China Security & Surveillance Technology, Inc. Q2 2008 Earnings Call Transcript

China Security & Surveillance Technology, Inc. (CSR)

Q2 2008 Earnings Call Transcript

August 4, 2008 5:00 pm ET

Executives

Bill Zima – IR, ICR

Terence Yap – Vice Chairman and CFO

Analysts

Adele Mao – Susquehanna International

Josh Jabs – Roth Capital

David Anderson – Anderson Hoagland

Michael Kim – Imperial Capital

Steve Brown [ph]

Brian Witner [ph] – Oppenheimer & Co.

Presentation

Operator

Good day, everyone. Welcome to China Security & Surveillance Technology second quarter 2008 earnings conference call. Today's conference is being recorded.

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

Bill Zima

Thank you, everyone, for joining us for the China Security and Surveillance Second Quarter 2008 Earnings Call. With us today is Terence Yap, China Security's and Vice Chairman and Chief Financial Officer.

Before we get started, I'm going to review the safe harbor statement regarding today's conference call. This conference call may contain forward-looking statements concerning China Security's business, which are intended to be covered by the safe harbor forward-looking statements covered by the Private Securities Litigation Reform Act of 1995.

The actual results may differ materially, depending on the number of risk factors, including, but not limited to, general, economic and business conditions, new product developments, installations, market acceptance, additional competition from existing and new competitors, changes in technology, and various other factors beyond the company's control.

All forward-looking statements are expressly qualified in their entirety by the cautionary statement and risk factors detailed in the company's filings with the SEC. China Security undertakes no duty to revise or update any forward-looking statements through select events or circumstances after the date of this conference call.

At this point, I'd like to turn – introduce Terence Yap to the investment community. Terence, please go ahead.

Terence Yap

Thank you very much, Bill. Good afternoon, everyone and for those in Asia, once again, this is very good early morning.

Welcome to our Second Quarter 2008 Conference Call. Today, we will discuss our financial results, talk about recent development and our strategic plans, and conclude our outlook for the remaining of 2008.

First of all, the financial results. We are very pleased with our second quarter results. Our brand has become increasingly visible and relevant within China. We have strengthened our position as a leading integrated provider of security and surveillance services.

Revenues in the second quarter grew 77.9% to $92.7 million compared to $52.1 million in the second quarter of 2007. Our revenue mix has also changed since last year. Our installation revenue in the second quarter totaled $62.2 million or 67% of revenue, compared to $39.4 million or 75.5% of revenue in the second quarter of 2007.

Manufacturing revenues were $20.3 million or 22% of revenues versus $12.8 million or 24.5% in the same period last year.

And during the second quarter, we continued to build our distribution segment to capture demand for security and safety products, including intruder security, access control, and video management systems. Our distribution segment contributed healthy $10.23 million, or 11% of our overall revenues. We expect this segment to grow – to be a growing contributor of our revenue base, and I believe it perfectly leverages on our sales expertise and distribution network.

Organic revenue during the second quarter 2008 was approximately $68.5 million or 73.9% of total revenues. As a result, organic revenues grew during the second quarter by $24.2 million or 54.6% from 44.3 million in the second quarter of 2007. Nonorganic revenue or revenues of acquired companies was approximately $24.2 million or 26.1% of total revenue in the first quarter of 2008.

We are pleased with both our organic growth – and our growth from acquisitions during the year, as we continue to stimulate growth in those businesses by applying strong marketing and branding of China Security in addition to our increased distribution, and management expertise, and a strong balance sheet.

Healthy economic development and, in fact, the Chinese population, in general, has become wealthier, continues to drive demand for security and surveillance products. The Chinese government continues to execute on the Safe City programs, which require the development of IT security programs and installation of electronic security/surveillance systems. The government sector as a percentage of our total revenues was roughly 44%.

Our corporate sector has also been a strong performer. Our projects in the second quarter include transportation management systems; gasoline stations; community centers; shopping malls; business centers; and entertainment venues, such as bars, cafes, and nightclubs. Corporate revenues as a percentage of our total revenues total roughly 55% for the quarter.

Second quarter gross profit increased $15.6 million or 104% to $30.5 million from $14.9 million for the same period last year. Gross margins for the second quarter were 32.8% compared to 28.6 for the same period of 2007. Gross margins of installation segment and manufacturing segment were approximately 34% and 35% respectively, compared to 27.8% and 31% for the same period last year. Gross margins of our newly established distribution segment was 21.6% in the second quarter of 2008. This is mainly due to the one-off gains obtained from the software sales during the first quarter of this year. However, as we have given math of establishing the distribution segment we will continue to see the fluctuations in the gross margins in this year. An increase in our overall gross margins was driven by the increased economies of scale and the growing recognition of higher margin Safe City projects.

