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I have been trading and investing in stocks and options for 20 years. I was an equity options market maker for years in New York and San Francisco.
  • NQ Mobile Has A DSO Problem 10 comments
    Sep 18, 2013 9:43 AM | about stocks: NQ

    NQ Mobile will need to restate earnings; DSO levels are far too high

    In NQ Mobile's (NYSE:NQ) most recent press release they announced that DSO (Days Sales Outstanding) had fallen to 145 days from 158 the previous quarter. DSO is a measure of how long on average it takes a company to get paid. It is calculated by dividing accounts receivable by revenue and then multiplying by the number of days in the period, which in this case is 90 days. At NQ, it is taking them almost 5 months on average to get paid.

    The company has repeatedly provided the following explanation for the lengthy time it takes to get paid in China. Unlike in the U.S., payments for smartphone applications are run through multiple companies before they reach NQ. First, the carrier is paid by the consumer. This can take 30-60 days. Then the carrier pays a 3rd party vendor, which can also take 30-60 days. Lastly the vendor pays NQ, which again can take 30-60 days. Simple math tells you that payment can therefore fall anywhere between 90-180 days. If one accepts NQ statements as true regarding the payment process in China, 145 days would not appear to be an unreasonable average. However that's just it. 145 days is the average across all of NQ revenue not just China Mobile Value Added revenue.

    (click to enlarge)Net Revenues Trailing Twelve Months

    Source: NQ Earnings Releases

    34% of NQ revenue is now from overseas which the company has stated have much faster rates of pay. Another 20% is enterprise revenue from NationSky where NQ bills the company directly. Presumably this revenue is at worst 30-60 day pay especially since a significant portion of this revenue is for hardware. Lastly, another 7% of revenue is advertising revenue or Offer Wall revenue. This revenue does not originate with the consumer but rather from 3rd parties, which should cut down the payment time by at least 30-60 days since it removes one of the transaction layers cited by NQ. So if over 60% of NQ's revenue is paying in 60-90 days then for the average to be 145 days the remaining revenue must be extremely delinquent.

    Per NQ's most recent quarterly earnings release over, there remained over $70MM in account receivables. To put this in perspective, total NQ revenue for the last 12 months was $130MM. Now also consider my statements in the paragraph above regarding revenue sources and it is clear that $70MM in account receivables is an extraordinary number. It is my opinion that a large chunk of the over $70MM of account receivables is revenue that was recorded well over a year ago from China sources that has no chance of ever being paid. In the most recent quarter, tucked away in the earning release was an increase in the allowance for doubtful accounts to $973,000. This was 4 times the size for the previous quarter. I expect this number to increase materially as NQ attempts to quietly bleed off the bad revenue but they won't be able to do it through the allowance for doubtful accounts alone. They will have to restate. There simply is too much recognized revenue that will not be paid.

    I further believe that the acquisition of Feiliu came with a disproportionately high level of account receivables as evidenced by the elevated increase in accounts receivables in Q4 2012, the quarter that the Feiliu acquisition closed. Account receivables rose by 36%(39.97M to $54.475M) from Q3 2012 to Q4 2012. Revenue during the same period rose by just 16%. Is it possible NQ miscalculated the credit worthiness of those receivables?

    My belief is that the company is attempting to grow its way out of the problem. NQ management has pointed out that DSO is declining. Declining DSO in the wake of increased current revenues masks the bad revenue problem but does not eliminate it. Since revenue is the denominator in the DSO calculation if one increases revenue by a greater percentage than account receivables, DSO must go down. The bad revenue still exists however. I believe NQ is postponing restating revenue for as long as possible in the hopes that it will appear to be less material in the face of significantly higher overall revenues.

    I had been an NQ bull for over a year. I have appreciated the careful analysis of other NQ bulls like Treasure Hunter and Toro Investment Partners. I have battled Gogsie on the Yahoo board under my CCPLP username. I exited my long investment in the $15 range obviously having left some money on the table. I could not ignore my growing concern over the quality of NQ revenues and thus I am now short.

    Disclosure: I am short NQ.

    Stocks: NQ
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Comments (10)
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  • michael_retired
    , contributor
    Comments (2) | Send Message
     
    Guess even great companies can have issues...
    thanks for your article.
    18 Sep 2013, 10:36 AM Reply Like
  • chimera2
    , contributor
    Comments (20) | Send Message
     
    Thanks for your article.

     

    I think the key problem I see in your reasoning is this: if they indeed show revenue that is based on A/R from 2012 that will never be paid, then they would have had to account for this in bad debt expense (or through restating revenue) already a long time ago. Therefore, your reasoning just leads back to the fundamental question: is NQ a fraud and is Management deliberately deceiving investors through fake accounting?

     

    That is the old thesis shorts have put up all along - and that I just do not believe based on all the research that has been done by credible parties (Toro, TH, Wedge et.al.).
    18 Sep 2013, 11:45 AM Reply Like
  • comf22
    , contributor
    Comments (25) | Send Message
     
    Author’s reply » Let me state for the record that I do not believe NQ is a fraud. I believe there are many degrees between fraud and total transparency. On this subject, in my opinion, they are not being completely forthcoming. Perhaps a more forgiving way to describe it is pathologically optimistic.
    18 Sep 2013, 12:32 PM Reply Like
  • chimera2
    , contributor
    Comments (20) | Send Message
     
    Thanks. I see what you are saying and this may (theoretically) apply to NQ's quarterly reporting as quarterly reports are not audited and are Non-GAAP, so that theoretically NQ could define this absurdely optimistic definition of A/R and not correct their revenue in their quarterly reporting.

