**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-QSB**





x**Quarterly
      Report Pursuant to Section 13 or 15(d) of the**


**Securities
      Exchange Act of 1934**





For
      the
      quarterly period ended September 30, 2006





Commission
      File Number: 033-15096




**TELESTONE
      TECHNOLOGIES CORPORATION**


(Exact
      Name of Small Business Issuer 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**


(Issuer’s
      Telephone Number, Including Area Code)





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act 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 þ No  ̈




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).




Yes  ̈ No þ




As
      of November
      11 ,
      2006, 8,935,106 shares
      of the Issuer's $.001 par value common stock were outstanding.




Transitional
      Small Business Disclosure Format:


Yes  ̈ No þ










**PART
      I**





**FINANCIAL
      INFORMATION**





**ITEM
      1.**   **FINANCIAL
      STATEMENTS**





**Telestone
      Technologies Corporation**




**Index
      to Financial Statements**





PageCondensed
                Consolidated Balance Sheets (Unaudited)
            
            3Condensed
                Consolidated Statements of Operations (Unaudited)
            
            4Condensed
                Consolidated Statement of Changes in Stockholders’ Equity
                (Unaudited)
            
            5Condensed
                Consolidated Statement of Cash Flows (Unaudited)
            
            6Notes
                to Condensed Consolidated Financial Statements (Unaudited)
            
            7-12




2


**Telestone
      Technologies Corporation**





**Condensed
      Consolidated Balance Sheets (Unaudited)**




**(Unaudited)**
              **As
                of**
              **September
                30,**
              **2006**
            
            As
                of
              December
                31,
              2005*Note*
            
            ***US$’000***
            
            *US$’000***ASSETS****Current
                assets**Cash
                and cash equivalents
            
            
            
            
            
            **3,781**
            
            
            3,605Accounts
                receivable
            
            
            *5*
            
            
            **24,892**
            
            
            22,530Due
                from related parties
            
            
            *8*
            
            
            **1,598**
            
            
            1,322Inventories
                - Finished goods
            
            
            
            
            
            **4,435**
            
            
            2,287Prepayment
            
            
            
            
            
            **408**
            
            
            535Other
                current assets
            
            
            
            
            
            **290**
            
            
            240Total
                current assets
            
            
            
            
            
            **35,404**
            
            
            30,519Property,
                plant and equipment, net
            
            
            *4*
            
            
            **857**
            
            
            1,031**Total
                assets**
            
            
            
            
            
            **36,261**
            
            
            31,550**LIABILITIES
                AND STOCKHOLDERS’ EQUITY****Current
                liabilities**Short-term
                bank loan
            
            
            *6*
            
            
            **1,239**
            
            
            -Accounts
                payable - Trade
            
            
            
            
            
            **5,699**
            
            
            4,223Customer
                deposits for sales of equipment
            
            
            
            
            
            **3**
            
            
            4Due
                to related parties
            
            
            *8*
            
            
            **1,991**
            
            
            2,133Taxes
                payable
            
            
            
            
            
            **4,359**
            
            
            5,556Accrued
                expenses and other accrued liabilities
            
            
            
            
            
            **1,021**
            
            
            1,703Total
                current liabilities
            
            
            
            
            
            **14,312**
            
            
            13,619**Commitments
                and contingencies**
            
            
            *10***Minority
                interests****Stockholders’
                equity**Preferred
                stock, US$0.001 par value, 10,000,000 shares authorized, no shares
                issued
            
            
            
            
            
            **-**
            
            
            -Common
                stock and paid-in capital, US$0.001 par value:
              Authorized
                - 100,000,000 shares as of September 30, 2006
              and
                December 31, 2005
            
            
            
            
            
            **-**
            
            
            -Issued
                and outstanding - 8,925,106 shares as of September 30, 2006 and 8,577,106
                shares as of December 31, 2005
            
            
            
            
            
            **8**
            
            
            8Dedicated
                reserves
            
            
            
            
            
            **2,131**
            
            
            2,131Additional
                paid-in capital
            
            
            
            
            
            **8,444**
            
            
            7,401Other
                comprehensive income
            
            
            
            
            
            **365**
            
            
            365Retained
                earnings
            
            
            
            
            
            **11,001**
            
            
            8,026Total
                stockholders’ equity
            
            
            
            
            
            **21,949**
            
            
            17,931**Total
                liabilities and stockholders’ equity**
            
            
            
            
            
            **36,261**
            
            
            31,550




The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.


3


**Telestone
      Technologies Corporation**





**Condensed
      Consolidated Statements of Operations (Unaudited)**





**(Unaudited)**
            
            **(Unaudited)****Three
                months ended September 30,**
            
            **Nine
                months ended September 30,****2006**
            
            2005
            
            **2006**
            
            2005*Note*
            
            ***US$’000***
            
            *US$’000*
            
            ***US$’000***
            
            *US$’000***Operating
                revenues**Net
                sales of equipment
            
            
            
            
            
            **4,026**
            
            
            3,131
            
            
            **10,851**
            
            
            8,766Service
                income
            
            
            
            
            
            **1,208**
            
            
            819
            
            
            **3,377**
            
            
            3,121**5,234**
            
            
            3,950
            
            
            **14,228**
            
            
            11,887**Operating
                expenses**Equipment
                and services
            
            
            
            
            
            **3,115**
            
            
            1,751
            
            
            **7,560**
            
            
            5,643Sales
                and marketing
            
            
            
            
            
            **780**
            
            
            844
            
            
            **2,010**
            
            
            2,064General
                and administrative
            
            
            
            
            
            **256**
            
            
            518
            
            
            **764**
            
            
            1,434Research
                and development
            
            
            
            
            
            **111**
            
            
            155
            
            
            **391**
            
            
            309Depreciation
                and amortization
            
            
            
            
            
            **60**
            
            
            54
            
            
            **158**
            
            
            150Total
                operating expenses
            
            
            
            
            
            **4,322**
            
            
            3,322
            
            
            **10,883**
            
            
            9,600**Operating
                income**
            
            
            
            
            
            **912**
            
            
            628
            
            
            **3,345**
            
            
            2,287Interest
                expense
            
            
            
            
            
            **(30**
            **)**
            
            (3
            )
            
            **(30**
            **)**
            
            (25
            )Other
                income, net
            
            
            
            
            
            **21**
            
            
            4
            
            
            **167**
            
            
            10**Income
                before income taxes**
            
            
            
            
            
            **903**
            
            
            629
            
            
            **3,482**
            
            
            2,272Income
                taxes
            
            
            *7*
            
            
            **(164**
            **)**
            
            -
            
            
            **(506**
            **)**
            
            -**Net
                income**
            
            
            
            
            
            **739**
            
            
            629
            
            
            **2,976**
            
            
            2,272**Earnings
                per share:**
            
            
            *3***Weighted
                average number of shares outstanding**Basic
            
            
            
            
            
            **8,608,128**
            
            
            8,574,280
            
            
            **8,597,981**
            
            
            8,472,253Dilutive
                effect of warrants
            
            
            
            
            
            **85,495**
            
            
            137,005
            
            
            **106,993**
            
            
            172,116Diluted
            
            
            
            
            
            **8,693,623**
            
            
            8,711,285
            
            
            **8,704,974**
            
            
            8,644,369**Net
                income per share of common stock****Basic:**Net
                income
            
            
            
            
            
            **0.09**
            
            
            0.07
            
            
            **0.35**
            
            
            0.27**Diluted:**Net
                income
            
            
            
            
            
            **0.09**
            
            
            0.07
            
            
            **0.34**
            
            
            0.26


The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.


