UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
 FORM
10-Q
 
 xQuarterly Report Pursuant to Section
13 or 15(d) of the
 Securities
Exchange Act of 1934
 
 For the
quarterly period ended March 31, 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 o
                Accelerated filer o
                Non-accelerated filer o (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 May 15, 2010, 10,548,264  shares of the Issuer’s $.001 par value
common stock were outstanding.
  
 
 TELESTONE
TECHNOLOGIES CORPORATION
 
 INDEX
 
 PART
I. FINANCIAL INFORMATION
 
 PageItem
      1. Condensed Financial Statements.
                      
                      
                      3Condensed Consolidated Statements
      of Operationsand Other Comprehensive Income,
      for the three months ended March 31, 2010  and 2009
      (unaudited)
                      
                      
                      3Condensed
      Consolidated Balance Sheets, as of March 31, 2010 (unaudited) and December
      31, 2009 (audited)
                      
                      
                      4Condensed
      Consolidated Statements of Cash Flows, for the three months ended March
      31, 2010 and 2009 (unaudited)
                      
                      
                      5Notes
      to Condensed Consolidated Financial Statements (unaudited)
                      
                      
                      6Item
      2. Management’s Discussion and Analysis or Plan of
    Operation.
                      
                      
                      20Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk.
                      
                      
                      38Item
      4. Controls and Procedures.
                      
                      
                      38PART
      II. OTHER INFORMATIONItem
      1. Legal Proceedings.
                      
                      
                      39Item 1A. Risk
      Factors.
                      
                      
                      39Item
      2. Unregistered Sales of Equity Securities and Use of
      Proceeds.
                      
                      
                      39Item
      3. Defaults Upon Senior Securities.
                      
                      
                      39Item
      4. (Removed and Reserved).
                      
                      
                      40Item
      5. Other Information.
                      
                      
                      40Item
      6. Exhibits.
                      
                      
                      40
  2
  ITEM
1. FINANCIAL STATEMENTS
 
 Telestone
Technologies Corporation
 Condensed
Consolidated Statements of Operations and Other Comprehensive
Income
 Three
months ended March 31, 2010 and 2009
  (Unaudited)Three months ended March31,2010
                          
                          
                          2009Note
                          
                          
                          US$’000
                          
                          
                          US$’000Operating
      revenues:Net
      sales of equipment
                          
                          
                          
                          
                          
                          5,100
                          
                          
                          
                          3,263Service
      income
                          
                          
                          
                          
                          
                          6,032
                          
                          
                          
                          4,633Total
      operating revenues
                          
                          
                          
                          
                          
                          11,132
                          
                          
                          
                          7,896Cost
      of operating revenues:Cost
      of net sales
                          
                          
                          
                          
                          
                          2,870
                          
                          
                          
                          1,898Cost
      of service
                          
                          
                          
                          
                          
                          3,323
                          
                          
                          
                          1,298Total
      cost of operating revenues
                          
                          
                          
                          
                          
                          6,193
                          
                          
                          
                          3,196Gross
      income
                          
                          
                          
                          
                          
                          4,939
                          
                          
                          
                          4,700Operating
      expenses:Sales
      and marketing
                          
                          
                          
                          
                          
                          2,728
                          
                          
                          
                          2,181General
      and administrative
                          
                          
                          
                          
                          
                          2,934
                          
                          
                          
                          843Research
      and development
                          
                          
                          
                          
                          
                          224
                          
                          
                          
                          136Depreciation
      and amortization
                          
                          
                          
                          
                          
                          71
                          
                          
                          
                          90Total
      operating expenses
                          
                          
                          
                          
                          
                          5,957
                          
                          
                          
                          3,250Operating
      (loss) income
                          
                          
                          
                          
                          
                          (1,018
                          )
                          
                          
                          1,450Interest
      expense
                          
                          
                          
                          
                          
                          (126
                          )
                          
                          
                          (41
                          )Other
      income, net
                          
                          
                          
                          
                          
                          335
                          
                          
                          
                          267(Loss)
      Income before income taxes
                          
                          
                          
                          
                          
                          (809
                          )
                          
                          
                          1,676Income
      taxes
                          
                          4
                          
                          
                          
                          (321
                          )
                          
                          
                          (529
                          )Net
      (loss) income
                          
                          
                          
                          
                          
                          
                          (1,130
                          )
                          
                          
                          1,147Other
      comprehensive incomeForeign
      currency translation adjustment
                          
                          
                          
                          
                          
                          
                          -
                          
                          
                          
                          245Total
      comprehensive (loss) income
                          
                          
                          
                          
                          
                          
                          (1,130
                          )
                          
                          
                          1,392(Loss)
      Earnings per share:
                          
                          3Weighted
      average number of common stock outstandingBasic
                          
                          
                          
                          
                          
                          
                          10,513,268
                          
                          
                          
                          10,404,550Dilutive
      effect of warrants
                          
                          
                          
                          
                          
                          
                          -
                          
                          
                          
                          -Diluted
                          
                          
                          
                          
                          
                          
                          10,513,268
                          
                          
                          
