Telestone Technologies (Nasdaq: TSTC), which provides local access networks for the telecommunications industry in China, posted positive results during the first quarter. But there are some problems underneath the stated figures.
Story behind the numbers
After posting a massive 84.5% jump in revenue in the last quarter of 2010, the company saw its revenues spike 30% in the seasonally slow first quarter. Telestone managed to turn a year-ago net loss of $1.1 million into a net income of $1.6 million this quarter. Looks pretty good, but don't stop there.
A quick scan through the balance sheet shows that total receivables for the company shot up 117%, to a massive $199.5 million in the first quarter of 2011, from just $91.9 million in the corresponding quarter of 2010. This was mainly due to an increase in accounts receivables to $198 million this quarter from $90.4 million in the year-ago quarter.
What this means is that the company has not been generating proceeds from buyers quickly enough, thus leading to a longer working capital cycle. In this case, the company has probably been extending more generous terms on its credit to buyers, which means that it may ultimately have trouble collecting on those sales.
This is definitely a concern to me, as continuing increases in working capital pressure cash flows. Cash from operations declined to a negative $5.6 million this quarter from a negative $1.1million last year. Clearly, book profits are not translating into cash inflows. This is a red flag.
More opportunities ahead
Despite the issues on the company's cash collection practices, there is good news. Way back in January, the company bagged a $10 million contract with China Beijing-Shanghai High Speed Rail. The contract allows the use of Telestone's wireless fiber-optic distribution system-enabled unified access network solution to cater to the complex communication needs of China's telecom majors: China Mobile Limited (NYSE: CHL), China Telecom (NYSE: CHA), and China Unicom (NYSE: CHU). This will, to a great amount, help these telecom players provide better wireless broadband Internet, 2G, and 3G wireless services to their subscribers using high-speed rail. As high-speed rail is a key initiative in China, this contract could foreshadow future wins.
The Foolish bottom line
Telestone's inefficient working capital management gives me strong reason to worry, as accounts receivables have been increasing for the past four quarters. While it might be inappropriate to compare Telestone to peers competing in more advanced markets where receivables collection is quicker, the specter of not collecting on a portion of these revenues could weigh on the company in the future. With thin profit margins, any receivables writedown could scuttle several quarters of profitability.
Deteriorating cash levels and increases in accounts receivable can definitely be a concern for the company going forward. Let's see how well it manages its cash levels in the coming quarters.