4




**Telestone
      Technologies Corporation**





**Condensed
      Consolidated Statement of Changes in Stockholders’ Equity
      (Unaudited)**





**Common
                stock****Number
                of shares**
            
            **Amount**
            
            **Additional
                paid-in capital**
            
            **Dedicated
                reserves**
            
            **Other
                comprehensive income**
            
            **Retained
                earnings**
            
            **Total***US$’000*
            
            *US$’000*
            
            *US$’000*
            
            *US$’000*
            
            *US$’000*
            
            *US$’000*Balance
                at January 1, 2006
            
            
            8,577,106
            
            
            8
            
            
            7,401
            
            
            2,131
            
            
            365
            
            
            8,026
            
            
            17,931Issuance
                of stock for warrant exercised
            
            
            25,000
            
            
            -
            
            
            75
            
            
            -
            
            
            -
            
            
            -
            
            
            75Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            717
            
            
            717Balance
                at March 31, 2006
            
            
            8,602,106
            
            
            8
            
            
            7,476
            
            
            2,131
            
            
            365
            
            
            8,743
            
            
            18,723Balance
                at April 1, 2006
            
            
            8,602,106
            
            
            8
            
            
            7,476
            
            
            2,131
            
            
            365
            
            
            8,743
            
            
            18,723Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,519
            
            
            1,519Balance
                at June 30, 2006
            
            
            8,602,106
            
            
            8
            
            
            7,476
            
            
            2,131
            
            
            365
            
            
            10,262
            
            
            20,242Balance
                at July 1, 2006
            
            
            8,602,106
            
            
            8
            
            
            7,476
            
            
            2,131
            
            
            365
            
            
            10,262
            
            
            20,242Issuance
                of stock for warrant exercised
            
            
            323,000
            
            
            -
            
            
            968
            
            
            -
            
            
            -
            
            
            -
            
            
            968Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            739
            
            
            739Balance
                at September 30, 2006
            
            
            8,925,106
            
            
            8
            
            
            8,444
            
            
            2,131
            
            
            365
            
            
            11,001
            
            
            21,949





The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.




5


**Telestone
      Technologies Corporation**





**Condensed
      Consolidated Statements of Cash Flows (Unaudited)**





**(Unaudited)****Nine
                months ended**
              **September
                30,****2006**
            
            2005***US$’000***
            
            *US$’000***Cash
                flows from operating activities****Net
                income**
            
            
            **2,976**
            
            
            2,272Adjustments
                to reconcile net income to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            **158**
            
            
            150Provision
                for doubtful accounts
            
            
            **-**
            
            
            707Changes
                in assets and liabilities:Accounts
                receivable
            
            
            (2,362
            )
            
            (6,296
            )Inventories,
                net
            
            
            (2,148
            )
            
            320Due
                from related parties
            
            
            (276
            )
            
            (63
            )Gain
                on disposal of property, plant and equipment
            
            
            (139
            )
            
            (66
            )Prepayment
            
            
            **127**
            
            
            23Other
                current assets
            
            
            (50
            )
            
            263Accounts
                payable
            
            
            **1,476**
            
            
            655Due
                to related parties
            
            
            (142
            )
            
            (143
            )Customer
                deposits for sales of equipment
            
            
            (1
            )
            
            (33
            )Taxes
                payable
            
            
            (1,197
            )
            
            687Accrued
                expenses and other accrued liabilities
            
            
            (682
            )
            
            802**Net
                cash used in operating activities**
            
            
            (2,260
            )
            
            (722
            )**Cash
                flows from investing activities**Purchase
                of property, plant and equipment
            
            
            (79
            )
            
            (346
            )Proceeds
                from disposal of property, plant and equipment
            
            
            **233**
            
            
            -**Net
                cash from (used in) investing activities**
            
            
            **154**
            
            
            (346
            )**Cash
                flows from financing activities**Repayment
                of debt
            
            
            **-**
            
            
            (605
            )Proceeds
                from short-term bank loan
            
            
            **1,239**
            
            
            -Proceeds
                from issuance of shares
            
            
            **1,043**
            
            
            1,101**Net
                cash provided by financing activities**
            
            
            **2,282**
            
            
            496**Net
                increase (decrease) in cash and cash equivalents**
            
            
            **176**
            
            
            (572
            )**Cash
                and cash equivalents, beginning of the period**
            
            
            **3,605**
            
            
            2,230**Cash
                and cash equivalents, end of the period**
            
            
            **3,781**
            
            
            1,658




The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.


6




**Telestone
      Technologies Corporation**




**Notes
      to Condensed Consolidated Financial Statements
      (unaudited)**




**1.
      ORGANIZATION AND PRINCIPAL ACTIVITIES**




Telestone
      Technologies Corporation (“TTC”), 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, the Company 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 TTC and had no business
      operations apart from investment holding since incorporation. Beijing Telestone
      Technology Company Limited (“Beijing Telestone”), a wholly-owned subsidiary of
      SMI, established in Beijing, the People’s Republic of China (the “PRC”) with
      operating period for an initial term of 20 years until April 12, 2024, it is
      engaged in the business of design, development, installation and trading of
      wireless telecommunication coverage system equipment.




Beijing
      Telestone Wireless Telecommunication Company Limited (“BTWTC”), being considered
      as a variable interest entity (“VIE”) owned by TTC’s directors and stockholders,
      was established in Beijing, the People’s Republic of China (the “PRC”) with a
      tenure of 20 years. As TTC adopted FIN 46 for all periods presented, the
      financial statements of BTWTC are consolidated in the financial statements
      of
      Beijing Telestone.




In
      this
      report, TTC, SMI, Beijing Telestone and BTWTC are collectively referred to
      as
      the “Company”.




The
      consolidated financial statements include the financial statements of TTC and
      its subsidiaries. All intercompany transactions and balances have been
      eliminated upon consolidation.




**2.
      PREPARATION OF INTERIM FINANCIAL STATEMENTS**




The
      accompanying unaudited condensed consolidated financial statements as of
      September 30, 2006, 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 September 30,
      2006 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 condensed
      consolidated financial statements should be read in conjunction with the audited
      financial statements and notes thereto incorporated by reference in the
      Company's Form-10KSB/A for the year ended December 31, 2005 filed on March
      31,
      2006. The balance as of December 31, 2005 and the related notes are derived
      from
      the audited financial statements for the year ended December 31, 2005. The
      results of operations for the nine-month periods ended September 30, 2006 and
      2005 are not necessarily indicative of the operating results to be expected
      for
      the full year.


7




**Telestone
      Technologies Corporation**




**Notes
      to Condensed Consolidated Financial Statements
      (unaudited)**




**2.
      PREPARATION OF INTERIM FINANCIAL STATEMENTS
      (CONTINUED)**




The
      condensed consolidated financial statements and accompanying notes are presented
      in United States dollars and prepared in conformity with accounting principles
      generally accepted in the USA ("USGAAP") which requires management to make
      certain estimates and assumptions that affect the reported amounts of assets
      and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      financial statements and the reported amounts of revenues and expenses during
      the reporting period. Actual results could differ from those
      estimates.




**3.
      EARNINGS PER SHARE**




Basic
      earnings per share is computed based on net income for the periods presented
      attributable to shareholders on the weighted average number of common stock
      outstanding during each period.




Diluted
      earnings per share is computed based on net income for the periods presented
      attributable to shareholders on the weighted average number of common stock
      outstanding during the periods 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 which were outstanding
      during the period is reflected in diluted earnings per share by application
      of
      the treasury stock method.