Selling and marketing expenses increased by 250% to $2.99 million in the second quarter from $0.86 million in the prior year, primarily due to the integration of our acquisitions. General and administrative expenses increased 234% to $108 million in the second quarter from $3.31 million in the prior year, primarily due to the integration of acquisitions in the addition of staff, the increase of costs associated with improving our intruder control, and professional expenses related to costs of being a publicly traded company.

Also included in the general and administrative expenses in Q2 2008 was $3.11 million noncash employees' stock compensation expense which was lower than we expected as we began to undergo a thorough review of expected compensation packages.

Income from operations increased 47.7% to $14.25 million from $9.65 million in the prior year's second quarter. Operating margin decreased by 15.4% from 18.5% in the second quarter last year, which is mainly due to the increase in noncash expenses as well as higher selling and general and administrative expenses.

Net income in the second quarter of 2008 increased 81.3% to $7.74 million from $4.27 million in the same quarter last year. Net income per diluted share was $0.17 versus $0.11 in the second quarter of 2007. On noncash expenses during the second quarter we recognized $4.4 million, or $0.10 per diluted share, as redemption accretion on convertible notes. We also incurred $3.1 million, or $0.07 per diluted share in the second quarter for noncash employee stock compensation. This was lower than our guidance as our board and our management team has decided to undergo review of stock-based compensation packages.

Lastly, we incurred approximately $2.33 million, or $0.05 per share in the quarter related to depreciation and amortization of long-list [ph] assets. Adjusted noncash items diluted earnings per share were about $0.39 in the second quarter compared to $0.26 per diluted share in the second quarter of '07.

We are pleased with this year-over-year performance, especially given that our diluted share count increased 16% in the second quarter of 2008 to 44.9 million shares from 38.8 million in the second quarter of 2007.

Taxes, our effective tax rate for second quarter was 22% compared to 29% in the same period last year. There were two main reasons for this decrease. First, on the March 16, 2007, the National Peoples' Congress of the Peoples' Republic of China adopted a new corporate income tax law which was passed in the late 2007 imposing in 2008 a unified Enterprise Income Tax Law of 25% of all Domestic invested enterprises and Foreign invested enterprises or FIE unless they qualify under certain exceptions. As a result, beginning 1^st January 2008, nearly all of our subsidiaries were to a new tax rate of 25% alongside other domestic businesses rather enjoying the FIE tax benefits and associated preferential treatments that we used to have.

Second, we are able to improve in our tax planning for various subsidiaries which resulted in certain subsidiaries and joint tax exemption. However, due to the nontax GAAP expenses we may expect to see fluctuations in the expected tax rate over next few quarters.

Backlog. In the second quarter, our backlog was $42.2 million, down from $50.1 million in the first quarter. The second quarter tends to be seasonally stronger for our business, but as we did in the first quarter, we remain conservative, we have chosen not to include letters of intent, framework agreements, and other agreements as they are subject to final individual agreements to be entered at a later date. The total backlog value of all the LOI and framework agreements that we have signed since the beginning of 2008 is more than $200 million.

Looking at the balance sheet, our cash position at the end of the second quarter was $88.6 million, up from $77.1 million at the end of the first quarter, mainly due to our strong net income cash provided by operating activities which was approximately $11 million compared to a deficit of $3.8 million during the same period last year. Second quarter inventory increased slightly to $40.6 million on 38 in the end of the first quarter.

DSO. Accounts receivable increased to $96 million, up from $78.2 million in the first quarter as a fulfillment on government contracts which have longer days outstanding and corporate continues to increase in our product mix shift to reflect the increase in sales of costs. Days of sales outstanding decreased to 94 days from 98 days in the first quarter. This is mainly due to an improvement in our receivable, collections to our subsidiaries.

However, we have to bear in mind that as a government sector continues to grow, we expect the DSOs to increase economy as a fulfillment of Phase III contracts commission by the government entities; hence we have longer payment cycle. Nevertheless, with the China Construction Bank and the IBM Global Financing facilities we are not concerned about the current trend.

Prepayments and deposits increased up to $5 million from $4.2 million in the first quarter as a result of robust business activities. Total debt at the end of the second quarter stood at $137.8 million, down from $140.6 million at the end of the first quarter. Our working capital at the end of the second quarter was $188.3 million versus $165 million at the end of the first quarter.

