China Security & Surveillance Technology, Inc.: Form 10-Q - Prepared by TNT Filings Inc.


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10−Q

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: June 30, 2008

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________ to _____________

 

Commission File Number: 000-25901


CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC.

(Exact name of small business issuer as specified in its charter)

 

Delaware

98-0509431

(State or other jurisdiction of

(I.R.S. Empl. Ident. No.)

incorporation or organization)

 

 

13/F, Shenzhen Special Zone Press Tower, Shennan Road

Futian District, Shenzhen, China 518034

 

(Address of principal executive offices, Zip Code)

 

(86) 755-8351-0888

(Registrant’s telephone number, including area code)

 

_____________________________________________________

(Former name, former address and former fiscal year, if changed since last report)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x                      No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer o

Accelerated Filer

x
Non-Accelerated Filer  (Do not check if a smaller reporting company) o

Smaller reporting company

o

 

The number of shares outstanding of each of the issuer’s classes of common equity, as of August 1, 2008 is as follows:

 

Class of Securities

 

Shares Outstanding

Common Stock, $0.0001 par value

 

45,122,541

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o                      No x

 

 


 

TABLE OF CONTENTS

 

 

PART I

Page

 

 

 

 

 

 

Item 1.

Financial Statements

3

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

29

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

46

Item 4T.

Controls and Procedures

47

 

 

 

 

 

 

 

PART II

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

48

Item 1A.

Risk Factors

48

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

48

Item 3.

Defaults Upon Senior Securities

48

Item 4.

Submission of Matters to a Vote of Securities Holders

48

Item 5.

Other Information

49

Item 6.

Exhibits

49

 

 

 

 


 

 PART I

FINANCIAL INFORMATION

 

 ITEM 1. FINANCIAL STATEMENTS.

 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

 

 

June 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

 

 

USD

 

USD

 

ASSETS

 

CURRENT ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

88,595

 

$

89,071

 

Accounts receivable, net

 

 

95,950

 

 

63,206

 

Related party receivables

 

 

214

 

 

549

 

Inventories, net

 

 

40,616

 

 

40,606

 

Prepayments and deposits

 

 

4,979

 

 

3,225

 

Advances to suppliers

 

 

8,699

 

 

2,877

 

Other receivables

 

 

12,090

 

 

13,171

 

Tax refundable

   

--

   

92

 

Deferred tax assets - current portion

 

 

128

 

 

137

 

Total current assets

 

 

251,271

 

 

212,934

 

 

 

 

 

 

 

 

 

Deposits for acquisition of subsidiaries, intangible assets and properties

 

 

36,395

 

 

46,443

 

Property, plant and equipment, net

 

 

34,436

 

 

24,066

 

Land use rights, net

 

 

2,611

 

 

1,379

 

Intangible assets

 

 

54,229

 

 

39,800

 

Goodwill

 

 

82,349

 

 

52,369

 

Deferred financing cost

 

 

132

 

 

150

 

Deferred tax assets - non-current portion

 

 

257

 

 

262

 

TOTAL ASSETS

 

$

461,680

 

$

377,403

 

 

 

 

 

 

 

 

 

 

See the accompanying notes to condensed consolidated financial statements

 

3

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)


 

 

June 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

 

 

USD

 

USD

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

CURRENT LIABILITIES

 

 

 

 

 

 

 

Notes payable - short term

 

$

5,380

 

$

12,814

 

Accounts payable

 

 

32,916

 

 

21,864

 

Accrued expenses

 

 

  6,614

 

 

5,108

 

Advances from customers

 

 

8,013

 

 

8,352

 

Taxes payable

 

 

2,381

 

 

4,153

 

Payable for acquisition of business

 

 

6,604

 

 

--

 

Deferred income

 

 

1,065

 

 

915

 

Total current liabilities

 

 

62,973

 

 

53,206

 

 

 

 

 

 

 

 

 

LONG-TERM LIABILITIES

 

 

 

 

 

 

 

Notes payable - long term

 

 

--

 

 

698

 

Convertible notes payable

 

 

132,427

 

 

123,701

 

Total liabilities

 

 

195,400

 

 

177,605

 

 

 

 

 

 

 

 

 

MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES

 

 

34

 

 

61

 

 

 

 

 

 

 

 

 

SHAREHOLDERS' EQUITY

 

 

 

 

 

 

 

Preferred stock, $0.0001 par value; 10,000,000 shares authorized, 0 shares issued and outstanding

Common stock, $0.0001 par value; 290,000,000 shares authorized, 45,122,541 (June 30, 2008) and 42,506,150 (December 31, 2007) shares issued and outstanding

 

 

5

 

 

4

 

Additional paid-in capital

 

 

149,100

 

 

110,254

 

Retained earnings

 

 

89,034

 

 

76,802

 

Statutory reserves

 

 

804

 

 

804

 

Accumulated other comprehensive income

 

 

27,303

 

 

11,873

 

Total shareholders' equity

 

 

266,246

 

 

199,737

 

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY

 

$

461,680

 

$

377,403

 

 

See the accompanying notes to condensed consolidated financial statements

 

4

 


 

 CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

 

 

USD

 

USD

 

USD

 

USD

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

92,740

 

$

52,125

 

$

164,517

 

$

90,576

 

 

 

 

   

 

 

 

 

   

 

 

 

Cost of goods sold

(including depreciation and amortization for the three and six months ended June 30, 2008 and 2007 of $203, $286, $0 and $0, respectively)

 

 

62,284

 

 

37,232

 

 

111,805

 

 

65,565

 

 

 

 

   

 

 

 

 

   

 

 

 

Gross profit

 

 

30,456

 

 

14,893

 

 

52,712

 

 

25,011

 

 

 

 

   

 

 

 

 

   

 

 

 

Selling and marketing

 

 

2,991

 

 

855

 

 

5,133

 

 

1,458

 

 

 

 

   

 

 

 

 

   

 

 

 

General and administrative

 

 

11,084

 

 

3,308

 

 

18,246

 

 

5,559

 

(including non-cash employee compensation for the three and six months ended June 30, 2008 and 2007 of $3,108, $6,066, $801 and $1,066, respectively)

 

 

   

 

 

 

 

   

 

 

 

 

 

 

   

 

 

 

 

   

 

 

 

Depreciation and amortization

 

 

2,130

 

 

1,084

 

 

3,947

 

 

1,890

 

 

 

 

   

 

 

 

 

   

 

 

 

Income from operations

 

 

14,251

 

 

9,646

 

 

25,386

 

 

16,104

 

 

 

 

   

 

 

 

 

   

 

 

 

Rental income received from related party

 

 

--

 

 

129

 

 

--

 

 

256

 

 

 

 

   

 

 

 

 

   

 

 

 

Interest income

 

 

51

 

 

143

 

 

106

 

 

225

 

 

 

 

   

 

 

 

 

   

 

 

 

Interest expense

 

 

(4,786

)

 

(4,105

)

 

(9,649)

 

 

(5,424

)

 

 

 

   

 

 

 

 

   

 

 

 

Other income, net

 

 

367

 

 

226

 

 

687

 

 

718

 

 

 

 

   

 

 

 

 

   

 

 

 

Income before income taxes and minority interest

 

 

9,883

 

 

6,039

 

 

16,530

 

 

11,879

 

 

 

 

   

 

 

 

 

   

 

 

 

Minority interest in income of consolidated subsidiaries

 

