Attached files
file | filename |
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EX-32.2 - TELESTONE TECHNOLOGIES CORP | v193500_ex32-2.htm |
EX-31.2 - TELESTONE TECHNOLOGIES CORP | v193500_ex31-2.htm |
EX-10.1 - TELESTONE TECHNOLOGIES CORP | v193500_ex10-1.htm |
EX-32.1 - TELESTONE TECHNOLOGIES CORP | v193500_ex32-1.htm |
EX-31.1 - TELESTONE TECHNOLOGIES CORP | v193500_ex31-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x Quarterly Report Pursuant to Section
13 or 15(d) of the
Securities
Exchange Act of 1934
For the
quarterly period ended June 30, 2010
Commission
File Number: 001-32503
TELESTONE
TECHNOLOGIES CORPORATION
(Exact
Name of Registrant as Specified in Its Charter)
Delaware
|
84-1111224
|
|
(State
or Other Jurisdiction of
|
(I.R.S.
Employer Identification No.)
|
|
Incorporation
or Organization)
|
|
Floor 6,
Saiou Plaza
No. 5
Haiying Road
Fengtai
Technology Park
Beijing,
People’s Republic of China 100070
(Address
of Principal Executive Offices)
(86 10)
8367-0505
(Registrant’s
Telephone Number, Including Area Code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securitie Exchange Act of 1934 during the
past 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to the filing requirements for at
least the past 90 days. Yes x No
¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes ¨ No
¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
|
Accelerated filer ¨
|
Non-accelerated filer ¨ (Do
not check if a smaller reporting
company)
|
Smaller reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No x
As
of August 12, 2010, 10,558,264 shares of the Issuer’s $.001 par value
common stock were outstanding.
TELESTONE
TECHNOLOGIES CORPORATION
INDEX
PART
I. FINANCIAL INFORMATION
Page
|
||||
Item
1. Condensed Financial Statements.
|
||||
Condensed Consolidated Statements
of Operations and Other Comprehensive Income,
for the three and six months ended June 30, 2010 and 2009
(unaudited)
|
3
|
|||
Condensed
Consolidated Balance Sheets, as of June 30, 2010 (unaudited) and December
31, 2009 (audited)
|
4
|
|||
Condensed
Consolidated Statements of Cash Flows, for the six months ended June 30,
2010 and 2009 (unaudited)
|
5
|
|||
Notes
to Condensed Consolidated Financial Statements (unaudited)
|
6
|
|||
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations.
|
19
|
|||
Item
3. Quantitative and Qualitative Disclosures About Market
Risk.
|
35
|
|||
Item
4. Controls and Procedures.
|
35
|
|||
PART
II. OTHER INFORMATION
|
||||
Item
1. Legal Proceedings.
|
36
|
|||
Item 1A. Risk
Factors.
|
36
|
|||
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
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36
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|||
Item
3. Defaults Upon Senior Securities.
|
36
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|||
Item
4. (Removed and Reserved).
|
36
|
|||
Item
5. Other Information.
|
36
|
|||
Item
6. Exhibits.
|
36
|
2
ITEM
1. FINANCIAL STATEMENTS
Telestone
Technologies Corporation
Condensed
Consolidated Statements of Operations and Other Comprehensive
Income
Six
months ended June 30, 2010 and 2009
(Unaudited)
|
(Unaudited)
|
||||||||||||||||||
Three
months ended June 30,
|
Six
months ended June 30,
|
||||||||||||||||||
2010
|
2009
|
2010
|
2009
|
||||||||||||||||
Note
|
US$’000
|
US$’000
|
US$’000
|
US$’000
|
|||||||||||||||
Operating
revenues:
|
|||||||||||||||||||
Net
sales of equipment
|
7,060 | 7,142 | 12,160 | 10,405 | |||||||||||||||
Service
income
|
9,559 | 4,988 | 15,591 | 9,621 | |||||||||||||||
Total
operating revenues
|
16,619 | 12,130 | 27,751 | 20,026 | |||||||||||||||
Cost
of operating revenues:
|
|||||||||||||||||||
Cost
of net sales
|
3,998 | 4,741 | 6,868 | 6,639 | |||||||||||||||
Cost
of service
|
5,123 | 2,382 | 8,446 | 3,680 | |||||||||||||||
Total
cost of operating revenues
|
9,121 | 7,123 | 15,314 | 10,319 | |||||||||||||||
Gross
income
|
7,498 | 5,007 | 12,437 | 9,707 | |||||||||||||||
Operating
expenses:
|
|||||||||||||||||||
Sales
and marketing
|
4,176 | 1,847 | 6,904 | 4,028 | |||||||||||||||
General
and administrative
|
882 | 478 | 3,816 | 1,321 | |||||||||||||||
Research
and development
|
191 | 193 | 415 | 329 | |||||||||||||||
Depreciation
and amortization
|
81 | 84 | 152 | 174 | |||||||||||||||
Total
operating expenses
|
5,330 | 2,602 | 11,287 | 5,852 | |||||||||||||||
Operating
income
|
2,168 | 2,405 | 1,150 | 3,855 | |||||||||||||||
Interest
expense
|
(134 | ) | (89 | ) | (260 | ) | (130 | ) | |||||||||||
Other
income, net
|
194 | 22 | 529 | 289 | |||||||||||||||
Income
before income taxes
|
2,228 | 2,338 | 1,419 | 4,014 | |||||||||||||||
Income
taxes
|
4
|
(508 | ) | (366 | ) | (829 | ) | (895 | ) | ||||||||||
Net
income
|
1,720 | 1,972 | 590 | 3,119 | |||||||||||||||
Other
comprehensive income
|
|||||||||||||||||||
Foreign
currency translation adjustment
|
- | (114 | ) | - | 131 | ||||||||||||||
Total
comprehensive income
|
1,720 | 1,858 | 590 | 3,250 | |||||||||||||||
Earnings
per share:
|
3
|
||||||||||||||||||
Weighted
average number of common stock outstanding
|
|||||||||||||||||||
Basic
|
10,549,143 | 10,404,550 | 10,531,304 | 10,404,550 | |||||||||||||||
Dilutive
effect of warrants
|
- | - | 21,647 | - | |||||||||||||||
Diluted
|
10,549,143 | 10,404,550 | 10,552,951 | 10,404,550 | |||||||||||||||
Net
income per share of common stock
|
|||||||||||||||||||
Basic
(US$)
|
0.16 | 0.19 | 0.06 | 0.30 | |||||||||||||||
Diluted
(US$)
|
0.16 | 0.19 | 0.06 | 0.30 |
3
Telestone
Technologies Corporation
Condensed
Consolidated Balance Sheets
As of
June 30, 2010 and December 31, 2009
(Unaudited)
As
of
June
30,
|
As
of
December
31,
|
||||||||||
2010
|
2009
|
||||||||||
|
Note
|
US$’000
|
US$’000
|
|
|||||||
ASSETS
|
|||||||||||
Current
assets:
|
|||||||||||
Cash
and cash equivalents
|
7,738 | 11,233 | |||||||||
Accounts
receivable, net of allowance
|
6
|
100,977 | 89,005 | ||||||||
Due
from related parties
|
|
13
|
1,963 | 1,963 | |||||||
Inventories,
net of allowance
|
10
|
6,375 | 4,442 | ||||||||
Prepayments
|
758 | 1,223 | |||||||||
Other
current assets
|
4,204 | 4,574 | |||||||||
Total
current assets
|
122,015 | 112,440 | |||||||||
Goodwill
|
7
|
3,119 | 3,119 | ||||||||
Property,
plant and equipment, net
|
8
|
1,202 | 1,181 | ||||||||
4,321 | 4,300 | ||||||||||
Total
assets
|
126,336 | 116,740 | |||||||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|||||||||||
Current
liabilities:
|
|||||||||||
Short-term
bank loans
|
9,
13
|
5,850 | 5,850 | ||||||||
Accounts
payable – Trade
|
18,532 | 15,678 | |||||||||
Customer
deposits for sales of equipment
|
1,589 | 1,582 | |||||||||
Due
to related parties
|
13
|
6,326 | 4,947 | ||||||||
Income
tax payable
|
8,095 | 7,132 | |||||||||
Accrued
expenses and other accrued liabilities
|
17,575 | 16,473 | |||||||||
Total
current liabilities
|
57,967 | 51,662 | |||||||||
Commitments
and contingencies
|
14
|
||||||||||
Stockholders’
equity:
|
|||||||||||
Preferred
stock, US$0.001 par value, 10,000,000 shares authorized, no shares
issued
|
|||||||||||
Common
stock and paid-in-capital, US$0.001 par value: Authorized
– 100,000,000 shares as of June 30, 2010 and
December 31, 2009
|
|||||||||||
Issued
and outstanding –10,558,264 shares as of June 30, 2010 and 10,404,550
shares as of December 31, 2009
|
12
|
11 | 11 | ||||||||
Additional
paid-in capital
|
21,690 | 18,989 | |||||||||
Dedicated
reserves
|
5,024 | 4,807 | |||||||||
Accumulated
other comprehensive income
|
5,682 | 5,682 | |||||||||
Retained
earnings
|
35,962 | 35,589 | |||||||||
Total
stockholders’ equity
|
68,369 | 65,078 | |||||||||
Total
liabilities and stockholders’ equity
|
126,336 | 116,740 |
4
Telestone
Technologies Corporation
Condensed
Consolidated Statements of Cash Flows
Six
months ended June 30, 2010 and 2009
(Unaudited)
|
||||||||
Six months ended June 30,
|
||||||||
2010
|
2009
|
|||||||
US$’000
|
US$’000
|
|||||||
Cash
flows from operating activities
|
||||||||
Net
income
|
590 | 3,119 | ||||||
Adjustments
to reconcile net income to net cash used in operating
activities:
|
||||||||
Depreciation and
amortization
|
152 | 174 | ||||||
Allowance
for doubtful accounts
|
- | 283 | ||||||
Stock-based
compensation
|
2,701 | - | ||||||
Changes
in assets and liabilities:
|
||||||||
Accounts
receivable
|
(11,972 | ) | (8,644 | ) | ||||
Due from related
parties
|
- | 398 | ||||||
Inventories
|
(1,933 | ) | (2,734 | ) | ||||
Prepayments
|
465 | (2,743 | ) | |||||
Other current
assets
|
370 | 444 | ||||||
Accounts payable
|
2,854 | 7,325 | ||||||
Customer
deposits for sales of equipment
|
7 | 169 | ||||||
Due
to related parties
|
1,379 | 34 | ||||||
Income tax payable
|
963 | (1,321 | ) | |||||
Accrued expenses and other accrued
liabilities
|
1,102 | (798 | ) | |||||
Net
cash used in operating activities
|
(3,322 | ) | (4,294 | ) | ||||
Cash
flows from investing activities
|
||||||||
Purchase
of property, plant and equipment
|
(173 | ) | (371 | ) | ||||
Net
cash used in investing activities
|
(173 | ) | (371 | ) | ||||
Cash
flows from financing activities
|
||||||||
Repayment
of short-term bank loans
|
(3,656 | ) | (2,918 | ) | ||||
Short-term
bank loans raised
|
3,656 | 3,652 | ||||||
Net
cash from financing activities
|
- | 734 | ||||||
Net
decrease in cash and cash equivalents
|
(3,495 | ) | (3,931 | ) | ||||
Cash
and cash equivalents, beginning of the period
|
11,233 | 7,866 | ||||||
Effect
on exchange rate changes
|
- | (33 | ) | |||||
Cash
and cash equivalents, end of the period
|
7,738 | 3,902 | ||||||
Supplemental
disclosure of cash flow information
|
||||||||
Interest
received
|
29 | 7 | ||||||
Interest
paid
|
(195 | ) | (65 | ) | ||||
Tax
paid
|
(221 | ) | (2,486 | ) |
5
Telestone
Technologies Corporation
Notes
to Condensed Consolidated Financial Statements
Six
months ended June 30, 2010 and 2009
1.
|
ORGANIZATION
AND PRINCIPAL ACTIVITIES
|
Telestone
Technologies Corporation (“TSTC”), formerly known as Milestone Capital, Inc.,
was organized under the laws of the State of Colorado in February 1987 under the
name Shield Enterprises, Inc. In August 2004, TSTC reincorporated in
the State of Delaware under the name Telestone Technologies
Corporation.
