Recon Technology, Ltd. — Form 10-Q Summary
Reporting period: Quarter ended March 31, 2015, the third quarter of the company’s fiscal year ending June 30, 2015. The filing also reports results for the nine months ended March 31, 2015. Financial statements are unaudited and amounts below are in RMB unless noted.
Business context
Recon supplies equipment, automation and software systems, tools, and services to China’s upstream oil and gas industry through its VIEs, Nanjing Recon and BHD. The company attributes weaker project activity to lower oil prices and reduced customer capital spending. Its financial statements consolidate the VIEs, which operate under contractual arrangements rather than direct ownership.
Financial performance
| Metric | Three months ended Mar. 31, 2015 | Nine months ended Mar. 31, 2015 |
|---|---|---|
| Revenue | RMB 20.0 million, up 9.8% year over year | RMB 45.7 million, down 39.9% |
| Gross profit and margin | RMB 6.25 million; 31.2% (28.8% prior year) | RMB 15.84 million; 34.7% (35.6% prior year) |
| Operating income (loss) | RMB 0.40 million, versus a RMB 0.57 million loss | RMB 1.65 million loss, versus RMB 7.83 million income |
| Net income (loss) | RMB 1.42 million loss; attributable to Recon, RMB 1.53 million loss | RMB 0.18 million income; attributable to Recon, RMB 0.36 million loss |
| Adjusted EBITDA | Not clearly provided for the quarter | RMB 2.92 million, down 75.1% |
Quarterly revenue growth came mainly from related-party hardware and software sales; non-related-party hardware revenue slipped slightly and service revenue was zero. For the nine-month period, lower furnace and automation-system sales drove the revenue decline. Nine-month operating results also reflected higher general and administrative expense, including consulting, salaries, and share-based compensation.
Cash flow and liquidity: Nine-month operating cash use was RMB 16.22 million, primarily reflecting working-capital needs, including receivables, inventory, and other receivables. Investing cash use was RMB 0.16 million; financing provided RMB 3.00 million. Cash fell from RMB 18.09 million at June 30, 2014 to RMB 4.67 million at March 31, 2015. Working capital was RMB 90.0 million; current assets were RMB 141.8 million and current liabilities RMB 51.7 million.
Debt: At March 31, 2015, short-term bank loans were RMB 8.0 million and short-term related-party borrowings were RMB 10.22 million. Related-party loans included founder borrowings bearing 6.0%–7.0% annual interest. The company also disclosed RMB 3.73 million of current other payables to related parties, including a non-interest-bearing, due-on-demand advance.
Material changes and unusual items
- Nine-month revenue fell sharply, while quarterly revenue increased year over year. Nine-month gross margin declined modestly; the quarter’s margin improved, partly due to higher-margin system-upgrade work.
- Warrant accounting materially affected reported results: the nine-month statements include a RMB 4.07 million gain from changes in warrant fair value and a RMB 1.91 million warrant-redemption loss. In February 2015, 163,950 warrants were exchanged for 204,938 ordinary shares.
- On January 29, 2015, shareholders approved increasing authorized ordinary shares from 25 million to 100 million. The company had 5,022,436 shares issued and outstanding as of May 11, 2015. It granted 400,000 options in January and issued restricted shares to executives and service providers.
- Subsequent to quarter-end, the company disclosed a $10 million at-the-market equity program, a RMB 1.0 million related-party loan, and a further warrant exchange completed May 13, 2015.
- Cash and cash equivalents were primarily held in PRC bank accounts, which the filing says are uninsured. A RMB 14.55 million long-term receivable is due from Beijing Yabei Nuoda under an agreement calling for four annual installments beginning in 2016. Other receivables include RMB 14.14 million of non-interest-bearing loans to third parties, due on demand.
Outlook, risks, and controls
Management expected project volumes and revenue to recover during the balance of fiscal 2015, but provided no quantified guidance. It cited progress in self-developed down-hole equipment and overseas business development, and identified SCADA/automation, gathering and transferring equipment, fracturing services, and down-hole tools as areas of focus. These expectations are exposed to oil prices, customer spending and procurement timing, competition, and project execution.
Management concluded that disclosure controls and procedures were ineffective in timely alerting it to information required in SEC filings. It described remediation efforts, including stronger review and documentation practices and adoption of the 2013 COSO framework. The filing reports no legal proceedings and says risk factors were not applicable; it estimates RMB 1.6 million of potential employee severance payments but considers payment remote and did not accrue the amount.
Important facts for investors to verify
- Whether the stated project recovery occurred, given the steep nine-month revenue decline and operating cash outflow.
- Collectability and timing of receivables, particularly the long-term Yabei Nuoda balance, third-party loans due on demand, and rising trade receivables.
- Liquidity and refinancing needs in light of reduced cash, related-party borrowing, and the near-term maturity of bank and related-party loans.
- The effect of warrant valuation and exchanges, equity awards, and the $10 million ATM program on earnings comparability and potential dilution.
- The status and effectiveness of remediation for ineffective disclosure controls, and the company’s dependence on VIE contractual arrangements.
- Reported values against the underlying statements: the filing’s MD&A contains apparent numerical or wording inconsistencies, including its quarterly gross-profit narrative. The financial tables report quarterly gross profit of RMB 6.25 million.