Recon Technology, Ltd. — Form 10-Q Summary
Reporting period: Fiscal second quarter ended December 31, 2015, and the six months then ended. The financial statements are unaudited and consolidate the company and its PRC variable interest entities (VIEs). Amounts below are in RMB unless otherwise noted; USD equivalents are included where useful.
Business context
Recon supplies oilfield equipment, automation systems, software, downhole tools and services to the Chinese oil and gas industry through Nanjing Recon and BHD, which it controls contractually as VIEs. Revenue is primarily from hardware sales.
Financial results and liquidity
| Metric | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2015 |
|---|---|---|
| Revenue | RMB 28.8 million; up 35.2% year over year | RMB 32.4 million; up 26.5% |
| Gross profit / margin | RMB 5.8 million / 20.0% | RMB 6.2 million / 19.0% |
| Operating income (loss) | RMB (3.3) million | RMB (12.0) million |
| Net income (loss) | RMB (2.5) million | RMB (11.4) million |
| Net income (loss) attributable to Recon | RMB (2.5) million | RMB (11.4) million |
| Adjusted EBITDA | Not provided for the quarter | RMB (8.1) million, versus RMB 1.2 million income a year earlier |
Six-month diluted loss per share was RMB 2.07 (USD 0.32); quarterly diluted loss per share was RMB 0.45 (USD 0.07). Hardware and software revenue to non-related parties rose, but software sales fell to zero in the reported periods. Management attributed lower gross margins mainly to the greater hardware mix, which has lower margins than software, and higher cost of goods sold. Six-month operating expenses rose 55.5% to RMB 18.1 million, including higher R&D spending on downhole tools and higher G&A costs, including bad-debt allowances and share-based compensation.
At December 31, cash was RMB 3.1 million (USD 0.5 million), down from RMB 12.3 million at June 30, 2015. Working capital was RMB 68.6 million, total assets RMB 123.5 million, and shareholders’ equity RMB 67.8 million. Net accounts receivable from third parties was RMB 67.0 million. Current liabilities were RMB 47.5 million.
For the six months, operating cash flow was positive RMB 1.0 million, compared with negative RMB 15.4 million a year earlier; the company cited changes in accounts payable and inventory. Investing cash outflow was RMB 0.5 million and financing cash outflow was RMB 9.9 million. Financing included RMB 15.5 million of repayments to related parties, RMB 0.5 million of bank-loan repayments and RMB 6.0 million of new related-party borrowing.
Debt at December 31 included RMB 6.5 million of short-term bank loans, at a floating 6.12% rate and due June 19, 2016, and RMB 7.2 million of short-term related-party borrowings. The filing says management believes current operations can meet daily working-capital needs, but the company may seek public or private capital for development and acquisitions.
Changes, outlook and notable items
- Revenue growth was driven mainly by hardware and automation-product sales. The company reported no software revenue in the three- or six-month periods, versus software revenue in the comparable prior periods; related-party hardware and software revenue also fell to zero as the company pursued direct oilfield customers.
- The prior-year six-month results included a RMB 4.1 million gain from changes in warrant fair value; no such gain was recorded in the current period. The company attributed much of the year-over-year deterioration in net results to this difference, lower gross profit and increased operating expenses.
- Management’s stated priorities include oilfield automation and SCADA, gathering and transfer equipment, fracturing services, wastewater treatment and expansion into downhole services. It anticipated demand opportunities but gave no quantified financial guidance. It cited lower oil prices and potentially reduced customer capital spending as industry concerns.
- On December 1, 2015, the company agreed to acquire 100% of Qinghai Hua You Downhole Technologies (QHHY), subject to shareholder approval. The related control agreements were not effective until approval was obtained.
- An at-the-market offering arrangement allowed up to USD 10 million in shares and was extended through February 29, 2016; no shares had been issued under the amended arrangement as of February 16, 2016.
- Disclosure controls and procedures were deemed ineffective at December 31, 2015. Management described planned remediation, including stronger review, monitoring and documentation procedures.
- Customer concentration was significant: CNPC accounted for 74.63% of six-month revenue and SINOPEC 11.54%. Two suppliers accounted for 57% of purchases. The company also disclosed that most PRC bank balances were uninsured.
- The filing estimated RMB 1.6 million of potential employee severance payments that were not recorded because the timing and amount of any payment were uncertain. It reported no legal proceedings and no material off-balance-sheet arrangements.
Key facts for investors to verify
- Whether QHHY acquisition approval was obtained, and the transaction’s eventual funding, terms and results.
- Collection timing and credit quality of the RMB 67.0 million third-party receivables, including the effect of the increased doubtful-account provision.
- Whether low gross margins persist if hardware continues to dominate revenue and software sales remain absent.
- Cash needs, repayment or refinancing of bank and related-party borrowings, and any use of the proposed ATM offering.
- Progress on remediating ineffective disclosure controls and procedures.
- Exposure to concentrated customers and suppliers, uninsured PRC bank deposits, VIE contractual-control risks and the unrecorded severance estimate.