FORM 10-K

x	Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the fiscal year ended June 30, 2013
¨	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from            to            .

RECON TECHNOLOGY, LTD

(Exact name of registrant as specified in its charter)

Ordinary Shares, $0.0185 par value per share		NASDAQ Capital Market
Title of each class		Name of each exchange on which registered

PART I		3
Item 1.	Business.	3
Item 1A.	Risk Factors.	15
Item 1B.	Unresolved Staff Comments.	15
Item 2.	Properties.	15
Item 3.	Legal Proceedings.	16
Item 4.	Mine Safety Disclosures.	16
PART II		17
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	17
Item 6.	Selected Financial Data.	18
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation.	18
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk.	28
Item 8.	Financial Statements and Supplementary Data.	28
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	28
Item 9A.	Controls and Procedures.	28
Item 9B.	Other Information.	30
PART III		31
Item 10.	Directors, Executive Officers and Corporate Governance.	31
Item 11.	Executive Compensation.	35
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.	36
Item 13.	Certain Relationships and Related Transactions, and Director Independence.	37
Item 14.	Principal Accountant Fees and Services.	39
Item 15.	Exhibits, Financial Statement Schedules.	40

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projections of revenue, earnings, capital structure and other financial items;

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statements of our plans and objectives;

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statements regarding the capabilities and capacities of our business operations;

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statements of expected future economic performance; and

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assumptions underlying statements regarding us or our business.

Item 1.

Business.

  

 

We are a provider of hardware, software, and on-site services to companies in the petroleum mining and extraction industry in China (“PRC”). We provide services designed to automate and enhance the extraction of petroleum. To date, we control by contract the PRC companies of Beijing BHD Petroleum Technology Co., Ltd. (“BHD”) and Nanjing Recon Technology Co., Ltd. (“Nanjing Recon”). We refer to BHD and Nanjing Recon collectively as the “Domestic Companies” in this report.

 

We are the center of strategic management, financial control and human resources allocation for the Domestic Companies. Through our contractual relationships with the Domestic Companies, we provide equipment, tools and other hardware related to oilfield production and management, and develop and sell our own specialized industrial automation control and information solutions. However, we do not engage in the production of petroleum or petroleum products.

 

We believe that one of the most important advancements in China’s petroleum industry has been the automation of significant segments of the exploration and extraction process. The Domestic Companies’ and our automation products and services allow petroleum mining and extraction companies to reduce their labor requirements and improve the productivity of oilfields. The Domestic Companies’ and our solutions allow our customers to locate productive oilfields more easily and accurately, improve control over the extraction process, increase oil yield efficiency in tertiary stage oil recovery, and improve the transportation of crude oil.

 

For the most recent few years, our capacity to provide integrated services has been a significant factor for long-term development. We treat simulation measures around fracturing as our entry point for our integrated service model. To date, we have formed new business modules through our own R&D, investment in service-team building and developed an integrated services solution for stimulation.

 

On June 27, 2013, we acquired a 32.22% equity interest in Avalon Oil and Gas Inc. (“Avalon”), a U.S. oil and natural gas company for approximately ¥1.5 million ($250,000). This strategic investment marks an important step in expanding our business in the U.S. market.

 

China is the world’s second-largest consumer of petroleum products, third-largest importer of petroleum and sixth-largest producer of petroleum. In the last twenty years, China’s demand for oil has more than tripled, while its production of oil has only modestly increased. China became a net importer of petroleum in 1983, and, as a result, oil production in China has been aimed at meeting domestic requirements. The oil industry in China is dominated by three state-owned holding companies: China National Petroleum Corporation (CNPC), China Petroleum and Chemical Corporation (Sinopec) and China National Offshore Oil Corporation (CNOOC). Foreign companies have also recently become involved in China’s petroleum industry; however, according to Chinese law, China’s national oil companies may take a majority (or minority) stake in any commercial discovery. As a result, the number of major foreign companies involved in the industry is relatively limited: and includes the following companies Agip, Apache, BP, ChevronTexaco, ConocoPhillips, Eni, ExxonMobil, Husky Energy, Kerr-McGee, Mitsubishi, Royal Dutch Shell, Saudi Aramco, and Total.

 

 

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In the past, China’s petroleum companies mined for petroleum by leveraging its abundance of inexpensive labor, rather than focusing on new technologies. For example, a typical, traditional oilfield with an annual capacity of 1,000,000 tons would require between 10,000 and 20,000 laborers. By contrast, when Baker CAC products were employed to explore and automate Cainan Oil Field, a desert oilfield in Xinjiang, annual capacity for the field reached 1,500,000 tons, with only 400 employees needed to manage the oilfield. After the introduction of Baker CAC’s products into China’s petroleum industry, Chinese companies have also sought to provide automation solutions.

 

In the primary oil recovery stage, oil pressure in an oil reservoir may be high enough to force oil to the surface. Approximately 20% of oil may be harvested at this stage. The secondary oil recovery stage accounts for another 5% to 15% of oil recovery and involves such efforts as pumps to extract petroleum and the injection of water, natural gas, carbon dioxide or other gasses into the oil reservoir to force oil to the surface. Most oilfields in China have now entered into the tertiary stage of oil recovery, at which oil extraction becomes increasingly difficult and inefficient. Tertiary recovery generally focuses on decreasing oil viscosity to make extraction easier and accounts for between 5% and 15% of oil recovery. Our efforts in tertiary recovery focus on reducing water content in crude oil in order to make extraction more efficient.

 

We currently provide products and services to oil and gas field companies, which focus on the development and production of oil and natural gas. Our products and services described below correlate to the numbered stages of the oilfield production system graphical expression shown below.

 

Our products and services include:

 

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We have received ISO9000 certifications for several of our processes. The International Organization for Standardization consists of a worldwide federation of national standards bodies for approximately 130 countries, and the ISO9000 certification represents an international consensus of these standards bodies, with the aim of creating global standards of product and service quality. We have received ISO9000 certification for the following:

 

We operate our business by cooperating with oil companies and their subsidiaries, petroleum administration bureau and local service companies. Most actual control of our direct and indirect clients can be traced to Sinopec and CNPC, the two major Chinese state-owned companies responsible for on-shore petroleum mining and extraction. We have conducted automation projects for plants in three of China’s four highest producing oilfields, Daqing, Shengli and Xinjiang. We have undertaken the automation projects at the following locations, among others:

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We provide products and services to Sinopec under a series of agreements, each of which is terminable without notice. We first began to provide services to Sinopec in 1998. Sinopec accounted for approximately 45.99% and 24.07% of our revenues for the fiscal years ended June 30, 2013 and 2012, respectively, and any termination of our business relationships with Sinopec would materially harm our operations.

 

 

 

 

We provide products and services to CNPC under a series of agreements, each of which is terminable without notice. We first began to provide services to CNPC in 2000. CNPC accounted for approximately 27.88% and 16.49% of our revenues in the fiscal years ended June 30, 2013 and 2012, respectively, and any termination of our business relationships with CNPC would materially harm our operations.

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Our goal is to help our customers improve their efficiency and profitability by providing them with software and hardware solutions and services to improve their ability to locate productive oil reservoirs, manage the oil extraction process, reduce extraction costs, and enhance recovery from extraction activities. Key elements of our strategies include:

   

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We face competition from a variety of foreign and domestic companies involved in the petroleum mining automation industry. While we believe we effectively compete in our market, our competitors hold a substantial market share.

 

A few of our existing competitors, as well as a number of potential new competitors, have significantly greater financial, technical, marketing and other resources than we do, which could provide them with a significant competitive advantage over us. We cannot guarantee that we will be able to compete successfully against our current or future competitors in our industry or that competition will not have a material adverse effect on our business, operating results and financial condition.

