Recon Technology, Ltd. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2014 (the company’s fiscal first quarter of FY2015; unaudited). The filing was signed November 13, 2014. The company provides oilfield equipment, automation systems, software and services in China through variable interest entities (VIEs).
Financial performance
| Metric | Three months ended Sep. 30, 2014 | Prior-year comparable quarter |
|---|---|---|
| Revenue | RMB 4.30 million (US$0.70 million) | RMB 11.51 million |
| Gross profit and margin | RMB 0.62 million; 14.3% | RMB 5.29 million; 46.0% |
| Operating income (loss) | RMB (4.45) million | RMB 0.50 million |
| Net income (loss) | RMB (4.16) million (US$0.68 million loss) | RMB 0.21 million |
| Operating cash flow | RMB (9.97) million | RMB (7.96) million |
| Adjusted EBITDA, non-GAAP | RMB (2.27) million | RMB 1.48 million |
Revenue fell 62.6%, primarily because lower CNPC and SINOPEC exploration and production spending and delayed customer projects reduced hardware sales, especially furnaces and automation systems. Software revenue also declined. The mix shift and weaker sales reduced gross margin by 31.7 percentage points. General and administrative expense rose 35.1% to RMB 3.70 million, including higher consulting fees, salaries, share-based compensation and travel costs.
At September 30, cash and cash equivalents were RMB 6.03 million (US$0.98 million), down from RMB 18.09 million at June 30. Current assets were RMB 125.99 million, current liabilities RMB 44.77 million, and reported working capital RMB 81.2 million. Total assets were RMB 145.58 million and total equity RMB 100.81 million. Cash used in investing activities was RMB 0.10 million; financing activities used RMB 2.00 million, reflecting repayment of bank loans.
Debt included RMB 8.00 million of short-term bank loans and RMB 5.21 million of short-term related-party borrowings. The bank loans carried stated rates of 5.6% or 6.0%; the founder borrowing carried a 6.6% annual rate. Cash and liquidity figures should be considered alongside the quarter’s operating cash outflow and substantial receivables, advances and other receivables.
Material changes and items to note
- Revenue from hardware and software sold to non-related parties decreased 61.7%; there were no related-party sales in the quarter, compared with RMB 0.42 million in the prior-year quarter. Management attributed this partly to gaining certification to sell directly to oilfield customers.
- CNPC and SINOPEC accounted for 34.16% and 1.64% of quarterly revenue, respectively, compared with 37.53% and 46.65% in the prior-year quarter.
- Net receivables included RMB 38.45 million of third-party current trade receivables, RMB 7.93 million of related-party current trade receivables and RMB 13.59 million of long-term receivables from a related party. The filing says a repayment agreement schedules the long-term Yabei Nuoda balance over four years.
- Other current receivables included RMB 9.85 million in demand, non-interest-bearing loans to third parties and RMB 9.00 million in business advances to staff. Purchase advances totaled RMB 26.50 million to third parties and RMB 1.50 million to a related party; the related-party advance was repaid October 27, 2014 after the purchase was cancelled.
- The company recorded RMB 1.17 million of restricted shares issued for consulting services and RMB 0.60 million of share-based compensation. It also reported a RMB 0.27 million gain from the change in fair value of warrant liabilities.
Outlook, risks and contingencies
Management expected delayed project completions to recover and revenue to continue increasing during the fiscal year ending June 30, 2015. It planned to pursue new and existing CNPC and SINOPEC work, and identified SCADA, furnaces and burners, fracturing services, down-hole tools and overseas projects as areas for development. These are expectations, not guaranteed results.
Key risks include reduced customer capital spending, project delays and acceptance timing, customer concentration, competitive pricing, collection of receivables and advances, and reliance on the PRC VIE structure. The Cayman Islands holding company has no operations of its own; its access to operating cash depends on distributions from domestic entities, subject to PRC legal and statutory-reserve restrictions. The filing also notes that most PRC bank balances are uninsured.
Management concluded that disclosure controls and procedures were ineffective as of September 30, 2014. No material change in internal control over financial reporting was reported during the quarter. The company disclosed estimated employee severance obligations of approximately RMB 1.4 million but did not accrue them because management considered payment remote. No legal proceedings were reported.
Subsequent event: On October 18, 2014, the company received a RMB 6.00 million loan from a founder, due October 20, 2015, at a floating annual rate of 120% of the benchmark rate.
Important facts for investors to verify
- Whether customer spending and delayed project completion recover as management expected, and whether this translates into accepted projects and revenue.
- Receivable aging, collection history and repayment performance for significant related-party balances, third-party loans, staff advances and supplier prepayments.
- The causes of ineffective disclosure controls, remediation plans and whether controls have since improved.
- Cash needs and access to operating-company funds, given operating cash use, debt maturities and the additional founder loan.
- The terms, collectability and governance of related-party transactions, and the enforceability and practical risks of the VIE arrangements.
- The impact of customer concentration and further CNPC or SINOPEC spending reductions on revenue and gross margins.