Recon Technology, Ltd. — Form 10-Q Summary
Period clarification: The filing covers the quarter ended March 31, 2012, and the nine months then ended (the company’s fiscal third quarter and year to date). It is not a 2011 third-quarter filing. Financial statements are unaudited and presented primarily in RMB.
Business context
Recon supplies oilfield equipment, automation and software, and technical services in China through its contractually controlled variable interest entities (VIEs), BHD and Nanjing Recon. Hardware remains the main revenue source. ENI was deconsolidated in December 2010 after the company lost the power to direct its activities, affecting year-over-year comparisons.
Key financial results
| Metric | Three months ended March 31, 2012 | Nine months ended March 31, 2012 |
|---|---|---|
| Revenue | RMB 13.02 million; up 48.6% | RMB 48.81 million; down 22.2% |
| Gross profit / margin | RMB 6.23 million / 47.88% (prior year: 16.44%) | RMB 17.83 million / 36.52% (prior year: 33.23%) |
| Operating income (loss) | RMB 0.10 million (prior-year loss: RMB 3.29 million) | Loss of RMB 1.04 million (prior-year loss: RMB 12.26 million) |
| Net income (loss) | RMB 0.26 million (prior-year loss: RMB 2.47 million) | Loss of RMB 1.56 million (prior-year loss: RMB 21.30 million) |
| Net income (loss) attributable to ordinary shareholders | RMB 0.12 million (prior-year loss: RMB 2.01 million) | Loss of RMB 1.89 million (prior-year loss: RMB 21.85 million) |
| Adjusted EBITDA, non-GAAP | RMB 0.99 million (prior-year loss: RMB 2.31 million) | RMB 0.32 million (prior-year loss: RMB 9.65 million) |
Quarterly revenue growth reflected increased automation sales, including business with Sinopec’s Southwest Branch, and horizontal-well-fracturing revenue. Quarterly gross margin improved mainly due to the higher margin of the newer fracturing business and the absence of costly delayed projects that affected the prior-year quarter. Year-to-date revenue fell largely because ENI was no longer consolidated; excluding the stated ENI deconsolidation effect, the filing’s table shows an RMB 4.74 million increase attributable to ongoing operations.
Cash flow, liquidity and debt
- Cash and cash equivalents were RMB 2.36 million at March 31, 2012, down from RMB 3.49 million at June 30, 2011.
- For the nine months, operating cash flow was negative RMB 9.24 million, investing cash flow was negative RMB 0.56 million, and financing cash flow was positive RMB 8.77 million. Management attributed operating cash use mainly to higher receivables and purchase advances; financing inflows included bank and related-party borrowing.
- Working capital was RMB 73.21 million; the current ratio declined to 2.68 from 3.75. Total current assets were RMB 116.92 million, including net trade receivables of RMB 63.75 million.
- At quarter-end, short-term bank loans were RMB 9.00 million, other short-term borrowings RMB 1.82 million, and related-party short-term borrowings RMB 5.11 million. The filing describes the bank loans and borrowings as short-term, although certain stated maturities extend into 2013.
- Total assets were RMB 131.32 million, total equity RMB 87.61 million, and current liabilities RMB 43.71 million.
Outlook, risks and unusual items
- Management intends to expand core business and focus on automation, SCADA and monitoring services, proprietary products, and horizontal-well-fracturing technology. It reported approximately RMB 10 million of revenue from proprietary oil/water separators and horizontal-well-fracturing technology during the nine-month period. No quantified company revenue or earnings guidance is provided.
- Customer concentration is significant: CNPC and Sinopec together represented 68.97% of quarterly revenue, according to management. The notes report 15.62% from CNPC and 53.35% from Sinopec for the quarter.
- Related-party balances and transactions merit attention. Related-party trade receivables were RMB 21.05 million net; the company also had RMB 5.11 million of related-party borrowings and RMB 1.91 million of related-party other receivables. A founder’s former 14% ownership in a customer was reduced to zero in November 2011.
- The company reported that disclosure controls were ineffective as of March 31, 2012, citing the nature of adjustments requiring restatement of two prior quarterly reports and the late filing of its fiscal 2011 annual report. Management described remediation steps, including improved review, testing, and documentation, but did not conclude that controls were effective.
- The company reported no legal proceedings and no material off-balance-sheet arrangements. It estimated RMB 1.01 million of potential employee severance payments but did not accrue them because payment was considered remote. Most PRC bank balances were uninsured. The holding-company structure and PRC restrictions may limit upstreaming cash to the parent.
- Year-to-date results benefited from the absence of the RMB 8.99 million prior-year ENI deconsolidation loss; comparisons also reflect ENI’s removal from consolidation. Government subsidy income was RMB 0.55 million for the nine months.
Important facts for investors to verify
- Whether receivables are collectible and whether the related-party and customer-concentration exposures have changed since quarter-end.
- Whether operating cash flow and cash conversion improve, given the rise in receivables and purchase advances and the low cash balance.
- Borrowing terms, maturities, refinancing needs, and the company’s dependence on related-party funding.
- Progress and testing results for the disclosure-control remediation plan, including any subsequent amendments or restatements.
- Sustainability of improved gross margins and traction in automation and fracturing services, separate from the effects of ENI’s deconsolidation.