Success
Million International Limited (“SMI”), a company established in the Hong Kong
Special Administrative Region of the People’s Republic of China (the “PRC”) on
August 23, 2004, is a wholly owned subsidiary of TSTC and had no business
operations since incorporation. Beijing Telestone Technology Company Limited
(“Beijing Telestone”), a wholly-owned subsidiary of SMI established in Beijing,
the PRC with an operating period until April 12, 2024, is engaged in the
business of design, development, installation and trading of wireless
telecommunication coverage system equipment.
Beijing
Telestone Wireless Telecommunication Company Limited (“BTWTC”)(note), a company
established in Beijing, the PRC with tenure of 20 years from June 17, 2005 to
June 16, 2025 for provision of wireless telecommunication networking and system
integration services, is owned by certain key management personnel of the
Company (the “Owners”). Contractual agreements have been entered into
between the Owners and Beijing Telestone so as to give effect that Beijing
Telestone is the beneficial owner of BTWTC. Beijing Telestone does not hold the
ownership interests in BTWTC directly because Beijing Telestone is considered as
a foreign entity under the PRC laws. Due to the restrictions on foreign
ownership to provide and engage in certain wireless telecommunication networking
services in the PRC, Beijing Telestone, through loans to the Owners, established
BTWTC with a view to conduct such operations without violating the relevant PRC
rules and regulations. As a result of the above contractual
arrangement, Beijing Telestone has obtained control and interest over
BTWTC. Beijing Telestone is considered as the primary beneficiary of
BTWTC and therefore BTWTC is considered as a variable interest entity (“VIE”) of
Beijing Telestone so that the financial statements of BTWTC are consolidated
into the financial statements of Beijing Telestone for all periods presented in
accordance with ASC Topic 810 – Consolidation (ASC 810).
On July
5, 2007, BTWTC, Shandong Guolian Telecommunication Technology Limited
(“Guolian”)(note) and owners of Guolian entered into a Share Transfer Agreement
(the “Agreement”). Under the Agreement, 100% equity ownership interests in
Guolian and its wholly owned subsidiary, Pan-pacific Telecommunication Company
Limited (“Pan-pacific”)(note), had been transferred by the owners of Guolian to
BTWTC. Guolian and Pan-pacific were established in Jinan, Shandong Province, the
PRC on February 9, 1999 and October 22, 1999 respectively. The principal
business activities of Guolian and Pan-pacific are design, development,
production and installation and trading of wireless telecommunication coverage
system equipment.
6
On
October 8, 2007, BTWTC has established a wholly-owned subsidiary company,
Beijing Telestone Communication Technology Corporation Limited (“BTCTC”)(note),
with operating period of 20 years until October 7, 2027. The principal activity
of BTCTC is developing and managing the business operation of the Company
outside the PRC.
In this
report, TSTC, SMI, Beijing Telestone, BTWTC, Guolian, Pan-pacific and BTCTC are
collectively referred to as the “Company”.
Note:
|
These
are direct translation of name in Chinese for identification purpose only
and are not the official name in
English.
|
2.
|
PREPARATION
OF INTERIM FINANCIAL STATEMENTS
|
Basis
of presentations
These
unaudited condensed consolidated financial statements have been prepared based
upon Securities and Exchange Commission ("SEC") rules that permit reduced
disclosure for interim periods and include, in the opinion of management, all
adjustments (consisting of normal recurring adjustments and reclassifications)
necessary to present fairly the financial position, results of operations and
cash flows as of June 30, 2010 and for all periods
presented.
Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America ("USA") have been condensed or omitted. These unaudited
condensed consolidated financial statements should be read in conjunction with
the audited financial statements and notes thereto included in the Company's
Form-10K for the year ended December 31, 2009 filed on March 31, 2010. The
results of operations for the three-month and six-month periods ended June 30,
2010 are not necessarily indicative of the operating results to be expected for
the year ending December 31, 2010.
The
unaudited condensed consolidated financial statements and accompanying notes are
presented in United States dollars and prepared in accordance with generally
accepted accounting principles in the USA ("USGAAP") which requires management
to make certain estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Basis
of consolidation
The
unaudited condensed consolidated financial statements include the accounts of
TSTC, its subsidiaries and a VIE. All significant intercompany
accounts and transactions have been eliminated upon consolidation.
3.
|
EARNINGS
PER SHARE
|
The
Company reports earnings per share in accordance with ASC Topic 260 – Earnings
Per Share (ASC 260). ASC 260 requires presentation of basic and diluted earnings
per share in conjunction with the disclosure of the methodology used in
computing such earnings per share.
Basic
earnings per share is computed based upon the weighted average number of shares
of common stock outstanding during each period presented.
Diluted
earnings per share is computed based on net income to stockholders and the
weighted average number of shares of common stock outstanding during each period
presented, adjusted for the effect of the dilutive common stock equivalents
outstanding during the periods presented.
The
dilutive effect of warrants to purchase common stock outstanding during the
periods ended June 30, 2010 and 2009 was reflected in the calculation of diluted
earnings per share by applying the treasury stock method. Any anti-dilutive
effect of the warrants is excluded from calculation of the earnings per
share.
7
4.
|
INCOME
TAXES
|
TSTC and
its subsidiaries are subject to income taxes on an entity basis on income
arising in or derived from the tax jurisdictions in which each entity is
domiciled.
TSTC had
net operating losses carry-forward for income tax reporting purposes that might
be offset against future taxable income. These net operating losses
carry-forward are severely limited when TSTC experiences a change in
control. Therefore, following the re-capitalization in August 2005,
the amount available to offset future taxable income is limited. No tax benefit
has been reported in the financial statements, because TSTC believes that it is
more likely than not that the tax loss carry-forward will finally expire and
therefore cannot be used. Accordingly, the potential tax benefits of
the loss carry-forward are offset by a valuation allowance of the same
amount.
No
provision for withholding or United States federal or state income taxes or tax
benefits on the undistributed earnings and/or losses of the Company's
subsidiaries has been made as the earnings of these subsidiaries, in the opinion
of the management, will be reinvested indefinitely.
The
Company’s income is principally generated in the PRC by Beijing Telestone,
BTWTC, BTCTC, Guolian and Pan-pacific. All these entities are subject to the
enterprise income tax (“EIT”) in the PRC at the following applicable
rates:
Unified
EIT rate
|
25 | % | ||
Small
scale / low profit enterprises
|
20 | % | ||
High
/ new technology enterprises (“Hi-tech enterprises”)
|
15 | % |
Beijing
Telestone and BTWTC are qualified as Hi-tech enterprises under the current
Enterprise Income Tax Law in the PRC, so they enjoy the preferential tax rate of
15% in the PRC for a three-year period commencing from the year 2009. All other
entities including BTCTC, Guolian and Pan-pacific are subject to the unified tax
rate of 25% for the 6-month periods ended June 30, 2010 and 2009.
Income
tax expenses, comprising EIT, have been provided at the following rates on the
respective subsidiaries’ / VIE’s estimated assessable income arising from PRC
during the periods.
(Unaudited)
Six months ended June 30,
|
||||||||
2010
|
2009
|
|||||||
%
|
%
|
|||||||
Beijing
Telestone
|
15 | 15 | ||||||
BTWTC
|
15 | 15 | ||||||
BTCTC
|
25 | 25 | ||||||
Guolian
|
25 | 25 | ||||||
Pan-pacific
|
25 | 25 |
8
5.
|
OPERATING
RISK
|
|
(a)
|
Concentration
of major customers and suppliers
|
(Unaudited)
|
||||||||
Six months ended June 30,
|
||||||||
2010
|
2009
|
|||||||
US$’000
|
US$’000
|
|||||||
Major
customers with revenues of more than 10% of the Company’s total operating
revenues
|
||||||||
Revenues from major
customers
|
27,132 | 17,547 | ||||||
Percentage of operating
revenues
|
98 | % | 88 | % | ||||
Number
|
3 | 2 | ||||||
Major
suppliers with purchases of more than 10% of the Company’s
purchases
|
||||||||
Purchases from major
suppliers
|
913 | 1,070 | ||||||
Percentage of
purchases
|
10 | % | 24 | % | ||||
Number
|
1 | 2 |
Accounts
receivable related to the Company’s major customers comprised 99% and 91% of the
total accounts receivables as of June 30, 2010 and December 31, 2009
respectively.
|
Credit
risk represents the accounting loss that would be recognized at the
reporting date if counter parties failed to perform as contracted.
Concentrations of credit risk (whether on or off balance sheet) arise from
financial economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or
other conditions. The major concentrations of credit risk arise from the
Company’s accounts receivable. Even though the Company has major
concentrations, it does not consider itself exposed to significant risk
with regards to the related
receivables.
|
|
(b)
|
Country
risks
|
|
The
Company may also be exposed to the risks as a result of its principal
operation being primarily in the PRC. These include risks associated with,
among others, the political, economic and legal environmental and foreign
currency exchange. The Company’s results may be adversely affected by
change in the political and social conditions in the PRC, and by changes
in governmental policies with respect to laws and regulations,
anti-inflationary measures, currency conversion and remittance abroad, and
rates and methods of taxation, among other things. The Company’s
management does not believe these risks to be significant. There can be no
assurance, however, those changes in political and other conditions will
not result in any adverse impact.
|
|
(c)
|
Cash
and time deposits
|
|
The
Company mainly maintains its cash balances with various banks located in
the PRC. In common with local practice, such amounts are not insured or
otherwise protected should the financial institutions be unable to meet
their liabilities. There has been no history of credit losses. There are
neither material commitment fees nor compensating balance requirements for
any outstanding loans of the
Company.
|
9
6.
|
ACCOUNTS
RECEIVABLE
|
(Unaudited)
As of
June 30,
2010
|
As of
December 31,
2009
|
|||||||
US$’000
|
US$’000
|
|||||||
Completed
contracts
|
101,778 | 89,835 | ||||||
Retentions
|
5,373 | 5,344 | ||||||
107,151 | 95,179 | |||||||
Allowance
for doubtful accounts
|
(6,174 | ) | (6,174 | ) | ||||
100,977 | 89,005 |
Of the
retentions balance as of June 30, 2010 and December 31, 2009, approximately
US$972,000 and US$903,000 respectively are expected to be collected after one
year.
7.
|
GOODWILL
|
Goodwill acquired in connection with
the acquisition of Guolian and Pan-pacific by BTWTC on July 5, 2007 represented
the excess of the purchase cost over the fair value of identifiable net assets
acquired at acquisition date. Goodwill is tested at least annually for
impairment in accordance with ASC Topic 350 – Goodwill and Other
Intangible.