                          10,404,550Net
      (loss) income per share of common stockBasic
      (US$)
                          
                          
                          
                          
                          
                          
                          (0.11
                          )
                          
                          
                          0.11Diluted
      (US$)
                          
                          
                          
                          
                          
                          
                          (0.11
                          )
                          
                          
                          0.11
  3
  Telestone
Technologies Corporation
 Condensed
Consolidated Balance Sheets
 As of
March 31, 2010 and December 31, 2009
  (Unaudited)
                                                    As of
                                                    March 31,
                                                  
                                                  
                                                  As of
                                                    December31,2010
                                                  
                                                  
                                                  2009Note
                                                  
                                                  
                                                  US$’000
                                                  
                                                  
                                                  US$’000ASSETSCurrent
      assets:Cash
      and cash equivalents
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  10,011
                                                  
                                                  
                                                  
                                                  11,233Accounts
      receivable, net of allowance
                                                  
                                                  6
                                                  
                                                  
                                                  
                                                  90,427
                                                  
                                                  
                                                  
                                                  89,005Due
      from related parties
                                                  
                                                  13
                                                  
                                                  
                                                  
                                                  1,963
                                                  
                                                  
                                                  
                                                  1,963Inventories,
      net of allowance
                                                  
                                                  10
                                                  
                                                  
                                                  
                                                  5,061
                                                  
                                                  
                                                  
                                                  4,442Prepayments
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  620
                                                  
                                                  
                                                  
                                                  1,223Other
      current assets
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  4,062
                                                  
                                                  
                                                  
                                                  4,574Total
      current assets
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  112,144
                                                  
                                                  
                                                  
                                                  112,440Goodwill
                                                  
                                                  7
                                                  
                                                  
                                                  
                                                  3,119
                                                  
                                                  
                                                  
                                                  3,119Property,
      plant and equipment, net
                                                  
                                                  8
                                                  
                                                  
                                                  
                                                  1,191
                                                  
                                                  
                                                  
                                                  1,1814,310
                                                  
                                                  
                                                  
                                                  4,300Total
      assets
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  116,454
                                                  
                                                  
                                                  
                                                  116,740LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Short-term
      bank loans
                                                  
                                                  9,
      13
                                                  
                                                  
                                                  
                                                  5,850
                                                  
                                                  
                                                  
                                                  5,850Accounts
      payable – Trade
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  15,718
                                                  
                                                  
                                                  
                                                  15,678Customer
      deposits for sales of equipment
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  1,558
                                                  
                                                  
                                                  
                                                  1,582Due
      to related parties
                                                  
                                                  13
                                                  
                                                  
                                                  
                                                  4,506
                                                  
                                                  
                                                  
                                                  4,947Income
      tax payable
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  7,661
                                                  
                                                  
                                                  
                                                  7,132Accrued
      expenses and other accrued liabilities
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  14,612
                                                  
                                                  
                                                  
                                                  16,473Total
      current liabilities
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  49,905
                                                  
                                                  
                                                  
                                                  51,662Commitments
      and contingencies
                                                  
                                                  14Stockholders’
      equity:Preferred
      stock, US$0.001 par value, 10,000,000 shares authorized, no shares
      issuedCommon
      stock and paid-in-capital, US$0.001 par value:Authorized
      – 100,000,000 shares as of March 31, 2010 and
      December 31, 2009
                                                      Issued and
      outstanding – 10,548,264 shares as of March 31, 2010 and 10,404,550 shares
      as of December 31, 2009
                                                  
                                                  12
                                                  
                                                  
                                                  
                                                  11
                                                  
                                                  
                                                  
                                                  11Additional
      paid-in capital
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  21,590
                                                  
                                                  
                                                  
                                                  18,989Dedicated
      reserves
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  4,872
                                                  
                                                  
                                                  
                                                  4,807Accumulated
      other comprehensive income
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  5,682
                                                  
                                                  
                                                  
                                                  5,682Retained
      earnings
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  34,394
                                                  
                                                  
                                                  
                                                  35,589Total
      stockholders’ equity
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  66,549
                                                  
                                                  
                                                  
                                                  65,078Total
      liabilities and stockholders’ equity
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  116,454
                                                  
                                                  
                                                  
                                                  116,740
  4
 Telestone
Technologies Corporation
 Condensed
Consolidated Statements of Cash Flows
 Three
months ended March 31, 2010 and 2009
  (Unaudited)Three months ended March 31,2010
                        
                        
                        2009US$’000
                        
                        
                        US$’000Cash
      flows from operating activitiesNet
      (loss) income
                        
                        
                        (1,130
                        )
                        
                        
                        1,147Adjustments
      to reconcile net (loss) income to net cash used in operating
      activities:Depreciation
      and amortization
                        
                        
                        71
                        
                        
                        
                        90Allowance
      for doubtful accounts
                        
                        
                        -
                        
                        
                        
                        307Stock-based
      compensation
                        
                        
                        2,601
                        
                        
                        
                        -Changes
      in assets and liabilities:Accounts
      receivable
                        
                        
                        (1,422
                        )
                        