Secondly, allow me to cover our recent development and strategic plans. First, we continue to build CSST as a preferred solution provider, both in the corporate and government sectors in China as well as international. We continue to see strong demand for our production services from various businesses, customers and government organizations.

Our phase three assets are increasingly encouraging, and did not envision any slowing of this business even after Olympics. Government concerns about recent bombing have increased awareness of our product and services and we believe this awareness and demand will continue. Our corporate sector business also remains healthy and we continue to add contract wins from backlog, including recently announced contract such as Peoples' Bank of China in Beijing. The Beijing capital international airport which also marks our entry into the City of Beijing for the first time.

As we continue to strengthen our position as a leading security and surveillance company in China, we have been focusing on increasing our Safe City projects. During the quarter, we announced several framework agreements. In April, we announced Qingzhou City project for approximate 200 million RMB. In May, we announced Qingzhou City project for approximately 260 million RMB.

In June, we announced the phase two project of Qingzhou City of approximately 64 million RMB. Following the close of the quarter we completed the Jining acquisition and mid last week we announced three more letter of intent further rounding out our Phase III offerings. The new LOIs are, firstly, Crystal which is a leading company primarily involved in antenna intelligent access control solution.

Secondly, DIT Digital, which is based in Zhuhai, well-known security company specializing in household consumer monitoring. Thirdly, Shenzhen Skyline Technology which is a leading hi-tech and software enterprise, specializing in development and designing manufacturing and selling digital video converting system.

We believe that a product offered by each acquisition will add to our range of products and services as we seek additional Safe City project and expand our business into rest of Asia and commercial markets, these three acquisitions will further position our company as a one-stop shop solution provider for security and surveillance needs.

I also like to point out that we do not anticipate additional acquisitions for the remaining 2008. We intend to focus on integration of our acquisitions as well as on to the continued expansion and development of our security product and service portfolio. Importantly, we remain comfortable with our cash position and a secured sufficient financing to have a stature as much [ph] Safe City business is possible and meet our ongoing working capital and acquisition integrations.

We will use our facilities on China Construction Bank to fund our working capital needs associated with the various Safe City projects and we obtained a lead financing certificate of Safe City project within China from IBM Global Financing. These agreements provide us with the base-day operating capital needed to foreseeable demand from Safe City contracts without compromising on our balance sheet.

We are also exploring ways to increase our visibility and our participation in international market. And a second step to begin that process. First, following the close of the quarter we enter into two non-exclusive MoUs with U.S. technology companies to help us strengthen our security offerings. Firstly, with FalconStor Software, we are exploring technologies in these areas of data storage, and professional software solution.

Secondly, with FLIR Systems. We will not only use FLIR Systems of imaging core component in our security timer solutions we also work with FLIR to explore other technological applications in the security business. Finally, we announced an MoU with Fujitsu Co. one of Japan's leading trading company to explore opportunities in distributing our products and services outside of China.

The second step that we have taken to increase our visibility as well as our understanding of an international market. With our announcement in last week about seeking a dual listing in Dubai, and now, $10 million private placements with UAE investors. So, Dubai, let's say we're provided with a wider market access and a higher profile in the Middle-East and give us a foothold in surrounding areas of Africa, India, Pakistan, and the rest of the gulf operating countries. Similarly, this is a near where our products and services could be infinite, can be a demand.

Further strengthening our position in the Middle East with our announcement that some very well-known and influential investors in the UAE have chosen to participate in the private equity offering of $10 million. We view this investment as a strategic equity partnership which provides us the relationship that will allow us expand our business operations in Dubai, and in UAE overall. The UAE economy is growing rapidly. And the infrastructure development in the UAE is significant resulting in an increase in demand of security related products and services. We are excited about the possibilities of these developments and continue to research cost-effective opportunities that makes strategic sense worldwide as we expand our reach beyond China.

Second, we will continue to obtain (inaudible) projects. During the quarter, we now only announced a framework agreement in Qingzhou City. We also announced on the 30^th of June that we want a second-phase project for a Safe City project in Qingzhou City.

The Safe City project is small in size, but is evidence of our growing brand awareness and the acknowledgment among our potential customers of our ability to provide a broad range of security services and products. We are excited by the momentum we see through each new project, and by the evidence of strong brand loyalty and the acceptance of our services. Once again, to remain conservative, this project will now include in our backlog numbers.