 

Our primary domestic competitors include the following:

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Beijing Echo Technologies Development Co., Ltd. (“BET”). BET provides a combination of software and hardware products for industrial automatic control systems in the petroleum industry. BET currently engages in research and development of software and hardware applied to industrial automatic control systems, manufacturing and installation of industrial automation instruments and integration of automatic control products.

	•		Beijing Golden-Time Petroleum Measurement Technology Co., Ltd. (“BGT”). BGT develops analysis software used in oilfields but does not yet, to our knowledge, produce a substantial amount of hardware products.
	•		Anton Oilfield Services Group (HKEx stock code: 3337) is a leading independent oilfield services provider offering one-stop oil and gas field technical development services to oil companies. Its services and solutions span across the drilling technology, well completion, down-hole operation, and oil production phases in the development cycle. Its fast growth benefits from the accelerated development of natural gas in China and the Group’s increased presence in the overseas markets.

 

We focus our research and development efforts on improving our development efficiency and the quality of our products and services. As of June 30, 2013, our research and development team consisted of 36 experienced engineers, developers and programmers. In addition, some of our support employees regularly participate in our research and development programs.

 

In the fiscal years ended June 30, 2013 and 2012, we spent approximately ¥8.5 million ($1.4 million) and ¥6.5 million, respectively, on research and development activities. These expenditures focused primarily on research into furnaces and improvement of services we provide.

 

Our success and competitive position is dependent in part upon our ability to develop and maintain the proprietary aspect of our technology. The reverse engineering, unauthorized copying, or other misappropriation of our technology could enable third parties to benefit from our technology without paying for it. We rely on a combination of trademark, trade secret, copyright law and contractual restrictions to protect the proprietary aspects of the Domestic Companies’ and our technology. We seek to protect the source code to the Domestic Companies’ and our software, documentation and other written materials under trade secret and copyright laws. While we actively take steps to protect the Domestic Companies’ and our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of the Domestic Companies’ and our intellectual property. This is particularly the case in China where the laws may not protect our proprietary rights as fully as in the United States.

 

We license the Domestic Companies’ and our software products under signed license agreements that impose restrictions on the licensee’s ability to utilize the software and do not permit the re-sale, sublicense or other transfer of the software. Finally, we seek to avoid disclosure of the Domestic Companies’ and our intellectual property by requiring employees and independent consultants to execute confidentiality agreements.

 

 

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Although the Domestic Companies and we develop our software products, each is based upon middleware developed by third parties. We integrate this technology, licensed by our customers from third parties in our software products. If our customers are unable to continue to license any of this third party software, or if the third party licensors do not adequately maintain or update their products, we would face delays in the releases of our software until equivalent technology can be identified, licensed or developed, and integrated into our software products. These delays, if they occur, could harm our business, operating results and financial condition.

 

There has been a substantial amount of litigation in the software industry regarding intellectual property rights. It is possible that in the future third parties may claim that our current or potential future software solutions infringe their intellectual property. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlap. In addition, we may find it necessary to initiate claims or litigation against third parties for infringement of our proprietary rights or to protect our trade secrets. Although the Domestic Companies and we may disclaim certain intellectual property representations to our customers, these disclaimers may not be sufficient to fully protect us against such claims. Any claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require the Domestic Companies and us to enter into royalty or license agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect on our business, operating results and financial condition.

 

Our standard software license agreements contain an infringement indemnity clause under which we agree to indemnify and hold harmless our customers and business partners against liability and damages arising from claims of various copyright or other intellectual property infringement by the Domestic Companies’ and our products. We have never lost an infringement claim, and our costs to defend such lawsuits have been insignificant. Although it is possible that in the future third parties may claim that our current or potential future software solutions or we infringe on their intellectual property, we do not currently expect a significant impact on our business, operating results, or financial condition.

We market our products under the following trademarks which are registered with the PRC Trademark Bureau under the State Administration for Industry and Commerce. We currently own or have applied for the following trademarks:

 

 

We currently own or have applied for the following 22 patents registered with the State Intellectual Property Office which are applied on our automated services products for the petroleum extraction industry:

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We have registered the following software products with the State Intellectual Property Office:

	1.	Recon automated monitoring system version 1 was published on July 30, 2011;
	2.	Recon automated maintenance and production-management system version 1 was published on July 10, 2011;
	3.	Recon SCADA field monitoring and data acquisition system software version 4 was published on January 28, 2011;

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	4.	Recon flow control computer monitoring system software was registered and published on February 8, 2008;
	5.	Recon SCADA field monitoring and data acquisition system software version 2 was published on August 18, 2003, and version 3 was registered and published on April 5, 2008;
	6.	Recon wireless field monitoring and data acquisition system software version 2 was published on January 8, 2011, and version 1 was registered and published on September 15, 2010;
	7.	Recon RCNAMT version 1 was published on April 27, 2012; and
	8.	Recon Process Auto version 1 was published on August 25, 2012.

 

We have not incurred material expenses in connection with compliance with Chinese environmental laws and regulations. We do not anticipate expending any material amounts for such compliance purposes for the remainder of our current or succeeding fiscal year.

 

In 1998, China established the State Intellectual Property Office (“SIPO”) to coordinate China’s intellectual property enforcement efforts. SIPO is responsible for granting and enforcing patents, as well as coordinating intellectual property rights related to copyrights and trademarks. Protection of intellectual property in China follows a two-track system. The first track is administrative in nature, whereby a holder of intellectual property rights files a complaint at a local administrative office. Determining which intellectual property agency can be confusing, as jurisdiction of intellectual property matters is diffused throughout a number of government agencies and offices, with each typically responsible for the protection afforded by one statute or one specific area of intellectual property-related law. The second track is a judicial track, whereby complaints are filed through the Chinese court system. Since 1993, China has maintained various intellectual property tribunals. The total volume of intellectual property related litigation, however, remains small.

 

Although there are differences in intellectual property rights between the United States and China, of most significance to the Company is the inexperience of China in connection with the development and protection of intellectual property rights. Similar to the United States, China has chosen to protect software under copyright law rather than trade secrets, patent or contract law. As such, we will attempt to protect our most significant intellectual property pursuant to Chinese laws that have only recently been adopted. Unlike the United States, which has lengthy case law related to the interpretation and applicability of intellectual property law, China has a less developed body of relevant intellectual property case law.

 

On March 1, 2009, the Ministry of Industry and Information Technology of China issued the Administrative Measures on Software Products, or the Software Measures, which became effective as of April 10, 2009, to strengthen the regulation of software products and to encourage the development of the Chinese software industry. Under the Software Measures, a software developer must have all software products imported into or sold in China tested by a testing organization supervised by the Ministry of Industry and Information Technology. The software industry authorities in provinces, autonomous regions, municipalities and cities with independent planning are in charge of the registration, report and management of software products. Software products can be registered for five years, and the registration is renewable upon expiration. Although some of Nanjing Recon’s current software products were registered in 2008, there can be no guarantee that the registration will be renewed in 2013 or that the Domestic Companies’ and our future products will be registered.

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China has adopted legislation governing intellectual property rights, including trademarks and copyrights. China is a signatory to the main international conventions on intellectual property rights and became a member of the Agreement on Trade Related Aspects of Intellectual Property Rights upon its accession to the WTO in December 2001.

 

Copyright. China adopted its first copyright law in 1990. The Standing Committee of the National People’s Congress amended the Copyright Law in 2001 to widen the scope of works and rights that are eligible for copyright protection. The amended Copyright Law extends copyright protection to software products, among others. In addition, there is a voluntary registration system administered by the China Copyright Protection Center. Unlike patent and trademark registration, copyrighted works do not require registration for protection. Protection is granted to individuals from countries belonging to the copyright international conventions or bilateral agreements of which China is a member. Nanjing Recon has ten copyrights for software programs.

