SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
| x |
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934.
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For
the
fiscal year ended: December 31, 2006
| 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: 000-50917
CHINA
SECURITY & SURVEILLANCE TECHNOLOGY, INC.
(Exact
Name Of Registrant As Specified In Its Charter)
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Delaware
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98-0509431
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(State
or other jurisdiction of incorporation or organization)
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(I.R.S.
Employer Identification Number)
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13/F,
Shenzhen Special Zone Press Tower, Shennan Road,
Futian
District, Shenzhen,
Peoples
Republic of China, 518034
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(86)
755-8351-0888
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(Registrant’s
telephone number, including area code)
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Securities
registered pursuant to Section 12(b) of the Act:
None
Securities
registered pursuant to Section 12(g) of the Act: Common Stock, $.0001
par value
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Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes o No ý
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o No ý
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 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 ý No o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ý
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
(Check one):
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Large
accelerated filer o
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Accelerated
filer o
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Non-accelerated
filer ý
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Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes o No ý
At
June
30, 2006, the last business day of the registrant’s most recently completed
second fiscal quarter, there were 24,524,667 shares of the registrant’s common
stock outstanding, and the aggregate market value of such shares held by
non-affiliates of the registrant (based upon the closing price of such shares
as
reported on the Over-the-Counter Bulletin Board) was approximately $54 million.
Shares of the registrant’s common stock held by the registrant’s executive
officers and directors have been excluded because such persons may be deemed
to
be affiliates of the registrant. This determination of affiliate status is
not
necessarily a conclusive determination for other purposes.
There
were 34,734,127 shares of common stock outstanding as of March 16,
2007.
DOCUMENTS
INCORPORATED BY REFERENCE:
Portions
of the registrant’s Proxy Statement for its Annual Meeting of Shareholders to be
filed with the Commission within 120 days after the close of the registrant’s
fiscal year are incorporated by reference into Part III of this Annual
Report on Form 10-K.
CHINA
SECURITY & SURVEILLANCE TECHNOLOGY, INC.
FORM
10-K
FOR
THE
YEAR ENDED DECEMBER 31, 2006
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INTRODUCTORY
NOTE
Except
as
otherwise indicated by the context, references to “CSST,” “we,” “us,” “our,”
“our Company,” or “the Company” are to China Security & Surveillance
Technology, Inc., a Delaware corporation and its direct and indirect
subsidiaries. Unless the context otherwise requires, all references to (i)
“Safetech” are to China Safetech Holdings Limited, a British Virgin Islands
corporation; (ii) “CSST HK” are to China Security & Surveillance Technology
(HK) Ltd., a Hong Kong corporation; (iii) “CSST China” are to China Security
& Surveillance Technology (PRC) Ltd., a corporation incorporated in the
People’s Republic of China; (iv)“Golden” are to Golden Group Corporation
(Shenzhen) Limited, a corporation incorporated in the People’s Republic of
China; (v) “Cheng Feng” are to Shanghai Cheng Feng Digital Technology Co. Ltd.;
(vi) “BVI” are to British Virgin Islands; (vii) “PRC” and “China” are to
People’s Republic of China; (viii) “U.S. dollar,” “$” and “US$” are to United
States dollars; (ix) “RMB” are to Yuan Renminbi of China; (x) “Securities Act”
are to Securities Act of 1933, as amended; and (xi) “Exchange Act” are to the
Securities Exchange Act of 1934, as amended.
Special
Note Regarding Forward Looking Statements
In
addition to historical information, this report contains forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. We use words such as “believe,” “expect,” “anticipate,”
“project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar
expressions are intended to identify forward-looking statements. Such statements
include, among others, those concerning our expected financial performance,
liquidity and capital resources and strategic and operational plans, as well
as
all assumptions, expectations, predictions, intentions or beliefs about future
events. You are cautioned that any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, as well
as
assumptions, that, if they were to ever materialize or prove incorrect, could
cause the results of the Company to differ materially from those expressed
or
implied by such forward-looking statements. Such risks and uncertainties, among
others, include:
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·
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General
economic and business conditions in China and in the local economies
in
which we regularly conduct business, which can affect demand for
the
Company’s products and services;
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·
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Changes
in laws, rules and regulations governing the business community in
China
in general and the security and surveillance industry in
particular;
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·
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Competition
and competitive factors in the markets in which we
compete;
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·
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Our
ability to attract new customers;
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·
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Our
ability to keep pace with technological developments in the security
and
surveillance industry, and to develop and commercialize new
products;
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·
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Our
ability to employ and retain qualified employees;
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·
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Our
ability to successfully integrate companies that we have acquired
and to
avoid or mitigate potential damages arising from risks associated
with
acquired companies and the legal structures utilized to effectuate
acquisitions of these companies; and
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·
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The
risks identified in Item 1A. “Risk Factors,” included
herein.
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All
statements other than statements of historical fact are statements that could
be
deemed forward-looking statements, including statements regarding new and
existing products, technologies and opportunities; statements regarding market
and industry segment growth and demand and acceptance of new and existing
products; any projections of sales, earnings, revenue, margins or other
financial items; any statements of the plans, strategies and objectives of
management for future operations; any statements regarding future economic
conditions or performance; uncertainties related to conducting business in
China; any statements of belief or intention;
and any statements of assumptions underlying any of the foregoing. The Company
assumes no obligation and does not intend to update these forward-looking
statements, except as required by law.
-1-
Overview
We
are a
holding company that owns two direct subsidiaries, Safetech and CSST China.
Safetech is a holding company that owns both Golden and CSST HK. CSST HK in
turn
owns Cheng Feng. Our primary business operations are conducted through our
indirect subsidiaries Golden and Cheng Feng. Golden’s business is focused on
manufacturing, distributing, installing and maintaining security and
surveillance systems in China. Cheng Feng’s business is focused on the
manufacturing, marketing and sales of security and surveillance related hardware
as well as the development and integration of software. Until our acquisition
of
Safetech in September 2005, our business strategy and ownership changed over
the
years as a result of several acquisitions of our stock that are discussed in
the
section below entitled “Our Background and History.”
The
chart
below demonstrates our corporate structure:
Our
Background and History
We
were
incorporated in the BVI on April 8, 2002 under the name “Apex Wealth Enterprises
Limited” as a corporation under the International Business Companies Ordinance
of 1984. In February 2006, we changed our name to China Security and
Surveillance Technology Inc. In November 2006, we changed our domicile from
the
BVI to Delaware by merging the BVI corporation into a newly incorporated
Delaware corporation China Security & Surveillance Technology, Inc. The main
reasons for the change of domicile were to comply with the covenants of a stock
purchase agreement that we entered into on April 4, 2006 in connection with
a
financing transaction, as well as to take advantage of the benefits of being
a
Delaware corporation, including the enhanced credibility, greater flexibility
in
corporate law and attractiveness for directors and officers.
-2-
Prior
to
our reverse acquisition of Safetech, which was consummated on September 12,
2005
and is discussed in more detail below, we were a development stage enterprise
and had not yet generated any revenues. Prior to the reverse acquisition, we
provided business advisory and management consulting services in greater China,
initially concentrating on the Hong Kong market. The focus of these services
was
on small to medium size enterprises.
From
and
after the reverse acquisition, our business became the business of our indirect,
wholly-owned subsidiary, Golden. Golden is a corporation incorporated in the
PRC
which is engaged in the business of manufacturing, distributing, installing
and
maintaining security and surveillance systems. Golden was organized in the
PRC
in January 1995. In 2006, we acquired Cheng Feng, a corporation incorporated
in
the PRC which is engaged in the business of manufacturing, marketing and sales
of security and surveillance related hardware as well as the development and
integration of software. We are headquartered in Shenzhen, China.
Reverse
Acquisition with Safetech
On
September 12, 2005, we acquired 50,000 shares of the issued and outstanding
capital stock of Safetech, constituting all of the issued and outstanding
capital stock of Safetech. The 50,000 shares of Safetech were acquired from
the
individual shareholders of Safetech in a share exchange transaction in return
for the issuance of 8,138,000 shares of our common stock. As a result of this
transaction, Safetech became our wholly-owned subsidiary, and Golden became
our
indirect wholly-owned subsidiary. Completion of the transaction resulted in
a
change in control of our Company. After the transaction, we were no
longer a shell company. The contracts relating to this transaction have been
filed as exhibits to our current report on Form 6-K that was filed with the
SEC
on July 22, 2005 and is incorporated herein by reference.
For
accounting purposes, this transaction was treated as a reverse acquisition,
with
Safetech as the acquirer and our Company as the acquired party. When we refer
in
this report to business and financial information for periods prior to the
consummation of the reverse acquisition, we are referring to the business and
financial information of Golden and Cheng Feng on a consolidated basis unless
otherwise specified.
Subsequent
Acquisitions
On
October 25, 2005, we entered into an agreement with the equity owners of
Shenzhen Yuan Da Wei Shi Technology Limited, or “Yuan Da,” which was
subsequently amended in April and May 2006. Pursuant to the agreement, as
amended, we acquired all of the assets of Yuan Da for RMB 1,000,000
(approximately $125,000) and 200,000 shares of our common stock. Yuan Da is
a
limited liability company established in Shenzhen, China and was principally
engaged in the sale and development of security and surveillance systems.
In
July
2006, we entered into an agreement with shareholders of Cheng Feng to acquire
100% ownership of Cheng Feng for a consideration of RMB 120 million
(approximately $15 million), consisting of RMB 60 million (approximately $7.5
million) in cash and 1,361,748 shares of our common stock. We received the
relevant Chinese government approval for such acquisition in December 2006.
Cheng Feng is a company that is engaged in the business of manufacturing,
marketing and sales of security and surveillance related
hardware
as well as the development and integration of software.
In
November 2006, we acquired the security and surveillance business of Jian Golden
An Ke Technology Co. Ltd., or “Jian An Ke,” Shenzhen Golden Guangdian Technology
Co. Ltd., or “Shenzhen Guangdian,” Shenyang Golden Digital Technology Co. Ltd.,
or “Shenyang Golden,” and Jiangxi Golden Digital Technology Co. Ltd., or
“Jiangxi Golden,” of which our CEO and director Guoshen Tu owned 80%, 60%, 42%
and 90%, respectively. We refer to these companies in this report as the
Four-Related Companies. Mr. Tu did not receive any consideration for the
acquisition of his interest in the Four-Related Companies. The minority
shareholders of these four companies and their designees received in aggregate
850,000 shares of our common stock. Shenzhen
-3-
Guangdian
is engaged in the business of manufacturing and distributing security and
surveillance products. The other three companies are engaged in the business
of
distributing security and surveillance products.
Industry
Background and Our Principal Market
The
Chinese surveillance and security industry was established at the beginning
of
the 1980s and the surveillance and security products were used primarily by
government agencies, financial institutions, transportation and mega-size
companies. Since then, the industry has experienced significant growth and
is
growing at an annual rate of approximately 40%, according to the China Public
Security Guide published by the Chinese Security and Protection Association,
which also predicts that the industry will grow by over 20% annually in the
near
future and the Chinese market for security and surveillance products and
services will reach approximately $160 billion by 2010.
In
2006,
the Chinese government promulgated Ordinance 458 which requires all
entertainment locations to install surveillance systems. In addition, the
booming Chinese real estate market and the increasing focus on the security
of
the Chinese mining industry provide great opportunities for the surveillance
and
security industry. The Chinese security and surveillance industry is also
expected to benefit from the expected spending of an estimated $6 billion to
$12
billion for security infrastructure by the Chinese government in preparation
for
the 2008 Beijing Olympics, along with the planned investment by the city of
Shanghai for the 2010 World’s Fair.
At
present, video surveillance is estimated to have a market of about RMB 60
billion (approximately $7.5 billion) and accounts for about 40% market share
of
the surveillance and security market. It is expected that the video surveillance
market share will increase to approximately 60% of the whole industry, according
to the China Public Security Guide published by the China Security and
Protection Association.
There
are
many companies in China that engage in the business of manufacturing, selling,
installing and maintaining of security and surveillance products. Due to the
high growth of the industry and the fact that it is still in the early stage
of
development, the Chinese security and surveillance market is highly fragmented
and there is no apparent market leader.
Principal
Products and Services
Through
our subsidiaries Golden and Cheng Feng, we engage in the business of
manufacturing, distributing, installing and maintaining surveillance and
security products, as well as the development and integration of related
software in China. We generate revenues primarily through the installation
of
security and surveillance systems and sales of security and surveillance
products.
Installation
Services
In
2006,
we derived approximately 88% of our revenues from the supply and installation
of
security and surveillance systems for various projects involving railways,
schools, banks, highways, commercial buildings, and public security and
government entities, among others. Generally, our installation projects involve
the following steps:
|
·
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Bidding
|
We
receive most of our installation projects through a bidding process. In a
typical bidding process, our potential client will send us and our competitors
a
request for proposal that outlines the work to be performed and the
specifications of the equipment to be installed. We then prepare and submit
our
bid and the potential client chooses the winning contractor from among all
the
bids submitted. On some projects, we also act as a subcontractor where a third
party has submitted a winning bid.
-4-
| · |
System
Design
|
Upon
winning a project, we provide the final project design for approval. System
design is generally conducted through the joint efforts of our research and
development personnel, sales department, project service department and quality
control department.
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·
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Manufacture
and Purchase of Security and Surveillance
Products
|
The
major
products used in our installation projects include computer accessories,
decoders, video capture cards, recorders and computer cases. We use equipment
manufactured by us in most of the installation projects, but also use products
from other manufacturers. Generally, approximately 60% of the equipment used
in
any given project is equipment we have manufactured.
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·
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Installation
|
We
have a
project service department that performs installations. We use subcontractors
for non-technical, labor intensive work. We usually assign a project group
with
5-10 members who are in charge of the technical components of the project and
manage the progress of each project.
|
·
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System
Software Design and Integration
|
System
software design and integration services are usually conducted by our technical
department. We design software for our customers’ security and surveillance
systems in accordance with our customers’ specifications. We generally test the
software on our own computer system before integrating it into our customers’
computer system. We then assign our technicians to the site of each project
to
assist in the integration of the security and surveillance system with our
customers’ computer system.
|
·
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Testing
|
Upon
integration, our technical department will test and examine the system to ensure
the proper functioning of the installed security and surveillance
system.
Our
Products
In
2006,
we derived approximately 12% of our revenues from sales of our products,
excluding products sold in connection with the installation projects described
above. The recent acquisition of Cheng Feng and the security and surveillance
businesses of Shenzhen Guangdian improved and will continue to enhance our
manufacturing capacity of our products. Cheng Feng’s Security Resources
Integrated Management (“SRIM”) software platform will enhance the functionality
and management control of our key products. SRIM
software platform is essential to and facilitates coordination among systems
such as DVRs, building automation systems, access control systems, intruder
alarm systems and air-conditioning systems.