**4.
      PROPERTY, PLANT AND EQUIPMENT, NET**


Property,
      plant and equipment is summarized as follows:





**(Unaudited)**
                **As
                  of**
              **September
                30,**
            
            As
                of
              December
                31,**2006**
            
            2005***US$’000***
            
            *US$’000*Building
            
            
            **67**
            
            
            181Leasehold
                improvement
            
            
            **98**
            
            
            98Plant
                and machinery
            
            
            **386**
            
            
            335Office
                equipment
            
            
            **540**
            
            
            494Motor
                vehicles
            
            
            **424**
            
            
            424**1,515**
            
            
            1,532Accumulated
                depreciation
            
            
            **(658**
            **)**
            
            (501
            )**857**
            
            
            1,031




8


**Telestone
      Technologies Corporation**




**Notes
      to Condensed Consolidated Financial Statements
      (unaudited)**





**5.
      ACCOUNTS RECEIVABLE**





**(Unaudited)**
              **As
                of**
              **September
                30,**
              **2006**
            
            As
                of
              December
                31,
              2005***US$’000***
            
            *US$’000*Completed
                contracts
            
            
            **26,902**
            
            
            24,139Retentions
            
            
            **530**
            
            
            931**27,432**
            
            
            25,070Less:
                Allowance for doubtful accounts
            
            
            **(2,540**
            **)**
            
            (2,540
            )**24,892**
            
            
            22,530




Of
      the
      retentions balance as of September 30, 2006 and December 31, 2005, approximately
      US$283,000 and US$777,000 respectively are expected to be collected after one
      year.




**6.
      SHORT-TERM BANK LOAN**




The
      bank
      loan was collateralized by a personal guarantee of Mr. Han Daqing, the Company’s
      Chief Executive Officer, repayable on September 16, 2007, and interest bearing
      at an interest rate that is adjusted monthly at 130% of the national standard
      rate established on a monthly basis by the People’s Bank of China.




**7.
      TAXATION**




TTC
      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.




TTC
      had a
      net operating loss carry-forward for income tax reporting purposes that might
      be
      offset against future taxable income. These net operating loss carry-forwards
      are severely limited when the Company 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 the Company believes that it is more likely
      than not that the carry-forwards will expire unused. Accordingly, the potential
      tax benefits of the loss carry-forwards 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 provided as the earnings of these subsidiaries, in the
      opinion of the management, will be reinvested indefinitely.





Determination
      of the amount of unrecognized deferred taxes on these earnings is not practical,
      however, unrecognized foreign tax credits would be available to reduce a portion
      of the tax liability.




9




**Telestone
      Technologies Corporation**




**Notes
      to Condensed Consolidated Financial Statements
      (unaudited)**




**7.
      TAXATION (CONTINUED)**




All
      of
      the Company’s income is generated in the PRC by Beijing Telestone and is subject
      to PRC income taxes at a rate of 24%. Since Beijing Telestone has registered
      as
      a wholly-owned foreign investment enterprise (“WOFIE”), it is subject to tax
      laws applicable to WOFIE in the PRC and is fully exempt from the PRC enterprise
      income tax of 24% for two years, followed by a 50% reduction for the next three
      years commencing in fiscal year 2006.





**8.
      RELATED PARTY TRANSACTIONS**





**Summary
      of related party transactions**




**(Unaudited)**
              **As
                of**
              **September
                30,**
              **2006**
            
            As
                of
              December
                31,
              2005***US$’000***
            
            *US$’000***Due
                from related parties**Other
                employees (Note (a))
            
            
            **390**
            
            
            114Ex-stockholders
                of SMI (Note (b))
            
            
            **1,208**
            
            
            1,208**1,598**
            
            
            1,322**Due
                to related parties**A
                director (Note (a))
            
            
            **695**
            
            
            835Related
                company (Note (c))
            
            
            **50**
            
            
            52Ex-stockholders
                of Beijing Telestone (Note (b))
            
            
            **1,246**
            
            
            1,246**1,991**
            
            
            2,133




Note:




(a)
            The
                amounts due from/to directors and employees represent unsecured advances
                made to 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 of US$1,246,000
                represent 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 “Indemnification”). However, an
                ex-stockholder of Beijing Telestone has initiated lawsuit against
                SMI and
                Beijing Telestone on December 14, 2005 alleging that the consideration
                amount has not been settled. According to the legal opinion issued
                on
                March 6, 2006 from Beijing Telestone’s attorney (Da Du Law Firm,
                registered in the PRC), the lawsuit as referred to above related
                to the
                dispute between the ex-stockholders of Beijing Telestone and there
                is no
                legal relationship between the ex-stockholder and SMI/Beijing Telestone.
                Accordingly, the outcome of the legal case, in the opinion of the
                directors, will have no legal implications on the ownership structure
                and
                control of Beijing Telestone. The court hearing process has commenced
                since May 10, 2006 and evidence has been collected from both parties
                for
                the court’s consideration, and up to the date of this report, the hearing
                has not finalized and no verdict has been drawn
                yet.




10


**Telestone
      Technologies Corporation**




**Notes
      to Condensed Consolidated Financial Statements
      (unaudited)**


**8.
      RELATED PARTY TRANSACTIONS (CONTINUED)**





(c)
            The
                Company is related to the extent that a director of the Company has
                beneficial interest in it. The amounts due to related company represent
                unsecured advances made to the Company. These amounts are interest
                free
                and repayable on demand.




**9.
      SEGMENT INFORMATION**





During
      the quarter ended September 30, 2006, all revenues of the Company are
      derived from its installation and trading of wireless telecommunication.
      Accordingly no financial information by business segment is presented.





The
      Company operates in the PRC and over 90% of its revenue and operating profit
      are
      from the PRC. Accordingly no geographical analysis is presented.





Major
      customers and suppliers with revenues and purchases of more than 10% of the
      Company’s sales and purchases are as follows:




**(Unaudited)**
                **Nine
                  months ended September 30,****2006**
            
            2005***US$’000***
            
            *US$’000*Major
                customers with revenues of more than 10% of the Company’s
                salesSales
                to major customers
            
            
            **13,044**
            
            
            10,361Percentage
                of sales
            
            
            **92**
            **%**
            
            87
            %Number
            
            
            **3**
            
            
            3Major
                suppliers with purchases of more than 10% of the Company’s
                purchasesPurchases
                from major suppliers
            
            
            **2,988**
            
            
            2,243Percentage
                of purchases
            
            
            **41**
            **%**
            
            54
            %Number
            
            
            **2**
            
            
            2




Accounts
      receivable related to the Company’s major customers comprised 91% and 95% of all
      accounts receivables as of September 30, 2006 and December 31, 2005
      respectively.




11


**Telestone
      Technologies Corporation**




**Notes
      to Condensed Consolidated Financial Statements
      (unaudited)**




**10.
      COMMITMENTS AND CONTINGENCIES**




The
      Company recongnizes 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 completed upon completion
      of
      all essential contract work and the installation has been accepted by the
      customers. 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, Beijing Telestone recognized revenue on an “invoice basis”
instead of when goods are delivered and service are rendered. This is not in
      strict compliance
      with the relevant laws and regulations. Accordingly, despite the fact that
      Beijing Telestone has made full tax provision in the financial statements,
      Beijing Telestone may be subject to a penalty for the deferred reporting of
      tax
      obligations. The exact amount of penalty cannot be estimated with any reasonable
      degree of certainty. The board of directors considers it is unlikely that the
      tax penalty will be imposed.




**11.
      STOCK OPTION PLAN**




On
      September 27, 2005, a Stock Option 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 as of the date of these financial
      statements.