8.
|
PROPERTY,
PLANT AND EQUIPMENT, NET
|
Property, plant and equipment are
summarized as follows:
Estimated useful life
|
(Unaudited)
As of
June 30,
2010
|
As of
December 31,
2009
|
|||||||||
(in
years)
|
US$’000
|
US$’000
|
|||||||||
Buildings
|
30
|
312 | 312 | ||||||||
Leasehold
improvement
|
5
|
87 | 87 | ||||||||
Plant
and machinery
|
5
|
749 | 734 | ||||||||
Office
equipment
|
5
|
1,174 | 1,087 | ||||||||
Motor
vehicles
|
5
|
738 | 667 | ||||||||
3,060 | 2,887 | ||||||||||
Accumulated
depreciation
|
(1,858 | ) | (1,706 | ) | |||||||
1,202 | 1,181 |
10
9.
|
SHORT-TERM
BANK LOANS
|
As of
June 30, 2010 and December 31, 2009, the balance included a bank loan of RMB15
million, equivalent to approximately US$2.19 million, which bears interests to
be charged quarterly at 20% above the standard short-term borrowing rate as
stipulated by the People’s Bank of China on the date of the first withdrawal and
is wholly repayable within one year. The loan is secured by guarantees provided
by Mr. Han Daqing (“Mr. Han”), a director of TSTC and a third party guaranty
company. The remaining bank loans of RMB25 million, equivalent to
approximately US$3.66 million, which bear interest to be charged annually at the
standard short-term borrowing rate as stipulated by the People’s Bank of China
on the date of the first withdrawal and are wholly repayable within one year.
The loans are secured by guarantee provided by a third party guaranty company.
The guarantee provided by the third party guaranty company is secured by the
followings:
|
(a)
|
Accounts
receivable of the Company with an aggregate carrying value as of June 30,
2010 and December 31, 2009 amounting to RMB51 million, equivalent to
approximately US$7.46 million, and RMB40 million, equivalent to
approximately US$5.86 million,
respectively;
|
|
(b)
|
Motor
vehicles of the Company with an aggregate carrying value as of June 30,
2010 and December 31, 2009 amounting to RMB1.1 million, equivalent to
approximately US$0.16 million, and RMB1.4 million, equivalent to
approximately US$0.21 million,
respectively;
|
|
(c)
|
Personal
guarantee provided by Mr. Han; and
|
|
(d)
|
Personal
real estate property and securities of the Company held by Mr.
Han.
|
10.
|
INVENTORIES
|
Inventories consisted of the
followings:
(Unaudited)
As of
June 30,
2010
|
As of
December 31,
2009
|
|||||||
US$’000
|
US$’000
|
|||||||
Raw
materials
|
1 | 1 | ||||||
Finished
goods and parts
|
6,810 | 4,877 | ||||||
6,811 | 4,878 | |||||||
Provision
for slow-moving and obsolete items
|
(436 | ) | (436 | ) | ||||
6,375 | 4,442 |
11
11.
|
SEGMENT
INFORMATION
|
During
the periods ended June 30, 2010 and 2009, all revenues of the Company are from
its network installation and optimization services and trading of wireless
telecommunication products. No financial information by business
segment is presented.
As the
Company operates mainly in the PRC and over 99% and 98% of its revenue and
operating income during the periods ended June 30, 2010 and 2009 respectively
are from the PRC, no geographical segment is presented.
12.
|
COMMON
STOCK
|
On
January 20, 2010 and June 22, 2010, TSTC issued 100,000 and 10,000 shares of
common stock respectively for zero consideration. The common stock was granted
to certain senior officers of the Company as an incentive stock-based
compensation for their services rendered in previous years in improving the
business result of the Company and their contribution to the success of the
Company. Details of the stock-based compensation are set out in note 16 to the
condensed consolidated financial statements.
TSTC had
10,558,264 and 10,404,550 shares of outstanding common stock as of June 30, 2010
and December 31, 2009 respectively.
The
following table summarizes activities of the warrants:
Number of
shares
|
||||
Warrants
outstanding as of January 1, 2009
|
192,403 | |||
Expired on March 24, 2009
(i)
|
(15,000 | ) | ||
Warrants
outstanding as of December 31, 2009
|
177,403 | |||
Cashless exercised on January
26, 2010 (ii)
|
(65,515 | ) | ||
Cashless exercised on January
27, 2010 (ii)
|
(26,222 | ) | ||
Issued on March 18, 2010
(iii)
|
40,000 | |||
Warrants
outstanding and exercisable as of June 30, 2010 (iv)
|
125,666 |
|
(i)
|
On
March 24, 2009, 15,000 shares of warrants
expired.
|
|
(ii)
|
On
January 26, 2010 and January 27, 2010, certain warrant holders elected to
exercise 65,515 and 26,222 shares of warrants respectively pursuant to the
cashless exercise provision of the warrants. Consequently, 30,590 and
13,124 shares of common stock were issued on a net share settlement basis
to these warrant holders on January 26, 2010 and January 27, 2010
respectively.
|
12
12.
|
COMMON
STOCK (CONTINUED)
|
|
(iii)
|
On
March 18, 2010, TSTC issued a total of 40,000 shares of warrants to a
third party service provider as stock-based compensation for part of the
cost of services. Details of the stock-based compensation are set out in
note 16 to the condensed consolidated financial
statements.
|
|
(iv)
|
As
of June 30, 2010, the 85,666 shares of outstanding warrants issued in
connection with the February 20, 2007 private placement are exercisable
over a 4-year period to year 2011 at a per share exercise price of US$11.6
and the remaining 40,000 shares of outstanding warrants are exercisable
over a three-year period from September 9, 2010 at a per share exercise
price of US$18.73. The warrants are classified as equity and the amounts
attributable to the warrants are recognized within additional paid-in
capital.
|
The
following table sets forth the outstanding warrant activity as of June 30, 2010
and changes during the 6-month period ended June 30, 2010.
Vested
|
Unvested
|
Total
|
Weighted-
average
exercise
price
|
|||||||||||||
Shares
|
Shares
|
Shares
|
US$
|
|||||||||||||
As
of January 1, 2010
|
177,403 | - | 177,403 | 11.60 | ||||||||||||
Cashless
exercise
|
(91,737 | ) | - | (91,737 | ) | 11.60 | ||||||||||
Granted
|
- | 40,000 | 40,000 | 18.73 | ||||||||||||
As
of June 30, 2010
|
85,666 | 40,000 | 125,666 | 13.87 | ||||||||||||
Weighted-average
remaining life (years)
|
0.64 | 3.19 | 1.45 |
13.
|
RELATED
PARTY TRANSACTIONS
|
Summary
of related party transactions
Note
|
(Unaudited)
As of
June 30,
2010
|
As of
December 31,
2009
|
|||||||||
US$’000
|
US$’000
|
||||||||||
Due
from related parties
|
|||||||||||
Employees
|
a
|
536 | 536 | ||||||||
Ex-stockholders
of SMI/Guolian
|
b
|
1,427 | 1,427 | ||||||||
1,963 | 1,963 | ||||||||||
Due
to related parties
|
|||||||||||
Directors
|
a
|
4,854 | 3,475 | ||||||||
Ex-stockholders
of Beijing Telestone/Guolian
|
b
|
1,472 | 1,472 | ||||||||
6,326 | 4,947 | ||||||||||
Guarantor
of short term loan
|
|||||||||||
A
director
|
9
|
5,850 | 5,850 |
13
Note:
|
(a)
|
The
amounts due from employees and due to directors represent unsecured
advances made to / from those parties from time to time. These amounts are
interest free and repayable on
demand.
|
|
(b)
|
The
amounts due to ex-stockholders of Beijing Telestone represented the
consideration arising from the consummation of the business combination.
The ex-stockholders of SMI had represented that they had fully settled the
amount with the ex-stockholders of Beijing Telestone and also undertaken
to fully indemnify SMI against any claims from the ex-stockholders of
Beijing Telestone (the “Undertaking”). However, an ex-stockholder of
Beijing Telestone has initiated lawsuit against SMI alleging that the
consideration amount has not been settled. The court hearing commenced on
May 10, 2006 and finalized on December 19, 2006. Verdict has been issued
by the Second Intermediate People’s Court of Beijing (“北京市第二中級人民法院”)
and announced that SMI and Beijing Telestone are not required to
compensate for the ex-stockholder of SMI. On October 23, 2007,
another verdict was issued by the High People’s Court of Beijing (“北京市高級人民法院”)
announcing that the verdict from the Second Intermediate People’s Court of
Beijing was kept and SMI was not required to compensate for the
ex-shareholder.
|
14.
|
COMMITMENTS
AND CONTINGENCIES
|
The
Company recognizes its revenue upon the completion of contract and has made full
tax provision in accordance with relevant national and local laws and
regulations of the PRC. A contract is considered as completed upon
completion of all essential contract work and the installation has been accepted
by the customer. It is the common practice in the PRC that invoices are not
issued to customers until payments are received. The Company follows the
practice of reporting its revenue for PRC tax purposes when invoices are issued.
All unbilled revenue will become taxable when invoices are issued. For PRC tax
reporting purpose, PRC subsidiaries of the Company recognizes revenue on an
“invoice basis” instead of when goods are delivered and services are rendered.
This is not in strict compliance with the relevant laws and
regulations. Accordingly, despite the fact that the PRC subsidiaries
of the Company had made full tax provision in the financial statements, these
PRC subsidiaries may be subject to penalties for the deferred reporting of tax
obligations. The exact amount of penalties cannot be estimated with any
reasonable degree of certainty. The board of directors considers it
is more-likely-than-not that the tax penalties will not be imposed.
15.
|
STOCK
OPTION PLAN
|
On June
27, 2005, a Stock Option Plan (the “Plan”) was approved at the 2005 annual
meeting of stockholders. The purpose of the Plan is to promote the growth and
general prosperity of the Company by permitting the Company to grant options to
purchase common stock and restricted stock of the Company to key employees,
non-employee directors, and advisors. The Plan is designed to help
the Company and its subsidiaries and affiliates attract and retain superior
personnel for positions of substantial responsibility and to provide key
employees, non-employee directors, and advisors with an additional incentive to
contribute to the success of the Company.
No
options have been granted to any parties during the six-month periods ended June
30, 2010 and 2009 and as of the date of these condensed consolidated financial
statements.
14
16.
|
STOCK-BASED
COMPENSATION
|
The
Company applies the fair value recognition and measurement provisions of ASC
Topic 718 Compensation – Stock Compensation (“ASC 718”) to account for
stock-based compensation to employee. ASC 718 requires a public entity to
measure the cost of services received in exchange for an award of equity
instruments based on the grant-date fair value of the award. The cost of
services is recorded at fair value as of the grant date and recognized as an
expense over the employee’s requisite service period (generally the vesting
period) or at the grant date when it is fully vested.
Stock-based
compensation for stock or similar instruments granted to non-employee is
determined in accordance with ASC Topic 505-50 Equity-Based Payments to
Non-Employees (“ASC 505-50”). ASC 505-50 addresses transactions in which equity
instruments are issued in exchange for the receipt of goods or services when the
counterparty to the transaction is other than an employee. Stock-based
compensation to non-employees shall be measured at the fair value of the
consideration received or the fair value of the equity instruments issued,
whichever is more reliably measurable. The measurement date shall be the earlier
of the date at which a commitment for performance by the counterparty to earn
the equity instruments is reached or the date at which the counterparty’s
performance is complete.
Stock-based
compensation to employee
On
January 20, 2010 and June 22, 2010, the Board of Directors of TSTC approved to
grant 100,000 and 10,000 shares of restricted common stock with three years
restriction for sale and one year restriction for sale respectively to certain
senior officers of the Company as an incentive compensation for their services
rendered in previous years in improving the business result of the Company and
their contribution to the success of the Company.
The
issuance of common stock is accounted for as equity instruments issued in
exchange for receipt of services. The stock-based compensation costs are
recognized and measured at the quoted price on the date of grant.
For the
6-month periods ended June 30, 2010 and 2009, the Company recognized stock-based
compensation to employees of US$2,209,000 and US$Nil respectively.