                        
                        (5,917
                        )Due
      from related parties
                        
                        
                        -
                        
                        
                        
                        (170
                        )Inventories
                        
                        
                        (619
                        )
                        
                        
                        (2,438
                        )Prepayments
                        
                        
                        603
                        
                        
                        
                        873Other
      current assets
                        
                        
                        512
                        
                        
                        
                        30Accounts
      payable
                        
                        
                        40
                        
                        
                        
                        2,860Customer
      deposits for sales of equipment
                        
                        
                        (24
                        )
                        
                        
                        35Due
      to related parties
                        
                        
                        (441
                        )
                        
                        
                        31Income
      tax payable
                        
                        
                        529
                        
                        
                        
                        789Accrued
      expenses and other accrued liabilities
                        
                        
                        (1,861
                        )
                        
                        
                        440Net
      cash used in operating activities
                        
                        
                        (1,141
                        )
                        
                        
                        (1,923
                        )Cash
      flows from investing activitiesPurchase
      of property, plant and equipment
                        
                        
                        (81
                        )
                        
                        
                        (203
                        )Net
      cash used in investing activities
                        
                        
                        (81
                        )
                        
                        
                        (203
                        )Cash
      flows from financing activitiesRepayment
      of short-term bank loans
                        
                        
                        (1,170
                        )
                        
                        
                        (1,172
                        )Short
      term bank loans raised
                        
                        
                        1,170
                        
                        
                        
                        -Net
      cash used in financing activities
                        
                        
                        -
                        
                        
                        
                        (1,172
                        )Net
      decrease in cash and cash equivalents
                        
                        
                        (1,222
                        )
                        
                        
                        (3,298
                        )Cash
      and cash equivalents, beginning of the period
                        
                        
                        11,233
                        
                        
                        
                        7,866Effect
      on exchange rate changes
                        
                        
                        -
                        
                        
                        
                        68Cash
      and cash equivalents, end of the period
                        
                        
                        10,011
                        
                        
                        
                        4,636Supplemental
      disclosure of cash flow informationInterest
      received
                        
                        
                        16
                        
                        
                        
                        7Interest
      paid
                        
                        
                        (110
                        )
                        
                        
                        (32
                        )Tax
      paid
                        
                        
                        (146
                        )
                        
                        
                        (1
                        )
  5
  Telestone
Technologies Corporation
 Notes
to Condensed Consolidated Financial Statements
 Three
months ended March 31, 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 translations of names in Chinese for identification purpose
only.
 
 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 March 31, 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 period ended March 31, 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 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, a subsidiary and a VIE and the VIE’s subsidiaries.  All
significant intercompany accounts and transactions have been eliminated upon
consolidation.
  7
  3.
                (LOSS)
      EARNINGS PER SHARE
 
 The
Company reports (loss) 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 (loss)
earnings per share.
 
 Basic
(loss) earnings per share is computed based upon the weighted average number of
shares of common stock outstanding during each period presented.
 
 Diluted
(loss) earnings per share is computed based on net (loss) 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 March 31, 2010 and 2009 was reflected in the calculation of
diluted (loss) earnings per share by applying the treasury stock method. Since
the warrants outstanding as of March 31, 2010 and 2009 were anti-dilutive, there
was no dilutive effect of the warrants.
  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 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 3-month periods ended March 31, 2010 and
2009.
  8
  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)
                      Three months ended
                      March 31,2010
                    
                    
                    2009%
                    
                    
                    %Beijing
      Telestone
                    
                    
                    15
                    
                    
                    
                    15BTWTC
                    
                    
                    15
                    
                    
                    
                    15BTCTC
                    
                    
                    25
                    
                    
                    
                    25Guolian
                    
                    
                    25
                    
                    
                    
                    25Pan-pacific
                    
                    
                    25
                    
                    
                    
                    25
  5.
                OPERATING
      RISK
  (a)
                Concentration
      of major customers and suppliers
 (Unaudited)
                        Three months ended
                        March 31,2010
                      
                      
                      2009US$’000
                      
                      
                      US$’000Major
      customers with revenues of more than 10% of the Company’s total operating
      revenuesRevenues
      from major customers
                      
                      
                      9,993
                      
                      
                      
                      7,447Percentage
      of operating revenues
                      
                      
                      90
                      %
                      
                      
                      94
                      %Number
                      
                      
                      2
                      
                      
                      
                      3Major
      suppliers with purchases of more than 10% of the Company’s
      purchasesPurchases
      from major suppliers
                      
                      
                      456
                      
                      
                      
                      1,073Percentage
      of purchases
                      
                      
                      13
                      %
                      
                      
                      25
                      %Number
                      
                      
                      1
                      
                      
                      
                      2
  Accounts
receivable related to the Company’s major customers comprised 91% and 91% of the
total accounts receivables as of March 31, 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.
  9
  (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.
  6.
                ACCOUNTS
      RECEIVABLE
 (Unaudited)
                      As of
                      March 31,
                      2010
                    