 

Trademark. The Chinese Trademark Law, adopted in 1982 and revised in 1993, 2001 and 2013, protects registered trademarks. The Trademark Office under the Chinese State Administration for Industry and Commerce handles trademark registrations and grants a term of ten years to registered trademarks. Trademark license agreements must be filed with the Trademark Office for record. China has a “first-to-register” system that requires no evidence of prior use or ownership. The Domestic Companies and we have registered a number of product names with the Trademark Office.

Foreign Currency Exchange. The principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations (1996), as amended, and the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996). Under these regulations, Renminbi are freely convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions, but not for most capital account items, such as direct investment, loan, repatriation of investment and investment in securities outside China, unless the prior approval of SAFE or its local counterparts is obtained. In addition, any loans to an operating subsidiary in China that is a foreign invested enterprise, cannot, in the aggregate, exceed the difference between its respective approved total investment amount and its respective approved registered capital amount. Furthermore, any foreign loan must be registered with SAFE or its local counterparts for the loan to be effective. Any increase in the amount of the total investment and registered capital must be approved by the PRC Ministry of Commerce or its local counterpart. We may not be able to obtain these government approvals or registrations on a timely basis, if at all, which could result in a delay in the process of making these loans.

The dividends paid by the subsidiary to its shareholder are deemed shareholder income and are taxable in China. Pursuant to the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises in China may purchase or remit foreign exchange, subject to a cap approved by SAFE, for settlement of current account transactions without the approval of SAFE. Foreign exchange transactions under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other relevant PRC governmental authorities.

Regulation of Dividend Distribution. The principal regulations governing the distribution of dividends by foreign holding companies include the Foreign Investment Enterprise Law (1986), as amended, and the Administrative Rules under the Foreign Investment Enterprise Law (2001).

 

Under these regulations, foreign investment enterprises in China may pay dividends only out of their retained profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign investment enterprises in China are required to allocate at least 10% of their respective retained profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered capital of the enterprises. These reserves are not distributable as cash dividends.

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Notice 75. On October 21, 2005, SAFE issued Notice 75, which became effective as of November 1, 2005. According to Notice 75, prior registration with the local SAFE branch is required for PRC residents to establish or to control an offshore company for the purposes of financing that offshore company with assets or equity interests in an onshore enterprise located in the PRC. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the offshore company or overseas funds raised by such offshore company, or any other material change involving a change in the capital of the offshore company.

 

Moreover, Notice 75 applies retroactively. As a result, PRC residents who have established or acquired control of offshore companies that have made onshore investments in the PRC in the past are required to complete the relevant registration procedures with the local SAFE branch. Under the relevant rules, failure to comply with the registration procedures set forth in Notice 75 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore company, including the increase of its registered capital, the payment of dividends and other distributions to its offshore parent or affiliate and capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.

 

PRC residents who control the Company are required to register with SAFE in connection with their investments in us. Such individuals completed this registration in 2007, and 2008, as amended. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future, such PRC residents will be subject to the registration procedures described in Notice 75.

 

Regulations on Foreign Investment in Automation Service Industry and Oil Exploration and Extraction Industry in PRC.  In accordance with the Catalogue of Industries for Guiding Foreign Investment (Revised 2007), the oil and gas automation service industries are in the catalogue of permitted industries, and thus there are no restrictions on foreign investment in such industry. In addition the following industries are encouraged for foreign investment in China:

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Manufacturing of equipment for oil prospecting, well drilling, and centralized transportation: floating well drilling system and floating production system operating at a water depth over 500m, seabed oil extraction & centralized transportation equipment operating at a water depth over 600m, deep-water oil driller with winch power over 3000KW, top driving power over 850KW and drilling pump power over, land-based oil driller & desert-based oil driller for drilling wells deeper than 9000m, 80 ton or bigger reciprocating piston compressor for use in oil refineries with a capacity of 10 million tons/year, CNC oil well measuring instrument, and oil drilling mud-hole equipment.

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Exploration and exploitation of oil and natural gas with venture capital (limited to equity joint ventures and cooperative joint ventures);

   

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Development and application of new technologies that increase the recovery ratio of crude oil (limited to equity joint ventures and cooperative joint ventures);

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Development and application of new oil exploration and exploitation technologies such as geophysical exploration, drilling, well logging, and downhole operation, etc. (limited to cooperative joint ventures); and

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Exploration and development of unconventional oil resources such as oil shale, oil sands, heavy oil, and excess oil (limited to cooperative joint ventures).

As of June 30, 2013, we had 82 employees, all of whom were based in China. Of the total, 11 were in management, 36 were in technical support and research and development, 13 were engaged in sales and marketing, 10 were in financial affairs, and 12 were in administration and procurement. We believe that our relations with our employees are good. We have never had a work stoppage, and our employees are not subject to a collective bargaining agreement.

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We do not have any business interruption, litigation or natural disaster insurance coverage for our operations in China. Insurance companies in China offer limited business insurance products. While business interruption insurance is available to a limited extent in China, we have determined that the risks of interruption, cost of such insurance and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Therefore, we are subject to business and product liability exposure. Business or product liability claims or potential regulatory actions could materially and adversely affect our business and financial condition.

 

We do, however, pay certain required insurance amounts in connection with our employees’ wages. The amount and types of insurance we must provide under Chinese and local requirements vary by the location of each of the Domestic Companies. The following table summarizes the types of insurance paid for each of the Domestic Companies:

Item 1A.

Risk Factors.

 

The Company is not required to provide the information required by this Item because the Company is a smaller reporting company.

Item 1B.

Unresolved Staff Comments.

 

The Company is not required to provide the information required by this Item because the Company is a smaller reporting company.

Item 2.

Properties.

 

We currently operate in three facilities throughout China. Our headquarters are located in Beijing.

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Office		Address		Rental Term		Space
Headquarters		Room 1902, Building C King Long International Mansion, Chaoyang District Beijing, PRC		July 1, 2013 to June 30, 2014		220 square meters
		Room 4C408-1, No. 4 West building, Entrepreneurship Centre, Jining City, PRC		July 30, 2012 to December 31, 2013		40 square meters
Nanjing Recon		Yongfeng Mansion, 14th Floor No. 123 Jiqing Road Nanjing City, PRC		July 10, 2012 to July 9, 2014		440 square meters
		Room 119, Software Road, Yuhuatai District, Nanjing City, PRC		May 10, 2013 to May 9, 2014		294 square Meters
BHD		18th Floor, Building C King Long International Mansion, Chaoyang District Beijing, PRC		January 1, 2012 to December 31, 2013		450 square meters
		West building, Zhengfu Street, Huo ying, Changping District, PRC		January 1, 2012 to December 31, 2013		900 square meters

Item 3.

Legal Proceedings.

 

From time to time, we may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such pending or threatened legal proceedings, claims, regulatory inquires or investigations that we believe will have a material adverse affect on our business, financial condition or operating results.

Item 4.

Mine Safety Disclosures.

This item is inapplicable to the Company.

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Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

(a) Market for Our Ordinary Shares

 

We completed our initial public offering on July 29, 2009. The following table sets forth the quarterly high and low sale prices for our ordinary shares as reported on the NASDAQ Capital Market.

 

As of June 30, 2013, there were approximately six holders of record of our ordinary shares. This excludes our ordinary shares owned by shareholders holding ordinary shares under nominee security position listings. On June 28, 2013, the last sales price of our ordinary shares as reported on the NASDAQ Capital Market was $1.88 per ordinary share.

 

We have never declared or paid any cash dividends on our ordinary shares. We anticipate that we will retain any earnings to support operations and to finance the growth and development of our business. Therefore, we do not expect to pay cash dividends in the foreseeable future. Any future determination relating to our dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions and future prospects and other factors the Board of Directors may deem relevant.

