Telestone Technologies (NASDAQ:TSTC)

Han Daqing, Richard Wu, John Harmon
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Introduction and Safe Harbor: John Harmon, CCG Investor Relations

 
Good morning and good evening to everyone in China.  Welcome to Telestone Technologies’ investor conference call.
 
With us today are Telestone Technologies’ Chairman and CEO, Mr. Han Daqing, and VP of Finance, Mr. Richard Wu.
 
Before I turn the call over to Mr. Han, 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 the protection of the safe harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today, due to such risks such as, but not limited to, changes in the company’s product and sales & marketing strategy, plans for proceeds from its recent share offering, plans regarding its bank credit facility, targets for accounts receivable and DSOs, and other information detailed from time to time in the Company's filings and future filings with the United States Securities and Exchange Commission. Although the Company believes that the expectations in such forward-looking statements are reasonable, there is no assurance that such expectations will prove to be correct. 

Therefore, the Company claims protection under the safe harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today, due to known and unknown risks and uncertainties, including all business uncertainties relating to product development, marketing, customer lists, raw material costs, market acceptance, future capital requirements, competition in general, and other factors that may cause actual results to be materially different from those described herein as “anticipated”, “believed”, “estimated” or “expected”.
 
In addition, any projections as to the Company’s future performance represent management’s estimates as of today, Thursday, December 9, 2010.  Telestone Technologies assumes no obligation to update these projections in the future as market conditions change.
 
For those of you unable to listen to the entire call at this time, today’s call is also being webcast and an archive will be available for one year.  Information on how to access the webcast is available in the press release issued on December 6, 2010.
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And now it’s my pleasure to turn the call over to Telestone Technologies’ Chairman, Mr. Han.

 
Opening Remarks:  Mr. Han Daqing, Chairman and CEO

 
Thank you, John.
 
Welcome everyone, and thank you for joining us today.  As many of you are aware, on November 24, we completed a secondary offering of 1.675 million shares, raising approximately $18.9 in net proceeds for the company.  There is also a 15% over-allotment that is valid for 30 days.  I would like to state clearly that the purpose of the secondary offering was to raise capital primarily for a facilities expansion, which should greatly improve our future margins, rather than to enhance our balance sheet.  In our third quarter, we were solidly profitable, with more than $12 million in net income.  EBITDA was more than $14 million in Q3, and amounted to nearly $15.5 million in the first nine months of 2010.  The offering was priced at a discount to make it attractive to investors and to take expected dilution into account, and our stock is down just 6% from where the offering was priced.
 
We are holding this conference call today to update our shareholders on our plans and strategy.
 
The topics we plan to discuss today include the following:
 1. Our WFDS strategy and deployment plans;   

 2. Our plans for the proceeds of our recent share offering;

 3. Our intentions for the recently secured bank credit facility;

 4. A discussion of our accounts receivable and days’ sales outstanding (DSOs);

 5. A reaffirmation of our 2010 guidance; and   6. Our near-term investor-relations strategy.

Afterwards, we will take questions from investors.
 
First of all, I would like to provide an update on the company’s product strategy.  We are very enthusiastic about our Wireless Fiber-optic Distribution System (WFDS) solution, which combines wireless and wireline voice, data, and video within a single fiber-optic cable that runs through large office buildings.  Our solution offers huge savings to carriers by eliminating the need for each carrier to install its own cables, repeaters and amplifiers in order to provide a clear cell phone signal in an office building.  Now with WFDS, a single set of equipment can be shared among multiple carriers for multiple services.
 
As the sole provider of WFDS in China, we expect to benefit from the China State Council’s directive in January 2010 to integrate the transmission of telecom, TV, and radio. Moreover, our WFDS-Unified Local Access Network (ULAN) technology has been approved by China’s “Big-3” telecom carriers—China Mobile, China Unicom, and China Telecom.  In the third quarter of 2010, WFDS accounted for 23.5% of revenues, with 45-50% gross margins.  We expect WFDS to contribute as much as 40% of next year’s revenues.