12


**ITEM
              2.**
            **MANAGEMENT'S
                DISCUSSION AND ANALYSIS OR PLAN OF **OPERATION****





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 "believes,"
      "anticipates," "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 Securities and
      Exchange Commission from time to time, which could cause actual results or
      outcomes to differ materially from those projected. Undue reliance should not
      be
      placed on these forward-looking statements which speak only as of the date
      hereof. We undertake no obligation to update these forward-looking statements.





Unless
      we
      indicate otherwise, references below to "we", "us", "our" and "Telestone" mean
      Telestone Technologies Corporation and its subsidiaries.





**BUSINESS
      DESCRIPTION**





We
      are a
      wireless communications coverage solutions provider in the People’s Republic of
      China (the “ PRC ” )
      . We
      principally provide mobile telecommunication coverage solutions to our customers
      in service networks in the PRC.





Our
      wireless coverage solutions business enhances mobile telecommunication coverage
      signals through the use of signals received from base stations. Our base
      stations amplify these coverage signals directly to an extended or designated
      area of coverage, and this process improves the quality of reception for mobile
      phone users. 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 vast countryside
      regions.





Our
      wireless coverage solutions business is comprised of research, development
      and
      application of wireless communications technology. In addition to sales of
      our
      internally designed wireless communication equipment, including repeaters,
      antennas and radio frequency accessories, we also provide project design,
      project management, installation, maintenance and other after-sales services
      in
      accordance with our customers' requirements. Since the establishment of
      Telestone in 1997, we have gradually developed business relationships with
      wireless operators. Our main customers are China Mobile Group ( “ China
      Mobile ” ),
      China
      Unicom Group ( “ China
      Unicom ” ),
      China
      Telecom Group ( “ China
      Telecom ” )
      and
      China Netcom Group ( “ China
      Netcom ” ).
      China
      Mobile and China Unicom are the leading wireless operators in the PRC, and
      both
      of these entities operate the Code Division Multiple Access ( “ CDMA ” )
      and
      Global System for Mobile Communications ( “ GSM ” )
      networks. China Mobile operates the GSM and China Unicom operates the GSM and
      CDMA.




Competition
      amongst PRC wireless operators has been intensifying in recent years. Fixed-line
      operators, such as the China Telecom and the China Netcom, have expressed
      interest in obtaining wireless licenses and entering the wireless communication
      business. In recent years, telecommunication operators such as the China Telecom
      and China Netcom have deployed alternative wireless networks, specifically
      personal handy-phone system (“PHS”)
      networks, in some cities and rural areas.





13


During
      2005, there was an improvement of the revenue received from China Telecom and
      China Netcom. Based on a Ministry of Information Industry ( “ MII ” )
      report
      from June 2006, the number of users of PHS, which is operated by China Telecom
      and China Netcom, increased to 92 million, an increase of 12 million from the
      corresponding period last year. In addition, both China Telecom and China Netcom
      increased their wireless coverage in anticipation of the launch of the third
      generation wireless communication network (the “ 3G
      network ” ).
      The
      Company has also started to expand its business into overseas markets such
      as
      Vietnam, India and Indonesia regions. Furthermore, the Company is planning to
      establish new offices in Dallas, Texas. At 20 Sept. 2006 the company had entered
      into first contract with Vinaphone of Vietnam. And Vinaphone is the largest
      mobile carrier in Vietnam. This successful bidding indicates that both products
      and technologies of the company have been fully recognized and we believe this
      bidding becomes a strong foundation in winning selected future business in
      the
      untapped Vietnam telecommunication market.





In
      2005,
      the Company completed the research & development ( “ R&D ” )
      of 3G
      application equipments, such as WCDMA, CDMA2000 and TD-SCDMA, three expected
      licenses in the 3G network . Before 3G licensed Chinese domestic carriers will
      face the problems of multi-carriers and multi-mobile telecommunication systems,
      our R&D center has developed a new third generation indoor coverage solution
      ( it
      is
      named 3D) ,
      which
      uses the fiber technology in the radio frequency signal distribution to transmit
      high speed data signals.





In
      the
      end of September, 2006 the
      company ’ s
      common
      shares began to be  traded
      on
      NASDAQ upon
      the
      completion of
      certain final regulatory requirements. Because NASDAQ offers better trade
      execution and also offers investors greater transparency and flexibility through
      a sophisticated computer and telecommunications network. Meanwhile, the Company
      believes that transferring its listing to NASDAQ will provide the Company with
      enhanced access to the broader capital markets.




**BUSINESS
      REVIEW**





Our
      net
      revenues during the nine months period ended September 30, 2006 were derived
      from installation and trading of wireless telecommunication. The majority of
      our
      revenues for the period were generated from mobile operators, while revenues
      from system integration providers were comparatively small.





For
      the
      reporting period, the Company provided new products and innovative solutions
      and
      we also developed new leads into other mobile telecommunication markets. We
      continue to deepen our penetration in the domestic markets such as Shanghai,
      Beijing, Tianjin, and Guangdong. The Company anticipates to  increase
      our marketing in these areas in fiscal year 2006. **** The
      Company is currently developing overseas markets for its products in south-east
      Asia, specifically Vietnam, Indonesia and India. We have also established
      business relationships with telecommunication carriers in these regions. We
      expect that new products, solutions and markets will enhance our business
      prospects.




Along
      with our R & D capabilities in developing new products, we have also
      implemented a series of effective cost control measures, including implementing
      price controls, optimizing our supply chain, and decreasing the use of raw
      materials, which we expect will improve our gross margin.





We
      believe that our revenues in 2006 will and eventually eclipse fiscal 2005's
      revenue totals with the application of our new products, solutions and the
      contribution of our newly developing markets, especially as the expected 3G
      network begins its construction. There has not been any public disclosure from
      the PRC about the anticipated launch of the 3G network, and as a result, the
      Company is not certain when the launch of the 3G network will occur. However,
      the Company believes that the anticipated 3G rollout will have a positive impact
      on our Company .





14


According
      to an MII report in 2005, revenue from the telecommunication industry in the
      PRC
      increased 11.7% compared to 2004 .
      The
      growth included revenue from mobile communication, which increased by 17.2%.
      We
      reiterate our earlier guidance for growth in 2006 of 20% to 30% in revenue,
      compared to 2005, without the inclusion of anticipated revenue generated from
      the upcoming 3G network deployment in China.





**New
      solutions of Telestone**





As
      of  September  30,
      2006,
      the Company has developed three new solutions:





The
      Company ’ s
      3D
      coverage system solution has been using optical fiber plus Cat-5E/6 or thin
      net
      cable distribution mode for indoor or outdoor coverage, which is the global
      leading 2G/3G coverage system. Because the 3D coverage system uses the
      intermediate frequency transmission, it has unique characteristics such as
      flexibility, high output, low uplink noise and intelligence, which can satisfy
      all kinds of coverage requirements. It focuses on providing stable indoor voice
      and wireless data service at a reasonable price, and is especially suitable
      for
      large-scale construction sites. It also has a consummate monitor system which
      can monitor each antenna. The trials include: Dongguan Mobile Hui Huang Da
      Sha,
      Dongguan Mobile Ju Hao Mu Zu Cheng, Shenzhen Mobile Guo Tong Fu lou, Hohhot
      Bridge Huabei Cellular Coverage and the Chinese Telecommunication Headquarters
      Building.





The
      PHS
      system optimization solution has transitioned to a network optimization period
      from network maintenance, aiming at solving the four major problems of the
      wireless network; namely, network coverage, network planning, network capacity
      and network disturbance. Our solutions have the following merits: investment
      reduction, traffic increase, increase of network utilization ratio and high
      quality network operation. The projects include:   Zhuhai Telecommunication
      Correspondence Building, Hohhot network optimization, Baise network optimization
      and Guilin road coverage optimization.