Stock-based
compensation to non-employee
On
September 9, 2009, TSTC entered into an investor relation consulting agreement
(the “Agreement”) with a third party service provider. The Agreement covers a
period of twelve months from date of the Agreement to September 9, 2010. Under
the Agreement, TSTC agreed to grant a total of 80,000 shares of warrants to the
services provider as part of the cost of services. The 80,000 shares of warrants
will vest on September 9, 2010 and carry a 3-year term from the date of vesting
to September 9, 2013.
Following
the completion of the first stage of services as stipulated in the Agreement,
TSTC granted 40,000 shares of warrants with an exercise price of US$18.73 to the
service provider on March 18, 2010. These warrants are accounted for as equity
instruments issued in exchange for receipt of services. Costs are measured at
the estimated fair value of the equity instruments issued on the completion date
of the services. The remaining 40,000 shares of warrants shall be
granted upon the completion of the second stage of services in September
2010.
15
Stock-based
compensation to non-employee (continued)
According
to a valuation report dated May 11, 2010 issued by an independent professional
valuer, the estimated per share fair value of the warrants is US$12.3. The
following table presents the assumptions used by the valuer to estimate the fair
value of the warrants using the Binomial Lattice option pricing
model:
Expected
life
|
3.5
years
|
|||
Expected
dividend yield
|
0.00 | % | ||
Expected
volatility
|
96.38 | % | ||
Risk-free
interest risk
|
1.62 | % |
Expected
volatility is based on historical volatility of the Company’s common stock.
Historical volatility was computed using daily pricing observations for recent
periods that correspond to the term of the warrants. The expected life is based
on the remaining term of the warrants. The risk-free interest rate is based on
U.S. Treasury yields in effect at the time of grant for periods corresponding
with the expected life of the warrants.
For the
6-month periods ended June 30, 2010 and 2009, the Company recognized stock-based
compensation to non-employees of US$492,000 and US$Nil
respectively.
The
following table presents the total stock-based compensation included in the
condensed consolidated statements of operations and other comprehensive income
for the 3-month and 6-month periods ended June 30, 2010 and 2009.
(Unaudited)
Three months ended June 30,
|
(Unaudited)
Six months ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
US$’000
|
US$’000
|
US$’000
|
US$’000
|
|||||||||||||
Sales
and marketing
|
- | - | 492 | - | ||||||||||||
General
and administrative
|
100 | - | 2,209 | - | ||||||||||||
Total
stock-based compensation
|
100 | - | 2,701 | - |
No tax
benefit was recognized for the stock-based compensation recorded for the six
months ended June 30, 2010.
17.
|
RECENT
ACCOUNTING PRONOUNCEMENTS
|
In
October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13,
Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements—a
consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”). ASU
2009-13 addresses the accounting for multiple-deliverable arrangements to enable
vendors to account for products or services separately rather than as a combined
unit and modifies the manner in which the transaction consideration is allocated
across the separately identified deliverables. ASU 2009-13 significantly
expands the disclosures requirements for multiple-deliverable revenue
arrangements. ASU 2009-13 will be effective for the first annual reporting
period beginning on or after June 15, 2010, and may be applied retrospectively
for all periods presented or prospectively to arrangements entered into or
materially modified after the adoption date. Early adoption is permitted,
provided that the guidance is retroactively applied to the beginning of the year
of adoption. The Company is currently evaluating the impact this update will
have on its consolidated financial statements.
16
In
December, 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R).
The amendments in this Accounting Standards Update replace the
quantitative-based risks and rewards calculation for determining which reporting
entity, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which reporting entity has the
power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling financial
interest in a variable interest entity. The amendments in this Update also
require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. The Company does not expect the adoption of this ASU to
have a material impact on its consolidated financial statements.
In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and
2. A reporting entity should disclose separately the amounts of significant
transfers in and out of Level 1 and Level 2 fair value measurements and describe
the reasons for the transfers. 2) Activity in Level 3 fair value
measurements. In the reconciliation for fair value measurements using
significant unobservable inputs (Level 3), a reporting entity should present
separately information about purchases, sales, issuances, and settlements (that
is, on a gross basis rather than as one net number). This update
provides amendments to Subtopic 820-10 that clarify existing disclosures as
follows: 1) Level of disaggregation. A reporting entity should provide fair
value measurement disclosures for each class of assets and liabilities. A class
is often a subset of assets or liabilities within a line item in the statement
of financial position. A reporting entity needs to use judgment in determining
the appropriate classes of assets and liabilities. 2) Disclosures about
inputs and valuation techniques. A reporting entity should provide disclosures
about the valuation techniques and inputs used to measure fair value for both
recurring and nonrecurring fair value measurements. Those disclosures are
required for fair value measurements that fall in either Level 2 or Level
3. The new disclosures and clarifications of existing disclosures are
effective for interim and annual reporting periods beginning after December 15,
2009, except for the disclosures about purchases, sales, issuances, and
settlements in the roll forward of activity in Level 3 fair value measurements.
Those disclosures are effective for fiscal years beginning after December 15,
2010, and for interim periods within those fiscal years. The Company is
currently evaluating the impact this update will have on its consolidated
financial statements.
In
February 2010, the FASB issued ASU 2010-09, Subsequent event. This ASC amends
certain recognition and disclosure requirements to FASB ASC 855. ASU 2010-09
requires an entity that is an SEC filter or is a conduit bond obligor for
conduit debt securities that are traded in a public market to evaluate
subsequent events through the date that the financial statements are issued but
remove the requirement for an SEC filer to disclose a date in both issued and
revised financial statements. These amendments are effective upon issuance of
the final Update, except of the use of the issued date for conduit debt
obligors. That amendment is effective for interim or annual periods ending after
June 15, 2010. The adoption of this ASU does not have a material impact on the
Company’s consolidated financial statements.
In April
2010, the FASB issued ASU 2010-13, Compensation – Stock Compensation. This
ASC provides amendments to FASB ASC 718 to clarify that an employee share-based
payment award with an exercise price denominated in the currency of a market in
which a substantial portion of the entity’s equity securities trade should not
be considered to contain a condition that is not a market, performance, or
service condition. As a result, an entity would not classify such an award as a
liability if it otherwise qualifies as equity. The amendments are effective for
fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2010. The adoption of this ASU is not expected to have a
material impact on the Company’s consolidated financial
statements.
17
In April
2010, the FASB issued ASU 2010-18, Receivables. The ASC provides amendments to
FASC ASC 310 As a result, modifications of loans that are accounted for within a
pool under Subtopic 310-30 do not result in the removal of those loans from the
pool even if the modification of those loans would otherwise be considered a
troubled debt restructuring. Effective for modifications of loans accounted for
within pools under Subtopic 310-30 occurring in the first interim or annual
period ending on or after July 15, 2010. The amendments are to be applied
prospectively. Early application is permitted. The adoption of this ASU is not
expected to have a material impact on the Company’s consolidated financial
statements.
In May,
2010, the FASB issued ASU No. 2010-19, Foreign Currency (Topic 830), which
provides guidance for disclosures where there are multiple exchange
rates. A Venezuelan official rate and a parallel Bolivar exchange
rate may result in a difference between actual US Dollar-denominated balances
and reported balances. This update guides the required disclosure. This update
has no effect on the Company’s current accounting practices or financial
reporting.
18.
|
SUBSEQUENT
EVENT REVIEW
|
The
Company has evaluated subsequent events up to the date that these consolidated
financial statements were approved and authorized for issue by the Board of
Directors.
18
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The
following is management's discussion and analysis of certain significant factors
which have affected our financial position and operating results during the
periods included in the accompanying consolidated financial statements, as well
as information relating to the plans of our current management. This report
includes forward-looking statements. Generally, the words "believe,"
"anticipate," "may," "will," "should," "expect," "intend," "estimate,"
"continue," and similar expressions or the negative thereof or comparable
terminology are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties, including the matters
set forth in this report or other reports or documents we file with the SEC
from time to time, which could cause actual results or outcomes to differ
materially from those projected. Undue reliance should not be place
on these forward-looking statements which speak only as of the date
hereof. We undertake no obligation to update these forward-looking
statements, except to the extent required by law.
The
following discussion and analysis should be read in conjunction with our
consolidated financial statements and the related notes thereto and other
financial information contained elsewhere in this Quarterly Report on Form
10-Q.
Overview
We are a
leading supplier of local access network solutions for communications networks
in China. We design, engineer and sell RF-based local access network solutions
for indoor and outdoor wireless coverage, IP-based products for Internet access,
and unified local access network, or ULAN, solutions based on our Wireless and
Fiber-Optics Distribution System, or WFDS, technology. Our local
access network solutions integrate and enhance communication coverage and
improve the signals quality of reception for wireless, Internet, wireline, cable
television and other end user applications. These solutions are used
in a variety of indoor and outdoor environments, such as hotels, residential
estates, office buildings, airports, exhibition centers, underground stations,
highways, tunnels and rural areas. As part of our comprehensive
network solution, we provide professional services, including upfront system
design, implementation and network maintenance. Our primary customers
are China Mobile, China Unicom and China Telecom, or the Big 3, and commercial
and residential property owners in China. We have 30 branches
throughout China, six international sales offices and an international network
of system integrator partners. We believe our solutions offer a
compelling value proposition to our customers as our solutions offer lower costs
of ownership and increase overall efficiency.
19
Since our
establishment in 1997, we have maintained business relationships with China
Mobile, China Unicom and China Telecom (the “Big 3”), who combined currently
account for over 95% of our annual revenue. Although we expect
customer concentration to decrease as we expand internationally outside of
China, we expect to increase our penetration within the Big 3 by leveraging our
state-of-the-art technology solutions. WFDS currently is the only
commercially available solution fully compatible with the service platforms of
the Big 3, and offering voice, video, data, wireless LAN, FTTH, Internet,
digital cable TV networks and video surveillance. Due to our
performance, cost savings to carriers, easy installation and minimal intrusion
to property owners, we expect to continue to expand our market share within
China.
During
2009, we saw a significant growth in revenue from sales of our products and
services to the Big 3. Our ability to continue to increase product
revenue will depend significantly on the growth of the Chinese
telecommunications market, continued adoption of WFDS technologies, our ability
to maintain relationships with China’s Big 3 carriers, our ability to capitalize
on China’s recent 3G government initiatives, and our ability to expand our
presence internationally. Our growth in professional services revenue
will depend upon increasing our installed base of customers along with the pace
at which our existing customers continue to migrate from 2G to 3G
services.
Our
future profitability and rate of growth will be directly affected by the
continued acceptance of our products in the marketplace, as well as the timing
and size of orders, average selling prices, costs of our products and general
economic conditions. Our ability to scale profitability will be
affected by our ability to effectively generate incremental business within
China for our higher-margin WFDS technology.
In
addition to China, we currently market to 29 countries, including Argentina,
Bangladesh, Brazil, Canada, Colombia, Costa Rica, Ecuador, Hong Kong, Iceland,
India, Indonesia, Ireland, Kazakhstan, Malaysia, Mexico, Mongolia, New Zealand,
Philippines, Russia, Saudi Arabia, Singapore, South Africa, South Korea,
Thailand, Turkey, the United States, the United Arab Emirates, Ukraine, and
Vietnam. Continuous expansion outside of China is one of our core
strategies. We believe that the quality of our products and services
will allow Telestone to become increasingly competitive
internationally.
We
believe that the high technology content in our business and our continued
effort to develop market leading next-generation technology have led to
recognition by China’s local and central government agencies and
organizations. In 2009, we received various technology awards,
certifications and honors. Most recently we were certified as a “High
and New Technology Enterprise” by the Beijing municipal
government. In addition, our trademark was recognized as a well-known
trademark of Beijing by the local Industry and Commerce Bureau. In
addition, we have won the title of “A-Rated Good Credit Enterprise” which
entitles us to credit guarantees by Beijing Z-Park Sci-tech Guarantee
Co.