Third, we will also continue to focus on larger projects. Historically, our average contract size for the Safe City projects were $1 to $1.5 million. However, since the second half of last year, we have increasingly signed Safe City contracts that range from $5 to $8 million. We are really encouraged and we are now winning projects very much higher than that

As our competitive strategy we now typically sign letters of intent, framework agreements first followed by finalizing and the individual separate contracts with specific scope of work and payment terms. These LOI and framework agreements are firm offers that have the same binding effect as actual contracts.

We should point out that the time duration to fulfill some of these larger contracts has increased from 6 to 12 weeks historically to as many as 22 to 25 weeks or longer. We anticipate that a majority of revenue of projects recently signed will be recognized in the next year, which also provides us with increased visibility moving into 2009. It is also important to note that we are seeing fewer competitors when bidding for larger Safe City projects.

Fourth, we will continue to focus on our main revenue streams for 2008 and also develop the foundation for sustainable future growth. As we discussed on our last quarter's conference call our company will be organizing in five different divisions. First, manufacturing of security and safety products; second, system installation and solutions; third, security and services; fourth, product distribution; fifth, software solutions.

On the manufacturing and system installation, we are excited about opportunities we are seeing in the marketplace for our flagship divisions. Our two core operating divisions, the manufacturing of security and safety products and the system installation solutions are both growing strongly. We are pleased with the traction we have established in the manufacturing and system installation business. And the momentum we continue to generate. We expect the two segments will continue to be our main revenue contributors for 2008.

And we are now beginning to explore opportunities on an international scale as well. On the security services we continue to build the foundation for sustainable, recurring services revenue in the future. The establishment of a service division, the right to provide security aided services for some of our Safe City projects, and the continued expansion of our corporate system installation projects, are all geared towards building of a sustainable customer base for our security service business. Once again, we expect to see meaningful revenues from the services division sometime during 2009.

On a product distribution, we are progressingly, steadily with the rollout of our distribution division, which now generates a small percentage of our overall revenue. We will continue to facilitate international security product vendors to enter the Chinese market by leveraging on our wide domestic distribution and sales network. We will explore distribution opportunities internationally as well. This will also allow us the opportunity to introduce a wider range of products and solutions into our system installation business.

On the software solutions the division was specifically looking to the development and deployment of software solutions for security-related applications over at the infrastructure for our current and future clients. This division will not only employ the technological resources within the group, it will also explore possible partnerships and collaborations with international security software solution providers. We do not expect to see meaningful revenues from this division in 2008.

Fifth, we'll also continue to align our goals of our management team, with a goal to our stakeholders. Recently, our management team made the decision to extend a lock up of our shares until 2011. Shares issued under employee incentive plan will be subjected to vesting periods. The management team will only be allowed to sell one-fifth of their unrestricted shares annually starting on 1^st January 2009. They chose to extend the lock up because we continue to believe in the long-term growth and a health of our business. We believe it is important for all of our shareholders to know that we have an ongoing vested interest in making this business successful.

Lastly, we have also continued to consolidate our operations. In this regard, we have mentioned a part of our plan to consolidate all our existing and acquired entities into a single location in Shenzhen to benefit from greater economies of scale. We hope to close acquisition of Huaqiang [ph] within Q3 this year.

For the outlook of remaining of our 2008, we believe we will continue to see strong organic growth coming primarily from the manufacturing and system installation associated with Safe City programs and from the corporate sector. We also expect to see continued growth from our acquired companies. In addition, the synergies from these acquisitions will increasingly be more apparent in the second half of 2008.

In the beginning of the quarter we closed the acquisition of Guanling, thereby increasing our overall service offering and expand our geographical presence in China, providing us with additional opportunities to strengthen our portfolio and further grow our revenue stream. We still have five more acquisition to close, including Huaqiang which is really an industrial park. We believe these acquisitions will continue to improve our business profile, increase our market share, and round out our product and service offerings and help us to continue to expand geographically.

With more than $88 million in cash on our balance sheet, as to an excess to short-term working capital financing we believe we are well-capitalized to meet our current goals. Our strategy has always been to be the market leader in the security and surveillance products and services within China. We have executed our strategy successfully and have begun to realize the benefits of it as we begin to see higher revenues, higher margins, and a greater number of larger Safe City contracts. We continue to capitalize on all security opportunities with the solid infrastructure that we have built. Additionally, we believe that this is the great time to begin the leverage our expertise and increase our brand awareness on a global scale. We remain confident about business and the growth of security industry.

For the third quarter of 2008, we expect to achieve revenues of $110 million to $115 million, which is expected to include any revenues from complete acquisitions. As we are still in the midst of consolidation and integration we remain comfortable to maintain an average gross margin of 30%.