The
      Company ’ s
      TD-SCDMA repeaters application solutions have the following merits: flexible
      network grouping, low construction cost, convenient and fast equipment
      installation and removal. It can be applied for signal coverage of blind spots
      such as signal blocked areas, tunnels and temporary meeting rooms. Because
      the
      TD-SCDMA system works in 2GHz frequency bands, it has weak penetrability
      compared with the 800MHz and the 900MHz frequency band of the 2G network. This
      weak penetrability will cause many blind signal spots and TD-SCDMA repeaters
      can
      be used to cover these blind signal spots. The Company anticipates that the
      TD-SCDMA repeaters application solutions will be very marketable in the PRC,
      because the development of the TD-SCDMA network will be completed in the PRC.





**CRITICAL
      ACCOUNTING POLICIES AND MANAGEMENT ESTIMATES**





Our
      discussion and analysis of our financial condition and results of operations
      are
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with accounting principles generally accepted in the United States.
      The preparation of these financial statements requires us to make estimates
      and
      judgments that affect the reported amounts of assets, liabilities, revenues
      and
      expenses, and related disclosure of contingent assets and liabilities. On an
      on-going basis, we evaluate our estimates based on historical experience and
      on
      various other assumptions that are believed to be reasonable under the
      circumstances, the results of which form the basis for making judgments about
      the carrying values of assets and liabilities that are not readily apparent
      from
      other sources. Actual results may differ from these estimates under different
      assumptions or conditions. We believe critical accounting policies as disclosed
      in our Annual Report on Form 10-KSB/A for the year ended December 31, 2005,
      reflect the more significant judgments and estimates used in preparation of
      our
      financial statements. We believe there have been no material changes to our
      critical accounting policies and estimates during the nine months ended
      September 30, 2006, compared to those discussed in our Annual Report on Form
      10-KSB/A for the year ended December 31, 2005.





15


**RESULTS
      OF OPERATIONS**





**REVENUES**





For
      the
      three months and nine months ended September 30, 2006, our net revenues were $5,234,000
      and $14,228,000, representing an increase of 32.46% and 19.68%, re spectively,
      when compared to the corresponding periods of 2005. The increase in net revenues
      was due to a mixed effect of: (1) China Mobile and China Telecom boosting its
      capital investment; and (2) China Unicom temporarily lowers its capital
      expenditure.





During
      the nine months ended September 30 2006, we managed to expand our revenue stream
      from sales of the indoor coverage solution, which included products and system
      integration services, to China Mobile and China Telecom. Although China Unicom’s
      temporarily drop in capital investment, the company still maintained certain
      market shares and had some increase in Shandong, Shanxi and Guizhou provinces
      in
      the reporting periods, which resulted in an increase in total revenues for
      the
      third quarter of 2006.





**BREAKDOWN
      BY NATURE**





Three
      months ended September 30, 2006


2006
              
              2005
              
              Increase/DecreaseUSD'000
              
              %
                  of revenue
              
              USD'000
              
              %
                  of revenue
              
              USD'000
              
              %product
                  sales
              
              
              4026
              
              
              76.92
              %
              
              3131
              
              
              79.27
              %
              
              895
              
              
              28.59
              %service
                  sales
              
              
              1208
              
              
              23.08
              %
              
              819
              
              
              20.73
              %
              
              389
              
              
              47.50
              %total
              
              
              5234
              
              
              
              
              
              3950
              
              
              
              
              
              1284
              
              
              32.51
              %




Nine
      months ended September 30, 2006


2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


product
                sales
            
            
            10851
            
            
            76.27
            %
            
            8766
            
            
            73.74
            %
            
            2085
            
            
            23.79
            %service
                sales
            
            
            3377
            
            
            23.73
            %
            
            3121
            
            
            26.26
            %
            
            256
            
            
            8.20
            %total
            
            
            14228
            
            
            
            
            
            11887
            
            
            
            
            
            2341
            
            
            19.69
            %





16





For
      the
      three months and nine months ended September 30, 2006, revenues generated from
      product sales were $4,026,000 and $10,851,000, which represented an increase
      of
      28.59% and 23.79%, respectively, compared to the corresponding periods of 2005.
      For the three months and nine months ended September 30, 2006, revenues
      generated from service sales were $1,208,000 and $3,377,000, which represented
      an increase of 47.50% and 8.20% respectively, compared to the same periods
      of
      2005. The increase of product sales was due to more sales to China Mobile and
      China Telecom. Wireless signal improvement service contract provided to the
      Neimeng Netcom and Shanghai Telecom which cause the increase of service
      sales.





For
      the
      three months and nine months ended September 30, 2006, revenues generated from
      product sales accounted for 76.92% and 76.27% of total revenues, respectively,
      compared to 79.27% and 73.74% for the corresponding periods of 2005. For the
      three months and nine months ended September 30, 2006, revenues generated from
      service sales accounted for 23.08% and 23.73% of total revenues, respectively,
      compared to 20.73% and 26.26% for the same periods of 2005.





**BREAKDOWN
      BY CUSTOMERS**





Three
      months ended September 30, 2006


2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


China
                Mobile
            
            
            1347
            
            
            25.74
            %
            
            971
            
            
            24.58
            %
            
            376
            
            
            38.72
            %China
                Unicom
            
            
            2033
            
            
            38.84
            %
            
            1711
            
            
            43.32
            %
            
            322
            
            
            18.82
            %China
                Netcom
            
            
            232
            
            
            4.43
            %
            
            130
            
            
            3.29
            %
            
            102
            
            
            78.46
            %China
                Telecom
            
            
            1344
            
            
            25.68
            %
            
            982
            
            
            24.86
            %
            
            362
            
            
            36.86
            %Others
            
            
            278
            
            
            5.31
            %
            
            156
            
            
            3.95
            %
            
            122
            
            
            78.21
            %Total
            
            
            5234
            
            
            
            
            
            3950
            
            
            
            
            
            1284
            
            
            32.51
            %




Nine
      months ended September 30, 2006




2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


China
                Mobile
            
            
            3513
            
            
            24.69
            %
            
            1754
            
            
            14.76
            %
            
            1759
            
            
            100.29
            %China
                Unicom
            
            
            5759
            
            
            40.48
            %
            
            6347
            
            
            53.39
            %
            
            -588
            
            
            -9.26
            %China
                Netcom
            
            
            894
            
            
            6.28
            %
            
            427
            
            
            3.59
            %
            
            467
            
            
            109.37
            %China
                Telecom
            
            
            3773
            
            
            26.52
            %
            
            2260
            
            
            19.01
            %
            
            1513
            
            
            66.95
            %Others
            
            
            289
            
            
            2.03
            %
            
            1099
            
            
            9.25
            %
            
            -810
            
            
            -73.70
            %Total
            
            
            14228
            
            
            
            
            
            11887
            
            
            
            
            
            2341
            
            
            19.69
            %





17





For
      the
      three months and nine months ended September 30, 2006, revenues generated from
      China Mobile were $1,347,000 and $3,513,000, which represented an increase
      of
      38.72% and 100.29%, respectively, compared to the corresponding periods of
      2005.
      For the three months and nine months ended September 30, 2006, revenues
      generated from China Unicom were $2,033,000 and $5,759,000, which represented
      an
      increase of 18.82% and a decrease of 9.26% respectively, compared to the same
      periods of 2005. The increase in revenues from China Mobile was due to the
      carrier's decision to increase its capital expenditure. In certain regions,
      specifically, the Guizhou province and Guangxi province, we captured more market
      shares from China Mobile, which increased our business. However, even though
      China Unicom temporarily slowed down its infrastructure investment; we still
      maintained certain market shares and had some increase in Shandong, Shanxi
      and
      Guizhou provinces in the reporting periods.