We are also making progress in selling our WFDS products in international markets.  Telestone currently markets its products in 29 countries, and we plan to use our existing sales network to market our WFDS solution.  On August 9, we announced a $2.0 million contract to deploy WFDS at a hospital in Houston, Texas, which is being implemented in phases and should be completed by early next year.  The installation supports several carriers including AT&T, Sprint, Verizon and T-Mobile, using a total of seven wireless frequency bands. Moreover, installations of wireless equipment are particularly challenging in hospitals, where there are signal transmission challenges and sensitive medical equipment, and we hope that this project opens the door to many similar projects in the future.  WFDS installations also drive sales of Telestone wireless repeaters and amplifiers.
 
Since our WFDS customers are primarily building contractors, rather than telecom carriers, we anticipate speedier payment, and over time, a reduction in our days’ sales outstanding.  Richard will give additional details later on.  I would also like to remind investors that WFDS represents a technology platform, not just one product, and we have a strong product pipeline, with other versions of our WFDS technology under development.  We are currently shipping WFDS-ULAN (for Unified Local-Access Networks in buildings.)  In the next six months, we plan to offer WFDS-UOINS for small, medium, and large-size businesses, and within the next 24 months, we plan to launch another version of the technology, WFDS-PINS, for large industrial and commercial zones.

Secondly, I’d like to discuss how we intend to use the proceeds from our recent share offering and our recent bank credit line.  First, the share offering:  Based on our expectations for the success of our WFDS products, we have decided to bring the assembly and test of some devices in-house. Earlier this year, we purchased 15 acres of land in nearby Hebei province, where we plan to build a manufacturing/assembly facility, an R&D center, and a training center for customers and distributors.  This new campus will require approximately $12 million in capital spending.  We believe that we could increase gross margins on products that we manufacture in-house to as much as 60% in three years, versus 30% or lower margins today.  The remaining proceeds will be used for working capital or for acquisitions.  Although it is too early to talk about specific acquisitions, we are looking at a number of companies whose products could complement our WFDS network.
 
On October 4, we announced that we had secured a five year, RMB 300 million ($44 million) line of credit with the Bank of Beijing.  This credit line provides us greater flexibility in funding our working capital needs over the next few years, and I would like to clearly state that the credit line is not earmarked for funding facilities expansion or acquisitions.  We are not required to use any part or all of this facility and we will only do so an as needed basis
 
Now I will turn the call over to our VP of Finance, Richard Wu, who will provide an update on the company’s financials and guidance.
 
Investor Conference Call—Financials: Richard Wu, VP of Finance
 
Thank you, Mr. Han.
 
First, I would like to discuss the schedule of our company’s accounts receivable.  Many investors have been concerned with the company’s high level of accounts receivable.  For instance, our Q3 accounts receivable amounted to approximately $134 million, which represents 280 days’ sales outstanding.  This level of receivables is related to the purchasing patterns of our customers.  It takes our customers about three months to approve their budgets for the new calendar year, plus another three months for construction to take place.  Once construction is completed, we expect our days’ sales outstanding to average about 180 days, which is typical in China.
 
Our three largest customers, China Mobile, China Unicom, and China Telecom, are large state-owned entities that clearly have a high degree of creditworthiness.  To-date, we have not experienced any significant write-downs or increases in bad-debt provisions.
 
With the exception of 2008, which was unusual due to the merger of China Unicom and Netcom, our DSOs have declined every year since 2007.  In Q3 we recorded DSOs of 280, which was lower than what we recorded annually for 2006-2009.  Investors should be aware, though, that due to our customers’ annual purchasing cycles, we anticipate DSOs to rise in Q4.  We are targeting DSOs in the range of 300-350 days for the 2011 business year, which would mark an improvement versus the 384 DSOs we recorded in 2009.  As the WFDS mix improves, we think our DSOs can decline further.

Our emerging and growing WFDS business has DSOs more in line with industry norms, as builders and international customers typically pay within 90 days.  As this business increases as a percentage of sales, we expect our DSOs to approach our long-term target of 120 days.  As Mr. Han commented, WFDS accounted for 23.5% of Q3 revenues, and we expect WFDS to represent approximately 40% of our revenues next year.  Our WFDS products also require less working capital per unit of revenue than our traditional wireless equipment, and as the WFDS mix increases, we expect our working-capital requirements to decrease.
 