 

6

 

 

(7

)

 

31

 

 

2

 

 

 

 

   

 

 

 

 

   

 

 

 

Income taxes

 

 

(2,153

)

 

(1,767

)

 

(4,329)

 

 

(3,083

)

 

 

 

   

 

 

 

 

   

 

 

 

Net income

 

 

7,736

 

 

4,265

 

 

12,232

 

 

8,798

 

 

 

 

   

 

 

 

 

   

 

 

 

Foreign currency translation gain

 

 

6,926

 

 

1,767

 

 

15,430

 

 

2,562

 

 

 

 

   

 

 

 

 

   

 

 

 

Comprehensive income

 

$

14,662

 

$

6,032

 

$

27,662

 

$

11,360

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.18

 

$

0.12

 

$

0.28

 

$

0.26

 

Diluted

 

$

0.17

 

$

0.11

 

$

0.28

 

$

0.24

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

43,600,020

 

 

35,770,742

 

 

43,169,108

 

 

34,429,780

 

Diluted

 

 

44,927,620

 

 

38,831,023

 

 

43,853,283

 

 

36,492,123

 

See the accompanying notes to condensed consolidated financial statements

 

5

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY

SIX MONTHS ENDED JUNE 30, 2008 (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts) 

 

 

 

Common Stock

 


Additional

Paid-in

Capital

 

 

 

Accumulated Other 

 

Statutory
Surplus

 

 

 

 

 

Shares

 

Par

Value

 

 

Retained

Earnings

 

Comprehensive Income

 

Reserve

Fund

 

Total

 

 

 

 

 

USD

 

USD

 

USD

 

USD

 

USD

 

USD

 

BALANCE AT JANUARY 1, 2008

 

 

42,506,150

 

$

4

 

$

110,254

 

$

76,802

 

$

11,873

 

$

804

 

$

199,737

 

Warrants exercised for cash per Securities Purchase Agreement

 

 

57,776

   

--

   

277

   

--

   

--

   

--

   

277

 

Common stock issued under Equity Incentive Plan

 

 

499,001

   

--

   

6,066

   

--

   

--

   

--

   

6,066

 

Forfeiture of restricted stock under Equity Incentive Plan

   

(27,845

)

 

--

   

--

   

--

   

--

   

--

   

--

 

Common stock issued in connection with Exclusive Cooperation Agreement  with Beijing DM Security & Technology Co., Ltd.

 

 

136,378

   

--

   

2,041

   

--

   

--

   

--

   

2,041

 

Common stock issued for acquisition of  Guangdong Stonesonic Digital Technique Co., Ltd.

 

 

953,918

   

1

   

14,489

   

--

   

--

   

--

   

14,490

 

Common stock issued for acquisition of  Shenzhen Longhorn Security Technology Co., Ltd.

   

790,502

   

--

   

12,030

   

--

   

--

   

--

   

12,030

 

Common stock issued for acquisition of Beijing Aurine Divine Land Technology Co., Ltd.

   

206,661

   

--

   

3,943

   

--

   

--

   

--

   

3,943

 

Foreign currency translation

 

 

--

   

--

   

--

   

--

   

15,430

   

--

   

15,430

 

 

 

 

                                     

 

Net income for the period

 

 

--

   

--

   

--

   

12,232

   

--

   

--

   

12,232

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE AT JUNE 30, 2008

 

 

45,122,541

 

$

5

 

$

149,100

 

$

89,034

 

$

27,303

 

$

804

 

$

266,246

 


See the accompanying notes to condensed consolidated financial statements


6


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

 

 

Six Months Ended June 30,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

USD

 

USD

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

12,232

 

$

8,798

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

   

 

 

 

Depreciation and amortization

 

 

4,233

 

 

1,890

 

Provision for bad debts

   

125

   

--

 

Amortization of consultancy services

 

 

67

 

 

60

 

Amortization of deferred financing cost

 

 

18

 

 

9

 

Non-cash employee compensation

 

 

6,066

 

 

1,066

 

Redemption accretion on convertible notes

 

 

8,726

 

 

4,975

 

Deferred taxes

 

 

40

 

 

8

 

Minority interest

 

 

(31

)

 

(2

)

 

 

 

   

 

 

 

Changes in operating assets and liabilities:

 

 

   

 

 

 

(Increase) decrease in:

 

 

   

 

 

 

Accounts receivable

 

 

(25,839

)

 

(4,217

)

Related party receivables

 

 

371

 

 

(109

)

Inventories

 

 

11,692

 

 

(7,602

)

Prepayments & deposits

 

 

(24

)

 

(2,549

)

Advances to suppliers

 

 

(4,826

)

 

(1,176

)

Other receivables

 

 

(1,207

)

 

(658

)

 

 

 

   

 

 

 

(Decrease) increase in:

 

 

   

 

 

 

Accounts payable and accrued expenses

 

 

4,232

 

 

(838

)

Advances from customers

 

 

(3,007

)

 

(4,310

)

Taxes payable

 

 

(1,896

)

 

856

 

Deferred income

 

 

91

 

 

16

 

Net cash provided by (used in) operating activities

 

 

11,063

 

 

(3,783

)

 

 

 

 

 

 

 

 

Continued

 

7

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

 

 

Six Months Ended June 30,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

USD

 

USD

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Additions to property, plant and equipment

 

 

(5,344

)

 

(1,528

)

Additions to intangible assets

 

 

(1,087

)

 

(15

)

Additions to land use rights

 

 

--

 

 

(565

)

Deposits paid for acquisition of subsidiaries

 

 

(3,878

)

 

(14,657

)

Deposits refunded for acquisition of subsidiaries

 

 

11,898

 

 

--

 

Deposits paid for acquisition of properties and intangible assets

   

(4,424

)

 

(5,366

)

Proceeds from disposal of land use rights and properties

   

3,379

   

--

 

Net cash outflow for acquisition of subsidiaries

(net of cash acquired in acquisitions)

 

 

(8,927

)

 

(30,275

)

Net cash used in investing activities

 

 

(8,383

)

 

(52,406

)

 

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

   

 

 

 

Due to a director

 

 

--

 

 

(74

)

Issuance of common stock, net of issuing expenses

 

 

--

 

 

2,318

 

Warrants exercised

   

277

   

--

 

New borrowings, net of issuing cost

 

 

4,274

 

 

116,291

 

Repayment of borrowings

 

 

(13,855

)

 

(2,055

)

Net cash (used in) provided by financing activities

 

 

(9,304

)

 

116,480

 

 

 

 

   

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

 

 

6,148

 

 

513

 

 

 

 

   

 

 

 

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

 

 

(476

)

 

60,804

 

 

 

 

   

 

 

 

Cash and cash equivalents, beginning of period

 

 

89,071

 

 

30,980

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

88,595

 

$

91,784

 

 

Continued

 

8

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)  

 

SUPPLEMENTARY CASH FLOW INFORMATION:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest paid

 

$

899

 

$

210

 

Income taxes paid

 

$

2,364

 

$

2,696

 

 

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

136,378 shares of common stock were issued in satisfaction of the equity portion of the purchase price of approximately $2,041 in the establishment of the exclusive cooperation agreement with Beijing DM Security & Technology Co., Ltd. ("DM") on January 18, 2008. (Note 11)

953,918 shares of common stock issuable in satisfaction of the equity portion of the purchase price of approximately $14,490 in the acquisition of Guangdong Stonesonic Digital Technique Co., Ltd. ("Stonesonic") were issued on June 4, 2008. (Note 3)

790,502 shares of common stock issuable in satisfaction of the equity portion of the purchase price of approximately $12,030 in the acquisition of Shenzhen Longhorn Security Technology Co., Ltd. ("Longhorn"), were issued on June 4, 2008. (Note 3)

206,661 shares of common stock issuable in satisfaction of the equity portion of the purchase price of approximately $3,943 in the acquisition of Beijing Aurine Divine Land Technology Co., Ltd.. ("Guanling"), were issued on June 4, 2008. (Note 3)


See the accompanying notes to condensed consolidated financial statements

9

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

1.