For
      the
      three months and nine months ended September 30, 2006, revenues generated from
      China Netcom were $232,000 and $894,000, which represented an increase of 78.46%
      and an increase of 109.37%, respectively, compared to the corresponding periods
      of 2005. For the three months and nine months ended September 30, 2006, revenues
      generated from China Telecom were $1,344,000 and $3,773,000, which represented
      an increased of 36.86% and 66.95%, respectively, compared to the corresponding
      periods of 2005. The increase in revenues from China Netcom was due to the
      fact
      that in the bidding stage, our Company’s tower mounted amplifiers successfully
      enrolled, and that our businesses increased in Neimeng and Hebei provinces.
      We
      managed to expand our revenue stream from sales of the PHS coverage solution
      to
      China Netcom and China Telecom during 2006. The growth in revenues from China
      Telecom was attributableto the
      sales increasein
      Xiamen Telecom, Shanghai Telecom and due to the fact that we acquired new
      business with Sichuan Telecom. The Company believes that this acquisition will
      aid in the development of our business.





Revenues
      from telecom carriers were our major revenue source for the nine months ended
      September 30, 2006 and China Mobile, China Unicom and China Telecom accounted
      for the majority change in revenue, compared to the corresponding period in
      2005. The change in the composition ratio of revenues was primarily driven
      by
      the following factors: (1) an increase in revenues received from China Mobile;
      and (2) increased revenues of PHS coverage solutions derived from China Netcom
      and China Telecom.





**BREAKDOWN
      BY SOLUTIONS**





Three
      months ended September 30, 2006:





2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


Indoor
            
            
            4639
            
            
            88.63
            %
            
            3276
            
            
            82.94
            %
            
            1363
            
            
            41.61
            %Outdoor
            
            
            302
            
            
            5.77
            %
            
            556
            
            
            14.08
            %
            
            -254
            
            
            -45.68
            %Others
            
            
            293
            
            
            5.60
            %
            
            118
            
            
            2.99
            %
            
            175
            
            
            148.31
            %Total
            
            
            5234
            
            
            
            
            
            3950
            
            
            
            
            
            1284
            
            
            32.51
            %





Nine
      months ended September 30, 2006:




2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


Indoor
            
            
            12471
            
            
            87.65
            %
            
            9428
            
            
            79.31
            %
            
            3043
            
            
            32.28
            %Outdoor
            
            
            841
            
            
            5.91
            %
            
            1299
            
            
            10.93
            %
            
            -458
            
            
            -35.26
            %Others
            
            
            916
            
            
            6.44
            %
            
            1160
            
            
            9.76
            %
            
            -244
            
            
            -21.03
            %Total
            
            
            14228
            
            
            
            
            
            11887
            
            
            
            
            
            2341
            
            
            19.69
            %




18





For
      the
      three months and nine months ended September 30, 2006, revenues generated from
      indoor wireless coverage solutions were $4,639,000 and $12,471,000, which
      represented an increase of 41.61% and 32.28%, respectively, compared to the
      corresponding periods of 2005. For the three months and nine months ended
      September 30, 2006, revenues generated from outdoor wireless coverage solutions
      were $302,000 and $841,000, which represented a decrease of 45.68% and a
      decrease of 35.26% respectively, compared to the same periods of 2005.





For
      the
      three months and nine months ended September 30, 2006, revenues generated from
      indoor wireless coverage solutions accounted for 88.63% and 87.65% of total
      revenues, respectively, compared to 82.94% and 79.31% for the corresponding
      periods of 2005. For the three months and nine months ended September 30, 2006,
      revenues generated from outdoor wireless coverage solutions accounted for 5.77%
      and 5.91% of total revenues, respectively, compared to 14.08% and 10.93% for
      the
      same periods of 2005.





The
      significant increase in indoor coverage revenues in the third quarter of 2006
      was due to more sales made to China Mobile and China Telecom as
      a
      result of their investment
      in capital expenditure. Carriers pay more attention on in-door wireless coverage
      solution and our revenue from in-door wireless coverage solution will still
      bigger than out-door wireless coverage solution.





**BREAKDOWN
      BY REGIONS**





Three
      months ended September 30, 2006:




2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


North
            
            
            2452
            
            
            46.85
            %
            
            1941
            
            
            49.14
            %
            
            511
            
            
            26.33
            %South
            
            
            1820
            
            
            34.77
            %
            
            1518
            
            
            38.43
            %
            
            302
            
            
            19.89
            %East
            
            
            962
            
            
            18.38
            %
            
            491
            
            
            12.43
            %
            
            471
            
            
            95.93
            %Total
            
            
            5234
            
            
            
            
            
            3950
            
            
            
            
            
            1284
            
            
            32.51
            %





Nine
      months ended September 30, 2006:




2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


North
            
            
            6494
            
            
            45.64
            %
            
            5034
            
            
            42.35
            %
            
            1460
            
            
            29.00
            %South
            
            
            4916
            
            
            34.55
            %
            
            5683
            
            
            47.81
            %
            
            -767
            
            
            -13.50
            %East
            
            
            2818
            
            
            19.81
            %
            
            1170
            
            
            9.84
            %
            
            1648
            
            
            140.85
            %Total
            
            
            14228
            
            
            
            
            
            11887
            
            
            
            
            
            2341
            
            
            19.69
            %




19


For
      the
      three months and nine months ended September 30, 2006, revenues generated from
      the North (covering areas such as Beijing, Tianjin, Xinjiang and etc.) were
      $2,452,000 and $6,494,000, which represented an increase of 26.33% and 29%,
      respectively, compared to the corresponding periods of 2005. For the three
      months and nine months ended September 30, 2006, revenues generated from the
      South (covering areas such as Guangdong, Fujian, Sichuan and etc.) were
      $1,820,000 and $4,916,000, which represented an increase of 19.89% and a
      decrease of 13.50% respectively, compared to the same periods of 2005. For
      the
      identical periods, revenues generated from the East (covering areas such as
      Shanghai, Nanjing and etc.) were $962,000 and $2,818,000, which represented
      an
      increase of 95.93% and 140.85%, respectively, compared to the corresponding
      periods of 2005.





For
      the
      three months and nine months ended September 30, 2006, revenues generated from
      the North accounted for 46.85% and 45.64% of total revenues, respectively,
      compared to 49.14% and 42.35% for the corresponding periods of 2005. For the
      three months and nine months ended September 30, 2006, revenues generated from
      the South accounted for 34.77% and 34.55% of total revenues, respectively,
      compared to 38.43% and 47.81% for the same periods of 2005. For the identical
      periods, revenues generated from the East accounted for 18.38% and 19.81% of
      total revenues, respectively, compared to 12.43% and 9.84% for the corresponding
      periods of 2005.





For
      the
      nine month 2006 reporting period, revenue increase in the North was mainly
      due
      to an
      increase in sales made to Shandong Unicom, Shanxi Unicom and Xinjiang Unicom
      as
      they increased capital expenditure. The revenue increase in the South was
      primarily because we
      increased business with Guangxi Mobile and Guizhou Mobile. The revenue increase
      in East was attributable to our
      sales increase in
      Shanghai Telecom and Xiamen Telecom.