We
manufacture the key components of the security and surveillance products and
rely on third party electronic assembling companies to assemble the final
products utilizing our technology. The final products are sold under our brand
names. Our main products include standalone digital video recorders, embedded
digital video recorders, mobile digital video recorders, digital cameras and
auxiliary apparatus.
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·
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Standalone
digital video recorders (Standalone
DVR)
|
The
Standalone DVR stores digital images captured via the security cameras. It
also
controls the recording functions of the cameras and manages the storage of
the
data. This product has a pre-installed surveillance software
system developed by us, which enables it to perform access control and recording
functions. It also has an upgradable hard drive which allows clients to
customize the digital storage capacity, network server functions which
allow the clients to access the digital images via Internet, MPEG-4 video
compression which allows a more efficient compression of the images and higher
image quality, and 4-16 signal input channels which allows 4 to 16 cameras
to be
connected to the Standalone DVR. This product has the competitive features
of
small size, low cost and high reliability. The primary markets for this product
are small to medium size businesses, non-profit organizations and home use.
It
is generally used for small sized security and surveillance
needs.
-5-
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·
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Embedded
digital video recorders (Embedded
DVR)
|
Similar
to the Standalone DVR, the Embedded DVR provides recording and compression
functions. It has a pre-installed surveillance software system developed by
us,
upgradable hard drive, network server function, MPEG-4 Video compression and
4-36 signal input channels, and uses the Windows operating system. The main
difference is that the Embedded DVR has expanded capacity to accommodate
recording functions for a greater number of cameras compared to the Standalone
DVR. In addition, it is operated via Microsoft’s Windows Operating
System. The primary markets for these products are large projects and
community security projects.
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·
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Mobile
digital video recorders (Mobile
DVR)
|
Similar
to the Standalone DVR, the Mobile DVR is smaller in size and has a maximum
of 4
ports. The Mobile DVR, which can be installed in a vehicle, enables recording
of
digital video images within the cabin. This product is easily installed,
supports GPS/GPRS and has 1 to 4 signal input channels and MPEG-4 video
compression. The primary markets for this product are the transportation
industry and governmental agencies.
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·
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Digital
Cameras
|
Digital
cameras can be easily installed in most locations on a customer’s site. The
range of cameras that we produce and sell includes high speed dome cameras,
color Charge Coupled Device (“CCD”) cameras, indoor color CCD dome cameras,
color/black and white CCD flying saucer cameras, Infra Red CCD multi-function
cameras, mini digital signal processing cameras, indoor stand alone sphere
CCD
cameras and network high speed sphere CCD cameras.
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·
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Auxiliary
apparatus
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Auxiliary
apparatus includes DVR compression cards, video capture cards, digital light
processing monitors, decoders, alarm notification switches, digital video fiber
optics systems and matrix switch/control systems.
Raw
Materials and Our Principal Suppliers
We
use
manufactured electronic components in our products. The main components of
our
products include camcorders, monitors, frames, decoders, lenses and outdoor
hoods.
Shenzhen
is one of the biggest and most concentrated bases for electronic products in
China. As a result, there are numerous suppliers and vendors of the components
that are needed for our products. Because of the high level of competition
among
the suppliers, the prices of our principal components are relatively stable
and
we are able to purchase these raw materials at reasonable prices. We have
entered into written contracts with several major suppliers and vendors. The
main suppliers to Golden are Shenzhen Ronghen Co. Ltd., Shenzhen Dongxun Shidai
Technology Co. Ltd., Shenzhen Kerui Electronic Co. Ltd., Shenzhen Huichuang
Computer Technology Co. Ltd. and Shenzhen Jingfeiya Electronic Co. Ltd. The
main
suppliers to Cheng Feng are Hangzhou Hengsheng Shiji Co., Ltd., Wuhan Hengyi
Electronics Technology Development Co., Ltd., Shanghai Dongyang Electronics
System Co., Ltd., Jiaenbi Electronics (Shenzhen) Co., Ltd. and Fushan
Yongxinlong Electronics Parts Co., Ltd. We believe we are not dependent on
any
of these suppliers and will be able to replace them, if necessary, without
material difficulties.
-6-
Our
Distribution, Marketing, Customers and Customer Programs
Our
customers are mainly government entities, non-profit organizations and
commercial entities throughout China, such as airports, customs agencies,
hotels, real estate developments, banks, mines, railways, supermarkets, and
entertainment enterprises. Because a large percentage of our revenues derive
from the installation of security and surveillance systems which are generally
non-recurring, we do not rely on one single or a small group of customers.
Not
one single customer accounted for more than 10% of our total revenue in 2006.
We
generally do not generate significant revenues from any existing client after
the installation project is completed unless that client has additional
installation sites for which our services might be required.
We
have
developed a multi-tiered marketing plan, allowing us to effectively market
products and services to our clients. We sell most of our products and services
through our own distribution network. Our distribution network covers all of
China.
We
have
approximately 400 engineers and sales personnel. We divide our market into
9
geographic regions. Each region is managed by a regional manager who is
responsible for technical support and management within the region as well
as
client relations. Golden has 37 branch offices in provincial capital cities
and
Cheng Feng has 22 distribution points throughout China.
In
addition to our own branch offices and employees, we cooperate with independent
sales agents and have established close relationships with these sales agents
in
order to take advantage of their regional resources and provide products and
services that are tailored to the needs of our customers in those regions.
Through
this distribution and marketing network, we believe we can continue to promote
our brand recognition, strengthen the management of our distribution network
and
improve our sales revenue and market share.
We
have
also been marketing and promoting our products through the following
means:
|
·
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participating
in various industrial shows to display our
products;
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·
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advertising
in industrial magazines and periodicals to introduce and promote
our
products;
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·
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publishing
our own magazine which is distributed to our suppliers and sales
agents so
that they can better understand our Company and strengthen their
confidence in us; and
|
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·
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utilizing
the internet to promote our products, such as the public safety network,
Chinese Security Association network and HuiChong
Network.
|
Competition
There
are
many companies in China engaged in the business of manufacturing surveillance
and security products and designing and installing security and surveillance
systems. The surveillance and security industry in China is still nascent and
no
company has monopolized it. In addition, it is difficult in the surveillance
and
security industry for very large companies to reap benefits from their size,
because most of the projects require the product to be specially tailored to
meet customers’ individual requirements.
-7-
In
the
security and surveillance industry, competition is based on price, product
quality, ability to distribute products, and ability to provide after sales
service.
Our
major
competitor in China is Hangzhou Haikang Weishi Digital Technology Co. Ltd.
which
focuses on the development of video and audio decoding technology and the
development and manufacture of digital video compression cards. Its most
successful product is a digital video compression card which we believe has
a
significant market share of such products in China.
Additional
competition comes from international companies, such as General Electric and
Honeywell. Some of our international competitors are larger than we are and
possess greater name recognition, assets, personnel, sales and financial
resources. However, these competitors generally have higher prices for their
products, and most of them do not have distribution networks in China that
are
as developed as ours.
We
believe that the range of our product and service offerings, our brand
recognition by the market, our capital resource, our relatively low labor cost
and our extensive distribution channels enable us to compete favorably in the
market for the security and surveillance products and services that we offer
in
China.
Intellectual
Property
We
have
registered with the Trademark office of the State Administration for Industry
and Commerce of China the following trademarks:
|
|
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Name
|
|
Trademark
No./
Application
No.
|
|
Type
|
|
Expiration
Date
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|
Status
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|
1
|
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Golden
Group
|
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4108508
|
|
Word
(Chinese)
|
|
July
2014
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|
Approved
|
|
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|
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2
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|
DVR
|
|
4108509
|
|
Word
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July
2014
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Approved
|
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3
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|
 |
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4108511
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|
Word
and Logo
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July
2014
|
|
Approved
|
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4
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|
 |
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4108510
|
|
Logo
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July
2014
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|
Approved
|
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5
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|
 威勒 |
|
3814725
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Word
and logo
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December
2013
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Approved
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6
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JDR
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N/A
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Word
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N/A
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Pending
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7
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小保安
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4142706
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Word
and Logo
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September
2016
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Approved
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8
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chenova
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4207147
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Word
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December
2016
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Approved
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9
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4207148
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Logo
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December
2016
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Approved
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10
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ITDVR
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4289504
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Word
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N/A
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Pending
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11
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AUNIQUE
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5205739
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Word
and Logo
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N/A
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Pending
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12
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AVK
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5205738
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Word
and Logo
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N/A
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Pending
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13
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chenovation
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4514946
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Word
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N/A
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Pending
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-8-
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Name
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Trademark
No./
Application
No.
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Type
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Expiration
Date
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Status
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14
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4142705
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Logo
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N/A
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Pending
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15
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ITVS
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4514947
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Word
and Logo
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N/A
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Pending
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16
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奥尼克
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5205737
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Word
and Logo
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N/A
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Pending
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We
have
registered the domain name www.csstf.com.
In
addition, our subsidiaries, Golden and Cheng Feng, have registered the domain
names www.goldengroup.cn
and
www.cf1688.com,
respectively.
We
hold
no patents under our own name. We protect our trade secrets through
confidentiality provisions of the employment contracts we enter into with our
employees. In addition, our engineers are generally divided into different
project groups, each of which generally handles only a portion of the project.
As a result, no one engineer generally has access to the entire design process
and documentation for a particular product.
Employees
We
have
approximately 580 full-time employees. Approximately 100 of them are
administrative and accounting staff, approximately 80 of them are research
and
development staff and approximately 400 of them are engineers and sales
staff.
Approximately
162 employees are located in Shenzhen, and the rest of the employees are located
in various branches throughout China.
Approximately
80% of our employees have bachelor degrees, and most of those majored in
computer sciences.
Our
employees are members in trade unions which protect employees’ rights, aim to
assist in the fulfillment of our economic objectives, encourage employee
participation in management decisions and assist in mediating disputes between
us and union members. We believe that we maintain
a satisfactory working relationship with our employees and we have not
experienced any significant labor disputes or any difficulty in recruiting
staff
for our operations.
As
required by applicable Chinese law, we have entered into employment
contracts with all of our officers, managers and employees. Our
employees in China participate in a state pension plan organized by Chinese
municipal and provincial governments. We are required to contribute
monthly to the plan at the rate of 23% of the average monthly
salary. As of the date of this report, we have complied with the
regulation and have paid the state pension plan as required by law.
In
addition, we are required by Chinese law to cover employees in China with
various types of social insurance. We have purchased social insurance for some
of our employees. For those whom we have not purchased social insurance, the
premium has been added into their salary so that they can purchase social
insurance in their individual capacity at the location of their recorded
residences.
With
the
expansion of our business operations and several anticipated acquisitions,
we
expect that the number of our employees will increase in the next 12
months.
-9-
Research
and Development
Currently,
we have approximately 80 employees devoted to our research and development
efforts, which are aimed at finding new varieties of products, improving
existing products, improving overall product quality and reducing production
costs. We have established a strategic partnership with Beijing University
through which we will provide funds to Beijing University for the research
and
development of video surveillance and security products. Our research and
development efforts are led by Dr. Yong Zhao, who worked for the research and
development department of a large international surveillance and security
company and has extensive research experience. Under the partnership agreement
with Beijing University, we have agreed to provide Beijing University up to
RMB
2 million (approximately $250,000) for their research and development efforts.
We paid RMB500,000 (approximately $62,500) under the agreement in
2006.
Government
Regulation
All
security and surveillance products produced in China must satisfy testing by
the
China Public Security Bureau, and manufacturers of such products must receive
the Security Technology Protection Product Manufacturing Permit from the
provincial agency. We satisfactorily completed this testing in 2002 and also
received a permit from Guangdong province in May 2003. In addition, we have
a
license from the Guangdong province for the design, installation and repair
of
security protection systems.
Because
our operating subsidiaries Golden and Cheng Feng are located in PRC, we are
regulated by the national and local laws of PRC.
There
is
no private ownership of land in China and all land ownership is held by the
government of the PRC, its agencies and collectives. Land use rights can be
obtained from the government for a period up to 70 years, and are typically
renewable. Land use rights can be transferred upon approval by the land
administrative authorities of the PRC (State Land Administration Bureau) upon
payment of the required land transfer fee. We have received the necessary land
use right certificate for the properties described under “Item 2 - Description
of Property.” See “Item 2 - Description of Property” for more
details.
In
addition, we are also subject to PRC’s foreign currency regulations. The PRC
government has control over RMB reserves through, among other things,
direct
regulation of the conversion or RMB into other foreign currencies. Although
foreign currencies which are required for “current account” transactions can be
bought freely at authorized Chinese banks, the proper procedural requirements
prescribed by Chinese law must be met. At the same time, Chinese companies
are
also required to sell their foreign exchange earnings to authorized Chinese
banks and the purchase of foreign currencies for capital account transactions
still requires prior approval of the Chinese government.
We
believe that we are in material compliance with all registrations and
requirements for the issuance and maintenance of all licenses required by the
governing bodies, and that all license fees and filings are current.
RISK
RELATED TO OUR BUSINESS
DUE
TO
THE NATURE OF OUR BUSINESS, WE DO NOT HAVE SIGNIFICANT AMOUNTS OF RECURRING
REVENUES FROM OUR EXISTING CUSTOMERS AND WE ARE HIGHLY DEPENDENT ON NEW BUSINESS
DEVELOPMENT.
Most
of
our revenues derive from the installation of security and surveillance systems
which are generally non-recurring. Our customers are mainly governmental
entities, non-profit organizations and commercial entities, such as airports,
customs agencies, hotels, real estate developments, banks, mines, railways,
supermarkets, and entertainment enterprises. We manufacture and install security
systems for these customers and generate revenues
from the sale of these systems to our customers and, to a lesser extent, from
maintenance of these systems for our customers. After we have manufactured
and
installed a system at any particular customer site, we have generated the
majority of revenues from that particular client. We would not expect to
generate significant revenues from any existing client in future years unless
that client has additional installation sites for which our services might
be
required. Therefore, in order to maintain a level of revenues each year that
is
at or in excess of the level of revenues we generated in prior years, we must
identify and be retained by new clients. If our business development, marketing
and sales techniques do not result in an equal or greater number of projects
of
at least comparable size and value for us in a given year compared to the prior
year, then we may be unable to increase our revenues and earnings or even
sustain current levels in the future.
-10-
IN
ORDER
TO GROW AT THE PACE EXPECTED BY MANAGEMENT, WE WILL REQUIRE ADDITIONAL CAPITAL
TO SUPPORT OUR LONG-TERM BUSINESS PLAN. IF WE ARE UNABLE TO OBTAIN ADDITIONAL
CAPITAL IN FUTURE YEARS, WE MAY BE UNABLE TO PROCEED WITH OUR LONG-TERM BUSINESS
PLAN AND WE MAY BE FORCED TO CURTAIL OR CEASE OUR OPERATIONS.
