tax deductible expenses and expired (ph) in some of our subsidiaries.

Heading to slide 11, net income attributable to the company. The GAAP net income to the company fell to $5.97 million in the second quarter of 2011, compared to $17.81 million in the second quarter of 2010. Net margin was 3.9% in the second quarter of 2011, compared to 10.6% in 2010. This dollar end percentage decrease was mainly due to the decrease in revenues and an increase in professional expenses related the proposed merger transactions and company’s advertising promotions to support its business expansion efforts and the increase in interest expense.

Fully diluted GAAP earnings per share were $0.07 in the second quarter of 2011, as compared with $0.23 in the second quarter of 2010. The decrease was due to the decreasing net income to the company and effected our weighted average value per share count increased 18% to 89.71 million share in the second quarter of 2011 from 76.01 million share in the same period of 2010.

Backlog: please refer to slide number 12. As of June 30, 2011, our total backlog was $266.43 million, down $64.54 million from $330.97 million as of March 31, 2010. We continue to executive on our existing order book, expect the majority of backlog to be realized within the next few quarters.

On a year-over-year basis, our backlog continues to be higher than the previous levels and increase in backlog was results of our continued efforts in pursuing higher margins, large share of government projects, which generally take a longer time for completion.

Once again, we have not included Letters of Intents, framework agreements and various other agreements in our backlog, as they are subject to final binding individual agreements to be entered into at a later date. These projects in our pipeline provide us with extra confidence in our outlook for years ahead.

Balance sheet; our balance sheet remains solid because it’s a snapshot at any given moment in time. I’d like to address selected line items that management believes may have material impact on our ongoing operations.

Accounts receivables. As of June 30, 2011, our accounts receivables increased to $491.37 million, up $57.3 million from $433.99 million at the December 31, 2010. The increase was mainly due to the customers’ payment practices of large-scale installation projects. We feel as we refer this, we expect to see fluctuations in the accounts receivables, which is also in line with our strong backlog. We will continue to monitor the AR closely, while capitalizing on our existing banking facilities with the Chinese banks.

Inventory. As of June 30, 2011, our inventory remains steady since the previous quarter at $43.10 million versus $59.37 million at December 31, representing a decrease of approximately $16.27 million over past six months. This was attributable to efficient execution and delivery on previous design contracts.

Working capital. Our working capital as of June 30, 2010, was $400.26 (ph) million versus $377.78 million as of December 31, 2010. The increase was attributable to improved cash position.

Slide 14, cash. As of June 30, 2011, we had a cash balance of $144.21 million in cash and cash equivalents. It was up from $65.16 million as of December 31, 2010.

Net cash inflow was $38.59 million in the first six months of 2011, as compared to $53.59 million provided in the first six months of 2010. The net cash used in operating activities in the first six months of 2011 was approximately $120.12 million versus $56.46 million of net cash used in operating activities in the first six months of 2010. The increase was primary due to advances to suppliers and the subcontractors.

Net cash used in investing activities for the first six months of 2011 was $13.23 million versus $32.30 million of net cash used in investing activities in the same period of 2010. The encouraging trend was primarily due to net cash provided by the processes we funded for business acquisitions, properties and intangible assets in the first half of 2011.

Net cash provided by financing activities in the first six months of 2011 totaled $182.04 million increased from net cash provided by financing activities of $140.51 million in the first six months of 2010. The increase was mainly attributable to the process of additional bank loans obtained in the first two quarters of 2011.

Corporate development in the second quarter of 2011. To summarize the financial results for ht second quarter of 2011, the first six months to-date, as I mentioned we continue to record meaningful gross margin improvements due to our – and we bring focus on large-scale projects. And we believe we are well positioned for future growth in the Chinese surveillance and safety market.

The decrease in revenues in the second quarter was attributable to the structural change in our customer mix and we expect to see better performance as we approach the last quarter, our best quarter. We maintain a discipline across the cost and are still expanding our business in key growth areas for our future. Furthermore, onetime costs and professional expenses related to the proposed merger plan introduce a one-off cost factor into the overall company balance sheet.

We continue to capitalize on our existing capital facilities with local banks to further strengthen our financial position that enable us to comfortably fund our expansion plans. And as we previously announced, in the second quarter of 2011, the company entered into definitive agreement and plan of merger with Rightmark Holdings Limited, a company wholly owned indirectly by Mr. Tu and Rightmark Merger Sub Limited, corporation wholly owned by Rightmark Holding.

Mr. Tu, is our Chief Executive Officer and Chairman of the Board Directors and beneficiary owns around 20.9% of the outstanding shares in the company’s common stock. Under the terms of the merger agreement, each share of the company, common stock issued in outstanding in immediately prior to the effective time of the merger, will become converted into the right to receive $6.50 in cash without interest except for certain conditions outlined in our filings with SEC. All available information pertaining to the privatization plan and a company’s action on it have been filed with SEC. Please review our previously issued PRs and SEC filings, if you like to get more details about the transaction.

Outlook for the rest of 2011, our long-term future remains positive. Demand for surveillance and safety products and the services in China, continues to grow and we believe we are well positioned to capture the opportunity. We made a decision to concentrate CSST’s strategic focus on the opportunities we saw flowing from large-scale government projects and security services business such direction is paying off through continuing margin expansion in a previous periods and quarters.

So, as we look forward to 2011, we plan to continue to grow revenues and earnings. We do expect the transfer of heavily backlog and accounts receivables to continue into the second half of 2011. Obviously, this is going to make things a little bit harder for us to product earlier in the year. But, with our prudent control on costs and accounts receivables as well as our solid relationships with local banks to provide financing facilities. We believe our business will continue to be strong. We are still confident in our strategic direction and embracing opportunities in last year projects that can yield sustainable higher margins.

Patrick, that concludes what I prepared for this conference call.

Patrick Yu

Thank you Terence. Thanks everyone for attending CSST second quarter, 2011 on this conference call. I will remind you again the company will not have Q&A session this time. We appreciate your understanding. Have a good day everyone. Bye.

Operator

Thank you ladies and gentlemen. This concludes our teleconference call. Thank you all for attending.

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