Now let me provide an update on our outlook
 
We are reaffirming our prior guidance for the 2010 business year.  We still expect revenues of $129.4 million and $22.9 million of net income, which translates to EPS of $2.17.  This guidance represents 80% revenue and nearly 80% EPS growth, which would mark a very strong year.  The guidance also translates to revenues of approximately $58.5 million, net income of $10.3 million, and EPS of about $0.97 for the fourth quarter.  Our guidance implies slightly lower EPS in Q4 than the $1.14 we reported in Q3, despite higher revenues, due to our expectation of a higher mix of equipment, which carries lower margins than services, which were especially strong in Q3.  Our backlog as of September 30, 2010 was $61.5 million.

In 2011, we plan to do more to communicate with our shareholders and the market.  We appreciate your interest in the company..  If you have any questions, please contact us or CCG, our investor-relations firm for further information.

Q&A was omitted from this transcript. 

Telestone Technologies Corporation  (NASDAQ: TSTC)
Date:    Friday, August 13, 2010
Time:   9:00 am Eastern

Executives:
Han Daqing, Chairman and CEO of Telestone
Ms. Xiaoli Yu – CFO
Ms. Liping Zhang – Board Secretary
John Mattio – SVP, HC International

Mr. Han

I would like to welcome our current and prospective shareholders to this call and thank you for your interest in Telestone Technologies. Based on what we have seen in aftermarket trading yesterday in our Company’s stock, I would like to restate that we are 100% confident we will meet our guided revenue target of $129.4 million and $22.9 million in net income by the end of the year. For those of you who have been following us for some time, you are familiar that our Company experiences strong seasonality by the end of the year when we book most of our sales. Our sales teams have reported to us approximately $106 million in back log estimates of projects we are confident to bill out in the third and fourth quarter of this year, and, as we have focused on higher-margin 3/G and WFDS sales this year, I am pleased to report that we have met our gross margin targets of 42% for the quarter and six months. We are equally confident the investments we made in marketing this quarter will pay off in Q3 and Q4. Contrary to news of slowdown in the telecom space in China, access network installations are peaking in demand and cell phone subscribers grow daily in China. We believe we are uniquely positioned to benefit from this ongoing growth as the total number of cell phone subscribers in China approach 1 billion by 2011. We appreciate your support and look forward to speaking to you again soon or hosting you at our facilities in Beijing”

John

Thank you Chairman Han. This is John Mattio again. Before I begin, I would like to provide our prospective investors and current investors joining us for the first time with an overview of Telestone’s business.

Telestone Technologies has been operating since 1997 when if first began network installations of what are now called 1G and 2G local access networks for cellular services. Telestone went public in 2004 and in 2005 began trading on the NASDAQ. Telestone Technologies is a project Company that is awarded ‘last mile’ local access network installation contracts from the "Big 3" telecommunication companies in China. These companies are: China Mobile, China Unicom and China Telecom. Based on its network design for a particular building site, Telestone procures telecommunications hardware and utilizes local contractors to install current 3/G and WFDS™ fiber optic local access networks for carriers. A majority of the Company’s project revenue is generated from its engineering and network design solutions for first-time installations or network upgrades. Telestone’s projects in turn generate a combination of equipment and professional service revenues. To a lesser extent, the Company generates revenue from equipment-only sales or services-only sales. There have been a number of favorable trends in the industry as of late which lend itself to Telestone’s proprietary network system, WFDS™. As cell phone users increase, traditional booster antennae systems can not handle the load of signals and thus local access networks must be installed in buildings to provide sufficient signals strength. As major telecoms compete for customers plus Beijing’s support for more telecom competition, certain coverage areas once serviced by a single telecom must now open up their markets to equal competition from all Chinese telecoms thus increasing the bandwidth demands on systems. As a result, more buildings must install local access networks. Lastly, Beijing is encouraging a convergence of all three cellular signals in China and would also like to see other voice, data and media services consolidate as part of its five year plan. Fiber optics is one of the few systems that can support these drivers in the market and Telestone is leading such installations with its wireless fiber optic distribution system, know as W F D S.

Skip to Q&A:

1. How much revenue comes from WFDS in your second quarter?

Answer: It is 21% of the revenue in second quarter.

2. the net equipment sales is year over year decrease, looking back to your last 4 quarters, you had over 50% at least, so what happened in your net sales of equipment?

