Recon Technology, Ltd. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2015, compared with the three months ended September 30, 2014. This is the company’s fiscal first quarter of FY2016; the filing itself identifies the September 30 quarter, rather than a calendar-year 2015 Q1. Financial statements are unaudited and presented mainly in RMB; USD figures are approximate translations.
Business context
Recon provides oilfield equipment, automation systems, software, tools and services to oil and gas companies in China. Operations are conducted through PRC entities consolidated as variable interest entities (VIEs), including Nanjing Recon and BHD. The company said lower oil prices and reduced customer capital spending had depressed business activity.
Key financial results
| Metric | Quarter ended Sep. 30, 2015 | Comparable 2014 quarter | Change |
|---|---|---|---|
| Revenue | RMB 3.59 million (about $0.57 million) | RMB 4.30 million | Down 16.5% |
| Gross profit / margin | RMB 0.40 million / 11.2% | RMB 0.62 million / 14.3% | Gross profit down 34.7%; margin down 3.1 percentage points |
| Operating expenses | RMB 9.08 million | RMB 5.06 million | Up 79.5% |
| Operating loss | RMB 8.68 million | RMB 4.45 million | Loss increased |
| Net loss attributable to Recon | RMB 8.85 million (about $1.39 million); RMB 1.63 loss per share | RMB 4.16 million; RMB 0.87 loss per share | Loss increased 112.6% |
| Adjusted EBITDA loss | RMB 7.00 million (about $1.10 million) | RMB 2.27 million | Loss increased by RMB 4.73 million |
Hardware revenue rose 15.3% to RMB 3.48 million, but software revenue fell from RMB 1.23 million to zero; service revenue increased to RMB 0.11 million. Management attributed lower gross profit and margin mainly to the loss of higher-margin software sales and increased costs on certain contracts. Selling, general and administrative, and R&D expenses all rose; G&A growth was attributed mainly to higher doubtful-account provisions and share-based compensation, while R&D growth reflected downhole-tool development.
Cash, liquidity and debt
- Cash and cash equivalents were RMB 3.88 million (about $0.61 million) at September 30, down from RMB 12.34 million at June 30, 2015.
- Working capital was RMB 66.5 million, versus RMB 72.4 million at June 30. Current assets were RMB 109.4 million and current liabilities RMB 42.9 million.
- Net cash used in operations was RMB 0.97 million, compared with RMB 9.97 million in the prior-year quarter. Investing activities used RMB 0.47 million; financing activities used RMB 7.13 million, including RMB 9.10 million repaid to related parties and RMB 1.80 million borrowed from a related party.
- Debt included RMB 7.0 million of short-term bank loans, bearing a 6.0% floating rate and due June 2016, and RMB 9.41 million of short-term related-party borrowings at quarter-end. Certain related-party borrowings were repaid after quarter-end; the company also reported a subsequent RMB 2.4 million short-term borrowing.
- Trade receivables, net, were RMB 51.5 million (about $8.1 million). Management said customer payments were more timely, but the quarter included a RMB 2.11 million doubtful-account provision. A customer repayment agreement moved a RMB 3.41 million net receivable to long-term collection, with installments beginning in 2017.
Changes, outlook and risks
- Revenue declined and net losses more than doubled year over year. The filing links the deterioration to weak oilfield conditions, lower software sales, rising operating expenses and doubtful-account allowances.
- Management planned to pursue oilfield measurement and SCADA, gathering and transfer equipment, fracturing services and downhole tools. It expected to generate revenue from the downhole-tools business in the coming year, but provided no quantified guidance.
- Management stated current operations could meet daily working-capital needs, while also noting possible public or private capital raising. An amended Maxim Group agreement authorized an at-the-market offering of up to $10 million through February 29, 2016; 313,071 shares had been issued under the agreement by November 13, 2015.
- Customer concentration was significant: CNPC represented 57.58% and SINOPEC 23.63% of quarterly revenue, compared with 46.65% and 1.64%, respectively, in the prior-year quarter. Four suppliers represented 60% of purchases in the 2015 quarter.
- Disclosure controls and procedures were deemed ineffective in timely alerting management to information required in SEC filings. Management described remediation steps; it reported no other material change in internal control over financial reporting during the quarter.
- The company’s PRC operations rely on VIE contractual arrangements. Its holding-company ability to fund itself or pay dividends depends on distributions from PRC entities and is subject to PRC legal restrictions. The filing also notes that most PRC bank balances are uninsured.
- An estimated RMB 1.6 million of potential employee severance payments was not recorded because the actual amount, if any, could not be predicted. BHD had agreed to invest RMB 80 million for a 54.05% interest in HHBHD, but no payment had been made by November 13, 2015, and BHD had no voting rights until payment.
- The board approved an incentive plan on October 18, 2015 to grant 800,000 restricted shares to management. The filing reports no legal proceedings.
Important facts for investors to verify
- Whether the large receivable balances and advances to suppliers are collectible, including the long-term customer repayment schedule and adequacy of doubtful-account reserves.
- Whether low cash, ongoing losses and related-party borrowing create additional financing needs, and the timing and terms of any ATM share issuance.
- Whether the reported downhole-tool and other growth initiatives produce revenue sufficient to offset weak oilfield spending and lost software sales.
- Progress and effectiveness of remediation for ineffective disclosure controls.
- Status, funding and contractual terms of the proposed RMB 80 million HHBHD investment, and the potential dilution and compensation cost of the management share grant.