Jadestone (JS) believes that the key statements and operating claims of Telestone (“TSTC” or “The Company”) are false and that the Company exaggerated its operations in an effort to mislead investors.
Our main findings include the following:
· Production capacity is roughly 75% BELOW official company's statements
· Telestone’s core “technology” - WFDS- is simplistic, easily duplicated, and unprofitable by legal means
· There are egregious gaps between Telestone’s financials per the SEC filings and local Chinese tax filings that reflect up to a 98% difference in results.
JS conducted this in-depth investigation to uncover Telestone’s actual performance.
As WFDS is the only product currently produced in Shijiazhuang, and as Telestone keeps announcing an overwhelming demand for WFDS products, JS expected to find a large, populated facility running at full-capacity, one that would justify the Company’s purchase of new land and the anticipated development of a new production facility (see below). Instead, we found a small, lightly staffed facility, where production typically only runs at 1/3 capacity. We believe these findings severely undermine the credibility of Telestone’s 2010 reported production and revenues.
This reports’ findings were attained from on-site visits to all of the company’s main facilities and interviews with company’s employees, among other sources.
We believe this report provides the most updated information in order to assess Telestone’s present condition and future prospects.
TSTC was a traditional provider of telecommunication solutions until 2008, at which time the Company developed its "cutting edge" WFDS technology. WFDS allowed TSTC to integrate data from different sources and then distribute this information via one fiber.
Using WFDS technology, TSTC launched their new operations in 2009 and began to experience revenue growth from WFDS in 2010. TSTC has relied on WFDS as their primary growth engine for two main reasons:
· Margins under WFDS are higher than of their traditional operations
· TSTC claims that WFDS improves the Company’s account receivables as it is being provided to non-traditional clients and therefore result in shorter DSOs. In 2010, TSTC reported that WFDS generated 23% of overall revenue, and it is expected to contribute roughly 40% of revenue in 2011. As a result, Telestone expects their annual revenue to increase in 2011 to $170M, reflecting 31% growth.
Telestone has released several announcements regarding the development of WFDS, from which we have derived the following installation track record:
· By Jan 1, 2010 – 43 total installations
· By June 30, 2010 – 108 total installations
· By Dec 31, 2010– 316 total installations
According to Telestone, 273 WFDS installations were completed in 2010, 208 of which were completed in the 2nd half of the year.Since Telestone claimed that WFDS contributed $36.6M of 2010 sales, it would be fair to assume that at least 500 WFDS systems will have to be produced and installed in 2011 in order to attain $70M of sales.
As we will show next, we believe that this level of production was not actually achieved and that projections of future performance cannot feasibly be achieved as well.
JS’s TSTC Production Findings
During JS’s visit to Telestone’s production facility, we were able to interview one of their senior managers about their production process. Currently, Telestone manufactures all of its WFDS products in-house, in a single production facility which is located in ShiJiaZhuang city. The facility previously occupied 4 floors but currently only occupy 1 floor that focuses on the assembly of WFDS devices.
The following is a brief video that shows the scope of TSTC’s WFDS production floor at its ShiJiaZhuang facility: www.youtube.com/watch?v=BpCuBKWwu7M.The video was taken on an ordinary working day inside the production facility, showcasing a small space that appears inadequate to support its claimed scale of production. Corroborating this finding was our team’s discovery that the production facility only produces 4 WFDS systems a month.
Given these facts, we believe that the production facility could never support the claimed 2010 output of 273 WFDS units. Even if the plant were to run at full capacity, the maximum annual WFDS output would only be 144 units, far lower than the 273 units purported by the Company.
In addition, upon investigation, the facility had less than 20 employees on the floor. In light of the small staff, we believe that it is highly improbable that 20, or even 40 employees, could assemble hundreds of WFDS systems a year – especially given that its current rate of production is only 4 systems a month.
The following is a satellite picture of the ShiJiaZhuang production complex. The complex is comprised of an eastern and a western section. TSTC is located on the 3rd floor of the eastern section, and its allotted facilities were measured to be only 1575 sqm versus the Company’s claim of 6000 sqm. It should be noted that this 1575 sqm of space is not limited to manufacturing only and also includes all storage and offices, as well as other utilities.
