Business context and reporting period
Recon Technology, Ltd. filed this Form 20-F for the fiscal year ended June 30, 2018—not for 2017 Q4. The Cayman Islands holding company provides oilfield equipment, automation systems, software and field services mainly in China through contractual arrangements with its PRC variable interest entities (VIEs), BHD and Nanjing Recon. Financial statements are prepared under U.S. GAAP; amounts below are RMB unless stated otherwise.
Key financial metrics
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | RMB 84.7 million ($12.8 million) | RMB 60.1 million |
| Gross profit / margin | RMB 4.2 million / 4.9% | RMB 16.0 million / 26.6% |
| Operating loss | RMB 40.9 million | RMB 30.6 million |
| Net loss | RMB 45.4 million | RMB 31.2 million |
| Net loss attributable to Recon | RMB 44.1 million | RMB 31.4 million |
| Net cash from (used in) operations | RMB (21.1) million | RMB 5.7 million |
| Cash and cash equivalents at year-end | RMB 45.3 million | RMB 3.8 million |
| Current assets / current liabilities | RMB 100.8 million / RMB 26.0 million | RMB 68.4 million / RMB 29.4 million |
| Total assets / total liabilities | RMB 121.8 million / RMB 34.9 million | RMB 71.2 million / RMB 29.4 million |
Year-end working capital was RMB 74.8 million. Debt included RMB 9.0 million of short-term related-party borrowings and a RMB 9.7 million long-term related-party loan (RMB 0.7 million current portion). FY2018 financing cash flow was RMB 76.9 million, including RMB 65.0 million in net ordinary-share proceeds; investing cash outflow was RMB 16.0 million.
Material changes versus prior year
- Revenue rose 41.1%, driven mainly by equipment and accessories, up 139.9% to RMB 64.0 million. Automation revenue fell 15.2% to RMB 19.0 million; environmental-protection revenue fell 84.0% to RMB 1.8 million.
- Cost of revenue increased 82.7% to RMB 80.6 million. Gross margin fell sharply to 4.9%, which management attributed to low-margin new-business contracts, particularly equipment sales and work for Shenhua Group.
- Operating loss widened by RMB 10.3 million. Net loss attributable to Recon increased by RMB 12.6 million, also reflecting RMB 4.0 million of impairment on the FGS investment.
- Operating cash flow shifted from RMB 5.7 million provided to RMB 21.1 million used. Cash nevertheless increased, supported by equity issuance and borrowing.
- Receivables and notes receivable declined overall, while inventory, other receivables and purchase advances increased. The company also began construction of an oily-sludge processing facility.
Outlook, risks and unusual items
- Management said lower margins and higher expenses from entering new markets were temporary and expected improvement in the coming year. It reported about RMB 20 million in Shenhua orders and RMB 16 million in contracts related to polycrystalline-silicon production; it also cited RMB 14.3 million of automation contracts on hand for Shenhua and RMB 4.49 million for Changqing projects, expected to be completed and accepted by the end of calendar 2018.
- Management expected the Gan Su oily-sludge projects to become operational by the end of calendar 2018 and generate annual revenue above RMB 50 million at full capacity. The project was estimated to require a further RMB 6.93 million, with completion then expected in February 2019. These are projections, not reported results.
- Customer concentration is significant: CNPC represented about 45% of FY2018 revenue and a new chemical-plant client about 43%. CNPC agreements may be terminated without notice. Two suppliers represented 58% of purchases.
- The company reported recurring net losses for FY2016–FY2018 and depends on related-party financing and equity funding. It does not expect to pay dividends in the foreseeable future.
- Management concluded disclosure controls and internal control over financial reporting were ineffective at June 30, 2018, citing insufficient U.S. GAAP/SEC-reporting expertise, an incomplete internal-audit function, and inadequate time and monitoring to evidence control effectiveness. Management described remediation plans; the auditor did not attest to internal controls.
- Other significant risks include reliance on contractual VIE arrangements and uncertainty over their enforceability in China; PRC foreign-exchange and dividend restrictions; lack of business-interruption and product-liability insurance; and dependence on a limited number of key personnel.
- After year-end, the company agreed to increase its FGS interest from 8% to 43% through cash payments totaling RMB 10 million and issuance of 2,435,284 restricted shares, subject to performance-related cancellation terms. It also approved 1,956,000 additional restricted stock units.
Important facts for investors to verify
- Whether reported margins recover and whether new contracts and the Gan Su facility achieve the stated completion, acceptance and revenue expectations.
- Collection timing and recoverability of receivables, supplier advances and other receivables; FY2018 included RMB 4.2 million of long-term receivables and RMB 12.7 million of net purchase advances.
- Current customer concentration, especially the continuation and payment terms of CNPC work and the contribution of the large new chemical-plant customer.
- Related-party loan terms, the company’s reliance on insider financing, and the effect of share issuance and restricted awards on dilution.
- Progress in remediating ineffective disclosure controls and material weaknesses in internal control over financial reporting.
- VIE contractual enforceability, PRC regulatory exposure, and the ability to move funds from operating entities to the offshore parent.