Industry
Background
As the
mobile market in China continues to mature, mobile operators have begun to
invest in the future. In particular, the Chinese telecommunications
industry has witnessed accelerated development in recent years with a rapid
rollout of 3G network investments and commitments to introduce 4G technology by
2011.
The
Rapid Growth of Wireless Subscribers in China
China has
repeatedly expressed a commitment to continuing economic growth, aimed at
improving the living standards of its population and at expanding its middle
class. This growth has led to increasing urbanization among the
Chinese population with migrant workers moving to cities. There is
now a growing demand among both enterprises and households in China for improved
wireless bandwidth and network performance. China is the largest
wireless market in the world with approximately 747 million mobile subscribers
in China. While this number is large, there is still opportunity to
expand as the mobile user penetration rate in China is currently relatively
low.
20
The
number of wireless subscribers in China across both 2G and 3G platforms is
projected to grow from 747 million at the end of 2009 to 925 million by the end
of 2011, a Compound Annual Growth Rate (CAGR) of 11%. According to
the Ministry of Industry and Information Technology, or MIIT, the number of 3G
wireless subscribers is expected to grow at a 216% CAGR, increasing from 15
million to 150 million during the same period.
Wireless
Infrastructure Growth Drivers in China
During
the 2G era, a majority of mobile traffic was voice, and hence network coverage
mainly focused on breadth rather than on depth. However, as we enter
into the 3G era in China, approximately 70% of the 3G traffic has focused on
data. As a result, in-depth network coverage has become 3G operators’
first priority and we believe that the demand for wireless enhancement equipment
has become much more important than in the past. We believe that the
room for growth in such demand is evident as the population coverage levels of
existing 3G networks are still below 70% in most cities currently covered, and
less than half of China’s 650 major cities are supported by 3G.
Chinese
Government Sponsored 3G Build-Out
Telecommunication
capital expenditure is expected in the coming years as the Big 3 plan to build
out their 3G coverage networks through Chinese government support and
incentives. According to MIIT, the Chinese government announced plans
to contribute $58.6 billion in 3G upgrades from 2009 to 2011, with $23.6 billion
already contributed in 2009, in an effort to extend 3G wireless coverage across
nearly all of China. With the Chinese government’s assistance, the
Big 3 have budgeted $70 billion of spending from 2009 to 2011 to deploy 3G
networks.
Significant
Construction of New Residential and Commercial Properties
Real
estate in China has exhibited growth with little slow down; total real estate
investment increased at a CAGR of 23% from 1998 – 2009. Demand for
new real estate construction is expected to remain healthy going forward as
evidenced by an anticipated shortage of supply in 2010. For example,
according to China’s National Bureau of Statistics, in 2009, 702 million square
meters of commercial and residential properties were constructed, while 937
million square meters of new property rights were sold.
The
Chinese government encourages fair competition among the Big 3 and cable service
providers to give consumers viable choices. As a result, property
owners install hardware platforms for the Big 3’s 2G and 3G technologies, cable
and Internet networks. This often results in eleven devices being deployed
on-site, which is inefficient and costly for property owners. As a
result, an increasing demand by properties owners for equipment that can
integrate coverage from the Big 3 and also provide integrated services in a
single platform is expected.
Growth
in Mobile Subscribers
Growth in
the wireless infrastructure market is also driven by the significant increase in
the number of mobile subscribers and in the amount of data transmitted over
wireless networks through smart phones in China. These growths result
in burdens being placed on the carriers’ wireless infrastructure that can
overload the network; overworked wireless networks result in poor wireless
service, slow data transfer rates and dropped calls. In order to
alleviate the constraints being put on wireless infrastructure and to increase
wireless network capacity, the Big 3 continue to deploy and upgrade wireless
infrastructure equipment.
21
Integration
of the Three Networks
There is
continued growth in the number of users of Internet, mobile phones and
cable/digital TV in China. This trend is causing legacy telecom,
Internet, TV/radio networks to become more dependent on each other to provide
services to their respective customers. For example, TV networks are
integrating with Internet networks to offer IPTV, cable networks are integrating
with Internet networks to offer cable Internet, and TV networks are integrating
with wireless networks to deliver mobile TV. According to the IChina
Research Center, $15.2 billion is expected to be spent on telecommunication
upgrades to support the integration.
“The
Internet of Things”
In China,
a budding phenomenon has developed, referred to as “The Internet of Things” in
organizations and businesses. The Internet of Things literally
translates into “the connection of things”, whether they are products,
components or systems, so that individuals can communicate intelligently with
one another and can communicate with their home and office computers and home
appliances remotely. Everything from home appliances, public
infrastructure and facilities, to logistic process will be assigned an IP
address and connected to the Internet of Things through wireline or wireless
connection. This demand is expected to increase the need for wireless
infrastructure.
Digital
Cable Network Reconstruction
Last year
marked the sixth year in the digitization of cable television in
China. At the end of 2009, cable subscribers numbered more than 174
million, and digital cable subscribers accounted for about 36% of the total,
reaching 62 million. Concurrent with the technology spending required to deliver
extras such as HDTV and programming on demand, an emphasis has been placed on
innovating cost-effective cables.
Increasing
and Evolving Need for Indoor Wireless Coverage
Historically,
“indoor wireless” meant only Wi-Fi enabled laptops, but currently, mobile users
in China also rely on mobile and smart phones, BlackBerry devices, PDAs, and
two-way radios to communicate. All of these devices require indoor
wireless coverage to operate effectively. However, while many
residential and commercial properties in China may have wireless LAN routers,
the vast majority do not have indoor wireless cellular coverage for mobile or
smart phones. In order to better serve the needs of their tenants, we
expect that property owners are increasingly looking to deploy indoor wireless
coverage solutions.
Recent
Shifts in Chinese Wireless Regulations
The
Chinese government is committed to simplifying the telecommunications industry
by standardizing the equipment used in order to create a more competitive market
environment. In addition to standardization, there is a near
unanimous government support of integration of high-speed Internet, Wi-Fi,
television programming, and voice and data networks. In order to
accelerate this integration, in January 2010, the State Council issued a
directive for the consolidation of China’s three primary communication networks
(telecommunications, television & radio broadcasting, and the Internet) into
one, within a five year window. As the number of products and
applications that need to be transmitted continues to compound, this directive
has opened up a great market opportunity for technology solutions capable of
consolidating telecommunications, television and radio broadcasting, and the
Internet into one simple form factor.
Limitations
of Competitive Solutions
We
believe that competitive wireless infrastructure solutions currently do not
comply with the Chinese government’s convergence initiatives and do not fully
meet the needs of the Big 3 and property owners. In
particular:
22
|
·
|
No other vendor integrates the
Big 3’s technology, cable and Internet service into one
solution. Historically, there has not been a single
platform compatible with disparate technology requirements of the Big 3
that can also provide integrated services. The lack of
integration results in eleven hardware deployments (equipment compatible
with 2G, 3G and internet coverage of each of the Big 3, cable TV, and
cable internet) to support the various services required by the tenants of
property owners.
|
|
·
|
Non-integrated
services require significant capital expenditure and are labor
intensive. The Big 3 have
significant upfront capital expenditures and labor requirements to fulfill
their respective deployments as competitive solutions do not integrate
carrier technology or
services.
|
|
·
|
Non-integrated services
requires large amount of space. Deployment of eleven
on-site hardware devices takes up valuable real estate
space.
|
|
·
|
Non-integrated
services are difficult to maintain. Installing, managing
and maintaining eleven on-site hardware devices is relatively cumbersome
and costly for the Big 3 and the property
owners.
|
Our
Solution
We
design, engineer and sell RF-based local access network solutions for indoor and
outdoor wireless coverage and WFDS solutions for unified local access network
coverage. In the past, our focus has been on the RF-based local
access network solution, but in the future we expect to leverage our WFDS
technology to transition our customers to a unified local access network
solution. Our WFDS solutions are designed for use by property owners
of all buildings including enterprises, municipalities, small businesses and
homes. Our unified local access network WFDS solutions integrate
multiple access services, have a lower total cost of ownership and provide
better wireless coverage.
Unified
Local Access Network WFDS Solution
We plan
to leverage our first-mover advantage with our WFDS technology in order to
increase our penetration in China and to strengthen our relationships with the
Big 3 for whom we believe our WFDS solution is a critical component to remain
aligned with industry trends and government-sponsored initiatives.
Key
benefits of our unified local access network WFDS solution include:
|
·
|
Compatibility with the Big 3’s
technologies and integrated services. Our WFDS solution
is an industry-first solution capable of providing integrated services on
a single integrated platform. Our unified solution approach as
well as our commitment to research and development, have strategically
positioned us to be a benefactor of the Chinese government’s directive for
network convergence.
|
|
·
|
Reduction in capital
expenditures. The combination of integrating services
along with the use of our patented fiber-optic technology should enable
the Big 3 to reduce their wireless infrastructure capital expenditures by
up to two-thirds.
|
|
·
|
Reduction in space
required. Utilizing our WFDS technology, property owners
can reduce the installation space required for Big 3, cable and Internet
service from eleven devices to one. In a single compact, all-
optical platform, we offer customers integrated solutions streamlined to
meet our customer’s requirements.
|
|
·
|
Easy to
install, use and maintain. Our WFDS solution
enables a property owner to deploy a single multi-functional platform in a
simple and consolidated form factor. WFDS is easy to install
and is centrally managed, is compatible with 2G and 3G services, and is
forward compatible with 4G
services.
|
23
RF-based
Local Access Network Solutions
We
provide RF-based local access network solutions to the telecommunications
industry for environments including hotels, residential estates, office
buildings, airports, exhibition centers, underground stations, highways and
tunnels. Our suite of products that we deploy as part of these
solutions includes base station and tower mounted amplifiers, antennas, couplers
and splitters. Our RF-based products support various 2G and 3G
transmission protocols, including CDMA, W-CDMA, GSM and TD-SCDMA.
Our
Competitive Strengths
We
believe the following competitive strengths enable us to compete effectively and
to capitalize on growth opportunities in our markets:
Leading
Local Access Network Solution Provider Poised to Benefit from Chinese Government
Initiatives
As an
innovative local access network solution provider, we are uniquely positioned to
benefit from the various Chinese government-sponsored initiatives. In
addition, we maintain good relations with the Ministry of Science and
Technology, the Ministry of Industry and Information Technology, the Beijing
municipal government and the Administrative Committee of
Z-Park. These relationships provide us with timely information
regarding opportunities to receive financing support, research and development
reimbursement, and tax incentives, thereby enabling us to plan our activities
timely. We intend to leverage our existing government support to
build our technology leadership position and to continue to pioneer industry
firsts.
State-of-the-Art
Unified Local Access Network WFDS Solution
We
believe our industry leading WFDS solution is the only commercially available
solution that is fully compatible with the Big 3’s respective technology
requirements and can offer integrated services in a single
platform. Our WFDS systems can be deployed in various types of
properties. We currently have received 60 patents for WFDS, and have
an additional 40 filed patent applications for WFDS under review. In
September 2009, WFDS technology successfully passed all United States Federal
Communications Commission, or FCC, testing procedures. The FCC
certification will not only apply to the U.S. market, but also to our WFDS
products in Central and South America. We expect to gain significant
traction in the indoor wireless coverage market through our first mover
advantage.
Leading
Research and Development Capabilities
We have
leading research and development capabilities in China, and we have won awards
from the Ministry of Science and Technology. We have more than 100
research and development specialists of which over 40% have at least a master’s
degree. Our research and development staff includes specialists in RF
and WFDS technology; these employees are comparatively difficult to recruit and
we believe our strong staff provides us with a competitive
advantage. Our research and development laboratory has
state-of-the-art equipment intended to give our personnel the tools to make
significant advances in wireless coverage technologies. In addition,
we provide our employees with continuing education administered through internal
programs.