 

Because we are a holding company with no operations of our own and all of our operations are conducted through our Chinese subsidiary, our ability to pay dividends and to finance any debt that we may incur is dependent upon dividends and other distributions paid. In addition, Chinese legal restrictions permit payment of dividends to us by our Chinese subsidiary only out of its accumulated net profit, if any, determined in accordance with Chinese accounting standards and regulations. Under Chinese law, our subsidiary is required to set aside a portion (at least 10%) of its after-tax net income (after discharging all cumulated loss), if any, each year for compulsory statutory reserve until the amount of the reserve reaches 50% of our subsidiaries’ registered capital. These funds may be distributed to shareholders at the time of its wind up. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Holding Company Structure.”

 

 

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Payments of dividends by our subsidiary in China to the Company are also subject to restrictions including primarily the restriction that foreign invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. There are no such similar foreign exchange restrictions in the Cayman Islands.

(b) We are not required to provide any disclosure under this item, as we have applied all of the net proceeds from our initial public offering, as disclosed in our annual report on Form 10-K for the year ended June 30, 2011. While we have filed a shelf registration statement on Form S-3 (SEC no. 333-190387, declared effective August 14, 2013), we have not sold any securities or received any proceeds under such registration statement.

 

(c) None.

Item 6.

Selected Financial Data.

 

The Company is not required to provide the information required by this Item because the Company is a smaller reporting company.

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operation.

The following discussion and analysis of our company’s financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors.

 

 

We are a company with limited liability incorporated in 2007 under the laws of the Cayman Islands. Headquartered in Beijing, we provide products and services to oil and gas companies and their affiliates through our Domestic Companies. As the company contractually controlling the Domestic Companies, we are the center of strategic management, financial control and human resources allocation.

Our business is mainly focused on the upstream sectors of the oil and gas industry. We derive our revenues from the sales and provision of (1) oilfield dedicated products and accessories, (2) stimulation technology and services. Our products and services involve most of the key procedures of the extraction and production of oil and gas, and include automation systems, equipment, tools and on-site technical services.

 

Our VIEs provide the oil and gas industry with equipment, production technologies, automation and services to enhance our customers’ efficiency.

 

	•	Nanjing Recon: Nanjing Recon is a high-tech company that specializes in automation services for oilfield companies. It mainly focuses on providing automation solutions to the oil exploration industry, including monitoring wells, automatic metering to the joint station production, process monitor, and a variety of oilfield equipment and control systems.
	•	BHD: BHD is a high-tech company that specializes in transportation equipment and stimulation productions and services. Possessing proprietary patents and substantial industry experience, BHD has built up stable and strong working relationships with the major oilfields in China.

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The oilfield engineering and technical service industry is generally divided into five sections: (1) exploration, (2) drilling and completion, (3) testing and logging, (4) production and (5) oilfield construction. Our businesses have mainly focused on production processes. As of this year, we are also expanding our business to well completion and horizontal well down-hole service process. We still believe that many existing oil wells and oilfields are in need of renewal and improvement on their current equipment to maintain production. We also believe that as many new wells are developed, our gathering and transferring equipment will be in great need. Accordingly, in the next year, we will focus on the following areas.

Measuring Equipment and Service. “Digital oil field” and the management of oil companies are highly regarded. We believe our oilfield Supervisory Control and Data Acquisition (“SCADA”) and related technical support services will address the needs of the oil well automation system market, for which we forecast strong needs in the short term. Through early cooperation with CNPC on Turkmenistan, we have developed our experience in this market. Although bidding has not yet commenced, we will continue pursuing overseas business projects in the coming second phase construction.

Gathering and Transferring Equipment. With more new wells developed, our management anticipates that demand for our furnaces and burners will grow more compared to last year, especially in the Jilin Oilfield and Xinjiang oilfield.

 

Fracturing business. We believe we cooperated well with Zhongyuan Oilfield in 2013 and expect to continue growing revenue from fracturing and related stimulation services in the coming year.

New business. Design and development of down-hole tools has always been an important technique for oilfield companies. Recently, this market has developed very rapidly. After a year test project for our client, we have developed experience with this technology and our products and servers have been accepted by our client. We received modest revenue this year and expect more revenue from this business in the coming year.

 

Despite uncertainty in the energy industry related to such matters as fluctuating prices and future opportunities for oil companies, our management believes there are still many factors to support our long-term development:

 

(1)           The opening of the Chinese oil industry to participation by non-state owned service providers and vendors played an increasingly important role in the high-end oilfield service segment to allow competition based on efficiency and price. As oil and gas fields are depleted, it becomes more challenging to find and convert reserves into usable energy sources. As the industry has permitted competition by private companies and oil companies have formed separate service companies, high-tech service has gradually opened up to private companies.

 

(2)            Speeding up the development of unconventional hydrocarbon resources such as shale gas and coal bed methane will bring more requirements of related technic and service. China is rich in unconventional hydrocarbon resources, but new exploration and development technology breakthroughs are urgently needed; and

 

(3)             Overseas assets of Chinese oilfield companies increased gradually, and they will provide more opportunity for domestic service companies to participate in foreign projects.

 

Management is focused on these factors and will seek to extend our business on the industrial chain, like providing more integrated services and incremental measures and growing our business from a predominantly up-ground business to include some down-hole services as well.

19

 

As a smaller local company, it is our basic strategy to focus on developing our onshore oilfield business, i.e. the upstream of the industry. Due to the remote location and difficult environment of China’s oil and gas fields, foreign competitors rarely enter those fields.

 

Large domestic oil companies prefer to focus on their exploration and development businesses to earn higher margins and keep their competitive advantage. With regard to private oilfield service companies, 90% specialize in the manufacture of drilling and production equipment. Thus, the market for technical support and project service is still in its early stage. Our management focuses on providing high quality products and service at oilfields where we have a geographical advantage. Such strategy allows us to avoid conflicts of interest with bigger suppliers of drilling equipment and keep our leading position within the market segment. Our mission is to increase the automation and safety levels of industrial petroleum production in China, and improve its efficiency and effectiveness through advanced technologies. At the same time, we are always looking to improve our business and to increase our earning capability.

 

On June 27, 2013, the Company acquired 32.22% of a U.S. oil and natural gas company's outstanding shares for approximately ¥1.5 million ($250,000). This strategic investment marks an important step in expanding our business in the U.S. market.

 

 

Our operating results in any period are subject to the general conditions typically affecting the Chinese oilfield service industry including:

 

	•	the amount of spending by our customers, primarily those in the oil and gas industry;
	•	growing demand from large corporations for improved management and software designed to enhance corporate performance;
	•	the procurement processes of our customers, especially those in the oil and gas industry;
	•	competition and related pricing pressure from other oilfield service solution providers, especially those targeting the oil and gas industry in China;
	•	the ongoing development of the oilfield service market in China; and
	•	inflation and other factors.

Unfavorable changes in any of these general conditions could negatively affect the number and size of the projects we undertake, the number of products we sell, the amount of services we provide, the price of our products and services or otherwise affect our results of operations.

 

Our operating results in any period are more directly affected by company-specific factors including:

	•	our continued ability to lead and to control all affiliated entities;
	•	our revenue growth;
	•	the proportion of our business dedicated to large companies;
	•	our ability to successfully develop, introduce and market new solutions and services;
	•	our ability to increase our revenues from customers both old and new in the oil and gas industry in China;

20

	•	our ability to effectively manage our operating costs and expenses; and
	•	our ability to effectively implement any targeted acquisitions and/or strategic alliances so as to provide efficient access to the markets in the oil and gas industry.

 

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which require us to make judgments, estimates and assumptions. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. We believe that the following policies involve a higher degree of judgment and complexity in their application and require us to make significant accounting estimates. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this quarterly report. Significant accounting estimates reflected in our Company’s consolidated financial statements include revenue recognition, allowance for doubtful accounts, and useful lives of property and equipment.