Answer: The first and second quarter are the tender season of the carriers, and they make fewer equipment purchase compared to the second half of year when they finished the tender. And in the first half year, the carriers still have the equipment which they purchased last year to use.

3. What is the split between equipment and service in the 2010 guidance of revenue?

Answer: Normally, because we are project-based for the revenue, roughly, the equipment sales and professional services sales are half and half.

4. If you have half and half of revenue in the equipment and services, according to your guidance and portion, you only did 20% of equipment revenue in the first half of year, versus over 35% of equipment sales in 2007, 2008, 2009 in the first half year, why there is such a downturn in 2010?
Answer: normally in a project, the revenues from equipment and services are half and half. But in some projects, the price of equipment is extremely low and we can not make profit from that. Therefore, sometimes we give up such kind equipment’s bidding from the carriers. And also in recent years, the margin of services sales is growing and becoming higher than the margin of equipment sales, which is the change of the business.

5. The overall revenue of the first half year 2010 is 21% of the guidance, versus 28% in 2009 and 35% in 2008, so you have significant growth in the second half of year in order to meet your guidance, where you see the growth, if you think WFDS will grow significantly. Given WFDS has higher margin, do you expect your margin will improve largely? Can we see that in the second half year?

Answer: Yes. We can confirm that. Compared to the traditional technology, WFDS has higher margin. Second quarter is the bidding season, we have taken most of shares in the provincial level, and that is why we are confident to reach the 2010 guidance. Importantly, due to the success of trials we made on WFDS last year, we have gained greater market shares from the carriers compared to the last one or two years. .

6. So you are confident that your gross margin will improve significantly in the second half 2010?

Answer: Yes. And the gross margin of WFDS is much higher than the traditional technology.

7. What is your backlog so far?

Answer: That depends on our business process. First, we need to get shares from our carriers in each province: we get projects and contact with building owners, and we sign agreements with them on behalf of the carriers. And we will hand over all the agreements to the carriers’ provincial branch and wait for the approval and budget from their headquarters. When we get approval, we will start engineering, and when we finish the project at the end of the year, the carriers will do the inspection and acceptance, then we can book revenue and waiting for the payment, which is the process.

8. What is the dollar amount of projects are in your hand now?

Answer: I have mentioned that in my speech, the backlog at this moment is at least 106 million.

9. How soon do you think you can recognize that backlog?

Answer: That is the process we need to follow as I mentioned above.

10. How long the process will take?

Answer: all our projects will be verified in Q3 and Q4 before the end of the year 2010.

11. Where is your capital resource, which will support about 100 million revenue growth in second half of 2010?

Answer: Though we have a comparably long DSO, all the revenue will be collected in 12 months. Based on this, we get more credit from china banks, we can get short-term loan once we need working capital. So this is not a big problem to the company.

12. About WFDS project, you signed a contract in the US. How much revenue you expect will generate from the US market?

Answer: It is hard to estimate at this moment. But we think in next 2 or 3 years, 1/3 of the revenue will be generated from the US market and also from the South American market.

13. Where you are on the relation to with other international sales and sales opportunities as the sort of relations you have in the US? Can you further flash the detail on any relationships you’re building with companies in other countries like the Quell relationship?

Answer: Besides the relations we have in the US, we also set up relationships in South America, like Brazil, Mexico and Columbia. We developed local partners and work together with them, which is very efficient. In the next half year, we will set up sales offices in Europe.

14. What is your DSO in Brazil and Columbia if it is equipment sales?

Answer: There is no DSO in the equipment sales. Now we need to give them technical support, and we believe we will gain more market shares in the future.

15. Can you please address the discount you may have to offer in your sales of equipment to Quell and the related profit margins for those sales that compared to similar sales on mainland China?

Answer: I would like to tell you about the profit margin. In the US, the equipment-only sales’ profit margin is about 50%. We are half price of the project competitors in the US. In China, the margin of WFDS, both product sales and equipment sales make the margin go well.

16. You had significant SG&A cost related to the training for your sales agent for WFDS in the second quarter; do you anticipate the same kind of expenses going forward or fall significantly?

Answer: At the beginning of our development of the market, the cost may be high. Once we runs well, the sales cost will not be so high as that of the beginning.