BASIS OF PRESENTATION

The accompanying financial statements, as of June 30, 2008 and for the three and six months ended June 30, 2008 and 2007, have been prepared by CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. (the "Company" or "CSST") without audit. Pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"), certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP") have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's audited annual financial statements for the year ended December 31, 2007, which are included in the Company's Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on March 10, 2008. Amounts as of December 31, 2007 are derived from these audited consolidated financial statements.

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the Company’s financial position as of June 30, 2008, results of operations for the three months and six months ended June 30, 2008 and 2007, and cash flows for the six months ended June 30, 2008 and 2007, have been made. The results of operations for the three months and six months ended June 30, 2008 are not necessarily indicative of the operating results for the full year.

2.

SUMMARY OF SELECTED SIGNIFICANT ACCOUNTING POLICIES

(a)

Accounts Receivable

Trade receivables are recognized and carried at the original invoice amount less allowance for any uncollectible amounts. An estimate for doubtful accounts is made when collection of the full amount is no longer probable. Bad debts are written off as incurred.

No trade receivables due from one individual customer exceeded 10% of total accounts receivable at June 30, 2008 and December 31, 2007.

(b)

Inventories

Inventories are stated at the lower of cost, determined on a weighted average basis, or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated costs necessary to make the sale.

When inventories are sold, their carrying amount is charged to expense in the year in which the revenue is recognized. Write-downs for declines in net realizable value or for losses of inventories are recognized as an expense in the year the impairment or loss occurs. There were no declines in net realizable value of inventory for the three and six months ended June 30, 2008 and 2007.

During the three months and six months ended June 30, 2008 and 2007, approximately 40%, 37%, 99% and 81%, of total inventory purchases were from five suppliers, respectively.

10

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

2.

SUMMARY OF SELECTED SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(c)

Accounting for Computer Software To Be Sold, Leased or Otherwise Marketed

The Company accounts for software development costs in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, " Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed ." Costs related to establishing the technological feasibility of a software product are expensed as incurred as a part of research and development in general and administrative expenses. Costs that are incurred to produce the finished product after technological feasibility is established are capitalized and amortized over the estimated economic life of 5 years. The Company performs periodic reviews to ensure that unamortized program costs remain recoverable from future revenue.

As of June 30, 2008 and December 31, 2007, unamortized computer software costs were $2,921 and $2,383, respectively. During the three and six months ended June 30, 2008 and 2007, $121, $375, $32 and $63 of amortization expense was charged to income, respectively.

(d)

Revenue Recognition

The Company derives the bulk of its revenue from the supply and installation of security and surveillance equipment and the two deliverables do not meet the separation criteria under Emerging Issues Task Force ("EITF") issue 00-21. 99% of the installation contract amount is recognized as revenue when installation is completed. 1% of the contract amount is deferred and amortized to income over the one-year warranty period.

Revenue from sales of security and surveillance video cameras, surveillance equipment and related products are recognized in accordance with Staff Accounting Bulletin ("SAB") No. 104: "Revenue Recognition" ("SAB No. 104"). Revenues are recognized when the following criterias are met:

(i)

Persuasive evidence of an arrangement exists – The Company requires evidence of an agreement with a customer specifying the terms and conditions of the products to be delivered typically in the form of a signed contract or purchase order;

(ii)

Delivery has occurred – For product sales, delivery generally takes place when titles to the products are shipped to or accepted by the customer;

(iii)

The fee is fixed or determinable – Fees are fixed or determinable based on the contract or purchase order terms; and

(iv)

Collection is probable – The Company performs a credit review of all customers with significant transactions to determine whether a customer is creditworthy and collection is probable.

Repairs and maintenance service revenue is recognized when the service is performed.

The sales contracts generally provide a one to three-year product warranty to customers from the date of purchase. We estimate the costs of satisfying warranty claims based on an analysis of past experience and provide for the future claims in the period the revenue is recognized. As of June 30, 2008 and December 31, 2007, no material product warranty reserve was accrued. Warranty costs incurred by the Company have not been material.

The Company derives a portion of its revenue from one-year software upgrades. These services are typical post-contract service ("PCS") arrangements according to AICPA Statement of Position ("SOP") 97-2. Under SOP 97-2, PCS revenue may be recognized together with the initial licensing fee on delivery of the software if all of the following conditions are met:

11

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

2.

SUMMARY OF SELECTED SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(d)

Revenue Recognition - continued

(i)

The PCS fee is included with the initial licensing fee;

(ii)

The PCS included with the initial license is for one year or less;

(iii)

The estimated cost of providing PCS during the arrangement is insignificant; and

(iv)

Unspecified upgrades/enhancements offered during PCS arrangements historically have been and are expected to continue to be minimal and infrequent.

Revenue from security and surveillance system one year software upgrades is recognized when delivery occurs and the risk of ownership passes to the customers, as the Company believes it meets the conditions in compliance with SOP 97-2.

(e)

Research and Development Costs

Research and development costs are expensed as incurred. Research and development costs included in general and administrative expenses for the three and six months ended June 30, 2008 and 2007 were $287, $346, $87 and $108, respectively.

(f)

Advertising Costs

The Company expenses advertising costs as incurred or the first time advertising takes place. During the three and six months ended June 30, 2008 and 2007, the Company incurred approximately $222, $277, $103 and $203, respectively.

(g)

Retirement Benefits

Retirement benefits in the form of contributions under defined contribution retirement plans to the relevant authorities are charged to the consolidated statements of income as incurred. The retirement benefit expenses (included in selling and marketing and general and administrative expenses) for the three and six months ended June 30, 2008 and 2007 were $248, $466, $73 and $127, respectively.

(h)

Share-based Payments

On February 7, 2007, the Company adopted the 2007 Equity Incentive Plan ("Plan"), which has a five-year term and provides for grants of stock options, stock appreciation rights, performance units, restricted stock units and performance shares. The total number of shares which may be issued under the plan is 8,000,000 shares of common stock. These restricted stocks are share-based payments subject to the provisions of revised Statement of Financial Accounting Standards ("SFAS") No.123, "Share-Based Payment" ("SFAS 123 (R)"). The fair values of these restricted stock awards are equal to the market value of the Company's stock on the date of grant, after taking into account certain discounts. Such restricted stock is subject to the risk of forfeiture upon the occurrence of certain events. During the three and six months ended June 30, 2008 and 2007, the Company has recognized $3,108, $6,066, $801 and $1,066 of compensation expense under the Plan, respectively. As of June 30, 2008 and December 31, 2007, there was $41,177 and $39,539 of unrecognized compensation expense related to the nonvested restricted stock, respectively. These expenses are expected to be recognized over a four-year period.

12

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

2.