We estimate that a noncash interest expense associated with the redemption accretion on the convertible notes and the employee stock compensation and the depreciation and amortization for the third quarter of 2008 will be approximately $4.4 million, $4 million, and $3.3 million, respectively. Excluding these noncash charges, we expect to achieve an adjusted net income of $19 million to $21 million and adjusted diluted EPS of $0.43 to $0.45 in the third quarter of 2008. This is based upon our current fully diluted outstanding share.

For the full year of 2008, we are raising our revenue and earnings forecast. We are now targeting revenues between $400 million to $410 million. 2008 revenue estimates include contributions from completed acquisitions. Our 2008 financial forecast includes contributions from competitors and pending acquisitions excluding Crystal, DIT, and Skyrise letters of intent announced on 1^st of August 2008.

Once again, manufacturing and system integration businesses will continue to be the main revenue contributors in 2008. Excluding noncash expenses, we continue to expect to achieve an adjusted net income of $73 million to $80 million and adjusted diluted EPS of $1.60 to $1.77 for the full year of 2008. These increased estimates compared to prior guidance of $380 million to $400 million of revenue, 70 to 76 million in adjusted income and adjusted diluted EPS or $1.59 to $1.76 respectively.

In closing, we remain committed in fulfilling our obligations to our shareholders by making going our business strategically. We are capitalizing on great opportunity by focusing on our resources on a Safe City project by executing our strategy carefully and successfully. We are very pleased with our growth trajectory, and we plan to continue to generate strong growth in our business across all our operating segments.

This concludes my prepared remarks for the second quarter of 2008. Operator, I'm now ready to take some questions, please.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And our first question comes from Adele Mao with Susquehanna International.

Adele Mao – Susquehanna International

Question. First of all is related to your backlog. You mentioned that in addition to $42 million of signed backlog there is additional $200 million worth of letter of intent, and framework agreements. I was wondering how much of that $200 million do you expect to go into 2008 versus 2009.

Terence Yap

As I mentioned because this put us a really larger. We expect to see majority of them recognized in 2009.

Adele Mao – Susquehanna International

I see. Is there a percentage that you could help us–?

Terence Yap

Not at this point in time.

Adele Mao – Susquehanna International

My second question relate to your expenses. Looks like this quarter G&A went up significantly over the past quarter. Could you just provide little more detail as to how much is that is related to the integration of the acquisitions which you obviously incurred this year [ph] and how much of that is related to staff addition, and what type of run rate quarterly expense run rate which you work with excluding any acquisition going forward?

Terence Yap

Right. I just want to – we have not provided, broken down those numbers, but if you look at the G&A which is increased by a fair bit lot of it due to the noncash stock compensation. Majority will probably be in terms of increasing number of headcount within the group. We have grown from 2,000 – 3,000 last year to close to 4,000 this year already. So increasingly the stock comp is one of the main growth in terms of G&A.

Adele Mao – Susquehanna International

I see. So you grow your head count from 3,000 to 4,000 already this year, in which area do you see the most head count growth?

Terence Yap

Mainly from acquired company.

Adele Mao – Susquehanna International

I see. Great. That's all I have. Thank you.

Terence Yap

Thank you, Ade.

Operator

And next question will come from Josh Jabs with Roth Capital.

Josh Jabs – Roth Capital

Hi, Terence, good morning.

Terence Yap

Hi, Josh.

Josh Jabs – Roth Capital

Can you give us an update on some of the larger Safe City projects that are in the pipeline, maybe progress, some maybe there, and then the number in total value the projects you're carrying with bidding on?

Terence Yap

We are currently bidding on a lot, but Josh, I cannot give you the exact dollar amount, because we have not disclosed this figure. But even the increasing visibility our government project team is constantly going through all the different cities, all over China, especially with the issues of earthquake, snow storm and also the recent bombings around China. We are increasingly seeing that the government is now seeing this as a priority and also a concern. So from our perspective, we are bidding for quite a lot of projects on a Safe City size, but we have not yet announced the exact profit dollar amount so far. We only announce projects that we have signed, we think we have an interest in. That's why so far we have announced close to about – more than $200 million of Safe City projects.

Josh Jabs – Roth Capital

Would you say the pipeline at the end of the second half is as stronger as it was when you were entering the year?

Terence Yap

Yes. Absolutely. Because the first half of the year is typically the slower part of the year, mainly because of the Chinese New Year, et cetera.

Josh Jabs – Roth Capital

And then on the framework agreements that you have announced so far how – any of those moved into the contract in phase, did they also move into the contracting in phase in Q2?

