Recon Technology, Ltd. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2012, the first quarter of fiscal 2013; filed November 14, 2012. The financial statements are unaudited and presented primarily in RMB. The filing describes a Cayman Islands holding company whose oilfield equipment, automation and service operations are conducted through Chinese subsidiaries and contractually controlled variable interest entities (VIEs).
Financial performance
| Metric | Three months ended September 30, 2012 | Comparable 2011 period |
|---|---|---|
| Revenue | RMB 9.05 million | RMB 4.94 million |
| Gross profit / margin | RMB 2.45 million / 27.01% | RMB 2.48 million / 50.12% |
| Operating loss | RMB 2.34 million | RMB 3.23 million |
| Net loss | RMB 2.34 million | RMB 3.41 million |
| Net loss attributable to ordinary shareholders | RMB 2.34 million | RMB 3.41 million |
| Adjusted EBITDA loss | RMB 1.45 million | RMB 2.80 million |
| Operating cash flow | RMB 0.24 million provided | RMB 1.36 million used |
Hardware revenue rose 134.82%; the company attributed about RMB 3.75 million of the year-over-year revenue increase to furnace and accessory sales. Service revenue was RMB 83,177, primarily maintenance; no fracturing-service revenue was recognized in the quarter. Cost of revenue rose 168.06%, outpacing sales, and gross margin fell 23.11 percentage points, mainly because furnaces sold in the period had lower margins and costs included subsequent expenses on prior projects. Selling and distribution expense increased 52.35%, while general and administrative expense declined 27.89%, partly reflecting lower research and development expense. Interest expense increased to RMB 329,756 from RMB 142,911.
Liquidity, debt and balance sheet
- At September 30, cash and cash equivalents were RMB 2.25 million; current assets were RMB 136.36 million and current liabilities RMB 59.70 million. Reported working capital was RMB 76.66 million.
- Total assets were RMB 147.07 million, total liabilities RMB 62.71 million and total equity RMB 84.37 million.
- Debt included RMB 23.00 million of short-term bank loans, RMB 1.82 million of short-term non-related borrowings, RMB 0.92 million of short-term related-party borrowings and RMB 3.01 million of long-term related-party borrowings. The company reported RMB 0.38 million net cash used in investing activities and RMB 1.14 million net cash used in financing activities.
- Trade receivables, net, totaled RMB 77.33 million, including RMB 19.86 million from related parties. Management expected substantial collections by December 2012 and during the first two months of 2013 and believed working capital would meet operating needs for the next 12 months.
Changes, outlook and risks
- Revenue increased 83.19%, but gross profit was slightly lower than a year earlier as margins compressed. Net loss and adjusted EBITDA loss improved, while operating cash flow turned positive.
- Management expected opportunities in SCADA and automation, furnaces and burners, fracturing and stimulation services, and down-hole tools. It cited anticipated demand in Chinese oilfields and potential overseas projects, but provided no quantified revenue or earnings guidance. Fracturing contracts with Sinopec Zhongyuan had an aggregate stated value of RMB 30 million; approximately half had been completed and recognized by June 30, 2012.
- Customer concentration was significant: CNPC accounted for 56.89% of quarterly revenue and Sinopec for 13.23%. One supplier represented 30.54% of purchases.
- Management concluded disclosure controls were ineffective, citing adjustments associated with restatements of two earlier quarterly reports and a late 2011 Form 10-K. It described remediation steps, including stronger review and documentation procedures.
- The company estimated RMB 1.12 million of potential employee severance payments that were not recorded in the financial statements. It reported no legal proceedings and no material off-balance-sheet arrangements. The filing warns that VIE assets and liabilities are tied to those entities, and that the holding company depends on distributions from its Chinese operating entities, subject to PRC restrictions.
- Other uncertainties include collection of large receivables, customer spending and procurement timing, pricing competition, costs of specialized or imported components, and execution of planned business expansion. The interim results may not indicate full-year results.
Important facts for investors to verify
- Whether the company collected the receivables management expected to collect by December 2012 and early 2013, including related-party balances.
- Whether furnace sales can sustain growth and whether gross margins recover from the quarter’s 27.01% level.
- Progress, remaining contract value and revenue recognition for the Sinopec Zhongyuan fracturing contracts and other anticipated service work.
- Debt repayment or renewal terms, particularly short-term loans and related-party borrowings, and the effect of higher interest expense on liquidity.
- Whether disclosure-control remediation was effective and whether any further restatements or reporting delays occurred.
- Final approval of BHD’s high-technology tax certificate extension, which was pending in the filing, and treatment of the unrecorded severance estimate.