SUMMARY OF SELECTED SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(i)

Income taxes

The Company adopted the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN 48"), on January 1, 2007. The Company did not have any material unrecognized tax benefits and there was no effect on its financial condition or results of operations as a result of implementing FIN 48.

On March 16, 2007, the National People's Congress of the People’s Republic of China ("PRC") adopted a new corporate income tax law in its fifth plenary session. The new corporate income tax law unifies the application scope, tax rate, tax deduction and preferential policy for both domestic and foreign-invested enterprises. The new corporate income tax law became effective on January 1, 2008.

(j)

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates.

(k)

Earnings Per Share

SFAS No. 128, "Earnings Per Share," requires dual presentation of basic and diluted earnings per share ("EPS") with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.

Earnings per basic share of common stock is based on the weighted average number of shares of common stock outstanding during each respective period. Earnings per diluted share of common stock adds to basic weighted shares the weighted average number of shares issuable under convertible securities, contingent issuances, stock options and warrants outstanding during each respective period, using the if-converted or treasury-stock methods.

The calculation of diluted earnings per share is based on the outstanding warrants for the three and six months ended June 30, 2008 and 2007. As of June 30, 2008 and 2007, warrants were outstanding to acquire 30,006 and 610,015 shares of common stock.

Approximately 5,452,000 shares of common stock underlying convertible notes were not included in the dilutive calculation for the three and six months ended June 30, 2008 and 2007, as the effect would be anti-dilutive.

The Company issued 1,951,081 shares of common stock in connection with business acquisitions in the three months ended June 30, 2008 (note 3). The impact of these shares has been included in dilutive weighted average number of shares from the date of the closing of the acquisitions.

13

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

3.

BUSINESS ACQUISITIONS

In the second quarter of 2008, the Company acquired three companies that are engaged in the security and surveillance business in China: Stonesonic, Longhorn and Guanling.

On April 2, 2008, the Company entered into an equity transfer agreement with the shareholder of Kit Grant Limited under which the Company agreed to pay a total consideration of RMB227,038 (approximately $32,299) in exchange for 100% ownership of Kit Grant Limited, the holding company of Stonesonic, consisting of RMB125,000 (approximately $17,809) in cash and 953,918 shares of the Company’s common stock valued at RMB102,038 (approximately $14,490). $11,205 of the cash portion of the purchase price was paid as a deposit in the first quarter of 2008. The balance of the cash portion of the purchase price is expected to be paid in the third quarter 2008. The Company issued 953,918 shares of the Company’s common stock to the shareholder of Kit Grant Limited and her designees in June 2008. Kit Grant Limited is a holding company with no assets other than 100% of the equity interests of Stonesonic. The acquisition was financed with proceeds from the Company's February Notes and April Notes (as defined in note 14).

The operational control of Stonesonic passed to the Company effective April 2, 2008. The results of Stonesonic’s operations from April 2, 2008 through June 30, 2008 are included in the Company's Consolidated Statements of Income and Comprehensive Income.

On April 2, 2008, the Company entered into an equity transfer agreement with the shareholder of Sincere On Limited, the holding company of Longhorn, under which the Company agreed to pay a total consideration of RMB120,558 (approximately $17,151) in exchange for 100% ownership of Sincere On Limited, consisting of RMB36,000 (approximately $5,121) in cash and 790,502 shares of the Company’s common stock valued at RMB84,558 (approximately $12,030). RMB36,000 (approximately $5,121) of the cash portion of the purchase price was paid before the execution of the equity transfer agreement. The Company issued 790,502 shares of the Company’s common stock to the shareholder of Sincere On Limited and her designees in June 2008. Sincere On Limited is a holding company with no assets other than 100% of the equity interests of Longhorn. The acquisition was financed with proceeds from the Company’s February Notes and April Notes (as defined in note 14).

The operational control of Longhorn passed to the Company effective April 2, 2008. The results of Longhorn's operations from April 2, 2008 through June 30, 2008 are included in the Company's Consolidated Statements of Income and Comprehensive Income.

On April 21, 2008, the Company entered into an equity transfer agreement with the shareholder of Sharp Eagle (HK) Limited, the holding company of Guanling, under which the Company agreed to pay a total consideration of RMB39,110 (approximately $5,587) in exchange for 100% ownership of Sharp Eagle (HK) Limited, consisting of RMB12,500 (approximately $1,644) in cash and 206,661 shares of the Company’s common stock valued at RMB26,610 (approximately $3,943). RMB12,500 (approximately $1,644) of the purchase price was paid as a deposit in January, 2008. The Company issued 206,661 shares of its common stock to the shareholder of Sharp Eagle (HK) Limited and her designees in June 2008. Sharp Eagle (HK) Limited is a holding company with no assets other than 100% of the equity interests of Guanling. The acquisition was financed with proceeds from the Company's February Notes and April Notes. (as defined in note 14).

The operational control of Guanling passed to the Company effective April 21, 2008. The results of Guanling’s operations from April 21, 2008 through June 30, 2008 are included in the Company's Consolidated Statements of Income and Comprehensive Income.

14

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

3.

BUSINESS ACQUISITIONS (CONTINUED)

The following represents the purchase price allocation at the dates of the acquisition of Stonesonic, Longhorn and Guanling based on a preliminary valuation report that is subject to finalization which was prepared by a third party appraisal firm:

 

 

Stonesonic

 

 Longhorn

 

 Guanling

 

 Total

 

                           

Cash and cash equivalents

 

$

1,623

 

$

1,660

 

$

638

 

$

3,921

 

Other current assets

 

 

6,837

 

 

2,545

 

 

3,652

 

 

13,034

 

Property, plant and equipment

 

 

3,533

 

 

978

 

 

79

 

 

4,590

 

Other assets

 

 

1,132

 

 

--

 

 

--

 

 

1,132

 

Intangible assets

 

 

5,947

 

 

4,990

 

 

690

 

 

11,627

 

Goodwill

 

 

17,440

 

 

8,415

 

 

4,123

 

 

29,978

 

Current liabilities

 

 

(3,522

)

 

(1,437

)

 

(3,595

)

 

(8,554

)

Long-term liabilities

 

 

(691

)

 

--

 

 

--

 

 

(691

)

 Total purchase price

 

$

32,299

 

$

17,151

 

$

5,587

 

$

55,037

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The following table shows supplemental information of the results of operations on a pro forma basis for the three months and six months ended June 30, 2008 and 2007 as if the acquisition of Stonesonic, Longhorn and Guanling had been completed at the beginning of the respective periods of 2008 and 2007:

 

For the three months ended June 30, 2008 (Unaudited)

 

 

 

Historical

 

 

 

  

 

 

 

CSST

 

Stonesonic, Longhorn and Guanling

 

Pro Forma Adjustments

 

 Pro Forma

 

 

 

 

 

 

 

 

 

  

 

Revenues

 

$

92,740

 

$

711

 

 

 

 

$

93,451

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

$

14,251

 

$

(39

 )

$

(11

)

$

14,201

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

7,736

 

$

(61

$

(11

)

$

7,664

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.18

 

 

 

 

 

 

 

$

0.17

 

Diluted

 

$

0.17

 

 

 

 

 

 

 

$

0.17

 

 

15

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

3.