 

 

We recognize an entity as a VIE if it either (i) has insufficient equity to permit the entity to finance its activities without additional subordinated financial support or (ii) has equity investors who lack the characteristics of a controlling financial interest. We consolidate a VIE as its primary beneficiary when we have both the power to direct the activities that most significantly impact the entity’s economic performance and the obligation to absorb losses or the right to receive benefits from the entity that could potentially be significant to the VIE. We will continue to make ongoing assessment whether our VIEs still continue to be VIEs and whether we continue to be the primary beneficiary.

 

Assets recognized as a result of consolidating VIEs do not represent additional assets that could be used to satisfy claims against our general assets. Conversely, liabilities recognized as a result of consolidating these VIEs do not represent additional claims on our general assets; rather, they represent claims against the specific assets of the consolidated VIEs.

 

 

We recognize revenue when the following four criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been provided; (3) the sales price is fixed or determinable; and (4) collectability is reasonably assured. Delivery does not occur until products have been shipped or services have been provided to the client and the client has signed a completion and acceptance report, risk of loss has transferred to the client, client acceptance provisions have lapsed, or the Company has objective evidence that the criteria specified in client acceptance provisions have been satisfied. The sales price is not considered to be fixed or determinable until all contingencies related to the sale have been resolved.

 

 

21

 

Hardware

 

Revenue from hardware sales is generally recognized when the product is shipped to the customer and when there are no unfulfilled company obligations that affect the customer’s final acceptance of the arrangement.

 

Software

 

The Company sells self-developed software. For software sales, the Company recognizes revenues in accordance with the provisions of Accounting Standards Codification, Topic 985-605, “Software Revenue Recognition,” and related interpretations. Revenue from software is recognized according to project contracts. Contract costs are accumulated during the periods of installation and testing or commissioning. Usually this is short term. Revenue is not recognized until completion of the contracts and receipt of acceptance statements.

 

Services

 

The Company provides services to improve software functions and system requirements on separated fixed-price contracts. Revenue is recognized when services are completed and acceptance is determined by a completion report signed by the customer.

 

Deferred income represents unearned amounts billed to customers related to sales contracts.

 

 

When the criteria for revenue recognition have been met, costs incurred are recognized as cost of revenue. Cost of revenues includes wages, materials, handling charges, the cost of purchased equipment and pipes, and other expenses associated with manufactured products and services provided to customers. We expect cost of revenues to grow as our revenues grow. It is possible that we could incur development costs with little revenue recognition, but based upon our past history, we expect our revenues to grow.

 

The carrying amounts reported in the consolidated balance sheets for trade accounts receivable, other receivables, advances to suppliers, trade accounts payable, accrued liabilities, advances from customers and notes payable approximate fair value because of the immediate or short-term maturity of these financial instruments. Long-term other receivables approximate fair value because the interest rate approximates the market rate. Long-term investment is carried at less than fair value, with fair value determined using level 1 inputs.

 

22

 

We review the carrying values of our long-lived assets for impairment whenever events or changes in circumstances indicate that they may not be recoverable. When such an event occurs, we project undiscounted cash flows to be generated from the use of the asset and its eventual disposition over the remaining life of the asset. If projections indicate that the carrying value of the long-lived asset will not be recovered, we reduce the carrying value of the long-lived asset by the estimated excess of the carrying value over the projected discounted cash flows. In the past, we have not had to make significant adjustments to the carrying values of our long-lived assets, and we do not anticipate a need to do so in the future. However, circumstances could cause us to have to reduce the value of our capitalized software more rapidly than we have in the past if our revenues were to significantly decline. Estimated cash flows from the use of the long-lived assets are highly uncertain and therefore the estimation of the need to impair these assets is reasonably likely to change in the future. Should the economy or the acceptance of our software change in the future, it is likely that our estimate of the future cash flows from the use of these assets will change by a material amount.

 

 

Recently issued accounting pronouncements- In February 2013 the FASB issued an accounting standards update ("ASU") No. 2013-02 "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income," requiring new disclosures for items reclassified out of accumulated other comprehensive income ("AOCI"), including (1) changes in AOCI balances by component and (2) significant items reclassified out of AOCI. The guidance does not amend any existing requirements for reporting net income or OCI in the financial statements. The standards update was effective for reporting periods beginning after December 15, 2012, to be applied prospectively. The Company is currently evaluating the impact of adopting this standard on its consolidated financial statements. As this guidance only requires expanded disclosures, the adoption of this guidance is not expected to have a significant impact on the Company's consolidated financial statements.

 

 

The following consolidated results of operations include the results of operations of the Company and its variable interest entities (“VIEs”), BHD and Nanjing Recon.

 

Our historical reporting results are not necessarily indicative of the results to be expected for any future period.

 

Revenue

 

 

Our total revenues for the year ended June 30, 2013 were approximately ¥76.6 million ($12.4 million), an increase of approximately ¥1.0 million or 1.4% from ¥75.5 million for the year ended June 30, 2012. This was mainly caused by:

 

	1.	Hardware business. During the year ended June 30, 2013, hardware revenues decreased mainly because we recorded significant revenue from our Turkmenistan project in 2012, while there is no such revenue in 2013.
	2.	Hardware – related parties. Sales of hardware to related-parties decreased because 1) one entity ceased to be a related party in 2013. In 2012, we generated revenues from two related parties. In 2013, we sold to the same two parties, but one was no longer a related party, and as a result, revenues from that party were included in hardware non-related parties revenue for the years ended June 30, 2012 and 2013; and 2) some revenue was allocated to software revenue-related parties.
	3.	Service business. Most of our increased revenue during the year ended June 30, 2013 was from our fracturing service business. During the year ended June 30, 2013, Recon BHD signed several fracturing service contracts with an aggregate contract value of RMB 30 million with Sinopec Zhongyuan oilfield. As of June 30, 2013, we have completed all those contracts and recognized the corresponding revenues from the contracts. We continue to perform fracturing work beyond those contracts.

23

	4.	Software business. The software sales increased approximately ¥1.6 million ($0.3 million). We record revenue as software sales when (1) the customer signs a separate software contract with us, or (2) the customer accepts VAT invoices for software. The amount of our revenues categorized as software sales may fluctuate because certain software may be sold with hardware at times as a whole product and not separately priced.
	5.	Software business – related parties. This revenue was from Ji Dong oilfield, which is considered related party revenue because we have done business with this oilfield through Beijing Yabei Nuoda, a company of which our chief executive officer is legal representative. As mentioned above, we recorded revenue as software sales only when it satisfies specific criteria. Revenue from software related parties should be considered together with hardware sales from related parties. This increase only reflected separately recorded software revenue increase, while our automation business with Ji Dong oilfield developed well.

 

Cost and Margin

 

 

Cost of Revenues. Our cost of revenues includes raw materials and costs related to design, implementation, delivery and maintenance of products and services. All materials and components we need can be purchased or manufactured under contracts. Usually the prices of electronic components do not fluctuate dramatically due to market competition and will not significantly affect our cost of revenues. However, specialized equipment and incentive chemical products may be directly influenced by the price fluctuation of metal and oil. Additionally, the prices of some imported accessories mandated by our clients can also impact our cost. Our cost of revenues increased from approximately ¥51.3 million in the year ended June 30, 2012 to approximately ¥51.5 million ($8.3 million) for the year ended June 30, 2013, an increase of approximately ¥0.3 million ($42,000) or 0.5%. As a percentage of revenues, our cost of revenues decreased from 67.9% in 2012 to 67.3% in 2013.

 

Gross Profit. Our gross profit increased to approximately ¥25.1 million ($4 million) for the year ended June 30, 2013 from approximately ¥24.3 million for the year ended June 30, 2012. Our gross profit as a percentage of revenue increased to 32.7% for the year ended June 30, 2013 from 32.1% for the same period in 2012.

