Chinese company has growing receivables issues

Telestone Technologies Corp. (Nasdaq: TSTC) doubled its
sales last year, with nearly all of the gains coming from the three big players
in China’s burgeoning wireless communications market.

The Beijing-based company, which provides equipment and
services to mobile telecommunications providers, reported revenue of $71.9
million and earnings of $12.5 million. It is projecting additional gains this
year, with sales rising to $129.4 million and profits jumping to $22.9 million.

But Sharesleuth’s review of Telestone’s SEC filings shows
that the company ended 2009 with $95.2 million in accounts receivable, before
adjustments for doubtful payments. That equates to all of its revenue for last
year, plus more than two-thirds of its revenue from the previous year.

At the end of this year’s first quarter — a period in which
Telestone reported $11.1 million in revenue – the company’s accounts receivable
still stood at $96.6 million, indicating that it made relatively little
progress in collecting on its outstanding bills.

Telestone said in its financially summary that its “Days
Sales Outstanding,” the average number of days it takes to collect revenue
after a sale, stood at 673 days. That’s the highest such figure Sharesleuth has
ever seen, and was up sharply from the 358 days the company listed at the end
of 2009.

Put another way, nearly all of Telestone’s reported growth
and earnings — which fueled a 20-fold increase in its stock price between
March 2009 and January of this year — was linked to revenue that the company had not yet collected and might
have continued difficulty collecting.

Telestone’s stock closed Wednesday at $13.52, giving it a market
capitalization of $142.6 million. The company is scheduled to announce its
quarterly results after the markets close on Thursday, and that report is
likely to include an update on its accounts receivable collections.

(Update: Telestone reported revenue of $16.6 million for the second quarter. It said its accounts receivable, before allowances for doubtful accounts, rose to $107.1 million, while its Days Sales Outstanding fell to 483 days). 

Telestone’s large backlog of receivables is significant for
investors because companies that are unable to convert sales to cash in a
timely manner often must fund their operations by taking on debt, which cuts
into earnings, or selling additional shares, which dilutes existing
shareholders.

Sharesleuth also noted that the SEC filings for Telestone’s
three main customers show that Telestone’s  characterization of its accounts receivable situation does
not necessarily square with the numbers and narratives in its customers’
financial reports.

Sharesleuth is not alleging any wrongdoing by Telestone. But
we think that investors who are considering the company because of its sharp
increase in sales and earnings and its attractive profit margins might want to
know more about the underlying numbers.

(Disclosure: No one affiliated with Sharesleuth.com has any position, short or long, in Telestone’s shares) 

CUSTOMERS

Telestone says that its three main customers – China Mobile
Ltd., China Unicom (Hong Kong) Ltd. and China Telecom Corp. — are large,
healthy companies that are unlikely to default on their obligations. It noted,
however, that it has little bargaining power over those companies, and thus
must enter into agreements with them on less favorable terms than it can
negotiate with other customers.

That power dynamic, Telestone says, is one reason for the
backlog of accounts receivables. The company also said in its SEC filings that
consolidation, restructuring and rapid growth in the Chinese telecommunications
industry is contributing to the delay in payments.

In response to questions submitted by Sharesleuth, Telestone
also noted that the nature of its business is an additional complication
because the branch offices of the Big 3 wireless companies are responsible for
approving projects and making payments – not the corporate headquarters.

“For Telestone to get paid after our project is completed
and approved, Big 3 Provincial offices “apply” for funds to pay for LAN (local area network) installation from Corporate,” Telestone said in a written reply to
Sharesleuth’s questions. “This is not as quick a process as we would like to
see as it adds several months to the actual payment of the invoice. Though we
invoice the local offices quickly and accordingly, by the time their
communication with corporate HQ is complete, several months have passed.”

CHINA MOBILE

China Mobile – Telestone’s biggest customer over the past
two years – said in its annual report with the SEC that it had no accounts
payable extending beyond 12 months, or 365 days. China Mobile provided $32.6
million of Telestone’s revenue last year and $16.7 million in 2008.

China Mobile said that more than three-quarters of its
payables to suppliers and other parties were due within one month, and that
more than 90 percent were due within three months.

The company also said this: “All of the accounts payable are
expected to be settled within one year or are repayable on demand.” Thus,
China Mobile’s filing suggests that Telestone already should have been paid for
much of its 2009 work and all of the 2008 work.

China Mobile has billions of dollars of cash on its balance
sheet, indicating that the ability to pay suppliers is not a problem.

Sharesleuth sent China Mobile a list of questions about its
accounts payable and Telestone’s accounts receivable. Although the company’s
investor relations manager responded to our email, he did not answer the
questions.

CHINA UNICOM

Telestone got almost as much revenue from China Unicom in
the past two years as it did from China Mobile.

Together, the wireless companies accounted for roughly 90
percent of Telestone’s sales for that period.According to Telestone, China Unicom accounted for $32.7
million of its revenue in 2009, and $15 million in 2008.

China Unicom said in its annual filing with the SEC that
roughly 87 percent of its accounts payable at the end of 2009 were due within
six months, and that an additional 4.5 percent were due in six months to a
year. It said the remaining 8.5 percent were due in more than a year.

The filing showed that those percentages were little changed
from the previous year, indicating that even as China Unicom grew, the time
horizons for its payments to contractors, equipment suppliers and
telecommunications product vendors did not slip.

China Unicom did not respond to a list of questions
submitted by Sharesleuth.

Neither China Unicom nor China Mobile reported any
delinquencies in their accounts payables.