BUSINESS ACQUISITIONS (CONTINUED)

For the three months ended June 30, 2007 (Unaudited)

 

 

Historical

 

 

 

 

 

 

 

CSST

 

Stonesonic, Longhorn and Guanling

 

Pro Forma Adjustments

 

  

 Pro Forma

 

 

 

 

 

 

 

 

 

  

 

Revenues

 

$

52,125

 

$

5,280

 

 

 

 

$

57,405

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

$

9,646

 

$

1,263

 

$

(290

)

$

10,619

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

4,265

 

$

1,051

 

$

(290

)

$

5,026

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.12

 

 

 

 

 

 

 

$

0.13

 

Diluted

 

$

0.11

 

 

 

 

 

 

 

$

0.12

 

 

For the six months ended June 30, 2008 (Unaudited)

 

 

Historical

 

 

 

  

 

 

 

CSST

 

Stonesonic, Longhorn and Guanling

 

Pro Forma

 Adjustments

 

 Pro Forma

 

 

 

 

 

 

 

 

 

  

 

Revenues

 

$

164,517

 

$

7,203

 

 

 

 

$

171,720

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

$

25,386

 

$

246

 

$

(301

)

$

25,331

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

12,232

 

$

76

 

$

(301

)

$

12,007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.28

 

 

 

 

 

 

 

$

0.27

 

Diluted

 

$

0.28

 

 

 

 

 

 

 

$

0.27

 

 

For the six months ended June 30, 2007 (Unaudited)

 

 

Historical

 

 

 

 

 

 

 

CSST

 

Stonesonic, Longhorn and Guanling

 

Pro Forma Adjustments

 

   Pro Forma

 

 

 

 

 

 

 

 

 

  

 

Revenues

 

$

90,576

 

$

8,932

 

 

 

 

$

99,508

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

$

16,104

 

$

1,346

 

$

(580

)

$

16,870

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

8,798

 

$

1,081

 

$

(580

)

$

9,299

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.26

 

 

 

 

 

 

 

$

0.26

 

Diluted

 

$

0.24

 

 

 

 

 

 

 

$

0.24

 

 

The pro forma adjustments represent the amortization of the intangible assets arising upon the acquisitions of Stonesonic, Longhorn and Guanling.

 

16

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

4.

ACCOUNTS RECEIVABLE

The Company provides an allowance for doubtful accounts related to its receivables. The receivables and allowance balances at June 30, 2008 and December 31, 2007 are as follows:

 

 

June 30,
 2008

 

December 31,

 2007

 

 

 

 

 

 

 

Accounts receivable

 

$

96,600

 

$

63,494

 

Less: allowance for doubtful accounts

 

 

(650

)

 

(288

)

Accounts receivable, net

 

$

95,950

 

$

63,206

 

 

5.

RELATED PARTY RECEIVABLES

The Company had receivables from several companies whose directors and shareholders are also directors or shareholders of the Company. All receivables arise from the rental of real estate properties. The receivables are classified as related party receivables on the balance sheets. The balances as of June 30, 2008 and December 31, 2007 are as follows:

 

 

June 30,
2008

 

December 31,

 2007

 

 

 

 

 

 

 

Related party receivables

 

$

214

 

$

549

 

Less: allowance for doubtful accounts

 

 

--

 

 

--

 

Related party receivables, net

 

$

214

 

$

549

 

 

The Company had leased offices to three related parties since January 1, 2004. The leases expired on December 31, 2007. The rental income was RMB990 ($127) and RMB1,980 ($256) for the three and six months ended June 30, 2007, respectively.  

6.

INVENTORIES

 

Inventories consist of the following as of June 30, 2008 and December 31, 2007:

 

 

June 30,

2008

 

December 31,

 2007

 

 

 

 

 

 

 

Raw materials

 

$

17,891

 

$

9,386

 

Work in progress

 

 

3,469

 

 

2,182

 

Finished goods

 

 

10,995

 

 

9,761

 

Installations in process

 

 

9,228

 

 

19,830

 

Total

 

 

41,583

 

 

41,159

 

Less: allowance for obsolete inventories

 

 

(967

)

 

(553

)

Inventories, net

 

$

40,616

 

$

40,606

 

 

17

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

7.

PREPAYMENTS AND DEPOSITS

Prepayments and deposits consist of the following as of June 30, 2008 and December 31, 2007:

 

 

June 30,

2008

 

December 31,  
2007

 

 

 

 

 

 

 

Current portion

 

$

4,979

 

$

3,225

 

Non current portion

- Deposits paid for acquisition of subsidiaries

 

 

16,197

 

 

22,545

 

- Deposits paid for acquisition of intangible assets and properties

 

 

20,198

 

 

23,898

 

 

 

$

36,395

 

$

46,443

 

 

The deposits paid for acquisition of subsidiaries and properties are refundable. There are no commitments to acquire the subsidiaries and properties.

8.

ADVANCE PAYMENTS

The Company has made payments to unrelated suppliers in advance of receiving merchandise. The advance payments are meant to ensure preferential pricing and delivery. The amounts advanced under such arrangements totaled $8,699 and $2,877 as of June 30, 2008 and December 31, 2007, respectively.

9.

PROPERTY, PLANT AND EQUIPMENT

At June 30, 2008 and December 31, 2007, property, plant and equipment, at cost, consist of

 

 

June 30,

2008

 

December 31,

 2007

 

Buildings

 

$

21,013

 

$

17,564

 

Leasehold improvements

 

 

2,650

 

 

1,029

 

Plant and equipment

 

 

4,607

 

 

3,158

 

Electronic equipment

 

 

7,598

 

 

2,444

 

Motor vehicles

 

 

4,418

 

 

3,113

 

 

 

 

40,286

 

 

27,308

 

Less: accumulated depreciation

 

 

(5,850

)

 

(3,242

)

Property, plant and equipment, net

 

$

34,436

 

$

24,066

 


Depreciation expense for the three and six months ended June 30, 2008 and 2007 was $885, $1,520, $228 and $405, respectively.

18

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

10.

LAND USE RIGHTS

Land use rights consist of the following as of June 30, 2008 and December 31, 2007:

 

 

June 30,

2008

 

December 31,

 2007

 

 

 

 

 

 

 

Cost of land use rights

 

$

2,874

 

$

1,428

 

Less: Accumulated amortization

 

 

(263

)

 

(49

)

Land use rights, net

 

$

2,611

 

$

1,379

 

Amortization expense for the three and six months ended June 30, 2008 and 2007 was $15, $21, $12 and $20, respectively.

 

Amortization expense for the next five years and thereafter is as follows:

 

2008 (for the remaining 6 months)

 

$

31

 

2009

 

 

61

 

2010

 

 

61

 

2011

 

 

61

 

2012

 

 

61

 

2013

 

 

61

 

Thereafter

 

 

2,275

 

Total

 

$

2,611

 


The Company disposed of land use rights and properties for total consideration of RMB 119,000 (approximately $16,119) in December 2007. The remaining proceeds of RMB 24,000 (approximately $3,379) were received in January 2008.