                    
                    As of
                      December31,
                      2009US$’000
                    
                    
                    US$’000Completed
      contracts
                    
                    
                    91,210
                    
                    
                    
                    89,835Retentions
                    
                    
                    5,391
                    
                    
                    
                    5,34496,601
                    
                    
                    
                    95,179Allowance
      for doubtful accounts
                    
                    
                    (6,174
                    )
                    
                    
                    (6,174
                    )90,427
                    
                    
                    
                    89,005
  Of the
retentions balance as of March 31, 2010 and December 31, 2009, approximately
US$868,000 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.
  10
  8.
                PROPERTY,
      PLANT AND EQUIPMENT, NET
  Property,
plant and equipment are summarized as follows:
 Estimated useful
                      life
                    
                    
                    (Unaudited)
                      As of
                      March 31,
                      2010
                    
                    
                    As of
                      December 31,
                      2009(in years)
                    
                    
                    US$’000
                    
                    
                    US$’000Buildings
                    
                    
                    30
                    
                    
                    
                    312
                    
                    
                    
                    312Leasehold
      improvement
                    
                    
                    5
                    
                    
                    
                    87
                    
                    
                    
                    87Plant
      and machinery
                    
                    
                    5
                    
                    
                    
                    769
                    
                    
                    
                    734Office
      equipment
                    
                    
                    5
                    
                    
                    
                    1,128
                    
                    
                    
                    1,087Motor
      vehicles
                    
                    
                    5
                    
                    
                    
                    676
                    
                    
                    
                    6672,972
                    
                    
                    
                    2,887Accumulated
      depreciation
                    
                    
                    
                    
                    
                    
                    (1,781
                    )
                    
                    
                    (1,706
                    )1,191
                    
                    
                    
                    1,181
  9.
                SHORT-TERM
      BANK LOANS
  As of
March 31, 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 independent guaranty company is secured by the
followings:
  (a)
                Accounts
      receivable of the Company with an aggregate carrying value as of March 31,
      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 March 31,
      2010 and December 31, 2009 amounting to RMB1.2 million, equivalent to
      approximately US$0.18 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.
  As of
March 31, 2010 and December 31, 2009, all the bank loans are secured by
guarantees provided by Mr. Han and a third party guaranty company,
interest-bearing at 7.47% per annum and wholly repayable within one
year.
  11
  10.
                INVENTORIES
  Inventories
consisted of the followings:
 (Unaudited)
                        As of
                        March 31,
                        2010
                      
                      
                      As of
                        December 31,
                        2009US$’000
                      
                      
                      US$’000Raw
      materials
                      
                      
                      1
                      
                      
                      
                      1Finished
      goods and parts
                      
                      
                      5,496
                      
                      
                      
                      4,8775,497
                      
                      
                      
                      4,878Provision
      for slow-moving and obsolete items
                      
                      
                      (436
                      )
                      
                      
                      (436
                      )5,061
                      
                      
                      
                      4,442
  11.
                SEGMENT
      INFORMATION
  During
the periods ended March 31, 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 95% and 98% of its revenue and
operating income during the periods ended March 31, 2010 and 2009 respectively
are from the PRC, no geographical segment is presented.
  12.
                COMMON
      STOCK
  On
January 20, 2010, TSTC issued 100,000 shares of common stock for zero
consideration. The common stock was granted to certain senior officers of the
subsidiaries of TSTC 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
10,548,264 and 10,404,550 shares of outstanding common stock as of March 31,
2010 and December 31, 2009 respectively.
  The
following table summarizes activities of the warrants:
 Number of
                          sharesWarrants
      outstanding as of January 1, 2009
                        
                        
                        192,403Expired
      on March 24, 2009 (i)
                        
                        
                        (15,000
                        )Warrants
      outstanding as of December 31, 2009
                        
                        
                        177,403Cashless
      exercised on January 26, 2010 (ii)
                        
                        
                        (65,515
                        )Cashless
      exercised on January 27, 2010 (ii)
                        
                        
                        (26,222
                        )Issued
      on March 18, 2010 (iii)
                        
                        
                        40,000Warrants
      outstanding and exercisable as of March 31, 2010 (iv)
                        
                        
                        125,666
  12
  (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.
  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.
 
 (iii)
                As
      of March 31, 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$11.60 while 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 March 31, 2010
and changes during the 3-month period ended March 31, 2010.
 Vested
                  
                  
                  Unvested
                  
                  
                  Total
                  
                  
                  Weighted
                      -average
                      exercise
                      priceShares
                  
                  
                  Shares
                  
                  
                  Shares
                  
                  
                  US$As
      of January 1, 2010
                  
                  
                  177,403
                  
                  
                  
                  -
                  
                  
                  
                  177,403
                  
                  
                  
                  11.60Cashless
      exercise
                  
                  
                  (91,737
                  )
                  
                  
                  -
                  
                  
                  
                  (91,737
                  )
                  
                  
                  11.60Granted
                  
                  
                  -
                  
                  
                  
                  40,000
                  
                  
                  
                  40,000
                  
                  
                  
                  18.73As
      of March 31, 2010
                  
                  
                  85,666
                  
                  
                  