NEW  EXECUTIVES

Telestone has made three key executive appoints in recent
months. The company announced on May 12 that it had appointed Xiaoli Yu as its
new chief financial officer. She replaced Hong Li, who the company said stepped
down for personal reasons.

In the same press release, Telestone announced that
Vicente Liu had joined the company as vice president of finance. The company
said he previously worked for Oppenheimer & Co.’s investment banking
division and was China representative for Cowen & Co.’s Asian investment
banking unit.

Telestone said at the start of June that Guobin Pan, a
10-year company veteran, had been promoted to president. Daqing Han, chairman
and chief executive, noted that Pan’s extensive relationships with Chinese
wireless carriers and his management oversight and marketing efforts
contributed significantly to Telestone’s revenue growth over the past year. 

SEC filings show that Telestone had $10 million in cash at
the end of the first quarter, down from $11.2 at the start of the year. The
company had $5.85 million in debt, more than half of which was secured by
receivables, and has noted that it could tap additional credit if necessary.

Telestone filed a shelf registration in March covering the
potential sale of as much as $150 million in new stock or other securities.

FIRST U.S. NETWORK DEAL

Telestone announced Monday that it had received its first
local access network contract in the United States, for a wireless
communications system at a Houston hospital. It said in a press release that
the project would be worth $2 million and would be completed by the end of the
year.

But the head of Teleston’s American partner told Sharesleuth
that some information in the release might have been lost in translation.

The initial
phase of the contract – the only part that has been formally approved — is
worth roughly $200,000 in equipment sales for Telestone, said David Ballard,
owner of Quell corp., which specializes in cellular coverage systems for
hospitals, government buildings and other properties.

That first phase should be finished by the end of December,
Ballard said. The additional phases of the project would bring Telestone the
remaining $1.8 million in sales, but that work will not materialize until next
year, he said.

A RIVAL’S RECEIVABLES

Telestone is not alone in having large receivables balances
with China Mobile, China Unicom and China Telecom.

China GrenTech Corp. (Nasdaq: GRRF), one of Telestone’s
competitors in the Chinese wireless communications market, said in its latest
annual filing
with the SEC that it also had a large backlog of outstanding
bills with those three companies and their local affiliates.

China GrenTech had $234.8 million in revenue last year, up
more than 60 percent from the previous year. The company said it had $197.8
million in gross receivables and $130.7 million in net receivables. It noted
that it typically sells some of its receivables to Chinese banks to help
maintain its cash flow.

China GrenTech said its receivables turnover was averaging
292 days at the end of 2009, down from 469 days at the end of 2008. The company
said $113.4 million of its gross receivables had been outstanding for less than
a year. It said $34 million had been outstanding for one to two years, $34.7
million had been outstanding for two to three years, and $15.7 million had been
outstanding for more than three years.

The company said $91 million of its receivables had come due
under the terms of its contracts with customers, but had remained unpaid.

Unlike Telestone, China GrenTech’s stock has lost ground
over the past year, and is currently trading for a little over $2 a share.

Another of Telestone’s competitors, Comba Telecom Systems
Holdings Ltd.
(Pink Sheets: COBJF.PK), said its accounts receivable turnover
was 139 days at the end of last year, compared with 171 days at the end of
2008.

Telestone attributed the varying collection periods to
differing business models. 

“We have a longer accounts receivable turnover period than
our main competitors due to our revenue generated from a higher mix of system
integration products,” said Wanchang “Winnie” Hong, an assistant to
Telestone’s chief financial officer, in an email response to our questions. “Our
main competitors are more focused on equipment sales, which tend to have
shorter receivable turnover periods.”

TELESTONE’S
REVENUE MIX

Telestone’s revenue for 2009 consisted of $30.2 million in
equipment sales and $41.7 million from service agreements, primarily the creation of local area networks in office buildings to provide wireless access for computers, cell phones and PDAs. Its $71.9 million in
total sales was more than double the $35.3 million it reported for 2008.

Telestone’s net income — $12.5 million – was up 78 percent
from the previous year.

The company’s annual filing with the SEC showed that its
receivables at Dec. 31 were up nearly 50 percent from the end of 2008, when the
balance was $62.1 million.

Telestone noted in its earnings release for 2009 that it had
made progress on the accounts receivable front, cutting its days sales
outstanding to 358 days, from 553 days at the end of 2008. However, its average
for the first quarter of 2010 represented a sharp reversal.

Telestone’s gross receivables at the end of last year did
not include $6.17 million in allowances for doubtful accounts – a figure that
was up slightly from $5.78 million in allowances at the end of 2008.

In an investor presentation in February, Telestone provided
a snapshot of one of its contracts, a wireless communications system for an
office building in China’s Anhui province. It broke down the payment terms as
follows: 10 percent at the start of the contract, 60 percent at six months, 20
percent at nine months and 10 percent at 24 months, which marks the end of the
company’s warranty period.

That summary suggests that Telestone should receive at least
70 percent of the revenue owed under such contracts within six months, and
should have 90 percent of the total within nine months.

Telestone said in its annual SEC filing that most of its
receivables had a credit period of six to nine months. It added that roughlly 10
percent of the value of each service contract is not payable until the 24-month
warranty period expires.

QUARTERLY
FLUCTUATIONS

Although Telestone had just $11.1 million in revenue for the
first quarter, it nevertheless told investors to expect more than $129 million
in revenue for all of 2010. SEC filings show that for the past three years,
Telestone has booked roughly half of its annual revenue in the final quarter of
each year.

SEC filings show that the company reported $38.9 million in
revenue for the first nine months of 2009, and finished the year with $71.9
million. Similarly, it had $20.9 million in revenue through the first three quarters
of 2008, and ended that year with $35.3 million.

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