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Telestone Technologies Corp (NASDAQ:TSTC)

Q2 2012 Results Conference Call

August 15, 2012 08:30 AM ET

Executives

John Harmon – CCG Investor Relations

Han Daqing – Chairman and CEO

Xiaoli Yu – Chief Financial Officer

Jun Man – Manager, Office of the Board of Directors

Operator

Good day, ladies and gentlemen, and welcome to the Telestone Technologies Corp second quarter 2012 financial results conference call. All participants will be listen-only mode. (Operator Instructions).

After today's presentation there will be an opportunity to ask questions. (Operations Instructions). Please note this event is being recorded I would now like to turn the conference over to Mr. John Harmon, of CCG Investor Relations.

John Hormon

Thank you, Janine. Good morning, and good evening to everyone in China, welcome to Telestone Technology's second quarter 2012 conference call. Present today at Telestone Technology's Chairman CEO, Mr. Han Daqing; Chief Financial Officer, Mr. Xiaoli Yu, and Mr. Jun Man, Manager of the Office of the Board of Directors.

Before I turn the call over to Man Jun, I would like to remind our listeners that management's remarks in this call contain forward looking statements, which are subject to risks and uncertainties and management may make additional forward-looking statements in response to your questions.

Therefore the company claims protection for the Safe Harbor for forward-looking statements, that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ to those discussed today, with such risks as but not limited to changes in the company's products and sales and marketing strategy, targets of revenues, net income sales WFDS products, international sales accounts receivable and DSOs, and general information detailed from time to time in the company's filing and futre filings with the united states securities and exchange commission.

Although the company believes that the expectation on such quarterly income statements are reasonable, there is no assurance, of such expectations will prove to be correct. In addition, any projections of the company's future performance, represents Management's estimates as of today, Wednesday August 15, 2012. Telestone Technologies assumes no obligation to update these projections in the future, but markets conditions change.

In the conference call, we will discuss adjusted non-GAAP financial measures. These adjusted financial measures which are used to measure sort of Company's performance, should be considered in addition to – not as a substitute for a – measure of the Company's financial performance prepared in accordance with the United States Generally Accepted Accounting Principles or GAAP.

The company, suggests financial measures maybe defined differently, than similar trends (Inaudible) [0:02:33] by other companies, accordingly, care should be exercised in understanding of the company defines it's adjusted financial measures.

Reconciliations of the company's adjusted (Inaudible) [0:02:42] revenues, GAAP measures were set forth in the section titled reconciliation of GAAP to non-GAAP results, in the earnings press release, sent to the wireless services this morning, there will be out shortly.

For those of you unable to listen to the entire call this time today's call is also being webcast and an archive will be available for 1 year. Information on how to access the webcast is available in the press release. And now it's my pleasure to turn the call over to Mr. Jun Man, Secretary of Telestone's Board of Director, who'll read the remarks for Telestone's Chairman and CEO Mr. Han.

After that I will read Telestone's financial commentary and outlook. Mr. Man.

Jun Man

Thank you, John. Welcome everyone and thank you for joining us. Despite continued industry headwinds we posted sequentially higher revenues in the second quarter and although the year-over-year comparison was still a challenge, revenues were largely in line with our expectations. Although we reported a loss in the second quarter, this was largely due to current weak capital spending environment, and allowance for doubtful accounts which is in line with our expectations.

This year, we have deliberately moderated our top line growth in order to improve collections so that we can position Telestone for a return to growth and focus on developing our U-DAS, or WFDS and TIPS technologies.

The following are the key points in Telestone's business performance in the second quarter of 2012, revenues were $17.9 million, a decrease of 26.6% as compared to $24.3 million in the year-ago quarter. Gross profit was $6.6 million, as compared to $10.6 million in the year-ago quarter.