                  40,000
                  
                  
                  
                  125,666
                  
                  
                  
                  13.87Weighted-average
      remaining life (years)
                  
                  
                  0.89
                  
                  
                  
                  3.44
                  
                  
                  
                  1.70
  13
  13.
                RELATED
      PARTY TRANSACTIONS
 Summary
of related party transactions
 (Unaudited)
                              As of
                              March 31,
                              2010
                            
                            
                            As of
                              December31,
                              2009Note
                            
                            
                            US$’000
                            
                            
                            US$’000Due
      from related partiesEmployees
                            
                            a
                            
                            
                            
                            536
                            
                            
                            
                            536Ex-stockholders
      of SMI/Guolian
                            
                            b
                            
                            
                            
                            1,427
                            
                            
                            
                            1,4271,963
                            
                            
                            
                            1,963Due
      to related partiesDirectors
                            
                            a
                            
                            
                            
                            3,034
                            
                            
                            
                            3,475Ex-stockholders
      of Beijing Telestone/Guolian
                            
                            b
                            
                            
                            
                            1,472
                            
                            
                            
                            1,4724,506
                            
                            
                            
                            4,947Guarantor
      of short term loanA
      director
                            
                            9
                            
                            
                            
                            5,850
                            
                            
                            
                            5,850
 
 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
  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 three-month periods ended
March 31, 2010 and 2009 and as of the date of these condensed consolidated
financial statements.
  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.
  15
 
 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, the Board of Directors of TSTC approved to grant 100,000
shares of restricted common stock with three years restriction for sale to
certain senior officers of the subsidiaries of TSTC 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
3-month periods ended March 31, 2010 and 2009, the Company recognized
stock-based compensation to employees of US$2,109,000 and US$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.
  16
  According
to a valuation report dated May 11, 2010 issued by an independent professional
valuation firm, the estimated per share fair value of the warrants is US$12.30.
The following table presents the assumptions used by the valuation firm to
estimate the fair value of the warrants using the Binomial Lattice option
pricing model:
 
 Expected
      life
                      
                      3.5
      yearsExpected
      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
3-month periods ended March 31, 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 periods ended March 31, 2010 and 2009.
 (Unaudited)
                        Three months ended
                        March 31,2010
                      
                      
                      2009US$’000
                      
                      
                      US$’000Sales
      and marketing
                      
                      
                      492
                      
                      
                      
                      -General
      and administrative
                      
                      
                      2,109
                      
                      
                      
                      -Total
      stock-based compensation
                      
                      
                      2,601
                      
                      
                      
                      -
 
 No tax
benefit was recognized for the stock-based compensation recorded for the three
months ended March 31, 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.
  17
 
 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.
  18
  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 is not expected to 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.
 
 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.
 
 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.
  19
 
 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.
 
 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.
  20
  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.
  21
 
 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.
 
 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 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.
  22


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.





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.


23





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:


·
            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.


24





·
            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.


25





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.


26





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.





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:


27





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.





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.


28





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;





·
            new
      product introductions and enhancements both by us and by our
      competitors;


·
              demand
      for our products and
services;




29




·
            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 1,010 full-time employees as of
March 31, 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.


30





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.





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)  professionalservices
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.


31


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
asubstantial 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.





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 March 31, 2010 and December 31,
2009.


32





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 March 31, 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 on a consolidated basis for the quarter ended
March 31, 2010, as compared to the quarter ended March 31, 2009.





The following is statement of our
operations for the three months ended March 31, 2010 and
2009.





Item
                                                
                                                2010 Q1
                                                
                                                
                                                2009 Q1
                                                
                                                
                                                Comparisons$'000
                                                
                                                
                                                % of revenue
                                                
                                                
                                                $'000
                                                
                                                
                                                % of revenue
                                                
                                                
                                                $'000
                                                
                                                
                                                %Revenue
                                                
                                                
                                                11,132
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                7,896
                                                
                                                
                                                
                                                
                                                
                                                
                                                3,236
                                                
                                                
                                                
                                                41.0
                                                %Cost
      of products and professional services
                                                
                                                
                                                6,193
                                                
                                                
                                                
                                                55.6
                                                %
                                                
                                                
                                                3,196
                                                
                                                
                                                
                                                40.5
                                                %
                                                
                                                
                                                2,997
                                                
                                                
                                                
                                                93.8
                                                %Gross
      profit
                                                
                                                
                                                4,939
                                                
                                                
                                                
                                                44.4
                                                %
                                                
                                                
                                                4,700
                                                
                                                
                                                
                                                59.5
                                                %
                                                
                                                
                                                239
                                                
                                                
                                                
                                                5.1
                                                %Sales
      and marketing expenses
                                                
                                                
                                                2,728
                                                
                                                
                                                
                                                24.5
                                                %
                                                
                                                
                                                2,181
                                                
                                                
                                                
                                                27.6
                                                %
                                                
                                                
                                                547
                                                
                                                
                                                
                                                25.1
                                                %General
      and administrative expenses
                                                
                                                
                                                2,934
                                                
                                                
                                                