11. INTANGIBLE ASSETS

 

 

June 30,
2008

 

December 31,
2007

 

 

 

 

 

 

 

Trademarks (life of 11 to 25 years)

$

14,645

$

12,081

 

Exclusive cooperation agreements (life of 20 years)

 

13,632

 

8,834

 

Customer base (life of 5 to 10 years)

 

8,488

 

7,225

 

Patents (life of 10 years)

 

4,541

 

4,532

 

Technical know-how (life of 9 to 10 years)

 

13,239

 

5,347

 

Non-compete agreements (life of 5 years)

 

1,303

 

1,303

 

Contracts in progress (life of 2 to 9 months)

 

410

 

410

 

Surveillance software (life of 5 years)

 

5,507

 

4,468

 

Surveillance recording system (life of 5 years)

 

500

 

500

 

Less: accumulated amortization

(8,036

(4,900

)

Intangible assets, net

$

54,229

$

39,800

 


On January 18, 2008, the Company entered into an exclusive cooperation agreement with DM, which is engaged in the business of designing, developing and selling security and surveillance products, pursuant to which the parties have agreed, among other things, that the Company’s subsidiary, China Security & Surveillance Technology (PRC) Inc. (“CSST PRC”) will provide various items to DM, including training services, technology licenses, equipment, consulting services, personnel and other related services. DM will subcontract all its work to CSST PRC or its designees to the extent permitted by the local laws and regulations at no less than 80% of the face value of the contract. DM has agreed to add CSST PRC’s name to its marketing materials and its marketing and business development activities will be conducted either in the name of both DM and CSST PRC or through a joint venture established by the parties. The valuation of the agreement was determined by an independent appraisal firm. The Company did not acquire any of the assets or liabilities of DM, and the entire purchase price was allocated to an intangible asset, consisting of an exclusive cooperation relationship. The Company’s total cost for entry into the exclusive cooperation agreement amounted to $4,798, after taking into account certain discounts of the shares issued to DM due to the fact that the issued shares are restricted shares. 136,378 restricted shares were issued in January 2008.

 

19

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

11.

INTANGIBLE ASSETS - CONTINUED

The Company acquired Stonesonic, Longhorn and Guanling during the second quarter of 2008. The valuations and allocation of the intangible assets were determined by a third party appraisal firm.

The amortization expense for the three and six months ended June 30, 2008 and 2007 was $1,433, $2,692, $844 and $1,465, respectively.

Estimated amortization expense for the next five years and thereafter is as follows:

2008 (for the remaining six months)

$

3,234

2009

 

7,266

2010

 

6,363

2011

 

4,796

2012

 

4,027

Thereafter

 

28,543

Total

$

54,229

12.

NOTES PAYABLE

The following is a summary of the Company’s short-term and long-term notes payable as of June 30, 2008 and December 31, 2007:

 

 

June 30,

2008

 

December 31, 2007

 

 

 

 

 

 

 

Bank loans

 

$

5,380

 

$

13,512

 

Less: current portion

 

 

(5,380

)

 

(12,814

)

Long-term portion

 

$

--

 

$

698

 

On November 15, 2007, the Company entered into a loan agreement with China Citic Bank. The Company borrowed RMB30,000 (approximately $4,374) with an annual interest rate of 7.29%. The loan is due in November 2008, and the interest is payable at the end of each month. The loan agreement requires the Company to use the loan proceeds only for the Company's operations. The loan is guaranteed by the CEO of the Company and subsidiaries of the Company.

The long term note payable is from Shenzhen Ping An Bank. As of June 30, 2008 and December 31, 2007, the liability relating to this loan was RMB 6,900 (approximately $1,006) and RMB8,700 (approximately $1,290), respectively, consisting of a 3-year loan payable to Shenzhen Ping An Bank. This loan was entered into on January 17, 2006 and matures on March 3, 2009, with an annual interest rate of 6.435%. The loan agreement requires the Company to use the loan proceeds only for the construction of the Company’s factory. The loan is collateralized by the personal assets of the CEO of one of the Company's subsidiaries.

In January 2008, the Company entered into a loan agreement with Shanghai Pudong Development Bank. The Company borrowed RMB30,000 (approximately $4,374) with an annual interest rate of 6.57%. The loan was due in July 2008, and the interest was payable at the end of each month. The loan was repaid in April 2008.

20

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

12.

NOTES PAYABLE - CONTINUED

On October 15, 2007, the Company entered into a loan agreement with Shanghai Pudong Development Bank. The Company borrowed RMB20,000 (approximately $2,916) with an annual interest rate of 6.561%. The loan was due in October 2008, and the interest was payable at the end of each month. The loan was repaid in the second quarter of 2008.

On February 16, 2007, the Company entered into a loan agreement with Shanghai Pudong Development Bank. The Company borrowed RMB 10,000 (approximately $1,425) with an annual interest rate of 6.39%. The loan was due in March 2008 and was repaid when due.

On February 2, 2007, the Company entered into a loan agreement with Shanghai Pudong Development Bank. The Company borrowed RMB 30,000 (approximately $4,275) with an annual interest rate of 6.12%. The loan was due in February 2008 and was repaid when due.

13.

DEFERRED INCOME

Deferred income balances as of June 30, 2008 and December 31, 2007 were $1,065 and $915, respectively, and represented amounts invoiced but deferred as revenues as an estimated warranty reserve.

14.

CONVERTIBLE NOTES PAYABLE

On February 20, 2007, pursuant to a note purchase agreement and indenture with Citadel Equity Fund Ltd. ("Citadel"), the Company issued to Citadel $60,000 aggregate principal amount of guaranteed senior unsecured convertible notes due 2012 (the "February Notes"). The terms of the February Notes indenture was subsequently amended on each of March 29, 2007 and April 24, 2007. The February Notes financing replaced the existing bridge financing that was closed on February 8, 2007 in which the Company had issued to Citadel $60,000 aggregate principal amount of senior notes. The February Notes bear an interest at 1% per annum. The net proceeds from the sales of the February Notes are and will be used for the Company’s working capital and acquisition plans.

Under the February Notes indenture, the February Notes are convertible by the holders thereof at any time on or prior to maturity, into common stock of the Company initially at the conversion price of $18 per share (subject to adjustment in certain circumstances, including semi-annual reset of the conversion price and upon occurrence of certain dilutive events, in each case subject to certain conditions). If the February Notes are not converted before maturity, the February Notes will be redeemed by the Company on the maturity date at a redemption price equal to 100% of the principal amount of the February Notes then outstanding plus an additional amount of 15.0% per annum, calculated on a quarterly compounded basis, plus any accrued and unpaid interest. In addition, if the 45-day variable weighted average price ("VWAP") during the one year period from February 16, 2009 to February 15, 2010 equals or is greater than $30.0 per share of common stock, the Company shall, within one trading day, force holders of the February Notes to convert 50% of the then-outstanding principal amount of the February Notes at the then applicable conversion rate on a pro rata basis (the "February Notes 2010 Mandatory Conversion"). If the 45-day VWAP during the one year period from February 16, 2010 to February 15, 2011 equals or is greater than $35.0 per share of common stock (the "February Notes 2011 Mandatory Conversion Trigger") and the February Notes 2010 Mandatory Conversion had occurred, the Company shall, within one trading day, force holders of the February Notes to convert all of the then-outstanding principal amount of the February Notes at the then applicable conversion price. If the February Notes 2011 Mandatory Conversion Trigger occurs and the February Notes 2010 Mandatory Conversion had not occurred, the Company shall, within one trading day, force holders of the February Notes to convert 50% of the then-outstanding principal amount of the February Notes at the then applicable conversion rate on a pro rata basis.

21

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

14.