Net loss was $1.3 million, or $0.09 per diluted share; non-GAAP net loss was $1.2 million, or $0.08 per diluted share. In addition, during the second quarter a related company received an initial RMB2.5 million or US$0.4 million investment from Zhongguancun Development Group for the research, development and commercialization of Telestone Intelligent Premise System Technology.

This investment is part of a RMB15 million or US$2.4 million total commitment awarded in May, which the Group is expected to fulfill over the next three to five years.

John Harmon

Now, I will read Telestone's second quarter 2012 financial commentary. Revenues in the second quarter of 2012 were $17.9 million, a 26.6% decrease from $24.3 million in the year-ago quarter. The year-over-year decrease in revenue was primarily attributable to a slow start to 4G network construction, the maturity of 3G deployment, intensified competition, and the Company's strategic moderation of growth in certain cities with longer accounts receivable collection periods.

Equipment sales decreased 32.6% to $6.0 million from $8.8 million in the year-ago quarter. Sales of Professional Services declined 23.2% to $11.9 million, as compared to $15.5 million in the year-ago quarter. Equipment sales declined more than sales of professional services due to market share changes in a more competitive equipment market.

Sales to non-telecom operators and overseas customers amounted to approximately [$2.0 million] in the second quarter, or 18.4% of total revenue. Sales of WFDS-enabled products were $5.6 million, accounting for 31.4% of sales in the quarter, representing a decrease of 1.2% from $5.7 million, or 23.4% of sales in the year-ago quarter.

In the second quarter, revenue from the Big-3 telecom carriers; China Mobile, China Unicom, and China Telecom, comprised 81.6% of total quarterly revenue, that's compared to 94.3% in the year-ago quarter.

Gross profit in the second quarter was $6.6 million, as compared to $10.6 million in the year-ago quarter. The gross margin decreased to 37.1% from 43.7% in the year-ago quarter. The year-over-year gross margins increased resulting from a lower margins contributions from (Inaudible).

Total operating expenses were $7.6 million, an increase of 47.7% from $5.1 million in the year-ago quarter. Sales and marketing expense was $3.0 million, roughly flat with the year-ago quarter. General and administrative expenses were $3.8 million, as compared to $1.4 million in the year-ago quarter. The increase in general and administrative expenses was primarily due to a $1.9 million allowance for doubtful accounts.

Research and development expense was $0.6 million, or 3.2% of revenues for the quarter, as compared to $0.6 million or 2.5% of revenues in the year-ago quarter. The operating loss was $1.0 million, as compared to operating income of $5.5 million in the year-ago quarter.

The net loss of $1.3 million, as compared to net income of $4.5 million in the year-ago quarter. Both basic and diluted loss per share in the second quarter of 2012 were $0.09 as compared to earnings per basic and diluted share of $0.37 in the year-ago quarter. Non-GAAP net loss, which excludes $0.2 million of non-cash stock compensation expense, was $1.2 million, as compared to non-GAAP net income of $5.0 million in the year-ago quarter.

The non-GAAP loss per diluted share was $0.08, versus non-GAAP earnings per share of $0.40 in the year-ago quarter.

Next, I'll discuss the six-months results.

Revenue for the six months ended June 30, 2012 was $35.0 million, a 9.9% decrease as compared to $38.8 million in the same period of 2011. Gross profit decreased 23.6% to $13.2 million from $17.2 million in the year-ago period.

Operating loss was $0.04 million, compared to operating income of $7.6 million in the year-ago period. Net loss was $0.8 million, or $0.06 per diluted share for the six months ended June 30, 2012, compared to net income of $6.1 million, or $0.50 per diluted share in the year-ago period.

Non-GAAP net loss was $0.5 million, or $0.04 per diluted share, compared to non-GAAP net income of $7.0 million, or $0.57 per diluted share in the year-ago period.

Now turning to the balance sheet. As of June 30, 2012, Telestone has $7.7 million in cash and cash equivalents, as compared to $18.9 million on December 31, 2011. Inventory was $10.7 million on June 30, as compared to $6.8 million at the end of 2011.

