DSO Analysis

[tradestar2012]

Doing some DSO analysis here. It seems to me the MW thesis now more or less rests on the DSO's being comprised of fictional sales. The allegation by MW is that NQ has been roundtripping, or just outright creating fictional sales. As a reminder, NQ calculates DSO as (Average AR / Sales x ~90 days). I looked at NQ's historical DSO's and for the most part, they've historically been between 130-150 days. The only big outlier seems to be from 12/31/12-3/31/13. You can see it creep up in 12/31/12 and then really show up on 3/31/13 as you now have two quarters of high AR. Anyhow, I decided to look at each quarter's AR, Sales and Collections and noticed that for the most part, AR and Sales seem to grow at almost the same rate (I just eyeballed this). One way you can artifically lower your DSO's is by stuffing sales, but that eventually catches up to you as you are not able to collect on those sales. Looking at their historical #'s, 12/31/12-3/31/13 might have had some channel stuffing, but given the strong cash collections and fall in DSOs on 6/30/13, it looks like the prior periods might have been more of an outlier than a trend. From my understanding part of the trends might also be due to expanding ex-china sales lengthening DSO's from 9/30/12 onwards, countered by growing China sales in 12/31/12 - 6/30/13 as Feiliu is acquired and Nationsky continues to ramp. One interesting thing to note is that pre-nationsky/feiliu, DSO's were fairly stable in a tight range of 130-135... Also, given what we've learned from the Company w/re to DSO's they should continue to fall in 3q. We'll know if DSO's fell due to revenue growth vs AR collections by looking at how fast they've been growing relative to historicals. We can also tell by looking at how collections have increased over the prior period. Anyhow, if there are any finance or accounting professionals that can add more color, please do. I've cut and pasted in the actual numbers I used (from their 6Ks)

Quarterly Actuals		9/30/2011	12/31/2011	3/31/2012	6/30/2012	9/30/2012	12/31/2012	3/31/2013	6/30/2013
AR		18	21	25	32	40	54	62	71
Sales		11	13	16	20	26	30	33	41
Collections			9	12	13	18	16	25	33
DSO			138	131	130	126	142	158	145
Quartlery Growth %
AR			19%	18%	29%	24%	36%	15%	13%
Sales			13%	25%	25%	29%	16%	11%	25%
Collections				29%	5%	42%	-14%	63%	31%

If you want to see what historical DSO's have been, refer to the 2q earnings mgmt. presentation, pg 23

http://ir.nq.com/phoenix.zhtml?c=243152&p=irol-EventDetails&EventId=4996529

[kshen]

Tradestar, Dr Gillis also pretty much dismisses the dso issue very casually.

http://www.chinaaccountingblog.com/weblo...obile.html

"Several experts interviewed by Bloomberg said the high days sales outstanding (DSO) was a red flag. High DSO usually is a red flag, but a fraud perpetrated in this way would be quite small compared to what Muddy Water’s alleges. Muddy Water’s says that over 90% of the business is fake, and you can’t cover that up by edging up DSO."

[tradestar2012]

Agreed. Thats why I've maintained from the beginning that once cash is confirmed, the rest is just noise. I put together the DSO analysis because there is still the off chance that its not "fraud" perse, but more of a restatement of earnings. Thats a real possibility given the lengthy DSOs. Now would a restatement justify a 60% haircut to share price? I dont know. It will depend on the magnitude of the restatement, if any. From what I can see, the historical DSO trends seem to be stabilizing and would not warrant a write down of any scale. We wont know for sure until 3q #'s come out.

[dietberd]

I just want to add one point on the DSO debate: high DSO are not at all problematic if the Company has a strong track record of minimal bad debt expense. That to me is really the key point here - NQ has had several billing cycles with its partners and the bad debt resulting from those was minimal, so therefore I do not see an issue with the DSO because an earnings restatement would only be required if ultimately your customers do not pay you, but there is multi-year evidence that this is not the case.

So even the concern on restatement is unwarranted, in my view.

[tradestar2012]

I just want to add one point on the DSO debate: high DSO are not at all problematic if the Company has a strong track record of minimal bad debt expense. That to me is really the key point here - NQ has had several billing cycles with its partners and the bad debt resulting from those was minimal, so therefore I do not see an issue with the DSO because an earnings restatement would only be required if ultimately your customers do not pay you, but there is multi-year evidence that this is not the case. So even the concern on restatement is unwarranted, in my view.

I think its still possible, although remote and likely small. Doubtful accounts rose by 973k last quarter (4x the historical avg) and the elongagted DSO's from 1q and 2q still need to work through the payment channels. ~150 day avg of DSO's means theres AR that could theoreticaly still be on the books in 3q, waiting to never be collected.

Again, I dont think its really that much, which was the point of this analysis. I just wanted to allay that fear that was being brought up by the short thesis. Theres more analysis that can be run, eg cash conversion cycle, but I think thats overkill.

[dietberd]

Agree - this is a concern, albeit a small one and should not be a overhang on the stock, in my opinion.