Terence Yap

Some has already.

Josh Jabs – Roth Capital

And then you talked a little bit about the strategy to expand internationally, we notice there was a partnership announced in India with Smile Security & Surveillance, sometime mid June, can you talk about the plans overall in India, and so the progress have been made to-date?

Terence Yap

Sure. India is another interesting market for us. Mainly because you look at a geographical also demographic of the country, it's somewhat similar to China. The CSST need surveillance systems that we can forecast as why and we are talking about building out in order to et cetera, so, we see a huge opportunity in India, Pakistan, also in the UAE as well. The partnership with Smile is actually our first step in looking at the Indian market. At this point in time we are still talking to them in terms of probably – distribute our product in India and also looking at some of the Safe City project, possibility of exporting our expertise and now know-how an experience that we have gained in China. At this point in time I would like to keep it as it for the moment. But we are not only looking in India, we are also looking at UAE, we are also looking at the Gulf corporate and council countries like Saudi Arabia, Kuwait, Qatar, Dubai, Abu Dhabi et cetera, so, that region for us is also another nice growing region.

Josh Jabs – Roth Capital

Regarding the acquisitions that – I know you are still working through the numbers on the recently announced LOIs, but can you give us some color on the valuations that you are seeing in the market? Are you still looking at ten times or so ten times net income for those acquisitions?

Terence Yap

Yes. We typically have less than ten times about the net income for evaluation.

Josh Jabs – Roth Capital

That's helpful. And then lastly here, on the taxes, I know it's a – the expectations, it's going to be belted [ph] around here a little bit, but is it still fair to you sort of a 30% tax rate going forward?

Terence Yap

To be conservative, yes.

Josh Jabs – Roth Capital

Great. Thank you. Great quarter.

Terence Yap

Thank you, Josh.

Operator

(Operator instructions). Next question comes from David Anderson with Anderson Hoagland.

David Anderson – Anderson Hoagland

Terry, in your comments you referenced growing individual wealth in China, and in one of your acquisitions I believe is a household monitoring company. Are you signaling or saying that you are interested now in getting into the high net worth individual security systems or did I hear that wrong?

Terence Yap

You are probably correct. One of our main strategy to build the services division – and if you look at experience in U.S. and even in Europe, ADT brings et cetera. In figures proportion of the market is really residential and complex. We believe that this also trend along same line in China as well. So, by entering into the residential market, this is really a signal for us to also preparing ourselves for the eventual rule out of security services well both the residential and the complex factors.

David Anderson – Anderson Hoagland

And then it's – it must be fair to say that that would also be a big sector in the Middle East.

Terence Yap

Yes. It is, but at this point in time we do not see ourselves as a service provider in the Middle East. We are now looking at business opportunities of distributing our products there. And also, on the looking at some of the Safe City projects – because as you probably know, some in the Middle East countries are building new city out from scratch, that's even out in its feet. So we see that an opportunity as well.

David Anderson – Anderson Hoagland

Great. Thank you very much.

Terence Yap

Thank you.

Operator

Moving on to Michael Kim with Imperial Capital.

Michael Kim – Imperial Capital

Hi, Terence. Couple of questions. First regarding your guidance – your top line guidance, can you outline approximately how much – what proportion would you expect that will be driven by organic revenue growth versus acquired growth? And then secondly, can you talk a little bit about your average working capital requirements going forward and provide some rough guidelines on that front as well?

Terence Yap

On a top line we have not broken out in terms of how much will be organic and how much will be nonorganic. But if you look at our historical numbers the organic numbers have always been growing strongly, even in this quarter, we have seen the organic growth as 73%. So we are confident that for the full year revenue the organic growth will be the main contributor. Once again the way we calculate the organic growth the once the companies we acquire anniversaries the 12-month, the 13-month is considered organic growth. On the second question, of working capital, we have not disclosed how much the working capital needs of the company, but if you look at the current working capital is about $150 million [ph]. Now, to address this issue we are in line with the China Construction Bank and also the IBM Global Financing. We may be looking at tapping them into working capital (inaudible).

Michael Kim – Imperial Capital

And maybe one last issue. Maybe there's along those lines address your needs if any to raise capital in the future. So, address some of those working capital requirements?

Terence Yap

At this point in time, once again, I need to reiterate that we do not need to raise money to see for our working capital or acquisition. If $88 million in cash and with the short-term financing we are comfortable with the position.

Michael Kim – Imperial Capital

Great. Perfect. Thank you very much, guys.