Working capital was $126.2 million as of June 30 versus $126.7 million at the end of 2011. The Company had $11.2 million in short-term debt, as well as $51.5 million in accounts payable at the end of the second quarter of 2012.

Shareholders' equity, including $1.5 million of non-controlling interests, totaled $143.4 million at the end of the second quarter, as compared to $142.8 million at the end of 2011. Cash used in operating activities was $7.5 million in the first half of 2012, as compared to $11.1 million of cash used in operating activities in the year-ago period.

As of June 30, 2012, Telestone's accounts receivable were $259.6 million versus $251.5 million at the end of 2011. The accounts receivable turnover period or DSOs for the quarter ended June 30 was 1,232 days. During the second quarter, Telestone collected $13.4 million in accounts receivable.

Now I'd like to offer some comments on Telestone's business outlook. For the full-year 2012, Telestone continues to expect revenues to increase to approximately $117 million.

Telestone believes that the current drought of spending is temporary and that the start of the carriers' large-scale 4G network construction, in addition to the development and growth of its U-DAS and TIPS technology-based products, will help Telestone hit its revenue target this year and create a bright future for the Company, its employees, and shareholders.

Thank you for listening and we would now like to open the call to your questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). [Frederick Race, Rocky Hill Associates].

Unidentified Analyst

Hi. Good morning, John. Good morning, Mr. Han. I was wondering -- I have a couple of questions, John. Could you comment on the $2 million that the government gave them? That's one of my questions. I have four actually.

Daqing Han

Okay. Actually the $2 million from Zhongguancun Investment Group is actually from the Beijing municipal government. The Zhongguancun Group is actually the manager of this firm. (Inaudible) because they're very interested in Telestone's leading-edge TIPS technology.

The government has given full credit to Telestone's TIPS technology in terms of its growth that is going to play in the integration of networks and smart city [admissions] in China, and they would present a lot of opportunities for the Company as well.

Unidentified Analyst

Thank you very much. That's what I was hoping you're going to say. My next question is could Mr. Han comment on the AR collections during the first six weeks since the Q2 end?

Daqing Han

Sorry, say it again?

Unidentified Analyst

The AR collections during the -- since the end of Q2, the AR collections?

Daqing Han

At this time, read from our financial statement by the end of the second quarter, we don't see very big increases in our accounts receivable. That's because we have put us as a top priority to improve our collections in the first half.

We have taken a number of initiatives and we believe this initiative will materialize into results for the Company in the second half of 2010 and in the first half of 2013.

I do -- may understand a softer collection of accounts receivable might have some impact on our new business development initiatives, especially in a telecom equipment market, this is a double-edged sword.

Unidentified Analyst

Okay. And I have one more -- actually two more. Why did they put doubtful debts, why was that allowance for doubtful debts put in this Q2 report?

Daqing Han

Actually the allowance for bad debt totals $1.9 million is mostly related to certain contracts that are up over two years. As we account through several increases, the length of time it takes to collect those receivables, [arbitrators] have given us much more pressure that -- so that we have to record some allowance for bad debt this quarter for the contracts -- for the receivables of over two years.

Actually if this -- we can collect these receivables in the future, the credit of our balance for financial statement, with allowance for bad debt is not actually -- it does not necessary mean that these are real bad debts.

Unidentified Analyst

I see. I appreciate Mr. Han being so open this morning. Could he answer one more question and I think this is the one that most of us here in America would like to have answered, just because we've never really understood this. How exactly do you figure the DSO of 1,232 days, how do you calculate that figure?

Daqing Han

Okay. So the DSO nominal is – the second quarter – average balance of the second quarter – the average balance of the company's DSO in the second quarter, divided just by the net revenue in the second quarter, divided by 230 days, multiplied by 90 days.