CONVERTIBLE NOTES PAYABLE - CONTINUED

On April 24, 2007, pursuant to another note purchase agreement with Citadel, the Company issued to Citadel $50,000 aggregate principal amount of guaranteed senior unsecured convertible notes due 2012 (the "April Notes"). The April Notes bear an interest at 1% per annum. All the net proceeds from the sales of the April Notes are and will be used for the Company's working capital and acquisition plan.

Under the April Notes indenture, the April Notes are convertible, by the holders thereof, at any time on or prior to maturity, into common stock of the Company initially at the conversion price of $23.60 per share (subject to adjustment in certain circumstances, including semi-annual reset of the conversion price and upon occurrence of certain dilutive events, in each case subject to certain conditions). If the April Notes are not converted before maturity, the April Notes will be redeemed by the Company on the maturity date at a redemption price equal to 100% of the principal amount of the April Notes then outstanding plus an additional amount of 15.0% per annum, calculated on a quarterly compounded basis, plus any accrued and unpaid interest. In addition, if the 45-day VWAP during the one year period from February 16, 2009 to February 15, 2010 equals or is greater than $40.0 per share of common stock, the Company shall, within one trading day, force holders of the April Notes to convert 50% of the then-outstanding principal amount of the April Notes at the then applicable conversion rate on a pro rata basis (the "April Notes 2010 Mandatory Conversion"). If the 45-day VWAP during the one year period from February 16, 2010 to February 15, 2011 equals or is greater than $45.00 per share of common stock (the "April Notes 2011 Mandatory Conversion Trigger") and the April Notes 2010 Mandatory Conversion had occurred, the Company shall, within one trading day, force holders of the April Notes to convert all of the then-outstanding principal amount of the April Notes at the then applicable conversion price. If the April Notes 2011 Mandatory Conversion Trigger occurs and the April Notes 2010 Mandatory Conversion had not occurred, the Company shall, within one trading day, force holders of the April Notes to convert 50% of the then-outstanding principal amount of the April Notes at the then applicable conversion rate on a pro rata basis.

The February Notes and April Notes indentures, the notes purchase agreements and certain investor rights agreements between the Company and Citadel entered into in connection with the February Notes and April Notes financings contain various covenants that may limit the Company's discretion in operating its business. In particular, the Company is limited in its ability to merge, consolidate or transfer substantially all of its assets, issue stock of subsidiaries, incur additional debt and create liens on assets to secure debt. In addition, if there is a default, or if the Company does not maintain certain financial covenants or does not maintain borrowing availability in excess of certain pre-determined levels, the February Notes and the April Notes may be accelerated with the balance becoming due and payable immediately and the Company may be unable to incur additional indebtedness, make restricted payments (including paying cash dividends on capital stock) or redeem or repurchase capital stock. As of June 30, 2008 and December 31, 2007, the Company has complied with all the required covenants.

The Company has accreted $4,363, $8,726, $3,812 and $4,975 for the three and six months ended June 30, 2008 and 2007 respectively of the additional redemption amount related to the February Notes and April Notes, which amount included in interest expense.

Approximately $176 of legal fees and other costs directly associated with the issuance of the February Notes and April Notes is recorded as deferred financing costs in the balance sheet at June 30, 2008 and December 31, 2007. The Company is amortizing these financing costs over the life of the February Notes and April Notes. During the three and six months ended June 30, 2008 and 2007, approximately $9, $18, $9 and $9 was amortized to interest expense, respectively.

15.

ISSUANCE OF COMMON STOCK AND WARRANTS

On July 6, 2006, the Company entered into a definitive securities purchase agreement with certain accredited investors relating to the private placement of units, consisting of one share of the Company’s common stock and a warrant to purchase one-fifth of one share of common stock.

Such securities purchase agreement was amended on each of July 30, 2006 and July 31, 2006 (as amended, the "Securities Purchase Agreement"). Closing thereunder occurred July 31, 2006. The purchase price of each unit was $3.50 and the exercise price for each whole warrant was set at $4.80. The warrants have a term of five years and include a cashless exercise feature which does not apply when there is an effective registration statement covering the shares underlying the warrants. In addition, the Company had granted a put right to all of the investors which would have allowed the investors to require the Company to repurchase all, but not less than all, of the securities issued pursuant to the Securities Purchase Agreement if the Company had failed to obtain the necessary governmental approvals to consummate the acquisition of Shanghai Cheng Feng Digital Technology Co., Ltd. ("Cheng Feng") on or before December 31, 2006. As such governmental approvals were obtained before December 31, 2006, the put right has terminated.

22

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

15.

ISSUANCE OF COMMON STOCK AND WARRANTS - CONTINUED

Pursuant to the Securities Purchase Agreement, the Company sold 4,634,592 units to certain accredited investors at $3.50 per unit for gross proceeds of $16,200.

Net proceeds to the Company from the sale of all of the units pursuant to the Securities Purchase Agreement were approximately $14,900, 57,776, 128,571 and 482,856 warrants were exercised at $4.80 per share during the three and six months ended June 30, 2008 and 2007, respectively.

In conjunction with execution of the Securities Purchase Agreement, the Company also executed a registration rights agreement under which it was obligated to file registration statements on Form S-4 and Form S-1, or any other available form, to register the shares and the shares underlying the warrants for resale, within 45 days and 55 days after the closing date, respectively. The Company was obligated to use its best efforts to cause the registration statement to be declared effective within 150 days of the closing date, and was liable for payment of penalties to the purchasers in the event the registration statement had not declared effective within the 150-day period. The Company filed the registration statements on Form S-4 and Form S-1 on October 3, 2006 and October 23, 2006 which were declared effective on November 13, 2006 and November 15, 2006, respectively.

The Company also issued warrants to purchase 324,421 shares of its common stock with an exercise price of $4.20 to two private placement agents as commission for their services in connection with the private placement. 97,326, and 324,421 of such warrants were exercised using the cashless exercise feature during the three and six months ended June 30, 2007.

A summary of the status of the Company’s warrants issued in 2006 as described above, and the changes during the three months ended June 30, 2008 and 2007, is presented below:

 

 

2008

 

2007

 

 

 

 

 

Weighted Average Exercise

 

 

 

Weighted Average Exercise

 

 

 

Shares

 

Prices

 

Shares

 

Prices

 

Outstanding at April 1

 

 

30,006

 

$

4.80

 

 

835,912

 

$

4.28

 

Granted

 

 

--

 

 

--

 

 

--

 

 

--

 

Exercised

 

 

--

 

 

--

 

 

(225,897

)

 

(4.34)

 

Outstanding at June 30

 

 

30,006

 

 

4.80

 

 

610,015

 

 

4.23

 

Warrants exercisable at June 30

 

 

30,006

 

$

4.80

 

 

610,015

 

$

4.23

 

 

A summary of the status of the Company’s warrants issued in 2006 as described above, and the changes during the six months ended June 30, 2008 and 2007, is presented below:

 

 

 

2008

 

2007

 

 

 

 

 

Weighted Average Exercise

 

 

 

Weighted Average Exercise

 

 

 

Shares

 

Prices

 

Shares

 

Prices

 

Outstanding at January 1

 

 

87,782

 

$

4.80

 

 

1,417,292

 

$

4.40

 

Granted

 

 

--

 

 

--

 

 

--

 

 

--

 

Exercised

 

 

(57,776

)

 

(4.80

)

 

(807,277

)

 

(4.50

Outstanding at June 30

 

 

30,006

 

 

4.80

 

 

610,015

 

 

4.23

 

Warrants exercisable at June 30

 

 

30,006

 

$

4.80

 

 

610,015

 

$

4.23

 

 

23

 


 

CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

16.