Long-Term,
Established Customer Relationships
We have
maintained long-term relationships with the Big 3 as customers for thirteen
years. Given the conservative nature of the Big 3, we believe that
our long-term relationship with them provides us with a competitive advantage
over new entrants or less mature Chinese companies in selling wireless
infrastructure in China. Additionally, with the significant ownership
the Chinese government has over the Big 3 and the protected nature of the
wireless equipment infrastructure market in China, we believe that it would be
difficult for international competitors to gain traction with the Big
3.
24
Extensive
Branch Network Providing Strong Sales Network and Customer Service
We employ
a group of experienced and technologically savvy sales and marketing staff in
China. Selling local access network solutions is a relationship
driven business and therefore requires extensive touch points. As our
business is based on a direct sales model, and covers a broad and diverse
customer base, we have 30 branches across all but one province in
China. Through this branch network, we have a strong sales effort and
can deliver timely customer service.
Experienced
Management Team with a Proven Track Record
Our
management team has a track record of success at both public and private
companies, including extensive experience within the Chinese wireless
communications market. Mr. Daqing Han, our founder, Chairman and
President, has extensive knowledge of the telecommunications industry in China
through over 25 years of experience. Mr. Han and most of our senior
management have worked together as a team for over 13 years and have
successfully built our business and increased revenue from $21.7 million in 2006
to $71.0 million in 2009.
Our
Growth Strategy
Our
strategic focus is to build on our position as a leading provider of local
access network solutions in China and increase our international market
presence. Key elements of our growth strategy include:
Increase
Market Share in China
We have
uniquely positioned ourselves to be a major benefactor of various Chinese
government-sponsored initiatives. We have built trust and earned
validation from the Big 3 and from the Chinese government, which continues to
exercise substantial control over virtually every sector of the Chinese economy
through regulation and state ownership. We plan on leveraging our
industry-leading local access network solutions, our track record of successful
deployment of our solutions in projects in various geographical regions in
China, and our strong relationships to increase our market share in
China.
Leverage
First Mover Advantage for WFDS
The
Chinese government recently issued a directive to integrate 2G and 3G wireless
signal coverage, Internet, TV and radio, and voice and data services into a
single platform. To help encourage the integration, the Chinese
government has committed to provide financial incentives in order to increase
competition and meet its projected timetable, which is expected to be completed
over the next five years. We believe our WFDS product is currently
the only solution in the market that can deliver an integrated
service.
Capitalize
on WFDS Leasing Model
We have
recently pioneered a new WFDS leasing model. As opposed to selling
our WFDS equipment to carriers, we are testing a leasing model in which we
maintain ownership of the equipment installed on the property
premise. The Big 3 pays us a monthly fee to “lease” bandwidth on the
WFDS solution in order to deliver integrated services to the property
tenants. We would in turn share a portion of the monthly leasing fee
with the property owners in return for them providing us with space on the
property to install our equipment. The Big 3 benefit as well as they
will no longer need to pay upfront for the equipment.
25
The
leasing model would not only provide a steady revenue stream, it would also
yield higher gross margins, and we expect it will be attractive to property
owners and the Big 3. We are currently engaged in four pilot
projects with the new model.
Extend
Our Research and Development Leadership and Product Development
We plan
to continue to invest in research and development and product development for
our solutions to enhance our leadership position for unified local access
network solutions. We have a dedicated team of over 100 research and development
specialists to continue the development of solutions and we expect to maintain
meaningful investments in research and development on a going-forward
basis.
Seek
Selective Acquisitions and Strategic Investments
We have
in-depth knowledge of smaller equipment vendors or solutions providers in the
Chinese local access network market. We may selectively acquire
smaller participants in the sector to expand our product offering or market
presence. Potential targets are companies that have strong traction
with the Big 3 in their local markets or have technologies to bolster our
product offering.
Strengthen
International Market Presence
We intend
to increase our international presence over the next few years. We
have already established partnerships with, and will continue to find and train
value-added resellers and systems integrators in international markets to sell
our solutions. We currently have six sales offices outside of China
and intend to increase this number in the near-term. While we
currently generate less than 5% of our revenue from sources outside of China, we
expect the international market, especially the U.S., will represent a
significant growth opportunity for us in the future.
Revenue,
Cost of Revenue and Operating Expenses
We derive
our revenue from sales of our RF-based local access network solutions for indoor
and outdoor wireless coverage, IP-based products for Internet access, and ULAN
solutions based on our WFDS systems, and professional
services. Professional services revenue consists of upfront system
design, implementation and network maintenance.
Our
revenue growth has been driven primarily by an expansion of our provincial-level
Big 3 customer base in China, an expansion of our product portfolio from
RF-based products to our newer WFDS product, and continued international
expansion. We believe the market for our products is very large as
China is the world’s largest mobile market.
Cost
of Products and Professional Services
Cost of
product revenue consists primarily of manufacturing costs for our products,
shipping and logistics costs, and expenses for warranty
obligations. We have outsourced the substantial majority of our
manufacturing to Shijiazhuang Spectrum Digital Communication Company, our
contract manufacturer who manufactures exclusively for us. Accordingly, the
substantial majority of our cost of revenue consists of payments to Shijiazhuang
Spectrum and our component suppliers.
Cost of
professional services revenue is primarily comprised of related personnel costs
and technical support costs, including personnel costs associated with our
internal support organization.
Gross
Margin
Our gross
margin has been, and will continue to be, affected by a variety of factors,
including:
product
mix and average selling prices;
26
new
product introductions and enhancements both by us and by our
competitors;
demand
for our products and services;
our
ability to attain volume manufacturing pricing from Shijiazhuang Spectrum and
our component suppliers;
losses
associated with excess and obsolete inventory; and
growth in
our headcount and other related costs incurred in our professional services
organization.
Operating
Expenses
Operating
expenses consist of sales and marketing expenses, general and administrative
expenses, and research and development expenses. The largest
component of our operating expenses is personnel costs. Personnel
costs consist of salaries, benefits and other compensation for our
employees. We have approximately 1,200 full-time employees as of June
30, 2010.
Sales and
marketing expenses represent the largest component of our operating expenses and
primarily consist of sales and marketing expenses, including all related
expenses and compensation for sales personnel and travel expenses related to
sales of products and market development. We expense sales and
marketing expenses as incurred. For fiscal 2010, we expect sales and
marketing expenses to increase on an absolute dollar basis.
We plan
to continue to invest strategically in sales and marketing with the intent to
add new customers and increase penetration within our existing customer base,
expand our China and international sales and marketing activities, build brand
awareness and sponsor additional marketing events. We expect future
sales and marketing expenses to continue to be our most significant operating
expense.
General
and administrative expenses primarily consist of compensation for personnel,
travel expenses, materials expenses related to ordinary administration, fees for
professional services, and provisions for doubtful accounts. For
fiscal 2010, we expect general and administrative expenses to increase on an
absolute dollar basis.
Research
and development expenses primarily consist of compensation for research and
development staff, material expenses, travel expenses and facility
expense. We expense research and development expenses as incurred. We
are devoting substantial resources to the continued development of additional
functionality for existing products and the development of new
products. We intend to continue to invest in our research and
development efforts because we believe it is essential to maintaining our
competitive position. The dollar amount invested in our research and
development activities will increase as we continue to increase our
revenue. However, as a percentage of revenue, research and
development costs are expected to remain relatively low.
Interest
Expense
Interest
expense includes interest we pay on our short-term bank loans.
Other
Income (Expense), net
Other
income (expense), net includes interest income on cash balances, gain or loss
from disposal of assets, gains or losses on conversion of non-Renminbi
transactions into Renminbi, and gains from governmental subsidy. Cash
has historically been invested in highly liquid investments with original
maturities of three months or less.
27
Income
Tax Expense
Income
tax expense is computed based on pre-tax income included in the consolidated
statement of operations. Income taxes have been provided, using the
liability method, which requires recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between the carrying amounts and tax bases assets and liabilities and their
reported amounts. The tax consequences of those differences are classified
as current or non-current based upon the classification of the related assets or
liabilities in the consolidated financial statements.
Critical
Accounting Policies
Our
consolidated financial statements are prepared in accordance with U.S. generally
accepted accounting principles (“GAAP”). These accounting principles
require us to make estimates and judgments that affect the reported amounts of
assets and liabilities as of the date of the consolidated financial statements,
as well as the reported amounts of revenue and expenses during the periods
presented. We believe that the estimates and judgments upon which we rely
are reasonable based upon information available to us at the time that these
estimates and judgments are made. To the extent there are material
differences between these estimates and actual results, our consolidated
financial statements will be affected. The accounting policies that
reflect our more significant estimates and judgments and which we believe are
the most critical to aid in fully understanding and evaluating our reported
financial results include revenue recognition, foreign currency translation,
inventory valuation, allowances for doubtful accounts, and
goodwill.
Revenue
Recognition
Our
revenue is derived primarily from two sources: (1) product revenue and
(2) professional services revenue.
Product
revenue represents the invoiced value of goods, net of value-added tax (“VAT”)
and returns. The Company generally recognizes product revenue when
persuasive evidence of an arrangement exists, delivery occurs, the fee is fixed
or determinable, and collectibility is probable. Professional service
revenue is recognized when the service is performed and accepted by the
customer.
As part
of professional services, the Company provides installation services for certain
sales of equipment under fixed-price contracts. Revenue from these
fixed-price service contracts are recognized on the completed-contract
method. Under the completed-contract method, revenue and costs of
individual contracts are included in operations in the year during which they
are completed. Losses expected to be incurred on contracts in progress are
recognized in the period such losses are determined. This method is used
because the contract is completed within a short period of time, and the
financial position and results of operations do not vary significantly from
those that would result from using the percentage-of-completion method. A
contract is considered completed upon completion of all essential contract work
and the installation has been accepted by the customer.
Foreign
Currency Translation
All major
subsidiaries of the Company consider Renminbi as their functional currency as a
substantial portion of their business activities is based in Renminbi.
However, the Company has chosen the United States dollar as its reporting
currency.
Transactions
in currencies other than the functional currency during the year are translated
into the functional currency at the applicable rates of exchange prevailing at
the time of the transactions. Monetary assets and liabilities denominated
in currencies other than the functional currency are translated into the
functional currency at the applicable rates of exchange in effect at the balance
sheet date. Exchange gains and losses are recorded in the consolidated
statements of operations.
28
For
translation of financial statements into the reporting currency, assets and
liabilities are translated at the exchange rate at the balance sheet date,
equity accounts are translated at historical exchange rates, and revenue,
expenses, gains and losses are translated at the weighted average rates of
exchange prevailing during the period. A translation adjustment, when
material, resulting from this process is recorded in accumulated other
comprehensive income within stockholders’ equity.
Inventory
Valuation
Inventory
consists of equipment and related component parts and is stated at the lower of
weighted average cost or market. We record inventory write-downs for potentially
excess inventory based on forecasted demand, economic trends and technological
obsolescence of our products. If future demand or market conditions are
less favorable than our projections, additional inventory write-downs could be
required and would be reflected in cost of product revenue in the period the
revision is made. At the point of the loss recognition, a new, lower-cost
basis for that inventory is established, and subsequent changes in facts and
circumstances do not result in the restoration or increase in that newly
established cost basis. Provision for slow moving and obsolete items
amounted to $0.4 million as of June 30, 2010 and December 31, 2009.