                                                26.4
                                                %
                                                
                                                
                                                843
                                                
                                                
                                                
                                                10.7
                                                %
                                                
                                                
                                                2,091
                                                
                                                
                                                
                                                248.0
                                                %Research
      and development expenses
                                                
                                                
                                                224
                                                
                                                
                                                
                                                2.0
                                                %
                                                
                                                
                                                136
                                                
                                                
                                                
                                                1.7
                                                %
                                                
                                                
                                                88
                                                
                                                
                                                
                                                64.7
                                                %Depreciation
      and amortization
                                                
                                                
                                                71
                                                
                                                
                                                
                                                0.6
                                                %
                                                
                                                
                                                90
                                                
                                                
                                                
                                                1.1
                                                %
                                                
                                                
                                                -19
                                                
                                                
                                                
                                                -21.1
                                                %Interest
      expenses
                                                
                                                
                                                126
                                                
                                                
                                                
                                                1.1
                                                %
                                                
                                                
                                                41
                                                
                                                
                                                
                                                0.5
                                                %
                                                
                                                
                                                85
                                                
                                                
                                                
                                                207.3
                                                %Other
      income
                                                
                                                
                                                335
                                                
                                                
                                                
                                                3.0
                                                %
                                                
                                                
                                                267
                                                
                                                
                                                
                                                3.4
                                                %
                                                
                                                
                                                68
                                                
                                                
                                                
                                                25.5
                                                %Income
      before tax
                                                
                                                
                                                -809
                                                
                                                
                                                
                                                -7.3
                                                %
                                                
                                                
                                                1,676
                                                
                                                
                                                
                                                21.2
                                                %
                                                
                                                
                                                -2,485
                                                
                                                
                                                
                                                -148.3
                                                %Income
      tax
                                                
                                                
                                                321
                                                
                                                
                                                
                                                2.9
                                                %
                                                
                                                
                                                529
                                                
                                                
                                                
                                                6.7
                                                %
                                                
                                                
                                                -208
                                                
                                                
                                                
                                                -39.3
                                                %Net
      income
                                                
                                                
                                                -1,130
                                                
                                                
                                                
                                                -10.2
                                                %
                                                
                                                
                                                1,147
                                                
                                                
                                                
                                                14.5
                                                %
                                                
                                                
                                                -2,277
                                                
                                                
                                                
                                                -198.5
                                                %




33





Revenue





Our
revenue during the three months ended March 31, 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.





For the
three months ended March 31, 2010, our revenue was $11.1 million, representing
an increase of 41.0% from the same period in 2009.  The increase was
primarily attributable to revenue generated from the first phase of a China
Mobile project in Inner-Mongolia to provide Wi-Fi coverage for subscribers, and
from a China Mobile project in Sichuan province as part of the rebuilding
efforts after the May 2008 earthquake.  Both projects involved the
implementation of WFDS systems.





Revenue
Breakdown





Three
months ended March 31, 2010 and 2009




2010 Q1
                                              
                                              
                                              2009 Q1
                                              
                                              
                                              Growth$'000
                                              
                                              
                                              % of revenue
                                              
                                              
                                              $'000
                                              
                                              
                                              % of
      revenue
                                              
                                              
                                              $'000
                                              
                                              
                                              
                                              %Product
      revenue
                                              
                                              
                                              5,100
                                              
                                              
                                              
                                              45.8
                                              %
                                              
                                              
                                              3,263
                                              
                                              
                                              
                                              41.3
                                              %
                                              
                                              
                                              1,837
                                              
                                              
                                              
                                              56.3
                                              %Professional
      services revenue
                                              
                                              
                                              6,032
                                              
                                              
                                              
                                              54.2
                                              %
                                              
                                              
                                              4,633
                                              
                                              
                                              
                                              58.7
                                              %
                                              
                                              
                                              1,399
                                              
                                              
                                              
                                              30.2
                                              %Total
                                              
                                              
                                              11,132
                                              
                                              
                                              
                                              100.0
                                              %
                                              
                                              
                                              7,896
                                              
                                              
                                              
                                              100.0
                                              %
                                              
                                              
                                              3,236
                                              
                                              
                                              
                                              41.0
                                              %





For the
three months ended March 31, 2010, revenue generated from product sales was $5.1
million, representing an increase of 56.3% from the same period in 2009. The
increase in product revenue was primarily attributable to increases in sales of
WFDS systems.  WFDS system sales continue to grow as our WFDS
solutions continue to gain market traction and as associated projects tend to be
relatively large.





For the
three months ended March 31, 2010, revenue generated from professional services
was $6.0 million, representing an increase of 30.2% from the same period in
2009.  The increase in professional services revenue was primarily
attributable to two 2G/3G coverage upgrade projects (Shandong province and Hebei
province) for China Mobile.





Revenue
generated from professional services accounted for 54.2% of total revenue,
compared to 58.7% for the same period in 2009.