EQUITY INCENTIVE PLAN

On February 7, 2007, the Company adopted the 2007 Equity Incentive Plan, which has a five-year term and provides for grants of stock options, stock appreciation rights, performance units, restricted stock units and performance shares. The total number of shares which may be issued under the plan is 8,000,000 shares of common stock. As of June 30, 2008 and December 31, 2007, the shares issued vest over a four-year period, and at issue resulted in total deferred compensation of $51,401 and $43,698, respectively. The fair values of these restricted stock awards are equal to the fair value of the Company's stock on the date of grant. Such restricted stock is subject to the risk of forfeiture upon the occurrence of certain events. During the three and six months ended June 30, 2008 and 2007, the Company has recognized $3,108, $6,066, $801 and $1,066 of compensation expense under the plan, respectively. As of June 30, and December 31, 2007, there was $41,177 and $39,539 of unrecognized compensation expense related to the nonvested restricted stock, respectively. This cost is expected to be recognized over a four-year period.

The following table summarizes the status of the Company’s nonvested restricted stock awards during the three months ended June 30, 2008 and 2007:

 

Nonvested Restricted Stock and

 

Nonvested Restricted Stock and

 

Stock Unit Awards

 

Stock Unit Awards

 

2008

 

2007

 

 

Weighted

 

 

Weighted

 

 

Average Grant

 

 

Average Grant

Number of Shares

Date Fair Values

Number of Shares

Date Fair Values

 

 

 

 

 

 

 

 

Outstanding at April 1

2,225,216

$

17.27

 

1,030,181

$

10.63

Granted

317,501

 

16.10

 

40,300

 

12.91

Vested

(184,244)

 

(16.84)

 

(65,702)

 

(10.75)

Forfeited

(5,333)

 

(14.09)

 

(28,900)

 

(12.24)

Outstanding at June 30

2,353,140

$

17.15

 

975,879

$

10.67

 

The following table summarizes the status of the Company’s nonvested restricted stock awards during the six months ended June 30, 2008 and 2007:

 

 

Nonvested Restricted Stock and

 

Nonvested Restricted Stock and

 

Stock Unit Awards

 

Stock Unit Awards

 

2008

 

2007

 

 

Weighted

 

 

Weighted

 

 

Average Grant

 

 

Average Grant

Number of Shares

Date Fair Values

Number of Shares

Date Fair Values

 

 

 

 

 

 

 

 

Outstanding at January 1

2,241,471

$

17.39

 

--

$

--

Granted

499,001

 

15.56

 

1,092,400

 

10.71

Vested

(359,487)

 

(16.85)

 

(87,621)

 

(10.66)

Forfeited

(27,845)

 

(12.37)

 

(28,900)

 

(12.24)

Outstanding at June 30

2,353,140

$

17.15

 

975,879

$

10.67

 

24


 

  CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

17.

CONSOLIDATED SEGMENT DATA

Segment information is consistent with how management reviews the businesses, makes investing and resource allocation decisions and assesses operating performance. The Company has set up a new segment for distribution of security and safety products and realigned its management and segment reporting structure effective January 1, 2008. The segment data presented reflects this new segment structure. The Company reports financial and operating information in the following three segments:

(a)

System installation: designs, sells, installs, services and monitors electronics security systems to residential, commercial, industrial and governmental customers (the "Installation Segment");

(b)

Manufacturing of security and safety products: designs, manufactures and sells security and safety products, including intrusion security, access control and video management systems (the "Manufacturing Segment"); and

(c)

Distribution of security and safety products: sells security and safety products, including intrusion security, access control and video management systems (the "Distribution Segment").

The Company also provides general corporate services to its segments and these costs are reported as "Corporate and others."

Selected information in the new segment structure is presented in the following tables for the three and six months ended June 30, 2008 and 2007:

Revenues by segment for the three months ended June 30, 2008 and 2007 are as follows:


Revenues (1)

 

2008

 

2007

 

 

 

 

 

Installation Segment

$

62,151

$

39,362

Manufacturing Segment

 

20,363

 

12,763

Distribution Segment

 

10,226

 

--

 

 

 

 

 

 

$

92,740

$

52,125


Revenues by segment for the six months ended June 30, 2008 and 2007 are as follows:


Revenues (1)

 

2008

 

2007

 

 

 

 

 

Installation Segment

$

121,691

$

73,393

Manufacturing Segment

 

28,491

 

17,183

Distribution Segment

 

14,335

 

--

 

 

 

 

 

 

$

164,517

$

90,576


(1) Revenues by operating segments exclude intercompany transactions.


25


 

  CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

17.

CONSOLIDATED SEGMENT DATA - (CONTINUED)

Income by segment for the three months ended June 30, 2008 and 2007 are as follows:


Income from operations:

 

2008

 

2007

 

 

 

 

 

Installation Segment

$

17,545

$

8,947

 

 

 

 

 

Manufacturing Segment

 

2,165

 

2,124

 

 

 

 

 

Distribution Segment

 

(203)

 

--

 

 

 

 

 

Corporate and others (1)

 

(5,256)

 

(1,425)

 

 

 

 

 

Income from operations

 

14,251

 

9,646

 

 

 

 

 

Corporate other income

 

367

 

355

 

 

 

 

 

Corporate interest income

 

51

 

143

Corporate interest expense

 

(4,786)

 

(4,105)

Income before income taxes and minority interest

 

9,883

 

6,039

Minority interest in loss of consolidated subsidiaries

 

6

 

(7)

Income taxes

 

(2,153)

 

(1,767)

Net income

$

7,736

$

4,265


Income by segment for the six months ended June 30, 2008 and 2007 are as follows:


Income from operations:

 

2008

 

2007

 

 

 

 

 

Installation Segment

$

32,519

$

17,429

 

 

 

 

 

Manufacturing Segment

 

3,252

 

1,965

 

 

 

 

 

Distribution Segment

 

387

 

--

 

 

 

 

 

Corporate and others (1)

 

(10,772)

 

(3,290)

 

 

 

 

 

Income from operations

 

25,386

 

16,104

 

 

 

 

 

Corporate other income

 

687

 

974

 

 

 

 

 

Corporate interest income

 

106

 

225

Corporate interest expense

 

(9,649)

 

(5,424)

Income before income taxes and minority interest

 

16,530

 

11,879

Minority interest in loss of consolidated subsidiaries

 

31

 

2

Income taxes

 

(4,329)

 

(3,083)

Net income

$

12,232

$

8,798


(1) Includes non-cash compensation, professional fees and consultancy fees for the Company.

 

26


 

  CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Expressed in thousands of U.S. dollars

(Except for share and per share amounts)

 

17.

CONSOLIDATED SEGMENT DATA - (CONTINUED)

Non-cash employee compensation by segment for the three months ended June 30, 2008 and 2007 are as follows:


Non cash employee compensation:

 

2008

 

2007

 

 

 

 

 

Installation Segment

$

468

$

380

 

 

 

 

 

Manufacturing Segment

 

620

 

210

 

 

 

 

 

Distribution Segment

 

345

 

--

 

 

 

 

 

Corporate and others

 

1,675

 

211

 

 

 

 

 

 

$

3,108

$

801


Non-cash employee compensation by segment for the six months ended June 30, 2008 and 2007