Operator

(Operator instructions) And we have a question from Josh Jabs with Roth Capital.

Josh Jabs – Roth Capital

Hey, Terence, just a couple additional questions here. Going back to the cash requirements here, how much of the cash payment is included in the deposits line on the balance sheet right now for your upcoming acquisitions?

Terence Yap

We have included under our deposits for acquisitions of subsidiaries is to about $36 million.

Josh Jabs – Roth Capital

$36 million. So, of what's last that – that gives you if – assuming you have sort of a 50-50 breakout stock and cash, I guess, (a) is that sure [ph] and then (b) it looks like that gets you at least half-a-way there?

Terence Yap

Correct.

Josh Jabs – Roth Capital

Okay. And what's your total – how much can you borrow currently under the CCB NAVL [ph]?

Terence Yap

It depends on a project. It's of now, the CCB is really selling off of AR [ph] and the IBM Global Financing is really more of a financing for the equipment for the Safe City project. So there is no set beneath there yet. I said CCB that probably about 2 billion RMB cash at the current point in time, but again, there is no CapEx at this point in time, because it's based on a project by project basis.

Josh Jabs – Roth Capital

That's helpful. On depreciation and amortization, did you give the expectation for Q3?

Terence Yap

Yes. We did.

Josh Jabs – Roth Capital

I think you gave amortization of intangibles. I was just wondering if you have the depreciation there as well.

Terence Yap

No, we didn't break it out. Sorry. We just lumped it together.

Josh Jabs – Roth Capital

Do you know what the number will be?

Terence Yap

Majority would still be amortization of intangible assets. I have not received that number.

Josh Jabs – Roth Capital

Okay. So we can maybe just go back into the bottle and we'll see what it was (inaudible) previously on the depreciation that?

Terence Yap

Yes.

Josh Jabs – Roth Capital

Then last one, I know DSOs are ticking up here a little bit, just given the ways that the Safe City projects are working. Do you have any idea as we get into the back half of the year of where that DSO number could go?

Terence Yap

I have not given any guidance on that yet. I think we have reduced DSO by few days, but this is certainly one of the key performance index for my division. That's why we have brought the China Construction Bank and also IBM Global financing. And we are definitely looking towards reducing this number. Once again, I need to – I can't give that because of the Safe City projects that maybe possibly (inaudible) – it may go up a little bit but we are doing our very best to try to reduce that as much as possible. So, I have not given any guidance in terms of what the full year is going to be at this point in time.

Terence Yap

Alright. Great. Thank you.

Josh Jabs – Roth Capital

Thank you, Josh.

Operator

Next question will come from Steve Brown with (inaudible) Advisors.

Steve Brown

Terence, good morning.

Terence Yap

Hey.

Steve Brown

Last earnings call, you'd said that you expected Chinese market to grow 35 to 45% at a minimum, I believe since then you announced several awards, transactions or framework agreements, did you expect that growth rate to increase? And how much market share are you expecting to gain so going into next year and 2010?

Terence Yap

We hope to continue increase and there is no official number in China. But we have given the traction here, gain in terms of the Safe City project. And given that we have seen less and less comparative in the lot of Safe City project. We feel confident in moving to 2009 as becoming the preferred solution provider. Then on the market share front, we are getting more and more Safe City projects. But in terms of actual percentage of a total market I do not have the exact picture at this point, but all I can say is probably we are less than 10% at this point in time.

Steve Brown

Right. So there is lot of room to gain and therefore, the market is growing at a minimum 35 to 45%. It's fair to say that you would be growing in excess of that, correct?

Terence Yap

Yes. We also – yes.

Steve Brown

Great. Thanks.

Terence Yap

Thank you.

Operator

Next question comes from Brian Witner [ph] Oppenheimer & Co.

Brian Witner – Oppenheimer & Co.

Hi, guys. Good quarter. Most of my questions have been answered, but as far as outside China, do you have any way to quantify like market opportunity there? And also how fast are those markets growing? And what type of margins do you see there, lower or higher then in China?

Terence Yap

We have not disclosed this figure. But (inaudible) of course we have our figures (inaudible). There are various reports out there. Some one's indicated that their market in outside China especially in the Middle East maybe growing about $5 to $10 million, et cetera. But, we think that Middle East region especially India, Pakistan – while you probably seeing the recent incidents in India, and also Turkey. These areas are kind of hot spots right now. We think that the government also concern about the safety of the people. So that's why we see a continued growth. Also, in Asia as well, we have read that – report that given that Malaysia is also building out a Safe City project, Indonesia, Thailand, Philippines, et cetera. So, we are confident that a market in these areas are growing – at least in the double-digit region, almost similar to what we see in China. In terms of the gross margins I would like to hold that back for now until we release certain in terms of the business traction that we see there.