**COSTS
      OF REVENUES**





Three
      months ended September 30, 2006:




2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


Costs
                of product sales
            
            
            1979
            
            
            37.81
            %
            
            1430
            
            
            36.20
            %
            
            549
            
            
            38.39
            %Cost
                of service sales
            
            
            1136
            
            
            21.70
            %
            
            321
            
            
            8.13
            %
            
            815
            
            
            253.89
            %total
            
            
            3115
            
            
            
            
            
            1751
            
            
            
            
            
            1364
            
            
            77.90
            %




Nine
      months ended September 30, 2006:




2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


Costs
                of product sales
            
            
            5378
            
            
            37.80
            %
            
            4050
            
            
            34.07
            %
            
            1328
            
            
            32.79
            %Cost
                of service sales
            
            
            2182
            
            
            15.34
            %
            
            1593
            
            
            13.40
            %
            
            589
            
            
            36.97
            %total
            
            
            7560
            
            
            
            
            
            5643
            
            
            
            
            
            1917
            
            
            33.97
            %




20




For
      the
      three months and nine months ended September 30, 2006, our total costs of
      revenues were $3,115,000 and $7,560,000, which represented an increase of 77.90%
      and 33.97%, respectively, as compared to the corresponding periods of 2005.





Costs
      of
      revenues include costs of product sales, costs of service sales.





For
      the
      three months and nine months ended September 30, 2006, our costs of product
      sales were $1,979,000 and $5,378,000, which represented an increase of 38.39%
      and 32.79%, respectively, as compared to the same periods of 2005.   The
      percentage increase in costs of product sales was mainly due to the growth
      in
      cost of raw materials, especially the cost of feeder lines. We are continuously working
      to
      lower our costs of product sales through a series of effective cost control
      measures, including reducing purchasing costs through large scale procurement,
      decreasing the use of raw materials through system design optimization,
      regularly improving our system integration technologies, and optimizing our
      supply chain to in turn receive better terms from suppliers.





For
      the
      three months and nine months ended September 30, 2006, our costs of service
      sales were $1,136,000 and $2,182,000, representing an increase of 253.89% and
      36.97%, respectively, as compared to the same periods of 2005. For the three
      months and nine months ended September 30, 2006, the increase
      in costs was
      mainly due to the fact that we had accomplished some trials
      and the
      trials are expensive and in this quarter the expense had been fixed and
      reflected in cost .
      Our trials
      received high
      reputation of carriers and these achievements will improve our business
      development in future. We
      are
      working out with these carriers to finalize the revenue from these trials and
      cover the related costs and now in Guizhou, Shanxi provinces
      we have made some
      progresses.





Our
      costs
      of product sales and costs of service sales for the nine months ended September
      30, 2006, accounted for 37.80%, 15.34% of total revenue, respectively, compared
      to 34.07%, and 13.40% for the corresponding period in 2005.





**GROSS
      PROFIT AND GROSS MARGIN**





For
      the
      three months and nine months ended September 30, 2006, our gross profit was
      $2,119,000 and $6,668,000, which represented a decrease of 3.64% and an increase
      of 6.79%, respectively, as compared to the same periods of 2005. Our gross
      margin for the three months and nine months ended September 30, 2006 was 40.49%
      and 46.87%, compared to 55.67% and 52.53% of the same period
      of
      2005, respectively.





Our
      gross
      profit decrease during
      the reporting period mainly
      due to the increase
      in cost of service and the decrease in
      sale
      price per product. We will take some effective measures to control product
      costs, and utilize our R&D capability to enhance our marketing
      competence.





21





**OPERATING
      EXPENSES**





Three
      months ended September 30, 2006:




2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


Sales
                and marketing
            
            
            780
            
            
            14.90
            %
            
            844
            
            
            21.37
            %
            
            -64
            
            
            -7.58
            %General
                and administrative
            
            
            256
            
            
            4.89
            %
            
            518
            
            
            13.11
            %
            
            -262
            
            
            -50.58
            %Research
                and development
            
            
            111
            
            
            2.12
            %
            
            155
            
            
            3.92
            %
            
            -44
            
            
            -28.39
            %Total
            
            
            1147
            
            
            
            
            
            1517
            
            
            
            
            
            -370
            
            
            -24.39
            %





Nine
      months ended September 30, 2006:




2006
            
            2005
            
            Increase/DecreaseUSD'000
            
            %
                of revenue
            
            USD'000
            
            %
                of revenue
            
            USD'000
            
            %


Sales
                and marketing
            
            
            2010
            
            
            14.13
            %
            
            2064
            
            
            17.36
            %
            
            -54
            
            
            -2.62
            %General
                and administrative
            
            
            764
            
            
            5.37
            %
            
            1434
            
            
            12.06
            %
            
            -670
            
            
            -46.72
            %Research
                and development
            
            
            391
            
            
            2.75
            %
            
            309
            
            
            2.60
            %
            
            82
            
            
            26.54
            %Total
            
            
            3165
            
            
            
            
            
            3807
            
            
            
            
            
            -642
            
            
            -16.86
            %




Operating
      expenses include sales and marketing expenses, general and administrative
      expenses and research and development expenses.





**SALES
      AND MARKETING EXPENSES**





Sales
      and
      marketing expenses include all related expenses and remunerations for sales
      personnel and travel expenses related to sales of products and market
      development.





For
      the
      three months and nine months ended September 30, 2006, sales and marketing
      expenses were $780,000 and $2,010,000, accounting for 14.90% and 14.13% of
      total
      revenues, as compared to $844,000 and $2,064,000, or 21.37% and 17.36% of total
      revenues, respectively, for the corresponding periods of 2005.





Sales
      and
      marketing expenses were higher in the
      third quarter of 2005 due to our efforts to expand our product sales range,
      penetrate into new markets; and open new branches and representative offices,
      as
      well as investments related to business expansion in new markets. In the third
      quarter of 2006, our sales and marketing expenses decreased due to the fact
      that
      our business benefited from investment, and we spent less in business
      development compared to the same period of last year.





22


**GENERAL
      AND ADMINISTRATIVE EXPENSES**





General
      and administrative expenses consist primarily of compensation for personnel,
      travel expenses, material expenses related to ordinary administration, fees
      for
      professional services, and allowance for doubtful accounts.





For
      the
      three months and nine months ended September 30, 2006, general and
      administrative expenses were $256,000 and $764,000, accounting for 4.89% and
      5.37% of total revenues, as compared to $518,000 and $1,434,000, or 13.11%
      and
      12.06% of total revenues, respectively, for the corresponding periods of 2005.
      General and administrative expenses for the three months and nine months ended
      September 30, 2006 decreased 50.58% and 46.72%, respectively, as compared to
      the
      same periods of last year.





The
      major
      reasons for the decrease in general and administrative expenses were
      attributable toour
      efforts to optimize the structure of the Company, improve work efficiency and
      cut the level of daily expenses.





**RESEARCH
      AND DEVELOPMENT EXPENSES**





Research
      and development expenses include remunerations for R&D staff, material
      expenses, travel expenses and facilities.





For
      the
      three months and nine months ended September 30, 2006, R&D expenses were
      $111,000 and $391,000, accounting for 2.12% and 2.75% of total revenues, as
      compared to $155,000 and $309,000, or 3.92% and 2.60% of total revenues,
      respectively, for the corresponding periods of 2005. R&D expenses for the
      three months and nine months ended September 30, 2006 decreased 28.39% and
      increased 26.54%, respectively, as compared to the same periods of last
      year.





We
      have
      directed some of our R&D efforts towards investing into wireless
      telecommunications research and development, primarily 3G related technologies
      and applications. We expect these research activities to enhance our
      technologies, reduce the cost of existing products and create future revenue
      streams through the launch of new products.





**Net
      Income**





For
      the
      nine months ended September 30, 2006, our net income was $2,9 76,000,
      which represented an increase of 31 %,
      as
      compared to the same period in 2005. The period-to-period increase in net income
      was primarily due to 1) an increase in revenue; 2) a decrease in sales and
      marketing expenses and a decrease in general and administrative
      expenses.