We
will
require additional working capital to support our long-term business plan,
which
includes identifying suitable targets for horizontal or vertical mergers or
acquisitions, so as to enhance the overall productivity and benefit from
economies of scale. Our working capital requirements and the cash flow
provided by future operating activities, if any, will vary greatly from quarter
to quarter, depending on the volume of business during the period and payment
terms with our customers. We may not be able to obtain adequate levels of
additional financing, whether through equity financing, debt financing or other
sources. Additional financings could result in significant dilution to our
earnings per share or the issuance of securities with rights superior to our
current outstanding securities. In addition, we may grant registration
rights to investors purchasing our equity or debt securities in the future.
If we are unable to raise additional financing, we may be unable to
implement our long-term business plan, develop or enhance our products and
services, take advantage of future opportunities or respond to competitive
pressures on a timely basis, if at all. In addition, a lack of additional
financing could force us to substantially curtail or cease
operations.
OUR
FUTURE SUCCESS DEPENDS IN PART ON ATTRACTING AND RETAINING KEY SENIOR MANAGEMENT
AND QUALIFIED TECHNICAL AND SALES PERSONNEL.
Our
future success depends in part on the contributions of our management team
and
key technical and sales personnel and our ability to attract and retain
qualified new personnel. In particular, our success depends on the continuing
employment of our CEO, Mr. Guoshen Tu; our CFO, Terence Yap; our Chief Technical
Officer, Dr. Yong Zhao; our Chief Operating Officer, Shufang Yang; our Vice
President, Jianguo Jiang; and our Vice President, Lingfeng Xiong. There is
significant competition in our industry for qualified managerial, technical
and
sales personnel and we cannot assure you that we will be able to retain our
key
senior managerial, technical and sales personnel or that we will be able to
attract, integrate and retain other such personnel that we may require in the
future. We also cannot assure that our employees will not leave and subsequently
compete against us. If we are unable to attract and retain key personnel in
the
future, our business, financial condition and results of operations could be
adversely affected.
OUR
GROWTH STRATEGY INCLUDES MAKING ACQUISITIONS IN THE FUTURE, WHICH COULD SUBJECT
US TO SIGNIFICANT RISKS, ANY OF WHICH COULD HARM OUR BUSINESS.
Our
growth strategy includes identifying and acquiring or investing in suitable
candidates on acceptable terms. We recently acquired the security and
surveillance business of the Four-Related Companies and acquired a 100%
ownership interest in Cheng Feng. We also expect to close the acquisitions
of
Shenzhen Hongtianzhi Electronics Co., Ltd., or “Hongtianzhi,” and HiEasy
Electronic Technology Development
Co., Ltd.,
or
“HiEasy,” and establish an exclusive cooperation relationship with Shenzhen
Chuang Guan Intelligence Network
Technology Co., Ltd., or “Chuang Guan,” in 2007. In addition, over time, we may
acquire or make investments in other providers of products that complement
our
business and other companies in the security industry.
-11-
Acquisitions
involve a number of risks and present financial, managerial and operational
challenges, including:
|
·
|
diversion
of management’s attention from running our existing
business;
|
|
·
|
increased
expenses, including travel, legal, administrative and compensation
expenses resulting from newly hired
employees;
|
|
·
|
increased
costs to integrate personnel, customer base and business practices
of the
acquired company with our own;
|
|
·
|
adverse
effects on our reported operating results due to possible write-down
of
goodwill associated with
acquisitions;
|
|
·
|
potential
disputes with sellers of acquired businesses, technologies, services,
products and potential liabilities;
and
|
|
·
|
dilution
to our earnings per share if we issue common stock in any
acquisition.
|
Moreover,
performance problems with an acquired business, technology, product or service
could also have a material adverse impact on our reputation as a whole. In
addition, any acquired business, technology, product or service could
significantly under-perform relative to our expectations, and we may not achieve
the benefits we expect from our acquisitions. For all of these reasons, our
pursuit of an acquisition and investment strategy or any individual acquisition
or investment could have a material adverse effect on our business, financial
condition and results of operations.
OUR
LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY MAY ADVERSELY AFFECT OUR
ABILITY TO COMPETE.
We
rely
on a combination of trademarks, copyrights, trade secret laws, confidentiality
procedures and licensing arrangements to protect our intellectual property
rights. A successful challenge to the ownership of our technology could
materially damage our business prospects. Our competitors may assert that our
technologies or products infringe on their patents or proprietary rights. We
may
be required to obtain from others licenses that may not be available on
commercially reasonable terms, if at all. Problems with intellectual
property rights could increase the cost of our products or delay or preclude
our
new product development and commercialization. If infringement claims
against us are deemed valid, we may not be able to obtain appropriate licenses
on acceptable terms or at all. Litigation could be costly and time-consuming
but
may be necessary to protect our technology license positions or to defend
against infringement claims.
WE
SOMETIMES EXTEND CREDIT TO OUR CUSTOMERS. FAILURE TO COLLECT THE TRADE
RECEIVABLES OR UNTIMELY COLLECTION COULD AFFECT OUR LIQUIDITY.
We
extend
credit to a large number of our customers while generally requiring no
collateral. Generally, our customers pay in installments, with a portion of
the
payment upfront, a portion of the payment upon receipt of our products by our
customers and before the installation, and a portion of the payment after the
installation of our products and upon satisfaction of our customer. Sometimes,
a
small portion of the payment will not be paid until after a certain period
following the installation. We perform ongoing credit evaluations of our
customers’ financial condition and generally have no difficulties in collecting
our payments. However, if we encounter future
problems collecting amounts due from our clients or if we experience delays
in
the collection of amounts due from our clients, our liquidity could be
negatively affected.
-12-
IF
OUR
SUBCONTRACTORS FAIL TO PERFORM THEIR CONTRACTUAL OBLIGATIONS, OUR ABILITY TO
PROVIDE SERVICES AND PRODUCTS TO OUR CUSTOMERS, AS WELL AS OUR ABILITY TO OBTAIN
FUTURE BUSINESS, MAY BE HARMED.
Many
of
our contracts involve subcontracts with other companies upon which we rely
to
perform a portion of the services that we must provide to our customers. There
is a risk that we may have disputes with our subcontractors, including disputes
regarding the quality and timeliness of work performed by those subcontractors.
A failure by one or more of our subcontractors to satisfactorily perform the
agreed-upon services may materially and adversely impact our ability to perform
our obligations to our customers, could expose us to liability and could have
a
material adverse effect on our ability to compete for future contracts and
orders.
SAFETECH
IS A BVI COMPANY, WHILE GOLDEN AND CHENG FENG ARE PRC COMPANIES, AND ALL OF
OUR
OFFICERS AND DIRECTORS RESIDE OUTSIDE THE UNITED STATES. THEREFORE, CERTAIN
JUDGMENTS OBTAINED AGAINST OUR COMPANY BY OUR SHAREHOLDERS MAY NOT BE
ENFORCEABLE IN THE BVI OR CHINA.
Safetech
is a BVI company and our operating subsidiaries Golden and Cheng Feng are PRC
companies. All of our officers and directors reside outside of the United
States. All or substantially all of our assets and the assets of these persons
are located outside of the United States. As a result, it may not be possible
for investors to effect service of process within the United States upon our
Company or such persons or to enforce against it or these persons the United
States federal securities laws, or to enforce judgments obtained in United
States courts predicated upon the civil liability provisions of the federal
securities laws of the United States, including the Securities Act and the
Exchange Act.
RISKS
RELATED TO OUR INDUSTRY
SEASONALITY
AFFECTS OUR OPERATING RESULTS.
Our
sales
are affected by seasonality. Our revenues are usually higher in the second
half
of the year than in the first half of the year because fewer projects are
undertaken during and around the Chinese spring festival.
OUR
SUCCESS RELIES ON OUR MANAGEMENT’S ABILITY TO UNDERSTAND THE HIGHLY EVOLVING
SURVEILLANCE AND SECURITY INDUSTRY.
The
Chinese surveillance and security industry is nascent and rapidly evolving.
Therefore, it is critical that our management is able to understand industry
trends and make good strategic business decisions. If our management is unable
to identify industry trends and act in response to such trends in a way that
is
beneficial to us, our business will suffer.
IF
WE ARE
UNABLE TO RESPOND TO THE RAPID CHANGES IN OUR INDUSTRY AND CHANGES IN OUR
CUSTOMERS’ REQUIREMENTS AND PREFERENCES, OUR BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED.
If
we are
unable, for technological, legal, financial or other reasons, to adapt in a
timely manner to changing market conditions or customer requirements, we could
lose customers and market share. The electronic security systems industry is
characterized by rapid technological change. Sudden changes in customer
requirements and preferences, the frequent introduction of new products and
services embodying new technologies and the emergence of new industry standards
and practices could render our existing products, services and systems obsolete.
The emerging nature of products and services in the electronic security systems
industry and their rapid evolution will require that we continually improve
the
performance, features and reliability of our products and services. Our success
will depend, in part, on our ability to:
-13-
|
·
|
enhance
our existing products and services;
|
|
·
|
anticipate
changing customer requirements by designing, developing, and launching
new
products and services that address the increasingly sophisticated
and
varied needs of our current and prospective customers;
and
|
|
·
|
respond
to technological advances and emerging industry standards and practices
on
a cost-effective and timely basis.
|
The
development of additional products and services involves significant
technological and business risks and requires substantial expenditures and
lead
time. If we fail to introduce products with new technologies in a timely manner,
or adapt our products to these new technologies, our business, financial
condition and results of operations could be adversely affected. We cannot
assure you that even if we are able to introduce new products or adapt our
products to new technologies that our products will gain acceptance among our
customers. In addition, from time to time, we or our competitors may announce
new products, product enhancements or technological innovations that have the
potential to replace or shorten the life cycles of our existing products and
that may cause customers to refrain from purchasing our existing products,
resulting in inventory obsolescence.
WE
MAY
NOT BE ABLE TO MAINTAIN OR IMPROVE OUR COMPETITIVE POSITION BECAUSE OF STRONG
COMPETITION IN THE SECURITY AND SURVEILLANCE INDUSTRY, AND WE EXPECT THIS
COMPETITION TO CONTINUE TO INTENSIFY.
The
Chinese security and surveillance industry is highly competitive. There are
about 15,000 companies in China that engage in the business of manufacturing,
designing and building surveillance and security products. In addition, since
China joined the World Trade Organization (“WTO”), we also face competition from
international competitors. Some of our international competitors are larger
than
us and possess greater name recognition, assets, personnel, sales and financial
resources. These entities may be able to respond more quickly to changing market
conditions by developing new products and services that meet customer
requirements or are otherwise superior to our products and services and may
be
able to more effectively market their products than we can because they have
significantly greater financial, technical and marketing resources than we
do.
They may also be able to devote greater resources than we can to the
development, promotion and sale of their products. Increased competition could
require us to reduce our prices, result in our receiving fewer customer orders,
and result in our loss of market share. We cannot assure you that we will be
able to distinguish ourselves in a competitive market. To the extent that we
are
unable to successfully compete against existing and future competitors, our
business, operating results and financial condition could be materially
adversely affected.
OUR
BUSINESS AND REPUTATION AS A MANUFACTURER OF HIGH QUALITY SECURITY AND
SURVEILLANCE PRODUCTS MAY BE ADVERSELY AFFECTED BY PRODUCT DEFECTS OR
SUBSTANDARD PERFORMANCE.
We
believe that we offer high quality products that are reliable and competitively
priced. If our products do not perform to specifications, we might be required
to redesign or recall those products or pay substantial damages. Such an event
could result in significant expenses, disrupt sales and affect our reputation
and that of our products. In addition, product defects could result in
substantial product liability. We do not have product liability insurance.
If we
face significant liability claims, our business, financial condition, and
results of operations would be adversely affected.
-14-
OUR
PRODUCT OFFERINGS INVOLVE A LENGTHY SALES CYCLE AND WE MAY NOT ANTICIPATE SALES
LEVELS APPROPRIATELY, WHICH COULD IMPAIR OUR PROFITABILITY.
Some
of
our products and services are designed for medium to large commercial,
industrial and government facilities desiring to protect valuable assets and/or
prevent intrusion into high security facilities in China. Given the nature
of
our products and the customers that purchase them, sales cycles can be lengthy
as customers conduct intensive investigations and deliberate between competing
technologies and providers. For these and other reasons, the sales cycle
associated with some of our products and services is typically lengthy and
subject to a number of significant risks over which we have little or no
control. If sales in any period fall significantly below anticipated levels,
our
financial condition and results of operations could suffer.
RISKS
RELATED TO DOING BUSINESS IN CHINA
ECONOMIC,
POLITICAL, LEGAL AND SOCIAL UNCERTAINTIES IN CHINA COULD HARM OUR FUTURE
INTERESTS IN CHINA.
All
of
our future business projects and plans are expected to be located in China.
As a
consequence, the economic, political, legal and social conditions in China
could
have an adverse effect on our business, results of operations and financial
condition. The legislative trend in China over the past decade has been to
enhance the protection afforded to foreign investment and to allow for more
active control by foreign parties of foreign invested enterprises. There can
be
no assurance, however, that legislation directed towards promoting foreign
investment will continue. More restrictive rules on foreign investment could
adversely affect our ability to expand our operations in China or repatriate
any
profits earned there. Some of the changes that could adversely affect us
include:
| · |
level
of government involvement in the
economy;
|
| · |
control
of foreign exchange;
|
| · |
methods
of allocating resources;
|
| · |
balance
of payments position;
|
| · |
international
trade restrictions; and
|
| · |
international
conflict.
|
The
Chinese economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development (“OECD”), in many ways. As
a result of these differences, we may not develop in the same way or at the
same
rate as might be expected if the Chinese economy were similar to those of the
OECD member countries.
THE
LEGAL
ENVIRONMENT IN CHINA IS UNCERTAIN AND YOUR ABILITY TO LEGALLY PROTECT YOUR
INVESTMENT COULD BE LIMITED.
The
Chinese legal system is a civil law system based on written statutes. Unlike
common law systems, it is a system in which precedents set in earlier legal
cases are not generally used. The overall effect of legislation enacted over
the
past 20 years has been to enhance the protections afforded to foreign-owned
enterprises in China. However, these laws, regulations and legal requirements
are relatively recent and are evolving rapidly, and their interpretation and
enforcement involve uncertainties. For
example, on March
16,
2007, PRC adopted new property and corporate income tax laws, and the
implications of these new laws are uncertain as of the date of this report.
These uncertainties could limit the legal protections available to
foreign investors, such as the right of foreign-invested enterprises to hold
licenses and permits such as requisite business licenses. In addition, all
of
our executive officers and our directors are residents of China and not of
the
United States, and substantially all the assets of these persons are located
outside the United States. As a result, it could be difficult for investors
to
effect service of process in the United States, or to enforce a judgment
obtained in the United States against us or any of these persons.
-15-
THE
CHINESE GOVERNMENT EXERTS SUBSTANTIAL INFLUENCE OVER THE MANNER IN WHICH WE
MUST
CONDUCT OUR BUSINESS ACTIVITIES.