 

 

24

 

In more detail:

 

		For the Years Ended
		June 30,
										Increase /				Percentage
		2012				2013				(Decrease)				Change
Total revenues-hardware and software- non related parties		¥	53,646,920			¥	41,408,517			¥	(12,238,403)				(22.8)	%
Cost of revenues -hardware and software- non related parties			37,740,629				26,617,786				(11,122,843)				(29.5)	%
Gross profit		¥	15,906,291			¥	14,790,731			¥	(1,115,560)				(7.0)	%
Margin %			29.6	%			35.7	%			6.1	%

 

Cost of revenue from hardware and software-related parties decreased, causing gross profit from non-related parties increased, was mainly because revenue from software business, which usually enjoying a higher margin, occupied larger proportion of our revenue.

 

		For the Years Ended
		June 30,
										Increase /				Percentage
		2012				2013				(Decrease)				Change
Total revenues-hardware and software- related parties		¥	7,909,994			¥	9,713,209			¥	1,803,215				22.8	%
Cost of revenues -hardware and software- related parties			4,584,221				6,346,850				1,762,629				38.4	%
Gross profit		¥	3,325,773			¥	3,366,359			¥	40,586				1.2	%
Margin %			42.0	%			34.7	%			(7.4)	%

 

Cost of revenue from hardware and software-related parties increased as revenue increased. While gross margin decreased was mainly because software revenue accounted for larger proportion last year.

 

		For the Years Ended
		June 30,
										Increase /				Percentage
		2012				2013				(Decrease)				Change
Total revenues- service		¥	13,985,465			¥	25,464,003			¥	11,478,538				82.1	%
Cost of revenues – service			8,945,100				18,567,123				9,622,023				107.6	%
Gross profit		¥	5,040,365			¥	6,896,880			¥	1,856,515				36.8	%
Margin %			36.0	%			27.1	%			(9.0)	%			—

 

Cost of revenue and gross margin from service business both increased as fracturing business increased dramatically. While as more popularization and completion in this aspect, general margin decreased. So did our business. So far, our management are trying to ease this negative situation through import substitution and training our own service team to save cost, thus to maintain a reasonable margin level.

25

Expenses

		For the Years Ended
		June 30,
										Increase /				Percentage
		2012				2013				(Decrease)				Change
Selling and distribution expenses			5,054,219				6,126,095				1,071,876				21.2	%
% of revenue			6.7	%			8.0	%			1.3	%
General and administrative expenses			16,484,972				10,978,942				(5,506,030)				(33.4)	%
% of revenue			21.8	%			14.3	%			(7.5)	%
Research and development expenses			6,270,919				8,513,680				2,242,761				35.8	%
% of revenue			8.3	%			11.1	%			2.8	%
Operating expenses		¥	27,810,110			¥	25,618,717			¥	(2,191,393)				(7.9)	%

Research and development (“R&D”) expenses. Research and development expenses consist primarily of salaries and related expenditures of our research and development projects. Research and development expenses increased by 35.8%, from approximately ¥6.3 million for the year ended June 30, 2012 to approximately ¥8.5 million ($1.4 million) for the same period of 2013. This increase was primarily due to the increase in R&D expenditure on our furnaces and fracturing services required to update our products and services.

 

Net Income

		For the Years Ended
		June 30,
								Increase /			Percentage
		2012			2013			(Decrease)			Change
Loss from operations		¥	(3,537,681)		¥	(564,747)		¥	2,972,934			(84.0)	%
Interest and other income (loss)			(196,851)			1,471,159			1,668,010			(847.3)	%
Income (loss) before income taxes			(3,734,532)			906,412			4,640,944			(124.3)	%
Provision (benefit) for income taxes			(220,050)			286,871			506,921			(230.4)	%
Net income (loss)			(3,514,482)			619,541			4,134,023			(117.6)	%
Less: Net income attributable to non-controlling interest			305,653			579,843			274,190			89.7	%
Net income (loss) attributable to ordinary shareholders		¥	(3,820,135)		¥	39,698		¥	3,859,833			(101.0)	%

 

Loss from operations. Loss from operations was approximately ¥0.6 million ($0.1 million) for the year ended June 30, 2013, compared to a loss of approximately ¥3.5 million for the same period of 2012. This decrease in loss from operations is attributed primarily to the increased revenue and decrease in general and administrative expenses.

 

Interest and other income (loss). Interest and other income was approximately ¥1.5 million ($0.2 million) for the year ended June 30, 2013, compared to interest and other loss of ¥0.2 million for the same period of 2012. The approximately ¥1.7 million ($0.3 million) increase in interest and other income was primarily due to increases in subsidy income, interest income, gain from foreign currency transactions and other income, offset by increase in interest expenses.

 

Provision (benefit) for income tax. Provision for income tax is based upon the liability method of accounting pursuant to US GAAP. Under this approach, deferred income taxes are recorded to reflect the tax consequences on future years of differences between the tax basis of assets and liabilities and their financial reporting amounts. A valuation allowance is recorded against deferred tax assets if it is not likely that the asset will be realized. We have not been subject to any income taxes in the United States or the Cayman Islands. Enterprises doing business in the PRC are generally subject to federal (state) enterprise income tax at a rate of 25%; however, Nanjing Recon and BHD were granted the certification of High Technology Enterprise and are taxed at a rate of 15% for taxable income generated.

 

Benefit for income tax for the year ended June 30, 2012 was ¥220,050, while the provision for income tax for the year ended June 30, 2013 was ¥286,871 ($46,358). Income taxes were higher in the 2013 period notwithstanding net losses because the VIEs had higher pre-consolidation taxable income, which could not be offset by losses of the consolidated entity.

 

Net income (loss) attributable to ordinary shareholders. As a result of the factors described above, net income attributable to ordinary shareholders was ¥39,698 ($6,415) for the year ended June 30, 2013, an improvement of approximately ¥4 million ($0.6 million) from net loss attributable to ordinary shareholders of approximately ¥3.8 million for same period of 2012.

 

Adjusted EBITDA. We define adjusted EBITDA as net income (loss) before income tax expense, interest expense, non-cash stock compensation expense, and depreciation and amortization expense. We believe it is useful to an equity investor in evaluating our operating performance because (1) it is widely used by investors in our industry to measure a company’s operating performance without regard to items such as interest expense, depreciation and amortization, which can vary substantially from company to company depending upon accounting methods, the book value of assets, the capital structure and the method by which the assets were acquired; and (2) it helps investors more meaningfully evaluate and compare the results of our operations from period to period by removing the impact of our capital structure and asset base from our operating results.

 

 

26

 

		For the Years Ended
		June 30,
		2012			2013			Increase /			Percentage				2013
		RMB			RMB			(Decrease)			Change				USD
Reconciliation of Adjusted EBITDA to Net Income (Loss)
Net income (loss)		¥	(3,514,482)		¥	619,541		¥	4,134,023			117.6	%		$	100,116
Provision (benefit) for income taxes			(220,050)			286,871			506,921			230.4	%			46,358
Interest expense and foreign currency adjustment			1,009,127			1,323,726			314,599			31.2	%			213,911
Stock compensation expense			1,239,788			1,852,656			612,868			49.4	%			299,385
Depreciation and amortization			361,790			618,552			256,762			71.0	%			99,957
Adjusted EBITDA		¥	(1,123,827)		¥	4,701,346		¥	5,825,173			518.3	%		$	759,727

 

Adjusted EBITDA improved by approximately ¥5.8 million ($1 million) to approximately ¥4.7 million ($0.8 million) for the year ended June 30, 2013 compared to loss of approximately ¥1.1 million for the same period in 2012 as a result of increased revenues and lower operating expenses. Compared to net income attributable to ordinary shareholders, we believe EBITDA more accurately reflects our operations.