34





Breakdown
by Customers





Three
months ended March 31, 2010 and 2009


2010
      Q1
                                        
                                        
                                        2009
      Q1
                                        
                                        
                                        Growth$’000
                                        
                                        
                                        %
      of revenue
                                        
                                        
                                        $'000
                                        
                                        
                                        %
      of revenue
                                        
                                        
                                        $'000
                                        
                                        
                                        %China
      Mobile
                                        
                                        
                                        8,910
                                        
                                        
                                        
                                        80.1
                                        %
                                        
                                        
                                        2,778
                                        
                                        
                                        
                                        35.2
                                        %
                                        
                                        
                                        6,132
                                        
                                        
                                        
                                        220.7
                                        %China
      Unicom
                                        
                                        
                                        1,083
                                        
                                        
                                        
                                        9.7
                                        %
                                        
                                        
                                        3,183
                                        
                                        
                                        
                                        40.3
                                        %
                                        
                                        
                                        -2,100
                                        
                                        
                                        
                                        -66.0
                                        %China
      Telecom
                                        
                                        
                                        947
                                        
                                        
                                        
                                        8.5
                                        %
                                        
                                        
                                        1,486
                                        
                                        
                                        
                                        18.8
                                        %
                                        
                                        
                                        -539
                                        
                                        
                                        
                                        -36.3
                                        %Overseas
                                        
                                        
                                        192
                                        
                                        
                                        
                                        1.7
                                        %
                                        
                                        
                                        171
                                        
                                        
                                        
                                        2.2
                                        %
                                        
                                        
                                        21
                                        
                                        
                                        
                                        12.3
                                        %Others
                                        
                                        
                                        0
                                        
                                        
                                        
                                        0.00
                                        %
                                        
                                        
                                        278
                                        
                                        
                                        
                                        3.5
                                        %
                                        
                                        
                                        -278
                                        
                                        
                                        
                                        -100.0
                                        %Total
                                        
                                        
                                        11,132
                                        
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        7,896
                                        
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        3,236
                                        
                                        
                                        
                                        41.0
                                        %





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.





Cost
of Products and Professional Services





Three
months ended March 31, 2010 and 2009




2010 Q1
                                      
                                      
                                      2009 Q1
                                      
                                      
                                      Growth$'000
                                      
                                      
                                      % of revenue
                                      
                                      
                                      $'000
                                      
                                      
                                      % of revenue
                                      
                                      
                                      $'000
                                      
                                      
                                      %Cost
      of products
                                      
                                      
                                      2,870
                                      
                                      
                                      
                                      25.8
                                      %
                                      
                                      
                                      1,898
                                      
                                      
                                      
                                      24.0
                                      %
                                      
                                      
                                      972
                                      
                                      
                                      
                                      51.2
                                      %Cost
      of professional services
                                      
                                      
                                      3,323
                                      
                                      
                                      
                                      29.8
                                      %
                                      
                                      
                                      1,298
                                      
                                      
                                      
                                      16.5
                                      %
                                      
                                      
                                      2,025
                                      
                                      
                                      
                                      156.0
                                      %Total
                                      
                                      
                                      6,193
                                      
                                      
                                      
                                      55.6
                                      %
                                      
                                      
                                      3,196
                                      
                                      
                                      
                                      40.5
                                      %
                                      
                                      
                                      2,997
                                      
                                      
                                      
                                      93.8
                                      %





For the
three months ended March 31, 2010, our total cost of products and professional
services were $6.2 million, representing an increase of 93.8%, from the same
period in 2009.





Gross
Profit and Gross Margin





For the
three months ended March 31, 2010, our gross profit was $4.9 million,
representing an increase of 5.1% from the same period in 2009.  Our
gross margin during the period was 44.4%, which decreased from 59.5% in the same
period in 2009 due to a decline in professional services gross margin as
described below.





Product
Gross Margin:


Our
product gross margin increased to 43.7% during the three months ended March 31,
2010, from 41.8% in the same period in 2009.  The increase in product
gross margin was primarily attributable to commencement of sales to higher gross
margin areas, including Inner Mongolia, in this quarter.





Professional
Services Gross Margin:


Our
professional services gross margin decreased to 44.9% during the three months
ended March 31, 2010, from 72.0% in the same period in 2009.  The high
professional services gross margin of the period ended March 31, 2009 was
because our professional services revenue was predominately driven by an
unusually high level of maintenance and design services, which are our highest
gross margin professional services and which contributed to a disproportionately
large amount to our professional services revenue.  This high level of
maintenance and design services did not occur in the same period of 2010. The
Big 3 have recently adopted centralized procurement and public bidding
processes, which required us to lower our contract prices in order to secure
potential tenders. This has also resulted in lower gross
profit margins in the quarter ended March 31, 2010.