China
only recently has permitted provincial and local economic autonomy and private
economic activities. The Chinese government has exercised and continues to
exercise substantial control over virtually every sector of the Chinese economy
through regulation and state ownership. Our ability to operate in China may
be
harmed by changes in its laws and regulations, including those relating to
taxation, import and export tariffs, environmental regulations, land use rights,
property and other matters. We believe that our operations in China are in
material compliance with all applicable legal and regulatory requirements.
However, the central or local governments of these jurisdictions may impose
new,
stricter regulations or interpretations of existing regulations that would
require additional expenditures and efforts on our part to ensure our compliance
with such regulations or interpretations.
Accordingly,
government actions in the future, including any decision not to continue to
support recent economic reforms and to return to a more centrally planned
economy, or regional or local variations in the implementation of economic
policies, could have a significant effect on economic conditions in China or
particular regions thereof, and could require us to divest ourselves of any
interest we then hold in Chinese properties or joint ventures.
FUTURE
INFLATION IN CHINA MAY INHIBIT OUR ACTIVITY TO CONDUCT BUSINESS IN
CHINA.
In
recent
years, the Chinese economy has experienced periods of rapid expansion and widely
fluctuating rates of inflation. During the past ten years, the rate of inflation
in China has been as high as 20.7% and as low as -2.2%. These factors have
led
to the adoption by the Chinese government, from time to time, of various
corrective measures designed to restrict the availability of credit or regulate
growth and contain inflation. High inflation may in the future cause the Chinese
government to impose controls on credit and/or prices, or to take other action,
which could inhibit economic activity in China, and thereby harm the market
for
our products.
WE
MAY BE
UNABLE TO COMPLETE A BUSINESS COMBINATION TRANSACTION EFFECTIVELY OR ON
FAVORABLE TERMS DUE TO COMPLICATED MERGER AND ACQUISITION REGULATIONS
IMPLEMENTED ON SEPTEMBER 8, 2006.
On
September 8, 2006, the PRC Ministry of Commerce, or “MOFCOM,” together with
several other government agencies, promulgated a comprehensive set of
regulations governing the approval process by which a Chinese company may
participate in an acquisition of its assets or its equity interests and by
which
a Chinese company may obtain public trading of its securities on a securities
exchange outside of the PRC. Depending on the structure of the transaction,
these regulations will require the Chinese parties to make a series of
applications and supplemental applications to the governmental agencies. In
some
instances, the application process may require the presentation of economic
data
concerning a transaction, including appraisals of the target business and
evaluations of the acquirer, which are designed to allow the government to
assess the transaction. Governmental approvals will have expiration dates by
which a transaction must be completed and reported to the governmental agencies.
Compliance with the new regulations is likely to be more time consuming and
expensive than in the past and the government now can exert more control over
the combination of two businesses. Accordingly, due to these new regulations,
our ability to engage in business combination transactions has become
significantly more complicated, time consuming and expensive and we may not
be
able to negotiate a transaction that is acceptable to our stockholders or
sufficiently protect their interests in a transaction.
The
new
regulations allow PRC government agencies to assess the economic terms of a
business combination transaction. Parties to a business combination transaction
may have to submit to MOFCOM and the other government agencies an appraisal
report, an evaluation report and the acquisition agreement, all of which form
part of the application for approval, depending on the structure of the
transaction. The regulations also prohibit a transaction at an acquisition
price
obviously lower than the appraised value of the Chinese business or assets
and
in certain transaction structures, require that consideration must be paid
within defined periods, generally not in excess of a year. The
regulations also limit our ability to negotiate various terms of the
acquisition, including aspects of the initial consideration, contingent
consideration, holdback provisions, indemnification provisions and provisions
relating to the assumption and allocation of assets and liabilities. Transaction
structures involving trusts, nominees and similar entities are prohibited.
Therefore, such regulations may impede our ability to negotiate and complete
a
business combination transaction on financial terms which satisfy our investors
and protect our stockholders’ economic interests and we may not be able to
negotiate a business combination transaction on terms favorable to our
stockholders.
-16-
In
addition to the above risks, in many instances, we will seek to structure
transactions in a manner that avoids the need to make applications or a series
of applications with Chinese regulatory authorities under these M&A
regulations. If we fail to effectively structure an acquisition in a manner
that
avoids the need for such applications or if the Chinese government interprets
the requirements of the M&A regulations in a manner different from our
understanding of such regulations, then acquisitions that we have effected
may
be unwound or subject to rescission. Also, if the Chinese government determines
that our structure of any of our acquisitions does not comply with these new
regulations, then we may also be subject to fines and penalties.
RESTRICTIONS
ON CURRENCY EXCHANGE MAY LIMIT OUR ABILITY TO RECEIVE AND USE OUR REVENUES
EFFECTIVELY.
The
majority of our revenues will be settled in RMB, and any future restrictions
on
currency exchanges may limit our ability to use revenue generated in RMB to
fund
any future business activities outside China or to make dividend or other
payments in U.S. dollars. Although the Chinese government introduced regulations
in 1996 to allow greater convertibility of the RMB for current account
transactions, significant restrictions still remain, including the restriction
that foreign-invested enterprises may only buy, sell or remit foreign currencies
after providing valid commercial documents, and only at those banks in China
authorized to conduct foreign exchange business. In addition, conversion of
RMB
for capital account items, including direct investment and loans, is subject
to
governmental approval in China, and companies are required to open and maintain
separate foreign exchange accounts for capital account items. We cannot be
certain that the Chinese regulatory authorities will not impose more stringent
restrictions on the convertibility of the RMB.
THE
VALUE
OF OUR SECURITIES WILL BE AFFECTED BY THE FOREIGN EXCHANGE RATE BETWEEN THE
U.S.
DOLLARS AND RENMINBI.
The
value
of our common stock will be affected by the foreign exchange rate between U.S.
dollars and RMB, and between those currencies and other currencies in which
our
sales may be denominated. For example, to the extent that we need to convert
U.S. dollars into RMB for our operational needs, should the RMB appreciate
against the U.S. dollar at that time, our financial position, the business
of
our Company, and the price of our common stock may be harmed. Conversely, if
we
decide to convert our RMB into U.S. dollars for the purpose of declaring
dividends on our common stock or for other business purposes, should the U.S.
dollar appreciate against the RMB, the U.S. dollar equivalent of our earnings
from our subsidiaries in China would be reduced.
ACCOUNTING
LAWS IN CHINA MANDATE ACCOUNTING PRACTICES WHICH MAY NOT BE CONSISTENT WITH
U.S.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND THEREFORE OUR FINANCIALS AND THEIR
INTERPRETATION INVOLVE UNCERTAINTIES.
The
PRC
accounting laws require an annual “statutory audit” to be performed in
accordance with PRC accounting standards and the books of foreign invested
enterprises to be maintained in accordance with Chinese accounting laws. These
Chinese accounting practices which may not be consistent with U.S. generally
accepted accounting
principles. Article 14 of the PRC Wholly Foreign-Owned Enterprise Law requires
a
wholly foreign-owned enterprise to submit certain periodic fiscal reports and
statements to designated financial and tax authorities. Noncompliance with
such
requirements may cause revocation of our business license. The translation
of
the financial statements from the requirements of the PRC to US GAAP, requires
interpretation and exercise of judgment.
-17-
RISKS
RELATED TO OUR COMMON STOCK
OUR
COMMON STOCK IS CURRENTLY QUOTED ONLY ON THE OTC BULLETIN BOARD, WHICH MAY
HAVE
AN UNFAVORABLE IMPACT ON STOCK PRICE AND LIQUIDITY.
Our
common stock is quoted only on the OTCBB. The OTCBB is a significantly more
limited market than the New York Stock Exchange or NASDAQ system. The quotation
of our shares on the OTCBB may result in a less liquid market available for
existing and potential stockholders to trade shares of the common stock, could
depress the trading price of the common stock and could have a long-term adverse
impact on our ability to raise capital in the future.
PROVISIONS
IN OUR CERTIFICATE OF INCORPORATION AND BYLAWS OR DELAWARE LAW MIGHT DISCOURAGE,
DELAY OR PREVENT A CHANGE OF CONTROL OF OUR COMPANY OR CHANGES IN ITS MANAGEMENT
AND, THEREFORE DEPRESS THE TRADING PRICE OF THE COMMON STOCK.
Delaware
corporate law and our certificate of incorporation and bylaws contain provisions
that could discourage, delay or prevent a change in control of our Company
or
changes in its management that our stockholders may deem advantageous. These
provisions:
| – |
deny
holders of our common stock cumulative voting rights in the election
of
directors, meaning that stockholders owning a majority of our outstanding
shares of common stock will be able to elect all of our
directors;
|
|
–
|
any
stockholder wishing to properly bring a matter before a meeting of
stockholders must comply with specified procedural and advance notice
requirements; and
|
|
–
|
any
vacancy on the board of directors, however the vacancy occurs, may
only be
filled by the directors.
|
In
addition, Section 203 of the Delaware General Corporation Law generally
limits our ability to engage in any business combination with certain persons
who own 15% or more of our outstanding voting stock or any of our associates
or
affiliates who at any time in the past three years have owned 15% or more of
our
outstanding voting stock. These provisions may have the effect of entrenching
our management team and may deprive you of the opportunity to sell your shares
to potential acquirors at a premium over prevailing prices. This potential
inability to obtain a control premium could reduce the price of our common
stock.
None.
-18-
All
land
in China is owned by the State. Individuals and companies are permitted to
acquire rights to use land or land use rights for specific purposes. In the
case
of land used for industrial purposes, the land use rights are granted for a
period of 50 years. This period may be renewed at the expiration of the initial
and any subsequent terms. Granted land use rights are transferable and may
be
used as security for borrowings and other obligations.
We
currently have land use rights to approximately 119,245 square meters consisting
of manufacturing facilities and office buildings in various parts of China,
including Shenzhen and Jiangxi province. We have fully paid the land use fees.
The chart below lists all facilities owned by us.
|
Location
|
|
Type
of Facility
|
|
Size
of the Land
(Square
Meters)
|
|
Size
of the Building
(Square
Meters)
|
|
|||
|
Shangtian,
Taihe County, Jiangxi Province
|
|
|
Manufacturing
|
|
|
64,533
|
|
|
45,878
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
No.
45 Jifu Road, Jiangxi Province
|
|
|
Manufacturing
|
|
|
28,593
|
|
|
5,224
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jishui
County, Jiangxi Province
|
|
|
Manufacturing
|
|
|
24,867
|
|
|
10,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4th
Floor, Building 3, Shaige Technology Park, Futian District,
Shenzhen
|
|
|
Office
and Manufacturing
|
|
|
1,252
|
|
|
1,252
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13/F,
Shenzhen Special Zone Press Tower, Shennan Road, Futian District,
Shenzhen
*
|
|
|
Office
|
|
|
|
|
2,069
|
|
|
|
3/F,
Block 89, No. 1122, Qin Zhou North Road, Shanghai
|
Office
and Manufacturing
|
1,139
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
119,245
|
|
|
65,967
|
|
| * |
Pursuant
to a trust agreement, dated August 21, 2006, by and between Golden
and
Zhiqun Li, Ms. Li holds this property in trust for Golden. Golden
has the
right to request Ms. Li to transfer the property to Golden without
consideration upon its request. In addition, without prior approval
from
Golden, Ms. Li has no right to dispose the
property.
|
In
order
to facilitate our business expansion, we plan to acquire an industrial park
in
Shenzhen in 2007. We believe our property is sufficient to meet our current
needs.
On
March
16, 2007, the National People’s Congress of the PRC adopted a new property law
in its fifth plenary session. The new property law will become effective
on
October 1, 2007. As of the date of this report, we cannot be sure of the
potential impact of such new property law on our financial position and
operating results.
From
time
to time, we have disputes that arise in the ordinary course of its business.
Currently, there are no material legal proceedings to which we are a party,
or
to which any of our property is subject, that we expect to have a material
adverse effect on our financial condition.
None.
-19-
Our
common stock has been quoted on the OTCBB since June 2005 and currently trades
under the symbol “CSCT.OB.” The CUSIP number is 16942J105.
The
following table sets forth the quarterly high and low bid prices of a share
of
our common stock as reported by the OTCBB for the periods indicated. The
quotations listed below reflect inter-dealer prices, without retail mark-ups,
mark-downs or commissions and may not necessarily represent actual transactions.
|
Closing
Bid Prices(1)
|
|||||||
|
High
|
Low
|
||||||
|
Year
Ended December 31, 2006
|
|||||||
|
1st
Quarter
|
$
|
4.40
|
$
|
3.50
|
|||
|
2nd
Quarter
|
8.10
|
3.60
|
|||||
|
3rd
Quarter
|
6.70
|
4.00
|
|||||
|
4th
Quarter
|
12.10
|
7.05
|
|||||
|
Year
Ended December 31, 2005
|
|||||||
|
1st
Quarter
|
N/A
|
N/A
|
|||||
|
2nd
Quarter
|
0.25
|
0.05
|
|||||
|
3rd
Quarter
|
4.50
|
0.05
|
|||||
|
4th
Quarter
|
3.00
|
1.85
|
|||||
| (1) |
The
above tables set forth the range of high and low closing bid prices
per
share of our common stock as reported by www.quotemedia.com for the
periods indicated.
|
Approximate
Number
of Holders of Our Common Stock
On
March
16, 2007, there were approximately 438 stockholders of record of our common
stock. This number excludes the 12,397,119 shares of our common stock owned
by
stockholders holding stock under nominee security position
listings.
Dividend
Policy
We
have
never declared or paid cash dividends. Any future decisions regarding dividends
will be made by our board of directors. We currently intend to retain and use
any future earnings for the development and expansion of our business and do
not
anticipate paying any cash dividends in the foreseeable future.
Recent
Sales of Unregistered Securities
In
March
2006, we issued 100,000 shares of common stock to Terence Yap as payment for
his
services which are being rendered through February 2009. The value attributed
to
these shares was $350,000 ($3.50 per share). These stock issuances were exempt
from registration pursuant to Section 4(2) of the Securities Act.
On
April
4, 2006, we completed a private placement in which we sold 2,666,667 shares
of
our common stock at a price of $3.00 per share for aggregate gross proceeds
of
$800,000 to certain accredited investors. We also issued warrants to purchase
416,667 shares of our common stock to certain entities as compensation for
their
services
in connection with the private placement, 150,000 of which have an exercise
price of $3.80 per share, while the remaining 266,667 are exercisable at a
price
of $3.00 per share. The issuance was made in reliance on the exemption
provided by Section 4(2) of the Securities Act for the offer and sale of
securities not involving a public offering and Regulation D promulgated
thereunder.
