Recon Technology, Ltd. — Form 10-Q Summary
Reporting period: Fiscal quarter and nine months ended March 31, 2016; filed May 16, 2016. The filing is for fiscal 2016 Q3, notwithstanding the request metadata’s “2015 Q3.” Amounts are in RMB unless stated otherwise; USD equivalents are included where useful.
Business context
Recon supplies oilfield hardware, automation and software, and technical services in China through operating entities consolidated as variable interest entities (VIEs). Its customers include major state-owned oil companies. The company attributed weak activity to low oil prices and reduced customer capital spending.
Financial performance
| Metric | Three months ended Mar. 31, 2016 | Nine months ended Mar. 31, 2016 |
|---|---|---|
| Revenue | RMB 4.54m ($0.70m), down 77.3% year over year | RMB 36.98m ($5.73m), down 19.0% |
| Gross profit / margin | RMB 1.70m; 37.5%, versus 31.2% | RMB 7.86m; 21.3%, versus 34.7% |
| Operating income (loss) | Loss of RMB 8.25m, versus income of RMB 0.40m | Loss of RMB 20.20m, versus loss of RMB 1.65m |
| Net income (loss) | Loss of RMB 9.63m ($1.49m), versus loss of RMB 1.42m | Loss of RMB 21.00m ($3.26m), versus income of RMB 0.18m |
| Operating cash flow | The filing does not provide a clear quarter-only value | Used RMB 1.29m ($0.20m), versus RMB 16.22m used |
- Quarterly revenue weakness was mainly from hardware; there were no software sales in the quarter. Nine-month hardware and software revenue declined, while service revenue rose to RMB 1.10m from RMB 0.10m.
- Quarterly gross margin improved partly because previously deferred income was recognized with little associated cost and because there were no lower-margin consignment sales. Nine-month margin fell as higher-margin software sales disappeared and competition pressured bundled project margins.
- Operating expenses rose 70.2% to RMB 9.95m for the quarter and 60.4% to RMB 28.07m for nine months. Nine-month general and administrative expense was RMB 18.87m and R&D expense RMB 5.76m.
- Adjusted EBITDA, a non-GAAP measure, was a loss of RMB 13.02m for nine months, compared with income of RMB 2.92m in the prior period.
Liquidity, debt and capital resources
- At March 31, cash was RMB 2.62m ($0.41m), down from RMB 12.34m at June 30, 2015. Working capital was RMB 64.29m, compared with RMB 72.43m.
- Total assets were RMB 102.42m; current assets RMB 98.81m; current liabilities RMB 34.51m; and shareholders’ equity RMB 59.67m.
- Short-term debt totaled RMB 15.56m: RMB 7.00m of bank loans and RMB 8.56m of related-party borrowings. Nine-month financing cash flow was negative RMB 8.05m, including repayment of RMB 16.75m in related-party borrowings and new related-party borrowing of RMB 8.53m.
- Net accounts receivable from third parties was RMB 50.25m. The company cited collection of receivables as a management priority. It also reported RMB 10.43m in net purchase advances and RMB 22.36m in other receivables.
- The company said current operations could meet daily working-capital needs, while noting it may seek public or private capital for growth or acquisitions. It is a holding company dependent on distributions from PRC operating entities; PRC rules limit distributions to accumulated profits and require statutory reserves.
Material changes, outlook and risks
- Management said low oil prices had led CNPC and Sinopec to reduce capital spending and production activity. It expected reduced revenue to continue for some time, although a partial oil-price rebound might ease the trend. No numerical guidance was provided.
- For the quarter, CNPC represented 71.17% of revenue; for the nine months, CNPC represented 74.21% and Sinopec 10.19%, indicating substantial customer concentration.
- Nine-month general and administrative expense included increased share-based compensation and provisions for doubtful purchase advances. The company recorded RMB 3.84m of purchase-advance provisions and RMB 4.33m of doubtful-account provisions during the nine months.
- Management reduced deferred tax assets to zero, recording a RMB 1.74m deferred tax provision in the nine-month period, based on its view that sufficient future taxable income was not more likely than not.
- Recon had agreed to acquire 100% of Qinghai Huayou Downhole Technologies; completion remained subject to shareholder approval and SEC review of the proxy statement. Its amended at-the-market offering authorization allowed up to $10m through August 15, 2016; no shares had been issued under it as of May 16, 2016.
- Disclosure controls and procedures were deemed ineffective in timely alerting senior officers to information required in SEC filings. Management described planned remediation, including stronger review, monitoring and documentation.
- The company estimated RMB 1.6m ($0.25m) in potential employee severance payments that were not recorded because the timing and amount were uncertain. It reported no legal proceedings and no other material contingent liabilities, apart from the matters disclosed.
Important facts for investors to verify
- Whether the sharp revenue decline and customer concentration persist, and whether CNPC/Sinopec spending recovers.
- Collection and recoverability of receivables, purchase advances and other receivables, including the basis for recorded allowances.
- Cash runway, related-party borrowing terms and refinancing needs as debt maturities approach.
- Progress and final approval of the Qinghai Huayou acquisition, and any funding or dilution associated with it or the ATM program.
- Remediation of ineffective disclosure controls and the continuing effect of share-based compensation and tax-asset reductions on reported results.