     

    BUT: the same does not hold for their annual report which they filed in Feb/Mar of this year. That is audited and according to US GAAP - and you cannot make the above optimistic definition of A/R according to US GAAP. Under US GAAP, there are very clearly defined rules when you have to write-down A/R and build up bad debt expenses.

     

    So that means that at least in their latest annual, NQ would have had to commit accounting fraud (and PwC, their auditor, would have had to miss this entirely) for your statements to be accurate.

     

    And that is just the point I cannot believe.
    18 Sep 2013, 01:57 PM Reply Like
  • Trade Star
    , contributor
    Comments (608) | Send Message
     
    From their 20f.
    "We generally offer third parties whose billing and payment systems we use credit terms ranging from 60 to 210 days for overseas payment and from 30 to 90 days for domestic payment."

     

    From their call transcript.
    "As a reminder, our DSOs are higher in some regions out of China like Southeast Asia and the Middle East."
    "Despite the length of the DSO, the quality of our receivables is extremely high. Our receivables continuously go through stringent and thorough analysis for contractual compliance and aging. You can see from our minimal bad debt expenses that the quality of the receivables is extremely high. In fact these are partners we have done business with for several years and have had several cycles of billing and collections with them over this timeframe."

     

    Pg. f12 of their 20 F shows that they have historically been able to collect on their AR. The doubtful accounts balance shows minimal charge offs. As a reminder, the 20f is audited. PWC would have done an AR Aging report to verify which accounts should be written off.

     

    I also dont buy the Feiliu argument. Prior to 4q, feiliu was barely generating any revenues. We're talking about a few million in annual sales at the most. The likelihood of being able to account for any material part of the $15M in AR bump is very small. If you look at the 20f statement, as part of the acquisition, NQ identified $4M in other tangible assets. If there was any AR to be acquired, it would be baked in there.

     

    Generally, small, fast growth companies have DSO issues as growth pushes up AR significantly relative to sales. Growing 100% yoy will do that to your DSOs. Its not as big a concern as you have implied. If the company is growing 15-20% each quarter, all of the incremental new revenue is adding on to AR balance vs the old AR getting collected and working down the balance. If the company had zero growth, then yes I would agree with you that the AR balance is too high and it should not be increasing. But thats obviously not the case.
    18 Sep 2013, 03:41 PM Reply Like
  • comf22
    , contributor
    Comments (25) | Send Message
     
    Author’s reply » Thank you Tradestar for your perspective and the company commentary you have provided. I am familiar with your knowledge of this company going all the way back to Summer/Fall 2012 when only about 4 people on Yahoo followed this stock. NQ has been kind to long term believers which I know you have been. The information from their 20F conflicts with the information that was verbally conveyed to me. Time will tell and I have said on the Yahoo board, I think the forward story is so strong that the past may not matter. My position is not long term bearish, it is short term opportunistic...hopefu...
    18 Sep 2013, 04:15 PM Reply Like
  • Trade Star
    , contributor
    Comments (608) | Send Message
     
    Thank you for the good analysis. Its refreshing to see someone who looks at an investment impartially rather than going the short and distort route taken by quite a few shorts on both SA and Yahoo or the over exuberance route without any substantiation.
    I definitely think you have a point with the DSO concern. Its something I have been following as well. I just think at this point in time, in NQ's life cycle, its too early to say if the long DSOs will turn into collect-ability issue as you've noted or are a natural byproduct of rapid growth. If there are outsized write-offs then I agree, it would be an excellent time to buy on any dips. Given how Omar has reiterated that "despite the length of DSO, the quality is extremely high" on both of the last 2 call transcripts, I'm more inclined to believe they will collect most if not all of what they are booking. I've been very pleased with my NQ investment.
    18 Sep 2013, 05:34 PM Reply Like
  • Bleecker Street Research
    , contributor
    Comments (497) | Send Message
     
    Looks like you nailed this one. Great job.
    28 Oct 2013, 02:27 AM Reply Like
  • Trade Star
    , contributor
    Comments (608) | Send Message
     
    I dont think so. I'm willing to bet DSO's fell for 3Q and that PWC signs off on 3q BS.
    28 Oct 2013, 02:46 AM Reply Like
  • comf22
    , contributor
    Comments (25) | Send Message
     
    Author’s reply » Thank you Christopher. For what its worth I covered my short and am now long(Sold some Nov 11 puts and bought some stock). I truly believe that what I would call NQ's shady days are behind them. I listened intently to the conference call and read MW report three times. I find the whole Level 1 vs 2 cash debate to be absurd. The classification is in line with some of the most respected Chinese companies. I think the MW report highlights some areas that NQ can do better job managing. I didn't particularly like Mark's explanation about why China DSO is 100 days but I think that is because he does not explain it properly. For instance, the way he explained it YDT payment terms are 30 days but since China mobile takes 60 days to pay YDT, DSO is 100 to NQ. When explained that way, it would seem that the fact that it takes YDT 60 days to collect from China Mobile is not NQ's problem. Their agreement with YDT, is for 30 days. I suspect that the agreement is likely that YDT must pay NQ within 30 days of receipt of payment by carrier. He should explain it that way.
    In any case, I look at it this way. If the MW report had not contained any issue with cash would the stock have gotten hit as hard. I don't think so and that is how I view it so I am long...mostly as a trade but might keep a little long term.
    28 Oct 2013, 08:38 AM Reply Like
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