-20-
On
July
31, 2006, we issued 4,634,592
units to 26 accredited investors for an aggregate gross cash purchase price
of
$16,221,093 at a price of $3.50 per share. Each unit consists of one share
of
our common stock and a warrant to purchase one-fifth of one share of our common
stock. We also issued warrants to purchase 324,421 shares of our common stock
with an exercise price of $4.20 to two placement agents as compensation for
their services in connection with the private placement. The issuance was made
in reliance on the exemption provided by Section 4(2) of the Securities
Act for the offer and sale of securities not involving a public
offering and regulation D promulgated thereunder.
In
October 2006, we issued 50,000 shares of our common stock to Hayden
Communications, Inc. as payment for their investor relationship services
rendered pursuant to a consulting agreement dated February 9, 2006. These stock
issuances were exempt from registration pursuant to Section 4(2) of the
Securities Act.
On
November 27, 2006, we issued 1,538,462 shares of our common stock to 3
accredited investors for a consideration of $10 million at a price of $6.50
per
share. The issuance was made in reliance on the exemption provided by Section
4(2) of the Securities Act for the offer and sale of securities not
involving a public offering and Regulation D promulgated thereunder.
In
instances described above where we issued securities in reliance upon Regulation
D, we relied upon Rule 506 of Regulation D under the Securities Act. These
stockholders who received the securities in such instances made representations
that (a) the stockholder is acquiring the securities for his, her or its own
account for investment and not for the account of any other person and not
with
a view to or for distribution, assignment or resale in connection with any
distribution within the meaning of the Securities Act, (b) the stockholder
agrees not to sell or otherwise transfer the purchased shares unless they are
registered under the Securities Act and any applicable state securities laws,
or
an exemption or exemptions from such registration are available, (c) the
stockholder has knowledge and experience in financial and business matters
such
that he, she or it is capable of evaluating the merits and risks of an
investment in us, (d) the stockholder had access to all of our documents,
records, and books pertaining to the investment and was provided the opportunity
to ask questions and receive answers regarding the terms and conditions of
the
offering and to obtain any additional information which we possessed or were
able to acquire without unreasonable effort and expense, and (e) the stockholder
has no need for the liquidity in its investment in us and could afford the
complete loss of such investment. Management made the determination that the
investors in instances where we relied on Regulation D are Accredited Investors
(as defined in Regulation D) based upon management’s inquiry into their
sophistication and net worth. In addition, there was no general solicitation
or
advertising for securities issued in reliance upon Regulation D.
In
instances described above where we indicate that we relied upon Section 4(2)
of
the Securities Act in issuing securities, our reliance was based upon the
following factors: (a) the issuance of the securities was an isolated private
transaction by us which did not involve a public offering; (b) there were only
a
limited number of offerees; (c) there were no subsequent or contemporaneous
public offerings of the securities by us; (d) the securities were not broken
down into smaller denominations; and (e) the negotiations for the sale of the
stock took place directly between the offeree and us.
The
selected consolidated statement of income and comprehensive income data for
the
years ended December 31, 2004, 2005 and 2006 and the selected balance sheet
data
as of December 31, 2005 and 2006 are derived from our audited consolidated
financial statements included elsewhere in this report. The selected
consolidated financial
data for the year ended December 31, 2003 and the selected balance sheet data
as
of December 31, 2004 are derived from our audited consolidated financial
statements not included in this report. The selected consolidated financial
data
for the year ended December 31, 2002 is derived from our unaudited consolidated
financial statements that are not included in this report.
-21-
The
following selected historical financial information should be read in
conjunction with our consolidated financial statements and related notes and
the
information contained in Item 7. “Management’s Discussion and Analysis of
Financial Condition and Results of Operations.”
All
amounts, other than percentages, in U.S. dollars.
|
2006
|
2005
|
|
2004
|
2003
|
2002
|
|||||||||||
|
Revenues
|
$
|
106,989,359
|
$
|
32,688,582
|
$
|
16,055,704
|
$
|
11,794,869
|
$
|
10,330,847
|
||||||
|
|
||||||||||||||||
|
Income
From Operations
|
$
|
25,341,730
|
$
|
7,478,842
|
$
|
6,130,779
|
$
|
3,262,057
|
$
|
2,234,128
|
||||||
|
|
||||||||||||||||
|
Net
Income
|
$
|
22,931,086
|
$
|
7,265,957
|
$
|
5,724,026
|
$
|
2,752,123
|
$
|
1,899,009
|
||||||
|
|
||||||||||||||||
|
Income
from Operations Per Share
|
||||||||||||||||
|
Basic
|
$
|
0.97
|
$
|
0.40
|
$
|
0.36
|
$
|
0.19
|
$
|
0.13
|
||||||
|
Diluted
|
$
|
0.94
|
$
|
0.40
|
$
|
0.36
|
$
|
0.19
|
$
|
0.13
|
||||||
|
|
||||||||||||||||
|
Total
Assets
|
$
|
114,527,263
|
$
|
29,116,672
|
$
|
22,008,920
|
$
|
16,976,999
|
$
|
13,581,661
|
||||||
|
|
||||||||||||||||
|
Total
Current Liabilities
|
$
|
22,603,709
|
$
|
4,504,926
|
$
|
5,208,364
|
$
|
5,900,469
|
$
|
4,126,166
|
||||||
|
|
||||||||||||||||
|
Net
Assets
|
$
|
89,819,528
|
$
|
24,611,746
|
$
|
16,800,556
|
$
|
11,076,530
|
$
|
9,455,495
|
||||||
|
|
||||||||||||||||
|
Weighted
Average Number of Shares Outstanding
|
||||||||||||||||
|
Basic
|
26,052,519
|
18,521,479
|
17,000,000
|
17,000,000
|
17,000,000
|
|||||||||||
|
Diluted
|
26,940,215
|
18,521,479
|
17,000,000
|
17,000,000
|
17,000,000
|
|||||||||||
|
|
||||||||||||||||
|
Total
Shareholders’ Equity
|
$
|
89,819,528
|
$
|
24,611,746
|
$
|
16,800,556
|
$
|
11,076,530
|
$
|
8,849,715
|
||||||
|
|
||||||||||||||||
|
Capital
Stock (excluding long term debt and redeemable preferred
stock)
|
$
|
318,249
|
$
|
215,580
|
$
|
170,000
|
$
|
170,000
|
$
|
170,000
|
||||||
|
|
||||||||||||||||
|
Number
of Shares Issued and Outstanding
|
31,824,938
|
21,558,000
|
17,000,000
|
17,000,000
|
17,000,000
|
|||||||||||
|
|
||||||||||||||||
|
Dividends
Per Share
|
||||||||||||||||
|
Basic
|
$
|
0
|
$
|
0
|
$
|
0
|
$
|
0
|
$
|
0
|
||||||
|
Diluted
|
$
|
0
|
$
|
0
|
$
|
0
|
$
|
0
|
$
|
0
|
||||||
|
Net
Income Per Share
|
||||||||||||||||
|
Basic
|
$
|
0.88
|
$
|
0.39
|
$
|
0.34
|
$
|
0.16
|
$
|
0.11
|
||||||
|
Diluted
|
$
|
0.85
|
$
|
0.39
|
$
|
0.34
|
$
|
0.16
|
$
|
0.11
|
||||||
-22-
Overview
We
manufacture, distribute, install and service security and surveillance products
and systems and develop security and surveillance related software in China.
Our
customers mainly comprise (i) governmental entities (including, but not limited
to, customs agencies, courts, public security bureaus and prisons), (ii)
non-profit organizations (including, but not limited to, schools, museums,
sports arenas and libraries) and (iii) commercial entities (including, but
not
limited to, airports, hotels, real estate, banks, mines, railways, supermarkets
and entertainment venues). These account for approximately 40%, 10% and 50%
of
revenues, respectively.
A
majority of our revenues is derived from the provision of a packaged solution
which includes the products, installation and after sale service maintenance
to
our customers. Because majority of our revenues is derived from the installation
of security and surveillance systems for our customers which are generally
non-recurring, our revenues are not concentrated within any one customer or
group of customers. Maintenance services in our packaged solution are included
within the first year from the date of completion. Our customers have an option
to sign up for the maintenance program after the first year.
Our
subsidiary Golden has 37 branch offices in provincial cities and Cheng Feng
has
22 distribution points throughout China as our customers are located across
the
country without any particular concentration in any region.
Our
Background and History
We
were
incorporated in the BVI on April 8, 2002 under the name “Apex Wealth Enterprises
Limited” as a corporation under the International Business Companies Ordinance
of 1984. In February 2006, we changed our name to China Security and
Surveillance Technology Inc. In November 2006, we changed our domicile from
the
BVI to Delaware by merging the BVI corporation into a newly incorporated
Delaware corporation. Prior to our reverse acquisition of Safetech, we were
a
development stage enterprise and had not yet generated any revenues. Prior
to
the reverse acquisition, we provided business advisory and management consulting
services in greater China, initially concentrating on the Hong Kong market.
The
focus of these services was on small to medium size enterprises.
From
and
after the reverse acquisition, our business became the business of our indirect,
wholly-owned subsidiary, Golden. Golden is a corporation incorporated in the
PRC
which is engaged in the business of manufacturing, distributing, installing
and
maintaining security and surveillance systems. Golden was organized in the
PRC
in January 1995. In 2006, we acquired Cheng Feng, a corporation incorporated
in
the PRC which is engaged in the business of manufacturing, marketing and sales
of security and surveillance related
hardware
as well as the development and integration of related software. We are
headquartered in Shenzhen, China.
Reverse
Acquisition with Safetech
On
September 12, 2005, we acquired 50,000 shares of the issued and outstanding
capital stock of Safetech, constituting all of the issued and outstanding
capital stock of Safetech. The 50,000 shares of Safetech were acquired from
the
individual shareholders of Safetech in a share exchange transaction in return
for the issuance of 8,138,000 shares of our common stock. As a result of this
transaction, Safetech became our wholly-owned subsidiary, and Golden became
our
indirect wholly-owned subsidiary. Completion of the transaction resulted in
a
change in control of our Company. After the transaction, we were no
longer a shell company.
-23-
For
accounting purposes, this transaction was treated as a reverse acquisition,
with
Safetech as the acquirer and our Company as the acquired party. When we refer
in
this report to business and financial information for periods
prior to the consummation of the reverse acquisition, we are referring to the
business and financial information of Golden and Cheng Feng on a consolidated
basis unless otherwise specified.
Subsequent
Acquisitions
On
October 25, 2005, we entered into an agreement with the equity owners of Yuan
Da, which was subsequently amended in April and May 2006. Pursuant to the
amended agreement, we acquired all of the assets of Yuan Da for RMB 1 million
(approximately $0.125 million) and 200,000 shares of our common stock. Yuan
Da
is a limited liability company established in Shenzhen, China and was
principally engaged in the sale and development of security and surveillance
systems.
In
July
2006, we entered into an agreement with shareholders of Cheng Feng to acquire
100% ownership of Cheng Feng for a consideration of RMB 120 million
(approximately $15 million), consisting of RMB 60 million (approximately $7.5
million) in cash and 1,361,748 shares of our common stock. We received the
relevant Chinese government approval for such acquisition in December 2006.
Cheng Feng is a company that is engaged in the business of manufacturing,
marketing and sales of security and surveillance related hardware as well as
the
development and integration of related software.
In
November 2006, we acquired the security and surveillance business of the
Four-Related Companies. Mr.
Tu did
not receive any consideration for the acquisition of his interest in the
Four-Related Companies. The minority shareholders of these four companies and
their designees, received in aggregate 850,000 shares of our common stock.
Shenzhen Guangdian is engaged in the business of manufacturing and distributing
security and surveillance products. The other three companies are engaged in
the
business of distributing security and surveillance products.
Recent
Development
On
February 5, 2007, we entered into a Notes
Purchase Agreement with
Citadel Equity Fund Ltd., or “Citadel,” pursuant to which, on February 8, 2007,
we offered and sold to Citadel a $60,000,000 Senior Notes due February 16,
2007.
Such notes were paid off on February 16, 2007.
On
February 16, 2007, we completed a Notes Purchase Agreement with Citadel for
a
$60 million guaranteed senior unsecured convertible notes financing. This
financing replaced the bridge financing discussed in the immediate above
paragraph. The notes bear an annual interest rate of 1% and are due in 2012.
The
notes carry an initial conversion price of $18 per share. The net proceeds
will
be used for our working capital and acquisition plan.
Effective
February 7, 2007, our board of directors adopted our 2007
Equity Incentive Plan. The plan
provides for grants of stock options, stock appreciation rights, performance
units, restricted stock, restricted stock units and performance shares. A total
of 8,000,000 shares of our common stock may be issued under the plan. The plan
has a 5-year term. On
February 27, 2007, we granted an aggregate of 1,052,100 shares of restricted
stock pursuant to the plan to 383 employees and consultants of the Company.
These shares will vest with respect to each of the 383 employees and consultants
over a period of four years.
Material
Opportunities and Challenges
Regulations
promulgated by governmental agencies in China relating to security and
surveillance industry often create opportunities for us. Currently, there are
a
number of formal and planned regulatory drivers which the Company believes
offer
significant growth opportunities. These include the estimated $6 billion to
$12
billion that the Chinese government expects to spend for security infrastructure
in preparation for the 2008 Olympics, along with the planned investment by
Shanghai for the 2010 Worlds Fair. In addition, several ordinances have been
passed by the Chinese government which require security surveillance systems
to
be installed in: (1) 660 cities throughout China for street surveillance; (2)
all entertainment locations starting from March 1, 2006; (3) all Justice
Departments and Courts; and (4) all coal mines in China (currently estimated
at
24,000) from the beginning of 2008.
-24-
We
are
actively pursuing near-term acquisition prospects and other strategic
opportunities. In 2006, we successfully acquired Cheng Feng and the security
and
surveillance business of the Four-Related Companies. We have also recently
announced plans to acquire Hongtianzhi, a China based security camera
manufacturer, and HiEasy, a digital recording system provider focusing on the
research and development of the compression technology industry. In addition,
we
expect to establish an exclusive cooperation relationship with Chuang Guan
in
2007 under which, among other things, Chuang Guan will subcontract or assign
certain of its businesses to our Company to the extent permitted by the
applicable PRC laws and regulations.
We
have a
government policy monitoring group within the Company that regularly monitors
changes in governmental regulations affecting the security and surveillance
industry in China. If we determine that a new regulation or a change to an
existing regulation presents an opportunity for us, we will actively pursue
such
opportunity. As a result, we act promptly on policy changes and are able to
turn
them into business opportunities.
We
also
face the long-term challenge of maintaining our rapid growth. In addition to
maintaining the growth of our existing businesses, we will employ an acquisition
strategy. In addition, to promote the continued growth of the group, we plan
to
explore others areas related to the security and surveillance industry
(including, but not limited to, the fire and alarm sectors, access control,
and
related security and surveillance services) and recurring revenue business
models within our existing business sectors.