Brian Witner – Oppenheimer & Co.

Thanks. That's helpful. And as far as the quarter went here, the breakdown as a customer mix between government and corporate?

Terence Yap

Yes. The government increased about 44%. The corporate sector is about 55%. 1% is just non-profit organization.

Brian Witner – Oppenheimer & Co.

Alright. Thanks, guys. Good quarter.

Terence Yap

Thank you.

Operator

Next question comes from Adele Mao with Susquehanna International.

Adele Mao – Susquehanna International

Hi. I have a couple of follow-up questions. First of all, regarding your gross margin trends, we have been a couple quarters just consisting improvement. Now, you have more agreements with international distributors targeting Chinese market. Will gross margin from this distribution business be higher in line or lower than your current corporate average?

Terence Yap

Gross margins from distribution segment are typically lower than the system integration and manufacturing. Because the – contributes to a significant amount of our total revenues we are still confident that the gross margins will be at least 30% moving forward.

Adele Mao – Susquehanna International

I see. Also, given that Chinese local banks have been tightening credits for small busyness in China. I was just wondering if you guys have seen your smaller competitors actually opted in the business because of non-availability of their working capital needs.

Terence Yap

This is also one remain contents quality, smaller competitors. That's why we were the first company to sign MoU with China Construction Bank and we are still the only security company that has such facility with China Construction Bank. Now, once again, China still is highly important being that there are New York Stock exchange and Hang Seng in China provides us with necessary advantages especially in China.

Adele Mao – Susquehanna International

Fair. That's good to hear. Thank you.

Terence Yap

Thank you.

Operator

And we will take another question from David Anderson with Anderson Hoagland.

David Anderson – Anderson Hoagland

Terence, I'm just surprised with the growth rate so strong, and your share market under 10%, I'm surprised to hear you say stopping the acquisition activity and consolidating for the rest of 2008. Is there something further behind that, because I think the opportunity to keep growing that way would be tremendous?

Terence Yap

Good question. Our strategy for acquisitions always been very strategic. We are not here to buy the whole security market. If you look at all the acquisitions that we have done so far in the past, each of them have been very strategic. Now, we are buying the top companies in the different vertical, either it's China manufacturing, hi-fi dome cameras, DBR, software, Trucking Management [ph], et cetera. So the strategy we are coming with that we are right now (inaudible) little pearls, stringing up a little pearls to present to our corporate friends and the government. Now, with the above 15,000 different vendors in the whole market, about 80% of them actual revenues of less than $10 million. It's a very young industry. So it's natural we have a highly front end market. It does not make sense for us to buy out in order to grow our revenue. So, our point of view why we have indicated that we are done (inaudible). We have almost got all the necessary pearls within our necklace. And we continue to integrate this company and push our products and services.

David Anderson – Anderson Hoagland

Quick follow-up on that part of the strategy has been the consolidation, the physical geographic consolidation in Shenzhen. Have you – can you give us a little color on how that's proceeding and what kind of other effects you're getting by having everybody in the same building or in the same complex?

Terence Yap

We announced (inaudible) we are acquiring an industrial corp. which is about 800 or 1,000 square feet in Shenzhen Special Industrial Zone. Now, because most of the companies that we acquired are really manufacturers by putting all of them into one single location. We are actually gaining further economies of scale by centralizing purchasing, centralizing some of the manufacturing processes like the manufacturing of the F&T lines, et cetera, for the printer setting [ph] process. So, and in our region, it is also for management stuff. So, by having all the manufacturing into one single location, we can also better manage the manufacturing division. As I mentioned, we are now moving into five different divisions, the first division is the manufacturing, headed by the industrial partner, second division is system integration, third division is the services software, and the fourth is the product distribution. So, our strategy is rightly the manufacturing division, we like to call the manufacturers into one single location to better manage, gain better economies of scale, and also manage – better management for the whole manufacturing process.

David Anderson – Anderson Hoagland

Great. That's good to hear, again. Thanks.

Terence Yap

Thank you.

Operator

(Operator instructions) At this time, there are no further questions. I would like to turn the conference back over to management.

Terence Yap

Thank you very much to all of you attending this call. Thank you for your time. I look forward to your continued support in helping us grow the company to next phase of business. Thank you.

Operator

That does conclude today's conference. We do thank you for your participation.

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