JS also interviewed a Telestone representative regarding the WFDS facility that revealed that there are only 4 WFDS production lines instead of the claimed 11 lines, which validates the low levels of production as well as the small facility size.
During our site visit, we counted only 20 employees and estimate there are not more than 40 employees in the whole facility, including the administration. Therefore, we believe that the number of employees is likely 60% lower than Telestone claims.
Our conclusion from our site visitis that it is impossible for a facility of that scope to produce $90M worth of WFDS systems a year. When we raised this concern with the company representative, he responded that TSTC’s production was actually closer to $15M a year. This figure is consistent with all of our findings and is 83% less than the Company’s reported annual production of$90M.
JS also calculated TSTC’s WFDS revenues and production in a best-case-scenario, given its reported statistics:
Assuming 3 full shifts (for maximum capacity; though usually they only run on 1 shift), the facility can produce roughly 144 systems annually. Telestone has stated that revenue from a WFDS system ranges from $100K to $500K, 50%-60% of which are realized from the sale of equipment. If we assume a maximum of $500K of revenue per project, 60% of which is generated from equipment sales, TSTC will generate $300K of revenue from the sale of equipment for each system and $45M of total annual revenue if production were operating at maximum capacity. Based on official figures provided by the company, this figure is at least 50% lower than claimed production capacity of at least $90M.
The fact that JS’s best-case-scenario calculation still yields significantly lower revenues and production than that reported by Telestone implies that Telestone’s published performances very likely exaggerated.
Summary of production according to different sources:
Telestone’s official claim
$90 M.- $200 M.*
$45 M. (best-case-scenario assumptions)
*$90 M. as stated in investor's ppt, Mar. 2010. $200 M. as presented to us by the company's marketing meeting and marketing ppt.
Similar findings were found at the R&D department, along with some troubling question marks surrounding the Chinese tax filing which might imply a severe misleading of US investors.
JS has completed first-person research and an in-depth investigation of Telestone’s operations in China. We believe we have found irrefutable evidence that most if not all of Telestone’s key statements and operating claims are false and that the Company exaggerated Telestone’s operations in an effort to mislead investors. We found that both production and R&D were nowhere near the levels of productivity and innovation that were announced to the public and that the Company has failed to develop facilities as promised. We believe these findings are reflected by the gross and inexplicable discrepancies between the US and Chinese filings
Please download out full report at http://www.jadeorstone.com/Telestone%20report%2009282011.pdf
We apologize if download takes longer than usual, please be patient.
For inquiries you may drop us an email at contactus@Jadeorstone.com
 DSOs – Accounts Receivable Days’ Sales Outstanding
 Source: Company Statement
 Source: Investor ppt. dated September 2010
 Source: Telestone 2010 10K
 It would be reasonable to assume more systems were produced but not installed by the end of 2010, and it would also be reasonable to assume Q4 is "busier" than Q2 according to company's reports and historical performance
 Every WFDS system is composed of several units: 1 MU that splits to up to 8 EU1s, which split to up to 8 EU2s which eventually result in up to 512 RUs. Therefore, the maximum number of components that needed to be assembled for a single system is 585
[7 ]The senior manager’s voice was removed from the video to keep him anonymous. To remove any doubt- the s. manager was granted with Telestone’s HQ permission to allow us to shoot the video; Both Telestone and the S.manger were not aware of the visit’s real purpose. Selected parts of the interview (Chinese) can be provided on demand.
 Moreover, the facility manufactures exclusively for Telestone (Q10, 2010, page 25) as Telestone would like to protect its “technology”. Those facts were provided to us by both Telestone and the production facility; Records can be given by demand. As for the number of floors, Exact date of transition unknown, but we estimate that they started to close the other floors sometime in 2009 and were only operating with one functioning floor by mid. 2010
 All videos were edited to avoid compromising specific Telestone’s employees
 It should be noted that Telestone claims to be currently occupied with Beijing-Shanghai railway project- their biggest project ever. We would have expected more activity given this project
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in TSTC over the next 72 hours.