Results
of Operations
The
following table summarizes the results of the Company’s operations during the
fiscal years ended December 31, 2006 and 2005 and provides information regarding
the dollar and percentage increase or (decrease) from the 2005 fiscal period
to
the 2006 fiscal period:
All
amounts, other than percentages, in millions of U.S. dollars
|
Years
Ended December 31,
|
|||||||||||||
|
Item
|
2006
|
2005
|
Increase
(Decrease)
|
%
Increase
(%
Decrease)
|
|||||||||
|
Revenue
|
$
|
106.99
|
$
|
32.69
|
74.30
|
227.29
|
%
|
||||||
|
Cost
of Goods Sold
|
75.98
|
23.47
|
52.51
|
223.73
|
%
|
||||||||
|
Gross
Profit
|
31.01
|
9.22
|
21.79
|
236.33
|
%
|
||||||||
|
Operating
Expenses
|
5.67
|
1.74
|
3.93
|
225.86
|
%
|
||||||||
|
Other
Income (expense)
|
1.48
|
0.57
|
0.91
|
159.65
|
%
|
||||||||
|
Provision
for Taxes
|
3.89
|
0.78
|
3.11
|
398.72
|
%
|
||||||||
|
Net
income
|
22.93
|
7.27
|
15.66
|
215.41
|
%
|
||||||||
-25-
The
following table summarizes the results of the Company’s operations during the
fiscal years ended December 31, 2005 and 2004 and provides information regarding
the dollar and percentage increase or (decrease) from the 2004 fiscal period
to
the 2005 fiscal period:
All
amounts, other than percentages, in millions of U.S. dollars
|
Years
Ended December 31,
|
|||||||||||||
|
Item
|
2005
|
2004
|
Increase
(Decrease)
|
%
Increase
(%
Decrease)
|
|||||||||
|
Revenue
|
$
|
32.69
|
$
|
16.06
|
16.63
|
103.55
|
%
|
||||||
|
Cost
of Goods Sold
|
23.47
|
8.80
|
14.67
|
166.70
|
%
|
||||||||
|
Gross
Profit
|
9.22
|
7.26
|
1.96
|
27.00
|
%
|
||||||||
|
Operating
Expenses
|
1.74
|
1.14
|
0.60
|
52.63
|
%
|
||||||||
|
Other
Income (expense)
|
0.57
|
0.47
|
0.10
|
21.28
|
%
|
||||||||
|
Provision
for Taxes
|
0.78
|
0.87
|
(0.09
|
)
|
(10.34
|
)%
|
|||||||
|
Net
income
|
7.27
|
5.72
|
1.55
|
27.10
|
%
|
||||||||
Revenue
Revenue
for the year ended December 31, 2006 increased by 227.29% to $106.99 million
as
compared to $32.69 million for 2005. Such increase was mainly due to the
following factors: First,
the population in China in general has became wealthier, as a result, the demand
for security and surveillance products has also grown. Demand within various
industries and organizations has also been increasing dramatically. Second,
the
Chinese government initiated several programs and regulatory drivers, such
as
the State Ordinance 458 and the “3111” program, that require many public places,
including city-wide surveillance systems, traffic surveillance systems, critical
government locations, cyber cafés, bars and discotheques, to install security
systems. Third, our strategic efforts to increase our distribution channels
during 2004 and 2005 turned out to be a highly successful way to capture the
wave of growth in market demand in 2006. Fourth, we have been successful in
raising sufficient working capital to facilitate expansion in the China market.
Finally, our increased brand recognition in 2006 also contributed significantly
to the growth in sales revenue. Management expects growth in 2007 to remain
strong due to (i) continued strong growth in the security and surveillance
market both within the corporate and government sectors, (ii) better
capitalization of the Company to fuel the growth, (iii) significantly enhanced
branding and profiling in China, and (iv) acquisition strategy intended to
boost
our market share and competitiveness.
Revenue
for the year ended December 31, 2005 increased by 103.55% to $32.69 million
against $16.06 million for 2004. Such increase was mainly due to the growth
of
the Chinese security and surveillance market and the public’s increased
awareness of the importance of having security and surveillance
systems.
Components
of Revenue
The
following table shows the different components comprising our total revenue
over
each of the past three fiscal years.
All
amounts in millions of U.S. dollars
|
Revenue
|
2006
|
2005
|
2004
|
|||||||
|
Project
income from supply and installation of security and surveillance
equipment
|
$
|
94.16
|
$
|
30.56
|
$
|
15.53
|
||||
|
Outright
sale of security and surveillance equipment
|
12.83
|
2.13
|
0.53
|
|||||||
-26-
Income
from installation projects contributed approximately 88% of total revenue in
2006 and was approximately 90% in each of 2004 and 2005. The main reason for
the
increase in outright sales revenue was due to the acquisition of Cheng Feng,
which generates most of its revenues from the sales of security and surveillance
equipment. Management believes that revenues from the installation projects
will
continue to be the Company’s major revenue source in the next a few years. With
the Company putting more resources into research and development, the
acquisition of Cheng Feng and the planned acquisitions as discussed above,
management believes that the percentage of revenue from the outright sale of
products will increase in the future.
Cost
of Goods Sold
Cost
of
goods sold for the year ended December 31, 2006 increased by 223.73% to $75.98
million as compared to $23.47 million for the prior year. Such increase was
mainly attributable to the increase of sales revenue.
Cost
of
goods sold for the year ended December 31, 2005 increased by 166.70% to $23.47
million as compared to $8.80 million in 2004. The increase was generally in
line
with the revenue increase.
The
following table illustrates the items constituting our cost of goods sold.
All
amounts, other than percentages, in millions of U.S. dollars
|
Cost
Item
|
2006
|
2005
|
2004
|
|||||||
|
Purchases
(of
raw material)
|
$
|
74.43
|
$
|
22.38
|
$
|
7.79
|
||||
|
Percentage
|
97.96
|
%
|
95.36
|
%
|
88.52
|
%
|
||||
|
Salary
|
1.55
|
1.09
|
1.01
|
|||||||
|
Percentage
|
2.04
|
%
|
4.64
|
%
|
11.48
|
%
|
||||
|
Total
Percentage
|
100
|
%
|
100
|
%
|
100
|
%
|
||||
Gross
Profit Margin
Our
gross
profit margin increased slightly from 28.20% for the year ended December 31,
2005 to 28.99% for the year ended December 31, 2006. Such increase was mainly
attributable to our efforts in price stabilization and cost controls.
Our
gross
profit margin decreased from 45.21% for the year ended December 31, 2004 to
28.20% for the year ended December 31, 2005. This was mainly attributable to
the
increase in competition in the security and surveillance business and our
strategic decision in taking some projects that had a lower profit margin,
but
were important for gaining market share.
Selling
and Marketing Expenses
Selling
and marketing expenses were $1.51 million for the year ended December 31, 2006,
a $1.22 million increase as compared to $0.29 million for the year ended
December 31, 2005. This was mainly attributable to the increase of our sales
revenue and our increased marketing and advertising campaigns to improve our
brand awareness and market penetration.
-27-
Selling
and marketing expenses were $0.29 million for the year ended December 31, 2005
as compared to $0.39 million for the year ended December 31, 2004. The $0.10
million decrease in selling and marketing expenses was mainly attributable
to
large costs incurred in connection with the initial setting up of branches
in
2004. All of our branch offices were set up by the end of 2004. As a result,
selling and marketing expenses decreased in 2005.
Depreciation
and Amortization
Depreciation
and amortization expenses were $1.12 million for the year ended December 31,
2006, a $0.86 million increase as compared to $0.26 million for the year ended
December 31, 2005. Such increase was mainly attributed to the acquisition of
Cheng Feng and the security and surveillance business of the Four-Related
Companies. The amortization of intangible assets increased as a result of these
acquisitions. In addition, the Company acquired more than $5.00 million of
property, plant and equipment during 2006, including new business premises
and
equipment to improve the production capacity of the Company.
Depreciation
and amortization expenses were $0.26 million for the year ended December 31,
2005 as compared to $0.22 million for the year ended December 31, 2004. Such
slight increase was mainly attributable the acquisition of new
equipments.
General
and Administrative Expenses
General
and administrative expenses were $3.04 million for the year ended December
31,
2006, a $1.85 million increase as compared to $1.19 million for the year ended
December 31, 2005. Such increase was primarily due to the hiring of additional
staff, increased property tax, research and development costs, and professional
expenses incurred in connection with being a public reporting company. The
number of our employees increased from approximately 400 in 2005 to
approximately 580 in
2006.
We believe such increase was generally in line with the increase in our revenue.
General
and administrative expenses were $1.19 million for the year ended December
31,
2005 as compared to $0.51 million for the year ended December 31, 2004. Such
increase was mainly attributable to the increase in daily office expenses
resulted from the expansion of our business and profession fees related to
being
a public reporting company.
Interest
Expense
In
2006,
we borrowed funds under 2 short- term loans and a long- term loan from local
Chinese banks and incurred a total interest expense of $0.11 million. We did
not
incur any finance costs in 2004 and 2005, as we had no bank loans during these
periods.
Income
Tax Expenses
We
incurred
income tax expenses of $3.89 million for the year ended December 31, 2006,
an
increase of 398.72% against $0.78 million for the year ended December 31, 2005.
Such increase was mainly attributable to the increase of sales revenue and
profits.
We
incurred income tax expenses of $0.78 million for the year ended December 31,
2005, a decrease of 10.34% from the $0.87 million for the year ended December
31, 2004. The provision for corporate income tax payable was $1.37 million
in
fiscal year 2005 due to higher revenue and profit. However, a net deferred
tax
asset of $0.59 million was recognized. As a result, the income tax expense
was
reduced to $0.78 million.
-28-
In
accordance with the relevant tax laws and regulations of the People’s Republic
of China for the Shenzhen Special Economic Zone, our Chinese subsidiary Golden
is subject to the Chinese enterprise income tax (“EIT”) rate of 15% for the
fiscal years 2006, 2005, and 2004. Cheng Feng is subject to an EIT rate of
7.5%
due to its software and high technology company status. We anticipate that
our
effective tax rate will change from the current 15% in 2007 because the
companies we acquired and intend to acquire are located in different cities
and
may have different tax rates.
On
March
16, 2007, the National People’s Congress of the PRC determined to adopt 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 will be effective on January 1, 2008. According
to the new corporate income tax law, the applicable income tax rate for our
operating subsidiaries may be subject to change. As the implementation
detail has not yet been announced, we cannot be sure of the potential impact
of
such new corporate income tax law on our financial position and operating
results.
Net
Income
We
earned
a net income of $22.93 million for the year ended December 31, 2006, an increase
of 215.41% against $7.27 million for the year ended December 31, 2005. Such
increase was mainly attributable to the increase in revenue.
We
earned
a net income of $7.27 million for the year ended December 31, 2005, an increase
of 27.10% from $5.72 million for the year ended December 31, 2004. Such increase
was mainly attributable to the increase in revenue.
Net
Income Margin
Net
income margin for the year ended December 31, 2006 was 21.43%, slightly
decreased from the 22.23% for the year ended December 31, 2005. The main reason
for the decrease was the increase in general and administrative expenses in
2006. Management believes that our future net income margin may continue to
decrease slightly due to the increase of costs associated with being a public
company.
Net
income margin for the year ended December 31, 2005 was 22.23%, decreased from
the 35.62% of the year ended December 31, 2004. The decrease was mainly due
to
the increase in general and administrative expenses related to the process
of
becoming a public company.
Amount
Due From/(to) Directors
In
the
past, we made advances to our directors which were non-interest bearing and
repayable upon demand. The balances due were $1 million on December 31, 2004
all
of which were repaid during 2005. Since our reverse acquisition of Safetech
in
September 2005, we have adopted a policy of not making any loans to our
officers, directors or affiliates in order to comply with the requirements
of
the Sarbanes-Oxley Act of 2002.
We
also
received advances from our director to facilitate our operations during the
years ended December 31, 2005 and 2004. Such loans were non-interest bearing
and
were payable upon demand. In 2006, we successfully raised funds from the capital
market and the need for directors to inject capital to facilitate the operations
of the Company no longer existed. The balances due at December 31, 2006 and
2005
were $0.08 million and $0.07 million, respectively. The balance at the end
of
2006 is expected to be paid off by the first quarter of 2007.
Inflation
We
believe our operations have not been materially adversely affected by inflation
or changing prices.
Foreign
Currency Translation Gains
Our
operating subsidiaries are located in China. The operating subsidiaries
purchase all products and render services in China, and receive payment from
customers in China using RMB as the functional currency. We do not engage
in currency hedging.
-29-
We
incurred a foreign currency translation gain of $1.66 million for the year
ended
December 31, 2006 as compared with the foreign currency translation gain of
$0.55 million for the year ended December 31, 2005. On July 21, 2005, China
reformed its foreign currency exchange policy, revalued RMB by 2.1 percent
and
allowed the RMB to appreciate as much as 0.3 percent per day against the U.S.
dollar. As a result, we implemented different exchange rates in translating
RMB
into U.S. dollars in our financial statements for fiscal year 2006. In 2006,
the
exchange rates of 7.80, 7.97 and 8.07 were implemented in calculating the assets
and liabilities, revenue and expenses, and shareholders’ equity, respectively,
which results in a $1.66 million foreign currency translation gain in fiscal
2006.
Liquidity
and Capital Resources
As
of
December 31, 2006, we had cash and cash equivalents of $30.98 million.
The following table provides detailed information about our net cash flow for
all financial statement periods presented in this report.
Cash
Flow
(in
millions of U.S. dollars)
|
Years
Ended December 31,
|
|||
|
2006
|
2005
|
2004
|
|
|
Net
cash provided by (used in) operating activities
|
$2.98
|
$0.80
|
$0.68
|
|
Net
cash provided by (used in) investing activities
|
(11.17)
|
(0.08)
|
(0.11)
|
|
Net
cash provided by (used in) financing activities
|
35.91
|
1.06
|
(1.05)
|
|
Net
cash flow
|
27.72
|
1.78
|
(0.48)
|
Operating
Activities:
Net
cash
provided by operating activities was $2.98 million for
the
year ended December 31, 2006 which is an increase of $2.18 million from
the
$0.80 million net
cash
provided by operating activities for the same period in 2005. The increase
was
mainly due to an increase in net income.
Net
cash
provided by operating activities in 2005 totaled $0.80 million, which is an
increase of $0.12 million from net cash provided by operating activities of
$0.68 million in 2004. The increase was mainly due to an increase in current
liabilities.
Investing
Activities:
Our
main
uses of cash for investing activities during 2006 were payments for the
acquisition of property, plant and equipment and businesses.
Net
cash
used for investing activities in the year ended December 31, 2006 was $11.17
million, which is an increase of $11.09 from
net
cash used for investing activities of $0.08 million in
the
same period of 2005 due to the increased acquisition of property, plant,
equipment and businesses in 2006.