Allowances
for Doubtful Accounts
We record
a provision for doubtful accounts based on historical experience and a detailed
assessment of the collectibility of our accounts receivable. In estimating
the allowance for doubtful accounts, our management considers, among other
factors, (1) the aging of the accounts receivable, including trends within and
ratios involving the age of the accounts receivable, (2) our historical
write-offs, (3) the credit-worthiness of each customer, (4) the economic
conditions of the customer’s industry, and (5) general economic
conditions. In cases where we are aware of circumstances that may impair a
specific customer’s ability to meet their financial obligations to us, we record
a specific allowance against amounts due from the customer, and thereby reduce
the net recognized receivable to the amount we reasonably believe will be
collected. The allowance for doubtful accounts was $6.2 million both as of June
30, 2010 and December 31, 2009.
Goodwill
We apply
ASC Topic 350 – Goodwill and Other Intangibles and perform an annual goodwill
impairment test, or test more frequently if events or changes in circumstances
indicate that the carrying value may be impaired. Goodwill is allocated to
cash-generating units for the purpose of impairment test and determination of
gain or loss on disposal.
Goodwill
on acquisition of businesses, being the excess of the cost of the acquisition
over the Company’s share of the fair value of the identifiable assets,
liabilities and contingent liabilities, is recognized as a separate asset.
Goodwill is carried at cost less accumulated impairment losses. An
impairment loss on goodwill is not reversed. We did not recognize
impairment charges in any of the periods presented.
RESULTS
OF OPERATION
Our
operating results are presented for the quarter ended June 30, 2010, as compared
to the quarter ended June 30, 2009.
29
The
following is statement of our operations for the three months ended June 30,
2010 and 2009.
Item
|
2010
Q2
|
2009
Q2
|
Comparisons
|
|||||||||||||||||||||
$'000
|
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
Revenue
|
16,619 | 12,130 | 4,489 | 37.0 | % | |||||||||||||||||||
Cost
of products and professional services
|
9,121 | 54.9 | % | 7,123 | 58.7 | % | 1,998 | 28.0 | % | |||||||||||||||
Gross
profit
|
7,498 | 45.1 | % | 5,007 | 41.3 | % | 2,491 | 49.8 | % | |||||||||||||||
Sales
and marketing expenses
|
4,176 | 25.1 | % | 1,847 | 15.2 | % | 2,329 | 126.1 | % | |||||||||||||||
General
and administrative expenses
|
882 | 5.3 | % | 478 | 4.0 | % | 404 | 84.5 | % | |||||||||||||||
Research
and development expenses
|
191 | 1.1 | % | 193 | 1.6 | % | -2 | -1.0 | % | |||||||||||||||
Depreciation
and amortization
|
81 | 0.5 | % | 84 | 0.7 | % | -3 | -3.6 | % | |||||||||||||||
Interest
expenses
|
134 | 0.8 | % | 89 | 0.7 | % | 45 | 50.6 | % | |||||||||||||||
Other
income
|
194 | 1.1 | % | 22 | 0.2 | % | 172 | 781.8 | % | |||||||||||||||
Income
before tax
|
2,228 | 13.4 | % | 2,338 | 19.3 | % | -110 | -4.7 | % | |||||||||||||||
Income
tax
|
508 | 3.1 | % | 366 | 3.0 | % | 142 | 38.8 | % | |||||||||||||||
Net
income
|
1,720 | 10.3 | % | 1,972 | 16.3 | % | -252 | -12.8 | % |
The
following is statement of our operations for the six months ended June 30, 2010
and 2009.
Item
|
2010
Six months
|
2009
Six months
|
Comparisons
|
|||||||||||||||||||||
$'000
|
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
Revenue
|
27,751 | 20,026 | 7,225 | 38.6 | % | |||||||||||||||||||
Cost
of products and professional services
|
15,314 | 55.2 | % | 10,319 | 51.5 | % | 4,995 | 48.4 | % | |||||||||||||||
Gross
profit
|
12,437 | 44.8 | % | 9,707 | 48.5 | % | 2,730 | 28.1 | % | |||||||||||||||
Sales
and marketing expenses
|
6,904 | 24.9 | % | 4,028 | 20.1 | % | 2,876 | 71.4 | % | |||||||||||||||
General
and administrative expenses
|
3,816 | 13.8 | % | 1,321 | 6.6 | % | 2,495 | 188.9 | % | |||||||||||||||
Research
and development expenses
|
415 | 1.5 | % | 329 | 1.6 | % | 86 | 26.1 | % | |||||||||||||||
Depreciation
and amortization
|
152 | 0.5 | % | 174 | 0.9 | % | -22 | -12.6 | % | |||||||||||||||
Interest
expenses
|
260 | 0.9 | % | 130 | 0.6 | % | 130 | 100.0 | % | |||||||||||||||
Other
income
|
529 | 1.9 | % | 289 | 1.4 | % | 240 | 83.0 | % | |||||||||||||||
Income
before tax
|
1,419 | 5.1 | % | 4,014 | 20.0 | % | -2,595 | -64.6 | % | |||||||||||||||
Income
tax
|
829 | 3.0 | % | 895 | 4.5 | % | -66 | -7.4 | % | |||||||||||||||
Net
income
|
590 | 2.1 | % | 3,119 | 15.6 | % | -2,529 | -81.1 | % |
Revenue
Our
revenue during the six months ended June 30, 2010 was derived from sales of
products and professional services primarily to domestic telecom carriers, and
to a lesser extent, direct product sales to system integrators and overseas
customers. Our major customers include provincial-level subsidiaries of
China Mobile, China Unicom, and China Telecom.
30
For the
three months and six months ended June 30, 2010, our revenue was $16.6 million
and $27.8 million, respectively, representing increases of 37.0% and 38.6%
respectively from the same periods in 2009. The increase was primarily
attributable to revenue generated from China Mobile WLAN projects and China
Telecom network coverage construction. These projects involved the
implementation of WFDS systems.
Revenue
Breakdown
Three
months ended June 30, 2010 and 2009
2010
Q2
|
2009
Q2
|
Growth
|
||||||||||||||||||||||
$'000
|
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
Product
revenue
|
7,060 | 42.5 | % | 7,142 | 58.9 | % | -82 | -1.1 | % | |||||||||||||||
Professional
services revenue
|
9,559 | 57.5 | % | 4,988 | 41.1 | % | 4,571 | 91.6 | % | |||||||||||||||
Total
|
16,619 | 100.0 | % | 12,130 | 100.0 | % | 4,489 | 37.0 | % |
Six
months ended June 30, 2010 and 2009
2010
Six months
|
2009Six
months
|
Growth
|
||||||||||||||||||||||
$'000
|
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
Product
revenue
|
12,160 | 43.8 | % | 10,405 | 52.0 | % | 1,755 | 16.9 | % | |||||||||||||||
Professional
services revenue
|
15,591 | 56.2 | % | 9,621 | 48.0 | % | 5,970 | 62.1 | % | |||||||||||||||
Total
|
27,751 | 100.0 | % | 20,026 | 100.0 | % | 7,725 | 38.6 | % |
For the
three months and six months ended June 30, 2010, revenue generated from product
sales was $7.1 million and $12.2 million, respectively, representing a decrease
of 1.1% and an increase of 16.9% respectively from the same periods in
2009.
For the
three months and six months ended June 30, 2010, revenue generated from
professional services was $9.6 million and $15.6 million, respectively,
representing increases of 91.6% and 62.1%, respectively, from the same periods
in 2009. The increase in professional services revenue was primarily
attributable to 3G coverage projects and WLAN projects for China
Mobile.
For the
three months and six months ended June 30, 2010, revenue generated from product
sales accounted for 42.5% and 43.8% of total revenue, respectively, compared to
58.9% and 52.0% respectively for the same period in 2009. For the aforementioned
periods, revenues generated from professional service sales accounted for 57.5%
and 56.2% of total revenues, respectively, compared to 41.1% and 48.0%,
respectively, for the same periods of 2009.
Breakdown
by Customers
Three
months ended June 30, 2010 and 2009
2010
Q2
|
2009
Q2
|
Growth
|
||||||||||||||||||||||
$'000 |
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
China
Mobile
|
8,694 | 52.3 | % | 4,195 | 34.6 | % | 4,499 | 107.2 | % | |||||||||||||||
China
Unicom
|
4,748 | 28.6 | % | 7,392 | 60.9 | % | -2,644 | -35.8 | % | |||||||||||||||
China
Telecom
|
2,750 | 16.6 | % | 303 | 2.5 | % | 2,447 | 807.6 | % | |||||||||||||||
Overseas
|
71 | 0.4 | % | 159 | 1.3 | % | -88 | -55.3 | % | |||||||||||||||
Others
|
356 | 2.1 | % | 81 | 0.7 | % | 275 | 339.5 | % | |||||||||||||||
Total
|
16,619 | 100.0 | % | 12,130 | 100.0 | % | 4,489 | 37.0 | % |
31
Six
months ended June 30, 2010 and 2009
2010
six months
|
2009
six months
|
Growth
|
||||||||||||||||||||||
$'000 |
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
China
Mobile
|
17,604 | 63.4 | % | 6,973 | 34.8 | % | 10,631 | 152.5 | % | |||||||||||||||
China
Unicom
|
5,831 | 21.0 | % | 10,575 | 52.8 | % | -4,744 | -44.9 | % | |||||||||||||||
China
Telecom
|
3,697 | 13.3 | % | 1,789 | 8.9 | % | 1,908 | 106.7 | % | |||||||||||||||
Overseas
|
263 | 1.0 | % | 330 | 1.7 | % | -67 | -20.3 | % | |||||||||||||||
Others
|
356 | 1.3 | % | 359 | 1.8 | % | -3 | -0.8 | % | |||||||||||||||
Total
|
27,751 | 100.0 | % | 20,026 | 100.0 | % | 7,725 | 38.6 | % |
Revenue
from the wireless telecom carriers was the Company’s major source of revenue
during the reporting period, and the majority of such revenue was generated from
China Mobile and China Unicom. The decrease of China Unicom revenue was
due to China Unicom’s comparably later initiation of bidding than China Mobile
in 2010. The increase of China Telecom revenue was attributable to the
large-scale investment in wireless coverage construction from the second quarter
of 2010. The reason for the increase of China Mobile revenue was that China
Mobile increased its investment in constructing WLAN projects.
Cost
of Products and Professional Services
Three
months ended June 30, 2010 and 2009
2010
Q2
|
2009
Q2
|
Growth
|
||||||||||||||||||||||
$'000
|
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
Cost
of products
|
3,998 | 24.1 | % | 4,741 | 39.1 | % | -743 | -15.7 | % | |||||||||||||||
Cost
of professional services
|
5,123 | 30.8 | % | 2,382 | 19.6 | % | 2,741 | 115.1 | % | |||||||||||||||
Total
|
9,121 | 54.9 | % | 7,123 | 58.7 | % | 1,998 | 28.0 | % |
Six
months ended June 30, 2010 and 2009
2010
Six months
|
2009
Six months
|
Growth
|
||||||||||||||||||||||
$'000
|
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
Cost
of products
|
6,868 | 24.8 | % | 6,639 | 33.1 | % | 229 | 3.4 | % | |||||||||||||||
Cost
of professional services
|
8,446 | 30.4 | % | 3,680 | 18.4 | % | 4,766 | 129.5 | % | |||||||||||||||
Total
|
15,314 | 55.2 | % | 10,319 | 51.5 | % | 4,995 | 48.4 | % |
For the
three months and six months ended June 30, 2010, our total cost of products and
professional services were $9.1 million and $15.3 million, respectively,
representing increases of 28.0% and 48.4%, respectively, from the same periods
in 2009.
Gross
Profit and Gross Margin
For the
three months and six months ended June 30, 2010, our gross profit was $7.5
million and $12.4 million, respectively, representing increases of 49.8% and
28.1%, respectively, from the same periods in 2009. Our gross margin
during the aforementioned period was 45.1% and 44.8%, respectively, compared to
41.3% and 48.5%, respectively, in the same periods in 2009.