**LIQUIDITY
      AND SOURCE OF CAPITAL**





We
      generally finance our operations from cash flow generated internally and through
      bank loans. As of September 30, 2006, we had current assets of $35,404,000.
      Current assets are comprised of inventories of $4,435,000, accounts receivable
      of $24,892,000, prepayments, deposits and other receivables of $2,296,000,
      and
      cash and cash equivalents of $3,781,000. Current liabilities comprised of
      accounts payable of $5,699,000, tax payables of $4,359,000, a short-term bank
      loan for $1,239,000, and other payables and accruals of $3,015,000.





Our
      trading terms with our customers are mainly on credit. As of September 30,
      2006,
      our accounts receivable were $24,892,000 compared to $22,530,000 as of December
      31, 2005. The credit period is generally less than one year. The gradual
      increase in the accounts receivable is mainly due to: 1) steady growth in
      revenues resulting from growth in business scale; 2) change in the settlement
      pattern of the mobile operators; and 3) our account receivable with China
      Unicom.





23


.
      We
      believe our accounts receivable will be recovered based on the fact that our
      major customers, China Unicom and China Mobile, are reputable and sizeable
      mobile operators in the PRC. Additionally, the Company has not experienced
      significant bad debts in the past. Notwithstanding this, we have paid special
      attention to lowering the turnover period of our accounts receivable balances
      and have taken the following measures:





(1)
      The
      provincial branch managers and the headquarters district managers are
      responsible for the
      collection of the account receivables, which form an important element of their
      performance evaluation.





(2)
      The
      Company will keep in touch with the management of
      key
      departments (such as the financial department and the planning department)
      of
      the carriers in headquarters as well as the provincial branches to monitor
      the
      collection of the account receivables.





(3)
      Our
      business strategy is to encourage sales to China Mobile, China Telecom, China
      Netcom and certain provincial branches of China Unicom who have good payment
      records such as Shandong Unicom, Tianjin Unicom, and Beijing Unicom. We believe
      these measures will optimize the structure of our account receivables and
      minimize our financial risks in the future.





We
      believe the above-mentioned measures will improve our accounts receivable
      turnover period and provide a better internal control environment for us to
      cope
      with the fast growing telecommunication industry in the PRC that we are facing
      in the coming future.





As
      of
      September 30, 2006, our inventories were $4,435,000, as compared to $2,287,000
      as of December 31, 2005, which represented an increase of 93%. The increase
      in
      the inventories is due to the following factors: (1) inventory reservations
      based on anticipated growth in sales in the fourth quarter; and (2) our ability
      to acquire a lower purchasing pricing through large scale
      procurement.





As
      of
      September 30, 2006, 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 currency. This may be a result of
      certain exchange risks.





We
      have
      experienced negative cash flows from operating activities for the periods ended
      September 30, 2006 and 2005, which is primarily the result of prolonged
      collection periods related to our accounts receivable, as mentioned above.
        A continuation of this situation could have negatively impact on our
      liquidity and in turn, our overall results of operations. In order to address
      this issue, apart from the implementation of the above-mentioned measures to
      reduce the turnover period, we are also exploring the possibility of obtaining
      third party financing as well as considering raising additional capital through
      debt or equity financing. On June 16, 2006 we entered into a loan of $1,239,000
      from Xing Ye Bank. The principal amount of the loan is 10 million RMB
      (approximately US$1,254,233), with an interest rate that is adjusted monthly
      at
      130% of the national standard rate established on a monthly basis by the Central
      Bank of China (on August 1, 2006, the interest rate on the loan was 7.60%).
      The
      term of the loan is from June 16, 2006 to June 16, 2007. The loan is collateralized
      by a personal guarantee by Mr. Han Daqing, the Company's Chief Executive
      Officer. The purpose of securing the loan is for operational purposes. The
      Company believes that this loan will effectively improve our business
      development.





24




Our
      gearing ratio, calculated as total debts over total assets, was 39.46% as of
      September 30, 2006 and 43.17% as of December 31, 2005, respectively.





**CONTINGENT
      LIABILITIES**





We
      recognize our revenue upon the completion of contracts and have made full tax
      provision in accordance with the 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. For PRC tax reporting purposes, we
      recognize revenue on an "invoice basis" instead of when goods are delivered
      and
      services are rendered. This is not in strict compliance with the United States
      laws and regulations. Accordingly, despite the fact that we have made full
      tax
      provision in the financial statements, we may be subject to a penalty from
      the
      PRC for the deferred reporting of tax obligations. The exact amount of any
      penalty cannot be estimated with any reasonable degree of certainty. The Board
      of Directors considers it is unlikely that such tax penalty will be imposed.





**EMPLOYMENT
      AND REMUNERATIONS**





We
      offer
      competitive remuneration schemes to our employees based on industry practices
      as
      well as our employees’ performance.





**ITEM****3.****CONTROLS
      AND PROCEDURES**





Prior
      to
      the conclusion of the period covered by this report, we carried out an
      evaluation, under the supervision and with the participation of our management,
      including our Chief Executive Officer ( “ CEO ” )
      and
      Chief Financial Officer ( “ CFO ” ),
      of the
      effectiveness of the design and operation of our disclosure controls and
      procedures pursuant to Exchange Act Rule 13(a)-14(c). Based upon that
      evaluation, our CEO and CFO concluded that our disclosure controls and
      procedures are effective in timely alerting them to material information
      relating to us (including our consolidated subsidiaries) required to be included
      in our periodic SEC filings.





There
      have been no significant changes in our internal controls or in other factors
      that could significantly affect internal controls subsequent to the date we
      carried out this evaluation.





While
      we
      believe that our existing disclosure controls and procedures have been effective
      to accomplish their objectives, we intend to continue to examine, refine and
      formalize our disclosure controls and procedures, and monitor ongoing
      developments in this area.





25


**PART II**





**OTHER
      INFORMATION**





**ITEM
      1.   LEGAL PROCEEDINGS******





A
      former
      stockholder of Telestone initiated arbitration proceedings in the PRC against
      SMI alleging the failure of SMI to settle the payment of the consideration
      owned
      to said stockholder as a result of the transaction pursuant to which SMI
      acquired all of the outstanding capital shares of Telestone. The value of the
      above claim is approximately $1.2 million. The claim was rejected because the
      court did not have jurisdiction to decide the case.





As
      a
      result of the rejected claim, the former shareholder initiated a legal
      proceeding in the PRC against SMI and Beijing Telestone Technologies Corp.
      for
      the same claim. The case is pending and is in the process of pretrial
      preparation. The value of this claim is nearly $1 million, however, management
      believes that the claim is without merit and will be resolved in SMI and Beijing
      Telestone Technologies Corp.’ ’ s
      favor.





**ITEM
      2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF****PROCEEDS****.******





None.





**ITEM
      3.   DEFAULTS UPON SENIOR SECURITIES****.**





None.





**ITEM
      4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS****.******





None.





**ITEM
      5.   OTHER INFORMATION****.******





None.





**ITEM
      6.   EXHIBITS****S.**





The
      following documents are filed as part of this report:




**Exhibit
              No.**
            
            **Description******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


26
  **SIGNATURES**





In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly
      authorized.





**TELESTONE
                TECHNOLOGIES CORPORATION**Date:****November
              12,
              2006
            By:
            /s/
              Han DaqingHan
                Daqing, Chief Executive Officer
              (Principal
                Executive Officer)


Date:****November
              12,
              2006
            By:
            /s/
              Liu
              DongpingLiu
                Dongping, Chief Financial Officer
              (Principal
                Financial Officer)




27