Net
cash
used for investing activities in the year 2005 was $0.08 million, which is
a
decrease of $0.03 million from net cash used for investing activities of $0.11
million in 2004. Such decrease was primarily the result of the decrease in
purchases of fixed assets.
-30-
Financing
Activities:
Net
cash
provided by financing activities in the year ended December 31, 2006 totaled
$35.91 million as
compared to $1.06 provided
by financing activities in 2005. The increase of cash provided by financing
activities was mainly attributable to the issuance of common shares in
connection with several financing transactions closed in 2006.
Net
cash
provided by financing activities was $1.06 million in 2005, an increase of
$2.11
million as compared to $1.05 million used for financing activities in 2004.
Such
increase was mainly attributable to the cash advance made to the Company by
one
of the directors in 2005.
In
2006,
we completed several private placement transactions. In April 2006, we completed
a private placement whereby we raised $8.00 million in gross proceeds, which
left us with approximately $7.35 million in net proceeds after the deduction
of
approximately $0.65 million of offering expenses. In July 2006, we completed
another private placement of our common shares and raised $16.2 million in
gross
proceeds, which left us with approximately $14.9 million in net proceeds after
the deduction of offering expenses in the amount of approximately $1.3 million.
A majority of the net proceeds of these two private placement transactions
was
used for the acquisition of Cheng Feng. In November 2006, we sold an aggregate
of 1,538,462 shares of our common stock for a consideration of $10 million
at a
price of $6.50 per share, raising a total of $10 million in net proceeds. The
proceeds were used primarily to finance our working capital.
In
addition, we have several loan agreements outstanding with various banks. Long
term liabilities are long term loans from banks. As of December 31, 2006, our
total long term liabilities were approximately $2.23 million, consisting of
a
10-year loan from China Construction Bank for the purposes of purchasing new
office premises in Shenzhen. This loan was granted on September 27, 2006. It
matures on September 26, 2016 and has an annual interest rate of
7.524%.
On
August
16, 2006, we entered into a loan agreement with a Chinese bank. We borrowed
RMB
10 million (approximately $1.28 million) with an annual interest rate of 5.94%.
The loan is due on February 16, 2007, and the interest is payable at the end
of
each month. The loan agreement requires us to use the loan proceeds only for
our
operations. The bank has the right to increase the interest rate and demand
repayment of the entire loan principal and unpaid interest if we use the loan
for purpose other than our operations. The loan is guaranteed by Mr. Tu, our
CEO.
On
October 3, 2006, we signed a banking facility agreement with China Construction
Bank, or “CCB,” under which CCB agreed to provide a new receivable based
facility to support our efforts in securing new contracts from the Safe
City
Project initiative
named “Plan 3111.” This facility will provide 3 possible financing options: (1)
the government takes a loan from CCB to finance the project; (2) we sell the
account receivables to CCB. 85% of total account receivables value will be
paid
by CCB to the Company and the remaining 15% will be collected by CCB from the
government. CCB will, in turn, retain the finance charges before paying the
Company; and (3) we take a loan from CCB to finance the project. As part of
this
agreement, we will make periodic deposits with CCB, which, depending upon the
specific project, will provide a maximum factoring capacity of five to ten
times
the amount deposited. None of the facility has been drawn down as of the date
of
this report.
On
November 1, 2005, Cheng Feng entered into a loan agreement with a Chinese bank
in its amount of RMB 6 million (approximately $0.77 million) with an annual
interest rate of 5.76%. The loan is due on November 7, 2007, and the interest
is
payable at the end of each quarter. The loan agreement requires us to use the
loan proceeds only for our operations. The bank has the right to increase the
interest rate and demand repayment of the entire loan principal and unpaid
interest if we use the loan for purpose other than operations.
As
of the
date of this report, we do not anticipate any financing activities to be carried
out in the near future as Management believes that the cash on hand will be
sufficient to finance our operations for the rest of the year and to cope with
our rapid expansion. However, in the event that we identify any other
opportunities of acquisition or business operational expansion, we may seek
further funding.
-31-
We
have
no material commitments for capital expenditures as of December 31, 2006. In
order to facilitate our business expansion, we plan to acquire an industrial
park within Shenzhen. We expect to close the transaction by the end of 2007.
We
believe that our currently available working capital, after receiving the
aggregate proceeds of the capital raising activities and bank loans referred
to
above, should be adequate to sustain our operations at our current levels
through at least the next twelve months.
Contractual
Obligations
Below
is
a table which sets forth our contractual obligations as of December 31,
2006:
|
|
Payments
due by period
|
|||||||||||||||
|
|
Total
|
Less
than 1 year
|
1-3
years
|
3-5
years
|
More
than 5 years
|
|||||||||||
|
Long-Term
Debt Obligations
|
$
|
2,231,960
|
$
|
221,962
|
$
|
670,427
|
$
|
510,643
|
$
|
828,928
|
||||||
|
Operating
Lease Obligations
|
65,702
|
65,702
|
—
|
—
|
—
|
|||||||||||
|
Total
|
$
|
2,297,662
|
$
|
287,664
|
$
|
670,427
|
$
|
510,643
|
$
|
828,928
|
||||||
Critical
Accounting Policies
The
preparation of financial statements, in conformity with accounting principles
generally accepted in the United States, requires our management to make
assumptions, estimates and judgments that affect the amounts reported in the
financial statements, including the notes thereto, and related disclosures
of
commitments and contingencies, if any. We consider our critical accounting
policies to be those that require the more significant judgments and estimates
in the preparation of financial statements, including the
following:
|
·
|
Basis
of Consolidation
-
The consolidated financial statements of the Company and its subsidiaries
are prepared in accordance with accounting principles generally accepted
in the United States of America and include the accounts of the Company
and its subsidiaries. All material inter-company accounts and transactions
have been eliminated in the
consolidation.
|
|
·
|
Intangible
Assets -
Intangible assets represent surveillance recording systems acquired
from
Yuan Da, the acquisition of Cheng Feng and the businesses of the
Four-Related Companies. The value of a surveillance recording system
was
established by an independent accounting firm. The valuations and
allocation of intangible assets for the acquisition of Cheng Feng
and the
businesses of the Four-Related Companies were determined by a third
party
appraisal firm. The value of the recording system is to be amortized
as
the following policies and rates: using the straight-line method
over its
estimated useful life of five years. The values of the intangible
assets
of the acquisition of Cheng Feng and the businesses of the Four-Related
Companies are to be amortized as the following policies and rates:
using
straight-line and accelerated method over its estimated useful life
of two
months to five years.
|
|
·
|
Goodwill
-
Goodwill represents the excess of the purchase price over the net
of the
fair value of the identifiable tangible and intangible assets acquired
and
the fair value of liabilities assumed in acquisitions. SFAS No: 142,
“Goodwill and Other Intangible Assets” (“SFAS142”) requires the testing of
goodwill and indefinite-lived intangible assets for impairment at
least
annually. We test goodwill for impairment in the fourth quarter each
year.
|
-32-
|
·
|
Inventories
-
Inventories are stated at the lower of cost, determined on a weighted
average basis, and 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.
|
·
|
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 EITF issue 00-21. The installation
is
not considered to be essential to the functionality of the equipment
having regard to the following criteria as set out in SAB
104:
|
| (i) |
The
security and surveillance equipment is a standard product with minor
modifications according to customers'
specifications;
|
| (ii) |
Installation
does not significantly alter the security and surveillance equipment's
capabilities; and
|
| (iii) |
Other
companies which possess the relevant licenses are available to perform
the
installation services.
|
In
early
2006, the Company began performing much larger security installation contracts
than it had been doing previously. As a marketing approach, the Company prepared
standard contracts with its new larger customers, whereby 90% of the contract
amount was due when installation was complete and payment of the remaining
10%
was deferred for one year. Because of the newness of the larger contracts and
the inability to immediately determine the amount of warranty work that would
be
required, the Company deferred recognizing the 10% of the contract amount as
revenue until empirical information was available to revise the estimate. During
the second and third quarters of 2006, the Company carefully monitored the
warranty work requested by its customers, and determined that very little
warranty work had been required to be performed.
Consequently,
effective October 1, 2006, the Company reduced its estimate of future warranty
requirements to approximately 1% of contract installation revenue. The fourth
quarter reflects this change in the estimated warranty expenses.
Revenue
from the outright sale of security and surveillance equipment is recognized
when
delivery occurs and risk of ownership passes to the customers.
|
·
|
Foreign
Currency Translation
-
The functional currency of the Company is RMB and RMB is not freely
convertible into foreign currencies. The Company maintains its financial
statements in the functional currency. Monetary assets and liabilities
denominated in currencies other than the functional currency are
translated into the functional currency at rates of exchange prevailing
at
the balance sheet date. Transactions denominated in currencies other
than
the functional currency are translated into the functional currency
at the
exchange rates prevailing at the dates of the transactions. Exchange
gains
or losses arising from foreign currency transactions are included
in the
determination of net income for the respective
periods.
|
For
financial reporting purposes, the financial statements of the Company which
are
prepared using the functional currency have been translated into United States
dollars. Assets and liabilities are translated at exchange rates at the balance
sheet dates and revenue and expenses are translated at the average exchange
rates and shareholders' equity is translated at historical exchange rates.
Any
translation adjustments resulting are not included in determining net income
but
are included in foreign exchange adjustment to other comprehensive income,
a
component of shareholders' equity. The exchange rates adopted are as
follows:
-33-
|
|
2006
|
2005
|
2004
|
|||||||
|
Year
end RMB: exchange rate
|
7.80
|
8.07
|
8.28
|
|||||||
|
Average
yearly RMB: exchange rate
|
7.97
|
8.19
|
8.28
|
|||||||
No
representation is made that the RMB amounts could have been, or could be,
converted into U.S. dollars at the rates used in translation.
|
·
|
Use
of Estimates -
The preparation of the financial statements in conformity with generally
accepted accounting principles in the United States of America 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.
|
|
·
|
Income
Taxes -
Income tax expense is based on reported income before income taxes.
Deferred income taxes reflect the effect of temporary differences
between
assets and liabilities that are recognized for financial reporting
purposes and the amounts that are recognized for income tax purposes.
In
accordance with Statement of Financial Accounting Standard (SFAS)
No. 109,
“Accounting for Income Taxes,” these deferred taxes are measured by
applying currently enacted tax
laws.
|
Seasonality
Our
operating results and operating cash flows historically have been subject to
seasonal variations. Our revenues are usually higher in the second half of
the
year than in the first half of the year because fewer projects are undertaken
during and around the Chinese spring festival.
Off-Balance
Sheet Arrangements
We
do not
have any off-balance sheet arrangements.
Interest
Rate Risk
The
Company deposits surplus funds with Chinese banks earning daily interest. The
Company does not invest in any instruments for trading purposes. The Company's
operations are not sensitive to fluctuations in exchange rates.
Foreign
Exchange Risk
While
our
reporting currency is the U.S. dollar, all of our consolidated revenues and
consolidated costs and expenses are denominated in RMB. All of our assets are
denominated in RMB except for cash. As a result, we are exposed to foreign
exchange risk as our revenues and results of operations may be affected by
fluctuations in the exchange rate between U.S. dollars and RMB. If the RMB
depreciates against the U.S. dollar, the value of our
RMB
revenues, earnings and assets as expressed in our U.S. dollar financial
statements will decline. We have not entered into any hedging transactions
in an
effort to reduce our exposure to foreign exchange risk.
-34-
Inflation
Inflationary
factors such as increases in the cost of our product and overhead costs may
adversely affect our operating results. Although we do not believe that
inflation has had a material impact on our financial position or results of
operations to date, a high rate of inflation in the future may have an adverse
effect on our ability to maintain current levels of gross margin and selling,
general and administrative expenses as a percentage of net revenues if the
selling prices of our products do not increase with these increased
costs.
The
full
text of our audited consolidated financial statements as of December 31, 2006
and 2005 begins on page F-1 of this Annual Report on Form 10-K.
The
following table sets forth certain unaudited financial information for each
of
the eight quarters ended December 31, 2006. The consolidated financial
statements for each of these quarters have been prepared on the same basis
as
the audited consolidated financial statements included in this report and,
in
the opinion of management, include all adjustments necessary for the fair
presentation of the results of operations for these periods. This information
should be read together with our audited consolidated financial statements
and
the related notes included elsewhere in this report.
All
amounts in thousands of U.S. dollars
|
2006
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
Total
|
|||||||||||
|
Revenue
|
$
|
14,594
|
$
|
8,015
|
$
|
43,448
|
$
|
40,932
|
$
|
106,989
|
||||||
|
|
||||||||||||||||
|
Gross
profit
|
$
|
4,397
|
$
|
3,037
|
$
|
12,862
|
$
|
10,717
|
$
|
31,013
|
||||||
|
|
||||||||||||||||
|
Income
before income taxes and minority interest
|
$
|
4,121
|
$
|
2,858
|
$
|
11,025
|
$
|
8,807
|
$
|
26,811
|
||||||
|
|
||||||||||||||||
|
Net
income
|
$
|
3,500
|
$
|
2,536
|
$
|
10,262
|
$
|
6,633
|
$
|
22,931
|
||||||
|
|
||||||||||||||||
|
Basic
income per share
|
$
|
0.26
|
$
|
0.10
|
$
|
0.40
|
$
|
0.12
|
$
|
0.88
|
||||||
|
|
||||||||||||||||
|
Diluted
income per share
|
$
|
0.26
|
$
|
0.10
|
$
|
0.39
|
$
|
0.10
|
$
|
0.85
|
||||||
|
|
||||||||||||||||
|
2005
|
||||||||||||||||
|
|
||||||||||||||||
|
Revenues
|
$
|
7,252
|
$
|
5,477
|
$
|
12,536
|
$
|
7,423
|
$
|
32,688
|
||||||
|
|
||||||||||||||||
|
Gross
profit
|
$
|
1,542
|
$
|
1,338
|
$
|
4,298
|
$
|
2,037
|
$
|
9,215
|
||||||
|
|
||||||||||||||||
|
Income
before income taxes and minority interest
|
$
|
1,716
|
$
|
967
|
$
|
4,148
|
$
|
1,215
|
$
|
8,046
|
||||||
|
|
||||||||||||||||
|
Net
income
|
$
|
2,618
|
$
|
1,210
|
$
|
3,365
|
$
|
73
|
$
|
7,266
|
||||||
|
|
||||||||||||||||
|
Basic
income per share
|
$
|
0.15
|
$
|
0.07
|
$
|
0.16
|
$
|
0.01
|
$
|
0.39
|
||||||
|
|
||||||||||||||||
|
Diluted
income per share
|
$
|
0.15
|
$
|
0.07
|
$
|
0.16
|
$
|
0.01
|
$
|
0.39
|
||||||
-35-
None.