Product
Gross Margin:
Our
product gross margin increased to 43.4% during the three months ended June 30,
2010, from 33.6% in the same period in 2009. The increase in product gross
margin was primarily attributable to sales of our new products (WFDS) with
higher gross margin to China Mobile in Inner Mongolia during the
quarter.
32
Professional
Services Gross Margin:
Our
professional services gross margin decreased to 46.4% for the three months ended
June 30, 2010 from 52.2% in the same period in 2009. The Big 3 have
adopted centralized procurement and public bidding processes, which required us
to lower our contract prices in order to secure potential tenders. This
has resulted in lower gross profit margins in the quarter ended June 30, 2010.
The high gross margin of maintenance and design services in early 2009 did not
occur in the quarter ended June 30, 2010.
Operating
Expenses
Three
months ended June 30, 2010 and 2009
Item
|
2010
Q2
|
2009
Q2
|
Comparisons
|
|||||||||||||||||||||
$'000
|
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
|||||||||||||||||||
Sales
and marketing expenses
|
4,176 | 25.1 | % | 1,847 | 15.2 | % | 2,329 | 126.1 | % | |||||||||||||||
General
and administrative
|
882 | 5.3 | % | 478 | 4.0 | % | 404 | 84.5 | % | |||||||||||||||
Research
and development
|
191 | 1.1 | % | 193 | 1.6 | % | -2 | -1.0 | % | |||||||||||||||
Total
|
5,249 | 31.5 | % | 2,518 | 20.8 | % | 2,731 | 108.5 | % |
Six
months ended June 30, 2010 and 2009
2010
Six months
|
2009
Six months
|
Comparisons
|
||||||||||||||||||||||
Item
|
$'000
|
%
of revenue
|
$'000
|
%
of revenue
|
$'000
|
%
|
||||||||||||||||||
Sales
and marketing expenses
|
6,904 | 24.9 | % | 4,028 | 20.1 | % | 2,876 | 71.4 | % | |||||||||||||||
General
and administrative
|
3,816 | 13.8 | % | 1,321 | 6.6 | % | 2,495 | 188.9 | % | |||||||||||||||
Research
and development
|
415 | 1.5 | % | 329 | 1.6 | % | 86 | 26.1 | % | |||||||||||||||
Total
|
11,135 | 40.2 | % | 5,678 | 28.3 | % | 5,457 | 96.1 | % |
Operating
expenses mainly include sales and marketing expenses, general and administrative
expenses and research and development expenses.
Sales
and Marketing Expenses
For the
three months and six months ended June 30, 2010, sales and marketing expenses
were $4.2 million and $6.9 million, respectively, representing increases of
126.1% and 71.4%, respectively, from the same periods in 2009. As a
percentage of revenue for the three months and six months ended June 30, 2010,
sales and marketing expenses accounted for 25.1% and 24.9% of total revenue,
respectively, as compared to 15.2% and 20.1% of total revenue, respectively, for
the same periods in 2009. The increase in sales and marketing expenses was
primarily due to our increased preliminary input in order to increase our market
share, our performance based bonuses granted to our branches’ staff,
and our expanded branches and recruitment of additional sales personnel during
this quarter.
General
and Administrative Expenses
For the
three months and six months ended June 30, 2010, general and administrative
expenses were $0.9 million and $3.8 million, respectively, accounting for 5.3%
and 13.8%, respectively, of total revenue, as compared to $0.5 million and $1.3
million of the same periods in 2009, respectively, accounting for 4.0% and 6.6%
of total revenue, respectively, for the corresponding periods of 2009.
General and administrative expenses for the three months and six months ended
June 30, 2010 increased 84.5% and 188.9%, respectively, from the same periods
last year. The increase in general and administrative expenses was
primarily attributable to the enlargement of our headquarters’ office space used
for WFDS products R&D. As a result, the office rent has been increased. In
addition, the consulting fee of Deloitte Touche Tohmatsu CPA Ltd., Beijing
Branch, which provides consulting services to the Company for satisfying the
requirements of SOX 404, increased during this quarter. Also, a stock-based
compensation expense of $2.2 million related to the issuance of stocks to
certain directors of Shandong Guolian Telecommunications Technology Limited for
their services rendered in previous years in improving business results and
their contribution to the Company’s success.
33
Research
& Development Expenses
For the
three months and six months ended June 30, 2010, research and development
expenses were $0.2 million and $0.4 million, respectively, accounting for 1.1%
and 1.5%, of total revenue, respectively, as compared to $0.2 million and $0.3
million for the same periods in 2009, respectively, accounting for 1.6% and 1.6%
of total revenue, respectively, for the corresponding periods in 2009.
Research and development expenses increased slightly.
The
increase in research and development expenses was due to our development of new
products during the three months ended June 30, 2010.
Interest
Expense and Other Income
For the
three months and six months ended June 30, 2010, interest expenses were $0.1
million and $0.3 million, respectively, accounting for 0.8% and 0.9% of total
revenue, respectively, as compared to $0.1 million and $0.1 million for the same
periods in 2009, respectively. Interest expenses rose as a result of
increased bank borrowings during the quarter to fund our working capital
needs.
For the
three months and six months ended June 30, 2010, other income was $0.2 million
and $0.5 million, respectively, accounting for 1.1% and 1.9% of total revenue,
respectively, as compared to $0.02 million and $0.3 million for the same periods
in 2009, respectively, accounting for 0.2% and 1.4% of total revenue,
respectively, for the same periods in 2009. Other income increased as a
result of additional government sponsorship income that was provided during the
quarter.
Net
Income
For the
three months and six months ended June 30, 2010, we had a net income of $1.7
million and $0.6 million, respectively, representing decreases of 12.8% and
81.1% from the same periods in 2009, respectively. Net income decreased
primarily as a result of the increase in operating expenses.
LIQUIDITY
AND CAPITAL RESOURCES
We
generally finance our operations from cash flow generated internally. As of June
30, 2010, our current assets comprised inventories of $6.4 million, accounts
receivable of $101.0 million, prepayments of $0.8 million, other receivables of
$4.2 million, due from related parties of $2.0 million, and cash and cash
equivalents of $7.7 million. As of June 30, 2010, our current liabilities
comprised accounts payable of $18.5 million, tax payables of $8.1 million, a
short-term bank loan of $5.9 million, trade deposits received of $1.6 million,
due to related parties of $6.3 million, and other payables and accruals of $17.6
million.
Our
trading terms with our customers are mainly on credit. As of June 30, 2010, our
accounts receivable were $101.0 million compared to $89.0 million as of December
31, 2009.
We
experience a longer accounts receivable turnover period than our main
competitors due to our revenue being generated from a higher mix of system
integration projects, which are typically billed in phases throughout the life
of the project. We believe that our main competitors are more focused on
equipment sales, which tend to have shorter receivable turnover periods.
Generally, we and our main competitors have traditionally experienced a longer
receivable turnover period due to the fact that our main customers are the three
state-owned telecommunications carriers, which tend to make payments
slower. Additionally, approximately 10% of our professional services
revenue are settled after 24 months of our warranty period. We have not
experienced any significant bad debts in the past.
34
As of
June 30, 2010, our inventories were $6.4 million, as compared to $4.4 million as
of December 31, 2009, representing an increase of 43.5%.
We
believe that the combination of present capital resources and unused financing
sources are more than adequate to meet cash requirements for 2010 and the
following years. We intend to meet our liquidity requirements, including capital
expenditures related to market expansion, research and development for new
products and technology, through cash flow provided by operations and additional
funds raised by short-term loan. We are an enterprise with good credit and our
relationships with these banks are in good standing. We believe that adequate
cash flow will be available to fund our operations and additional needs in the
future.
As of
June 30, 2010, our cash and bank balances were mainly denominated in Renminbi
(“RMB”) and United States dollars (“US$”) while our bank borrowings were mainly
denominated in RMB. Our revenue and expenses, assets and liabilities are
mainly denominated in RMB and US$. Recently, the exchange rate
fluctuations in the PRC have led to an appreciation of RMB. This may
result in certain exchange risks.
OFF-BALANCE
SHEET ARRANGEMENTS
We do not
have any off-balance sheet arrangements
CONTINGENT
LIABILITIES
We
recognize our revenue upon the completion of contracts and have made full tax
provision in accordance with relevant national and local laws and regulations of
the PRC. A contract is considered completed upon completion of all
essential contract work and when installation has been accepted by the
customer. It is the common practice in the PRC that invoices are not
issued to customers until payments are received. We follow the practice of
reporting our revenue for PRC tax purposes when invoices are issued. All
unbilled revenue will become taxable when invoices are issued. Despite the fact
that we have made full tax provision in the financial statements, we may be
subject to surcharge and penalty for the deferred reporting of tax
obligations. The Board of Directors considers it is unlikely
that the surcharge and tax penalty will be imposed.
Item
3. Quantitative and Qualitative Disclosures About Market Risk
Not
required for smaller reporting company.
Item
4. Controls and Procedures
(a)
Evaluation of disclosure controls and procedures
Under
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as of the end of the period covered by this
Quarterly Report on Form 10-Q (the “Evaluation Date”); and whether any change
has occurred in the Company’s internal control over financial reporting pursuant
to Exchange Act Rules 13a-15(d) and 15d-15(d). Disclosure controls and
procedures are designed to ensure that information required to be disclosed in
our reports filed under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms. This information is accumulated and communicated
to management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosures. Based on this evaluation, our principal executive officer and
principal financial officer concluded as of the Evaluation Date that our
disclosure controls and procedures were not effective due to the fact that the
material weaknesses in the Company’s internal control over financial reporting
described in the Company’s Annual Report on Form 10-K for the fiscal year ended
December 31, 2009 have not been remediated as of Evaluation Date, although steps
have been taken toward remediation during the quarter ended June 30,
2010.
35
It should
be noted that any system of controls, however well designed and operated, can
provide only reasonable, and not absolute, assurance that the objectives of the
system are met. In addition, the design of any control system is based in
part upon certain assumptions about the likelihood of future
events. Because of these and other inherent limitations of control
systems, there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions.
(b)
Changes in internal control over financial reporting
During
the quarter ended June 30, 2010, there were no changes to our internal controls
over financial reporting that have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.
PART
II
OTHER
INFORMATION
Item
1. Legal Proceedings.
None.
Item
1A. Risk Factors.
Not
required.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
On June
22, 2010, the Company issued 10,000 restricted shares of common stock to Ren Hu,
former secretary to the board of the Company, for his services rendered prior to
his resignation in April 2010.
The
aforementioned restricted shares of common stock were issued pursuant to the
private offering exemption under Section 4(2) of the Securities Act of 1933, as
amended.
Item
3. Defaults Upon Senior Securities.
None.
Item
4. (Removed and Reserved).
Item
5. Other Information.
None.
Item
6. Exhibits.
The
following documents are filed as part of this report:
10.1
|
Form
of Employment Contract of the Company
|
|
31.1
|
Chief
Executive Officer Certification furnished pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
31.2
|
Chief
Financial Officer Certification furnished pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
32.1
|
Chief
Executive Officer Certification furnished pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|
|
32.2
|
Chief
Financial Officer Certification furnished pursuant to Section 906 of the
Sarbanes-Oxley Act of
2002
|
36
SIGNATURES
In
accordance with the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TELESTONE
TECHNOLOGIES
CORPORATION
|
||
Date:
August 12, 2010
|
By:
|
/s/
Han Daqing
|
Han
Daqing, Chief Executive Officer
|
||
(Principal
Executive Officer)
|
||
Date:
August 12, 2010
|
By:
|
/s/
Yu Xiaoli
|
Yu
Xiaoli, Chief Financial Officer
|
||
(Principal
Financial
Officer)
|
37