Unidentified Analyst

Okay. Just one more, Mr. Han, comment on this 4G rollout now, which I think it's what probably has most people here excited about Telestone going forward, (inaudible) just the Big-3 are going to start with the 4G rollout. Could he just talk briefly about what he thinks about that? That's my last question.

Daqing Han

In terms of 4G rollout, China Mobile is taking a very proactive approach in the process of developing some [pilot] network congestion. The other two carriers like China Unicom and Telecom, they are just enrolling some pilot projects. If China Mobile's pilot network can be – have significant progress in terms of equipment on network within this year, we expect a massive rollout for 4G next year.

China Mobile's 4G rollout will have a significant impact on Telestone U-DAS WFDS platform, it will enhance our market in a very strong way. So far, we haven't seen any competitors that are able to -- coming up with Telestone's U-DAS or WFDS network. It's distribution technology not a simple [equation trend dilution].

You know we have U-DAS, a very long term working experience with China Mobile, as China Mobile's 4G deployment proceeds ahead, we expect a lot of opportunities in the (inaudible).

Unidentified Analyst

Thank you very much. Would you please tell Mr. Han that I greatly appreciate his openness and his engagement this morning with this talk, that he was very open. And I've been listening to these calls for two years, and I appreciate Mr. Han answering these questions and being as open and transparent as he was this morning. Would you please tell him that?

Daqing Han

Sure. Thank you, very much.

Operator

(Operator Instructions). The next question will come from Bruce Zuberg, a private investor. Please go ahead sir.

Bruce Zuberg

Good morning. Thank you for taking my call; and I also want to reiterate, thank you for being so open and transparent with the answers this morning. Like to piggyback on some of the questions that were just asked regarding the DSO. In 2010, Mr. Han, in an interview was explaining that typical DSOs for TSTC was 280 days, typical in China was 180. The following year, the DSOs were up between 360 and 720, now we are at 1,200.

Most of the jittery, nervous for investors, and I am assuming the resulted stock prices, because we are hearing over and over again that DSOs are aggressively being addressed, but the number is increasing steadily. How can you help us to understand why that is happening, and why we should believe as investors, that there's going to be substantial collections?

Daqing Han

Okay, thank you for the question. I think the collection is just primarily dependent on the nature of the carrier network business. But, now what we do is carriers are primary integration, are (Inaudible) the project design, planning and some equipment.

In efforts over the years, we had actually only like 280 days of DSO. You know, our accounts receivable vary in four quarters due to the nature of integration business. In terms of our input and output.

(Inaudible) [30:25] reflects that normally we have the best quarter in terms of DSO in the fourth quarter with the rest of the three quarters performing not that well.

[Accounts creation] for long-term DSOs is actually resulted from – can be traced back to 2009 when China's 3G deployment has [expected] growth.

In 2010, we recorded a 100% revenue growth. Due to the rapid ramp-up of revenue, this resulted in a large amount of accounts receivables.

China carriers is what draw into accounts in terms of 3G deployment from the second, third quarter and fourth quarter of 2011. But from this year, they have had not formulated very clear terms on 4G development in terms of capital spending.

In terms of access network or converge network carriers, investment is quite normal. That's why we have very ugly numbers for accounts – for DSOs because of this certain pattern of account receivable situation.

Looking ahead to the end of 2012 or first half of 2013, we missed the accounts receivable collection (inaudible), our average rate.

As a conclusion, one primary contributing to the current situation of our long-term cash flow is really the nature of the carrier business because they first invest and then we have to collect collections in both.

Actually in terms of the nature of the carrier business and how we view is the carriers, we have provided us a very detailed explanation on that in the form of 8-K issued in fall of 2010. You may refer to that at the end. Does that answer your question sir?

Unidentified Analyst

Yes, addresses most of that question. Can you tell me of the current 259 million in outstanding accounts receivables? Can you give me the date that you would expect to have that selected?

Daqing Han

We are not in a position to provide a very precise estimate, although we can collect them because it really depends upon extra (inaudible) of the telecom carriers, but we are very confident that majority of the current accounts receivables will be collected within one year.