We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed by us in the reports that we file or submit
to the Securities and Exchange Commission under the Exchange Act, is recorded,
processed, summarized and reported within the time periods specified by the
Securities and Exchange Commission’s rules and forms, and that information is
accumulated and communicated to our management, including our Chief Executive
Officer and our Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. The effectiveness of our disclosure
controls and procedures is subject to certain limitations, including the
exercise of judgment in designing, implementing and evaluating the controls
and
procedures, the assumptions used in identifying the likelihood of future events,
and the inability to eliminate errors or misconduct completely. As a result,
there can be no assurance that our disclosure controls and procedures will
detect all errors or fraud. By their nature, any system of internal control,
including our system, can provide only reasonable assurance regarding
management’s control objectives.
Under
the
supervision and with the participation of our management, including our Chief
Executive Officer and our Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Exchange Act) as December
31,
2006, the end of the period covered by this report. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of December 31, 2006.
Management
does not expect that the Company’s disclosure controls and procedures or its
internal control over financial reporting will prevent or detect all errors
and
all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control systems are met. Further, the design of a control system must reflect
the fact that there are resource constraints, and the benefits of controls
must
be considered relative to their costs. Because of the inherent limitations
in a
cost-effective control system, no evaluation of internal control over financial
reporting can provide absolute assurance that misstatements due to error or
fraud will not occur or that all control issues and instances of fraud, if
any,
within the Company have been detected.
As
part
of our normal operations, we update our internal controls as necessary to
accommodate any modifications to our business processes or accounting
procedures. There have not been any other changes in our internal controls
or in
other factors that materially affected, or are reasonably likely to materially
affect these controls as of the end of the period covered by this
report.
None.
-36-
Information
required by Item 10 of Part III is included in our Proxy Statement relating
our 2007 Annual Meeting of Stockholders and is incorporated herein by
reference.
Information
required by Item 11 of Part III is included in our Proxy Statement relating
our 2007 Annual Meeting of Stockholders and is incorporated herein by reference.
Information
required by Item 12 of Part III is included in our Proxy Statement relating
our 2007 Annual Meeting of Stockholders and is incorporated herein by reference.
Information
required by Item 13 of Part III is included in our Proxy Statement relating
our 2007 Annual Meeting of Stockholders and is incorporated herein by reference.
Information
required by Item 14 of Part III is included in our Proxy Statement relating
our 2007 Annual Meeting of Stockholders and is incorporated herein by
reference.
(a) The
following
documents are filed as part of this report:
(1) Financial
Statements
The
consolidated financial statements filed as part of this Form 10-K are located
as
set forth in the index on page F-1 of this report.
(2) Financial
Statement Schedules
Not
applicable.
(3) Exhibits
The
list
of exhibits included in the attached Exhibit Index is hereby incorporated herein
by reference.
-37-
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf
by
the undersigned, thereunto duly authorized.
Date:
March
21,
2007
|
|
CHINA
SECURITY & SURVEILLANCE TECHNOLOGY,
INC.
|
|
|
|
By:
|
/s/
Guoshen Tu
|
|
|
|
Guoshen
Tu
Chief
Executive Officer and
President
|
|
|
By:
|
/s/
Terence Yap
|
|
|
|
Terence
Yap
Chief
Financial Officer
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the Company in the capacities
and on the dates indicated.
Each
person whose signature appears below hereby authorizes Guoshen Tu and Terence
Yap, or any of them, as attorneys-in-fact to sign on his behalf, individually,
and in each capacity stated below, and to file all amendments and/or supplements
to this Annual Report on Form 10-K.
|
Signature
|
Date
|
|||
|
/s/
Guoshen Tu
|
Chief
Executive Officer, President and director
|
March
21, 2007
|
||
|
Guoshen
Tu
|
(Principal Executive Officer) | |||
|
/s/
Terence Yap
|
Chief
Financial Officer and director
|
March
21, 2007
|
||
|
Terence
Yap
|
(Principal
Financial Officer and Principal Accounting Officer)
|
|||
|
/s/
Shufang Yang
|
Chief
Operating Officer and director
|
March
21, 2007
|
||
|
Shufang
Yang
|
||||
|
/s/
Lingfeng Xiong
|
Vice
President and director
|
March
21, 2007
|
||
|
Lingfeng
Xiong
|
||||
|
/s/
Jiangguo Jiang
|
Vice
President and director
|
March
21, 2007
|
||
|
Jiangguo
Jiang
|
-38-
FINANCIAL
STATEMENTS.
CHINA
SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND
SUBSIDIARIES
CONSOLIDATED
FINANCIAL STATEMENTS
FOR
THE YEARS ENDED
DECEMBER
31, 2006, 2005 AND 2004
CHINA
SECURITY & SURVEILLANCE TECHNOLOGY, INC.
AND
SUBSIDIARIES
TABLE
OF CONTENTS
|
|
Pages
|
|
|
|
|
Reports
of Independent Registered Public Accounting Firms
|
F2 -
F3
|
|
|
|
|
Consolidated
Balance Sheets as of December 31, 2006 and 2005
|
F4
|
|
|
|
|
Consolidated
Statements of Income and Comprehensive Income for the
|
|
|
years
ended December 31, 2006, 2005 and 2004
|
F5
|
|
|
|
|
Consolidated
Statements of Changes in Shareholders' Equity for the
|
|
|
years
ended December 31, 2006, 2005 and 2004
|
F6
|
|
|
|
|
Consolidated
Statements of Cash Flows for the years ended December 31,
|
|
|
2006,
2005 and 2004
|
F7
- F8
|
|
|
|
|
Notes
to Consolidated Financial Statements for the years ended December
31,
2006, 2005 and 2004
|
F9
- F27
|
F-1
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The
Board
of Directors and Shareholders
China
Security & Surveillance Technology, Inc.
We
have
audited the accompanying consolidated balance sheets of China Security &
Surveillance Technology, Inc. and subsidiaries as of December 31, 2006 and
2005
and the related consolidated statements of income and comprehensive income,
changes in shareholders' equity and cash flows for each of the years in the
two-year period ended December 31, 2006. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an
opinion on these financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present
fairly,
in all material respects, the financial position of China Security &
Surveillance Technology, Inc. and subsidiaries as of December 31, 2006 and
2005,
and the results of their operations and their cash flows for each of the
years
in the two-year period ended December 31, 2006 in conformity with accounting
principles generally accepted in the United States of America.
/s/
GHP
Horwath, P.C.
GHP
Horwath, P.C.
Denver,
Colorado
March
21,
2007
F-2
 |
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
The Board of Directors and Stockholders
China
Security & Surveillance Technology, Inc.
We
have audited the accompanying consolidated statements of income
and
comprehensive income, changes in shareholders’ equity and cash flows of
Golden Group Corporation (Shenzhen) Ltd. (predecessor to China
Security
& Surveillance Technology, Inc.) for the year ended December 31,
2004.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
financial
statements based on our audit.
We
conducted our audit in accordance with the standards of the Public
Company
Accounting Oversight Board (United States of America). Those standards
require that we plan and perform the audit to obtain reasonable
assurance
about whether the financial statements are free of material misstatement.
The Company was not required to have, nor were we engaged to perform,
an
audit of its internal control over financial reporting. Our audit
included
consideration of internal control over financial reporting, as
a basis for
designing audit procedures that are appropriate in the circumstances,
but
not for the purpose of expressing an opinion on the effectiveness
of the
Company’s internal control over financial reporting. Accordingly, we
express no such opinion. An audit includes examining, on a test
basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our
audit
provides a reasonable basis for our opinion.
In
our opinion, the financial statements referred to above present
fairly, in
all material respects, the results of operations and cash flows
of Golden
Group Corporation (Shenzhen) Ltd. (predecessor to China Security
&
Surveillance Technology, Inc.) for the year ended December 31,
2004, in
conformity with accounting principles generally accepted in the
United
States of America.
/s/
Child, Van Wagoner & Bradshaw, PLLC
Child,
Van Wagoner & Bradshaw, PLLC
Salt
Lake City, Utah
September
1, 2005
|
F-3
CHINA
SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND
SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS AS OF DECEMBER 31, 2006 AND 2005
Expressed
in thousands of U.S. dollars
(Except
for share and per share amounts)
|
ASSETS
|
|||||||
|
|
December
31,
2006
|
December
31,
2005
|
|||||
|
CURRENT
ASSETS
|
|
|
|||||
|
Cash
and cash equivalents
|
$
|
30,980
|
$
|
2,277
|
|||
|
Accounts
receivable, net
|
26,754
|
11,643
|
|||||
|
Related
party receivables
|
440
|
3,783
|
|||||
|
Inventories,
net
|
19,721
|
5,311
|
|||||
|
Prepayment
and deposits
|
3,533
|
—
|
|||||
|
Advances
to suppliers
|
2,889
|
1,493
|
|||||
|
Other
receivables
|
1,697
|
415
|
|||||
|
Deferred
tax assets - current portion
|
125
|
129
|
|||||
|
Total
current assets
|
86,139
|
25,051
|
|||||
|
|
|||||||
|
Plant
and equipment, net
|
8,339
|
1,952
|
|||||
|
Land
use rights, net
|
1,152
|
1,142
|
|||||
|
Intangible
assets
|
9,997
|
511
|
|||||
|
Investment,
at cost
|
12
|
—
|
|||||
|
Goodwill
|
8,426
|
—
|
|||||
|
Deferred
tax assets - non-current portion
|
462
|
460
|
|||||
|
TOTAL
ASSETS
|
$
|
114,527
|
$
|
29,116
|
|||
|
|
|||||||
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|||||||
|
CURRENT
LIABILITIES
|
|||||||
|
Notes
payable - short term
|
$
|
2,272
|
$
|
—
|
|||
|
Accounts
payable
|
4,000
|
1,077
|
|||||
|
Accrued
expenses
|
749
|
763
|
|||||
|
Advances
from customer
|
5,432
|
—
|
|||||
|
Taxes
payable
|
1,660
|
1,115
|
|||||
|
Payable
for acquisition of business
|
7,500
|
593
|
|||||
|
Deferred
income
|
831
|
887
|
|||||
|
Due
to director
|
76
|
70
|
|||||
|
Deferred
tax liabilities
|
84
|
—
|
|||||
|
Total
current liabilities
|
22,604
|
4,505
|
|||||
|
|
|||||||
|
LONG
TERM LIABILITIES
|
|||||||
|
Notes
payable - long term
|
2,010
|
—
|
|||||
|
Total
liabilities
|
24,614
|
4,505
|
|||||
|
MINORITY
INTEREST IN CONSOLIDATED SUBSIDIARIES
|
94
|
—
|
|||||
|
SHAREHOLDERS'
EQUITY
|
|||||||
|
Common
stock, $0.01 par value; 100,000,000 shares authorized 31,824,938
(2006)
and 21,558,000 (2005) shares issued and outstanding
|
319
|
216
|
|||||
|
Additional
paid-in capital
|
45,004
|
4,494
|
|||||
|
Retained
earnings
|
41,483
|
18,552
|
|||||
|
Statutory
surplus reserve fund
|
804
|
804
|
|||||
|
Accumulated
other comprehensive income
|
2,209
|
545
|
|||||
|
Total
shareholders' equity
|
89,819
|
24,611
|
|||||
|
TOTAL
LIABILITIES AND SHAREHOLDERS' EQUITY
|
$
|
114,527
|
$
|
29,116
|
|||
See
accompanying notes to the consolidated financial
statements.
F-4
CHINA
SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR
THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Expressed
in thousands of U.S. dollars
(Except
for share and per share amounts)
|
|
2006
|
2005
|
2004
|
|||||||
|
|
|
|
|
|||||||
|
|
|
|
|
|||||||
|
Revenues
|
$
|
106,989
|
$
|
32,688
|
$
|
16,056
|
||||
|
Cost
of goods sold
|
75,976
|
23,473
|
8,796
|
|||||||
|
Gross
profit
|
31,013
|
9,215
|
7,260
|
|||||||
|
|
||||||||||
|
Selling
and marketing
|
1,511
|
288
|
391
|
|||||||
|
|
||||||||||
|
General
and administrative
|
3,036
|
1,189
|
513
|
|||||||
|
|
||||||||||
|
Depreciation
and amortization
|
1,124
|
260
|
225
|
|||||||
|
Income
from operations
|
25,342
|
7,478
|
6,131
|
|||||||
|
|
||||||||||
|
Rental
income from related parties
|
496
|
439
|
478
|
|||||||
|
Other
income (expense), net
|
711
|
120
|
(25
|
)
|
||||||
|
Interest
income
|
63
|
9
|
13
|
|||||||
|
Interest
expense
|
(108
|
)
|
—
|
—
|
||||||
|
Gain
on sale of affiliated company
|
307
|
—
|
—
|
|||||||
|
Income
before income taxes and minority interest
|
26,811
|
8,046
|
6,597
|
|||||||
|
Minority
interest in income of consolidated subsidiaries
|
9
|
—
|
—
|
|||||||
|
Income
taxes
|
(3,889
|
)
|
(780
|
)
|
(873
|
)
|
||||
|
Net
income
|
22,931
|
7,266
|
5,724
|
|||||||
|
Foreign
currency translation gain
|
1,664
|
545
|
—
|
|||||||
|
COMPREHENSIVE
INCOME
|
$
|
24,595
|
$
|
7,811
|
$
|
5,724
|
||||
|
|
||||||||||
|
NET
INCOME PER SHARE
|
||||||||||
|
BASIC
|
$
|
0.88
|
$
|
0.39
|
$
|
0.34
|
||||
|
DILUTED
|
$
|
0.85
|
$
|
0.39
|
$
|
0.34
|
||||
|
WEIGHTED
AVERAGE NUMBER OF SHARES OUTSTANDING
|
||||||||||
|
BASIC
|
26,052,519
|
18,521,479
|
17,000,000
|
|||||||
|
DILUTED
|
26,940,215
|
18,521,479
|
17,000,000
|
|||||||
See
accompanying notes to the consolidated financial statements.
F-5
CHINA
SECURITY & SURVEILLANCE TECHNOLOGY, INC. AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR
THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Expressed
in thousands of U.S. dollars
(Except
for share and per share amounts)
|
|
|
|
|
|
|
|||||||||||||||||
|
|
Common
Stock Shares
|
Par
Value
|
Additional
Paid-in
Capital
|
Retained
Earnings
|
Accumulated
Other
Comprehensive
Income
|
Statutory
Surplus
Reserve Fund
|
Total
|
|||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||
|
BALANCE
AT JANUARY 1, 2004
|
17,000,000
|
$
|
170
|
$
|
4,540
|
$
|
6,366
|
$
|
—
|
$
|
—
|
$
|
11,076
|
|||||||||
|
Net
income for the year
|
—
|
—
|
—
|
5,724
|
—
|
—
|
5,724
|
|||||||||||||||
|
BALANCE
AT DECEMBER 31, 2004
|
17,000,000
|
170
|
4,540
|
12,090
|
—
|
—
|
16,800
|
|||||||||||||||
|
Common
stock issued for consulting services
|
1,420,000
|
14
|
||||||||||||||||||||