Cash and Cash Equivalents. Cash and cash equivalents are comprised of cash on hand, demand deposits and highly liquid short-term debt investments with stated maturities of no more than six months. As of June 30, 2013, we had cash and cash equivalents in the amount of approximately ¥12.4 million ($2 million).

 

Indebtedness. As of June 30, 2013, we had approximately ¥0.6 ($0.1 million) of short-term borrowings from third parties, approximately ¥5.5 million ($0.9 million) of short-term borrowings from related parties, and ¥10 million ($1.6 million) in commercial loans from two local banks. Other than these amounts, we did not have any finance leases or purchase commitments, guarantees or other material contingent liabilities.

 

Holding Company Structure. We are a holding company with no operations of our own. All of our operations are conducted through our Domestic Companies. As a result, our ability to pay dividends and to finance any debt that we may incur is dependent upon the receipt of dividends and other distributions from the Domestic Companies. In addition, Chinese legal restrictions permit payment of dividends to us by our Domestic Companies only out of their accumulated net profit, if any, determined in accordance with Chinese accounting standards and regulations. Under Chinese law, our Domestic Companies are required to set aside a portion (at least 10%) of their after-tax net income (after discharging all cumulated loss), if any, each year for compulsory statutory reserve until the amount of the reserve reaches 50% of our Domestic Companies’ registered capital. These funds may be distributed to shareholders at the time of each Domestic Company’s wind up.

 

Off-Balance Sheet Arrangements. We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. In addition, we have not entered into any derivative contracts that are indexed to our own shares and classified as shareholders’ equity, or that are not reflected in our financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. Moreover, we do not have any variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

 

27

 

Capital Resources. To date we have financed our operations primarily through cash flows from operations, bank loans and short-term borrowings. As of June 30, 2013, we had total assets of approximately ¥135.5 million ($21.9 million), which includes cash amounting to approximately ¥12.4 million ($2 million), net accounts receivable from third parties amounting to approximately ¥38.6 million ($6.2 million), and net accounts receivable from related parties amounting to approximately ¥18.7 million ($3 million). Working capital amounted to approximately ¥82.0 million ($13.2 million), and shareholders’ equity amounted to approximately ¥81.5 million ($13.2 million). Our management believes, as most of our accounting receivables can be collected in one year, our working capital will be sufficient to satisfy our liquidity requirement of current operations for the next 12 months.

 

Cash from Operating Activities. Net cash provided by operating activities was approximately ¥24.8 million ($4 million) for the year ended June 30, 2013. This was an increase of approximately ¥46.5 million ($7.5 million) compared to net cash used in operating activities of approximately ¥21.7 million for year ended June 30, 2012. This increase was mainly due to the fact that we earned net profit in fiscal 2013 while we experienced net losses in fiscal 2012. In more detail:

 

Cash from Investing Activities. Net cash used in investing activities was approximately ¥2.1 million ($0.3 million) for the year ended June 30, 2013, an increase of ¥1.3 million ($0.2 million) from ¥0.8 million for the same period of 2012. The increase in net cash used in investing activities was mainly due to an approximately ¥1.5 million increase in long-term investment for a 32.2% equity investment in a U.S. oil and natural gas company offset by ¥0.2 million increase in proceeds from disposal of fixed assets and a decrease of approximately ¥86,000 in purchase of property and equipment.

 

Cash from Financing Activities. Net cash used in financing activities amounted to approximately ¥14.2 million ($2.3 million) for the year ended June 30, 2013, compared to cash flows provided by financing activities of approximately ¥22.7 million for the year ended June 30, 2012. During the year ended June 30, 2013, we repaid ¥23 million ($3.7 million) in commercial bank loans and received ¥10 million ($1.6 million) in loans from two banks, which were guaranteed by one of our shareholders, Mr. Chen Guangqiang, who is also an officer and director of our company.

 

Working Capital. Total working capital as of June 30, 2013 amounted to approximately ¥82 million ($13.2 million), compared to approximately ¥74.2 million as of June 30, 2012. Total current assets as of June 30, 2013 amounted to approximately ¥128.7 million ($20.8 million), a decrease of approximately ¥11.4 million ($1.6 million) compared to approximately ¥140.1 million at June 30, 2012. The decrease in total current assets at June 30, 2013 compared to June 30, 2012 was mainly due to decrease of trade accounts receivable and inventory.

 

Current liabilities amounted to approximately ¥46.7 million ($7.6 million) at June 30, 2013, in comparison to approximately ¥65.9 million at June 30, 2012, a decrease of approximately ¥19.2 million ($3.1 million). This reduction of liabilities was attributable mainly to payment of trade accounts payable and taxes and repayment of short-term bank loans and short-term borrowings of non-related parties.

 

 

The Company is not required to provide the information required by this Item because the Company is a smaller reporting company.

 

The Company’s financial statements and the related notes, together with the report of Friedman LLP for the years ended June 30, 2013 and 2012 are set forth following the signature pages of this report.

 

 

None.

 

 

As of June 30, 2013, our company carried out an evaluation, under the supervision of and with the participation of management, including our Company’s chief executive officer and chief financial officer, of the effectiveness of the design and operation of our Company’s disclosure controls and procedures. Included in this Annual Report on Form 10-K, the chief executive officer and chief financial officer concluded that our Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) were ineffective in timely alerting them to information required to be included in the Company’s periodic U.S. Securities and Exchange Commission (the “Commission”) filings.

 

Management continues to focus on internal control over financial reporting. As of June 30, 2013, the Company has completed certain documentation of our internal controls and implemented the following remedial initiatives:

28

 

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:

 

(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets;

 

(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that the Company’s receipts and expenditures are being made only in accordance with the authorization of its management and directors; and

 

(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

The Company’s management assessed the effectiveness of its internal control over financial reporting as of June 30, 2013. In making this assessment, management used the 1992 framework set forth in the report entitled Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework(old) summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Based on this assessment, the Company’s management believes that, as of June 30, 2013, its internal control over financing reporting is not effective based on those criteria.

 

The specific material weaknesses identified by the Company’s management as of June 30, 2013 are described as follows:

We did not have sufficient skilled accounting personnel who are either qualified as Certified Public Accountants in the U.S. or who have received education from U.S. institutions or other educational programs that would provide enough relevant education relating to U.S. GAAP. The Company’s CFO and Controller have limited experience with U.S. GAAP and are not U.S. Certified Public Accountants. Further, our operating subsidiaries are based in China, and in accordance with PRC laws and regulations, are required to comply with PRC GAAP, rather than U.S. GAAP. Thus, the accounting skills and understanding necessary to fulfill the requirements of U.S. GAAP-based reporting, including the preparation of consolidated financial statements, are inadequate, and determined to be a material weakness.

 

We recently completed our designs of our internal controls and assessments for all of our financial reporting cycles during fiscal year 2013, and we are unable to declare effectiveness of our controls due to lack of sufficient time to obtain evidence of operating effectiveness as of June 30, 2013 due to lack of monitoring of our internal controls (lack of self-testing of internal controls). Therefore, we determined that the lack of time to evaluate our design and operating effectiveness is a material weakness. It should be noted, however, that (a) many actions had been undertaken to enhance the control environment during the year; and (b) there are other remedial activities that are scheduled to be take place in fiscal 2014.

 

As a result, the Company has developed remedial actions to strengthen its accounting and financial reporting functions as well as the related disclosure controls and procedures. Such plan will require the hiring of additional resources and the deployment of other corporate resources for the accounting department in relation to the financial reporting process. Such additional resources will include the establishment of a work force dedicated to the task of correcting past financial irregularities and maintaining correct financial reporting on an on-going basis. To strengthen the Company’s internal control over financial reporting, the Company engaged outside consultants that are skilled in SEC reporting and Section 404 compliance to assist in the implementation of the following remedial actions, which have been completed as of the date of this report:

 

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In addition to the foregoing efforts, the Company expects to implement the following remedial actions during fiscal year 2014:

• Develop a comprehensive training and development plan, for our finance, accounting and internal audit personnel, including our Chief Financial Officer, Controller, and others, in the principles and rules of U.S. GAAP, SEC reporting requirements and the application thereof.