35





Sales
and Marketing Expenses





For the
three months ended March 31, 2010, sales and marketing expenses were $2.7
million, representing an increase of 25.1% from the same period last
year.  As a percentage of sales, sales and marketing expenses
accounted for 24.5% of total revenue, as compared to 27.6% of total revenue for
the corresponding period in 2009.  The increase in sales and marketing
expenses was primarily due to a stock-based compensation expense of $0.5 million
in relation to the issuance of 40,000 warrants to Hayden Communications
International, Inc. for professional services rendered.  Excluding the
effects of the stock-based compensation expense, our sales and marketing
expenses would have been $2.2 million, or 20.1% of total revenue.  As
a percentage of revenue, our sales and marketing expenses decreased during the
three months ended March 31, 2010, when compared to the same period in
2009.  This indicates we are spending our sales and marketing expenses
more efficiently.  We did not incur significant costs in advertising,
benefiting from the highly concentrated customer base.  Our sales and
marketing expenses are mostly exhibition and conference expenses.





General
and Administrative Expenses





For the
three months ended March 31, 2010, general and administrative expenses were $2.9
million, accounting for 26.4% of total revenue, as compared to $0.8 million or
10.7% of total revenue, for the corresponding periods of
2009.  General and administrative expenses for the three months ended
March 31, 2010 increased 248.0% from the same period last year.  The
increase in general and administrative expenses was primarily attributable to a
stock-based compensation expense of $2.1 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.  Excluding
the effects of stock-based compensation expense, our general and administrative
expenses would have been $0.8 million, or 7.4% of total revenue.





Research
& Development Expenses





For the
three months ended March 31, 2010, research and development expenses were $0.2
million, accounting for 2.0% of total revenue, as compared to $0.1 million, or
1.7% of total revenue, for the corresponding period in 2009.  Research
and development expenses increased by 64.7%, compared to the same period in
2009.





The
increase in research and development expenses was due to our development of new
products during the three months ended March 31, 2010.


36





Interest
Expense and Other Income





For the
three months ended March 31, 2010, interest expenses were $0.1 million,
accounting for 1.1% of total revenue, as compared to $0.0 million for the
corresponding period in 2009.  Interest expenses rose as a result of
increased bank borrowings during the quarter to fund our working capital
needs.





Other
income was $0.3 million, accounting for 3.0% of total revenue, as compared to
$0.3, or 2.4% of total revenue, for the corresponding period 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 ended March 31, 2010, we had a net loss of $1.1
million, representing a decrease of 198.5% from the same period in
2009.  Excluding the effects of the previously-mentioned noncash
charges of $2.1 million and $0.5 million, our net income would have been $1.5
million, or 13.2% as a percentage of total revenue.





LIQUIDITY
AND CAPITAL RESOURCES





We
generally finance our operations from cash flow generated internally. As of
March 31, 2010, our current assets comprised inventories of $5.1 million,
accounts receivable of $90.4 million, prepayments of $0.6 million, other
receivables of $4.1 million, due from related parties of $2.0 million, and cash
and cash equivalents of $10.0 million.  As of March 31, 2010, our
current liabilities comprised accounts payable of $15.7 million, tax payables of
$7.7 million, a short-term bank loan of $5.9 million, trade deposits received of
$1.6 million, due to related parties of $4.5 million, and other payables and
accruals of $14.6 million.





Our
trading terms with our customers are mainly on credit. As of March 31, 2010, our
accounts receivable were $90.4 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.





As of
March 31, 2010, our inventories were $5.1 million, as compared to $4.4 million
as of December 31, 2009, representing an increase of 13.9%.


37


As of
March 31, 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).  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 March 31, 2010.





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.


38





(b) Changes in internal control over
financial reporting.





During
the quarter ended March 31, 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
January 20, 2010, the Company issued 100,000 restricted shares of common stock
to Lian Renguang, Shao Mingjun, Yu Yongjing and Ding Yanying, senior officers of
Shandong Guolian Communication Technologies Co. Ltd., a subsidiary of BTWTC, for
their services rendered in improving the business results of the Company since
December 2006, when BTWTC acquired Shandong Guolian Communication Technologies
Co. Chen Jiefan holds the shares of common stock as nominee for the
aforementioned four beneficiaries.





On March
18, 2010, the Company issued to Hayden Communications International, Inc.
warrants to purchase 40,000 shares of common stock for investor relations
consulting services. The warrants have an exercise price of $18.73 and an
exercise period from September 9, 2010 to September 9, 2013 or when a
liquidation event occurs. The warrants do not contain cashless exercise
provisions.





The
aforementioned restricted shares of common stock and warrants 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.


39





Item
4.  (Removed and Reserved).








Item
5.   Other Information.





None.





Item
6.   Exhibits.





The
following documents are filed as part of this report:




31.1
                    
                    Chief
      Executive Officer Certification furnished pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200231.2
                    
                    Chief
      Financial Officer Certification furnished pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200232.1
                    
                    Chief
      Executive Officer Certification furnished pursuant to Section 906 of the
      Sarbanes-Oxley Act of 200232.2
                    
                    Chief
      Financial Officer Certification furnished pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002




40


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
                        CORPORATIONDate:
      May 17, 2010
                      By:
                      /s/ Han
      DaqingHan
      Daqing, Chief Executive Officer(Principal
      Executive Officer)Date:
      May 17, 2010
                      By:
                      /s/ Yu
      XiaoliYu
      Xiaoli, Chief Financial Officer(Principal
      Financial
Officer)




41