Once we have collected these accounts receivables, we have to invest them in our ongoing projects. We are here to – our operating strategy is we have plenty of investment in carriers and on accounts receivables and sufficient cash flow.

Given carriers mentioned pattern, we have actually accounts receivable as extra asset under our management.

Unidentified Analyst

Okay. Thank you very much.

Daqing Han

Okay.

Unidentified Analyst

And if I may just an unrelated question to accounts receivable. Can you tell me is there any more plans for expanding outside of China and what were those goals be or are there any specific target markets that you can mention?

Daqing Han

Outside China and Asia Pacific, Telestone primary targets are North America and South American markets.

We have been three or four years in American markets, is doing some preliminary market research and as funding we understand that our RF or PA business have very low margin in that market. And therefore, we are no longer taking RF or PA equipment products to our primary seller selling point.

After comparing our users and the peer products of our competitors in American markets, we have realized that we have our various advantages in term of its application in those markets.

Back in 2009 we had a project in Houston Memorial Hospital and that project has been actually recognized by the four carriers in the US. This project has currently being extended to other -- to additional (Inaudible) communities. Actually, U-DAS platform has been invited by [Verizon] to participate EMEA's supplier conference as the only non-US provider.

But in terms of commercialization of U-DAS in the American market, it depends upon carriers and integrated report. We have -- we are currently proactively working with carriers and [Christian] providers on the basis of our two, on how the projects link these in our birth markets.

In conclusion, our unit technology has been widely recognized by the four carriers and integration providers in American markets as compared to all the peer products from our competitors.

We expect a lot of opportunities in terms of (inaudible) in American markets. Telestone has met some culture on management challenges. While working with American partners we are very optimistic of our sales -- of our [expenditure] materialized, turned efforts into future sales. That's all.

Unidentified Analyst

Very good. Thank you very much again for the -- just giving good accurate and open information. Thank you very much.

Daqing Han

Thank you.

Operator

The next question will come from [John Haro of Haro and Associates]. Please go ahead.

Unidentified Analyst

What's funny and what cracks me up is that people actually calling in on this conference call asking questions if Telestone is actually a legitimate business. I mean, guys put out a conference call PR but no earnings PR, yet you host a conference call. I mean, seriously. How stupid are we to…

John Harmon

Sir, do you have a question?

Unidentified Analyst

My question is, I'm just wondering when this scam is going to come to an end?

John Harmon

Operator, next question please.

Operator

I'm showing no questions in the queue. We have a follow-up question from [Frederick Race of Rocky Hill Associates]. Please go ahead.

Unidentified Analyst

Hi. I have one question that I wanted to ask Mr. Han. Is he -- because I know Mr. Han's very respected, is Mr. Han in touch with and does he know personally the CEOs of the big three, does he talk to them and does -- is there an intercourse with them where they understand the amount of money that they own Telestone, does he know those CEOs personally?

Daqing Han

Actually the big three telecom carriers not only owe money to Telestone, but a lot of money to other providers, suppliers, et cetera. If you have an opportunity to come to China to meet out with us, our suppliers will recommend our solutions to the big three, you will hear a lot of complaints from them actually. The fact that the carries (inaudible) trade but also the ones to be launched. The fundamental problem actually is the government's mechanism that's currently in place. The fate of the companies are actually the [darling] of the government. We are actually begging the [darling] for the money to be honest.

Unidentified Analyst

Okay, thank you.

Daqing Han

Anyway, thank you for your questions.

Operator

And showing no additional questions in the queue, this will conclude our question-and-answer session. I would like to turn the conference over to Mr. John Harmon of CCG Investor Relations for his closing remarks

John Harmon

Thank you. On behalf of Telestone Technologies' management team, we would like to thank you for your interest and participation on this call. Thanks again for joining us, and this call is now concluded.

Operator

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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