Recon Technology, Ltd. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2011, compared with the three months ended September 30, 2010. This is the company’s fiscal first quarter of fiscal 2012; the filing was signed January 31, 2012. Financial statements are unaudited and presented primarily in RMB.
Business context
Recon supplies oilfield equipment, automation systems and related services in China through contractually controlled variable interest entities (VIEs), principally Beijing BHD and Nanjing Recon. The company is a holding company without independent operations. ENI ceased to be a VIE and was deconsolidated effective December 16, 2010.
Financial performance
| Metric | Three months ended Sep. 30, 2011 | Prior-year quarter |
|---|---|---|
| Revenue | RMB 4.94 million (US$772,062) | RMB 21.80 million |
| Gross profit / margin | RMB 2.48 million / 50.12% | RMB 7.72 million / 35.40% |
| Operating expenses | RMB 5.71 million | RMB 6.02 million |
| Operating income (loss) | RMB (3.23) million | RMB 1.69 million |
| Net income (loss) | RMB (3.41) million; loss per share RMB 0.86 | RMB 1.18 million |
| Adjusted EBITDA | RMB (2.80) million | RMB 2.64 million |
| Operating cash flow | RMB (1.36) million | RMB (19,313) |
| Investing cash flow | RMB (101,131) | RMB (6,639) |
All current-quarter revenue came from hardware; there was no software or service revenue. Revenue fell 77.33%, reflecting ENI’s deconsolidation and lower sales amid project delays and seasonality. Gross margin improved, which management attributed mainly to removing ENI’s lower-margin trading business from consolidation. G&A increased 15.50% to RMB 4.88 million, including higher R&D, audit and legal costs; lower revenue made expenses especially large relative to sales. No government subsidy income was recorded in the quarter, versus RMB 451,520 a year earlier.
Financial position and liquidity
At September 30, 2011, cash was RMB 2.03 million, total assets RMB 113.13 million, working capital RMB 70.74 million, and shareholders’ equity RMB 78.51 million. Current assets were RMB 99.02 million against current liabilities of RMB 28.27 million; the current ratio was 3.50, down from 3.75 at June 30, 2011. Cash declined RMB 1.45 million during the quarter.
Debt included a RMB 5.00 million bank loan and RMB 2.65 million in other short-term borrowings, including RMB 0.91 million from related parties. The bank loan was due December 22, 2011; other borrowing maturities extended from November 2011 to May 2012. Net accounts receivable were RMB 45.81 million, including RMB 22.13 million from related parties. The filing also reports a RMB 17.77 million loan receivable from former VIE ENI, with an agreed three-year repayment schedule and 4% annual interest; the first four quarterly payments were set at RMB 1.2 million each.
Outlook, risks and unusual items
- Management planned to expand oilfield SCADA, monitoring and service work, and stated that a new service business was expected to begin generating revenue in the quarter ending December 31, 2011. No quantified earnings or revenue guidance was provided.
- Management cited project delays, seasonality in customer procurement and the loss of ENI’s contribution. It expected selling costs to rise as it expanded into Sichuan and Qinghai and opened local offices.
- Customer concentration is significant. CNPC and Sinopec together accounted for a substantial share of revenue; the filing’s customer percentages are not clearly presented in the text and should be checked against the original exhibit.
- Related-party exposures include receivables, advances, sales and borrowings. The filing reports RMB 4.88 million of other receivables from related parties and RMB 1.21 million of related-party purchase advances.
- Management concluded disclosure controls were ineffective, following non-reliance on and restatement of quarterly reports for periods ended December 2010 and March 2011. Remediation was underway, including outside consultants and added accounting resources, with actions targeted for completion by June 2012.
- The filing estimates RMB 897,250 of potential employee severance payments but did not accrue the amount because payment was considered remote. It reports no legal proceedings and no material off-balance-sheet arrangements.
- The company operates through PRC VIE arrangements; the filing cautions that consolidated VIE assets are not available to satisfy claims against the parent’s general assets. Cash held at PRC banks was uninsured.
Most important facts for investors to verify
- Reconcile reported revenue and cost figures: the MD&A contains a revenue figure of RMB 4.924 million in one passage, while the financial statements report RMB 4.943 million.
- Confirm the original customer-concentration disclosures and current-period dependence on CNPC and Sinopec.
- Assess collectability and repayment progress for the ENI loan, related-party receivables, and other large receivable balances.
- Check whether the company repaid or refinanced the bank loan and other short-term borrowings after quarter-end.
- Monitor execution of the internal-control remediation plan and whether previously restated periods or the current filing require further correction.
- Compare subsequent results with management’s expected launch of new services and anticipated software and service revenue.