 

• Hire a full-time employee who possesses the requisite U.S. GAAP experience and education

 

• Monitoring of internal controls by performing self-testing of various key controls.

Despite the material weaknesses and deficiencies reported above, our management believes that our consolidated financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented and that this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

None.

 

 

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The following table sets forth our executive officers and directors, their ages and the positions held by them:

Name		Age		Position Held
Mr. Yin Shenping		44		Chief Executive Officer and Director
Ms. Liu Jia		30		Chief Financial Officer
Mr. Chen Guangqiang		50		Chief Technology Officer and Director
Mr. Zhao Shudong		67		Independent Director
Mr. Nelson N.S. Wong		51		Independent Director (Audit Committee Chair)
Mr. Hu Jijun		48		Independent Director

 

Yin Shenping. Mr. Yin is our Chief Executive Officer. In 2003, Mr. Yin founded Nanjing Recon, a Chinese company that provides services to automate and enhance the extraction of petroleum in China, and has been the Chief Executive Officer since that time. Prior to founding Nanjing Recon, Mr. Yin served as a sales manager for Fujian Haitian Network Company from 1992 through 1994. Mr. Yin has founded and operated a number of companies: Xiamen Hengda Haitian Computer Network Co., Ltd. (1994), Baotou Hengda Haitian Computer Network Co., Ltd. (1997) and Beijing Jingke Haitian Electronic Technology Development Co., Ltd. (1999), and Jingsu Huasheng Information Technology Co., Ltd. (2000). In 2000, Mr. Yin merged the former Nanjing Kingsley Software Engineering Co., Ltd. into Nanjing Recon. Mr. Yin received his bachelor’s degree in 1991 from Nanjing Agricultural University in information systems. Mr. Yin has been chosen as a director because he is one of the founders of the Company and we believe his knowledge of the Company and years of experience in our industry give him the ability to guide the Company as a director.

Liu Jia. Ms. Liu has served as our Chief Financial Officer since 2008. In 2008 Ms. Liu assisted Heilongjiang Province Jintian Group with financial due diligence, field surveys and data analysis. While in college Ms. Liu served internships in Xinghua Certified Public Accountants, Ltd., Beijing Zhongweihuahao Accountants Affairs Office, Tiantong Securities Co., Ltd. and Industrial and Commercial Bank of China, which internships focused on auditing, accounting and data analysis. Ms. Liu received her bachelor’s degree in 2006 from Beijing University of Chemical Technology, School of Economics and Management and her master’s degree in industrial economics in 2009 from Beijing Wuzi University.

 

Chen Guangqiang. Mr. Chen has served as our Chief Technology Officer since 2003. Mr. Chen was a geological engineer for the Fourth Oil Extraction Plant of Huabei Oil Field from 1985 through 1993. From 1993 through 1999, Mr. Chen was a chief engineer for Xinda Company, CNPC Development Bureau. From 1999 through 2003, Mr. Chen served as the general manager of Beijing Adar. Mr. Chen received his bachelor’s degree in 1985 from Southwest Petroleum Institute. Mr. Chen has been chosen as a director because he is one of the founders of the Company and we believe we can benefit from his years of engineering experience and management experience in the oil extraction industry.

 

Nelson N.S. Wong. Mr. Wong joined our Board of Directors in 2008. In 1990 Mr. Wong joined the Vigers Group, a real estate company that provides services in valuation, corporate property services, investment advisory services, general practice surveying, building surveying, commercial, retail and industrial agency, and property and facilities management. Mr. Wong became the Vice Chairman and CEO of the Vigers Group in 1993. In 1995 Mr. Wong established the ACN Group, a business consulting firm, where he has worked continuously and continues to serve as the Chairman and Managing Partner. Mr. Wong received a bachelor’s degree in arts from the PLA Institute of International Relations in Nanjing in 1983. Mr. Wong has been chosen as a director because we believe we can benefit from his leadership skills and management experience.

 

 

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Hu Jijun. Mr. Hu joined our Board of Directors in 2008. From 1988 to 2003, Mr. Hu served in a variety of positions at our No. 2 test-drill plant, including technician of installation, assets equipment work, electrical installation, control room production dispatcher, Deputy Chief Engineer of the Technology Battalion, and Deputy Director of Production. From 2003 to 2005 he served as Head of the Integrated Battalion and he is currently the Head of the Transport Battalion, Senior Electric Engineer. Mr. Hu graduated as an automated professional from the China University of Petroleum in 1988. Mr. Hu has been chosen as a director because we believe his years of experience and knowledge gained while working at our No. 2 test-drill plant will prove beneficial to the guidance of the Company.

 

Zhao Shudong. Before retiring in 2006, Mr. Zhao spent over 30 years working in the oilfield industry. From 1970 to 1976, Mr. Zhao worked as a technician in the Daqing oilfield. From 1976 to 1982, Mr. Zhao served as the vice director of the Hubei Oilfield Generalized Geologic Technical Research Institute. Mr. Zhao then spent 11 years as a director and section chief at the Scientific and Technological Development Department of the Huabei Petroleum Administrative Bureau. He was subsequently appointed Chief Geologist of the bureau, a position he held from 1993 to 1999. From 1999 to 2006, Mr. Zhao served as the General Manager of the Huabei Oilfield Company of CNPC. Mr. Zhao studied at the Northeast Petroleum Institute from 1965 to 1970. Mr. Zhao has been chosen as a director nominee because of his extensive experience in the oilfield industry.

 

We have employment agreements with each of our Chief Executive Officer, Chief Technology Officer and Chief Financial Officer. With the exception of the employment agreement with our Chief Financial Officer, each of these employment agreements provides for an indefinite term. Such employment agreements may be terminated (1) if the employee gives written notice of his or her intention to resign, (2) the employee is absent from three consecutive meetings of the Board of Directors, without special leave of absence from the other members of the Board of Directors, and the Board of Directors passes a resolution that such employee has vacated his office, or (3) the death, bankruptcy or mental incapacity of the employee. The employment agreement for our Chief Financial Officer provides for a one-year term, currently expiring on March 12, 2014. Such employment agreement may be terminated if the employee gives thirty days’ written notice of her intention to resign, or if the Board of Directors determines she can no longer perform her duties as Chief Financial Officer and provides her with thirty days’ written notice of termination.

 

Under Chinese law, we may only terminate employment agreements without cause and without penalty by providing notice of non-renewal one month prior to the date on which the employment agreement is scheduled to expire. If we fail to provide this notice or if we wish to terminate an employment agreement in the absence of cause, then we are obligated to pay the employee one month’s salary for each year we have employed the employee. We are, however, permitted to terminate an employee for cause without penalty to the Company, where the employee has committed a crime or the employee’s actions or inactions have resulted in a material adverse effect to us.

 

In connection with our initial public offering, we established a pool for share options for the Domestic Companies’ and our employees. This pool contains options to purchase up to 790,362 of our ordinary shares. The options will vest at a rate of 20% per year for five years and have an exercise price of the market price of our shares on the date the options are granted. To date, we issued 608,000 options out of our employee share option pool. We initially granted 293,000 options in 2009. We held a shareholder meeting in December 2010 and announced the resignation of three directors, and as a result, 100,000 options were forfeited and went back to the pool. In 2012, we granted an additional 415,000 options. Currently, we have 608,000 options outstanding.

 

 

Our board of directors currently consists of five (5) members. There are no family relationships between any of our executive officers and directors.

 

 

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The directors are divided into three classes, as nearly equal in number as the then total number of directors permits. Class I directors shall face re-election at our annual general meeting of shareholders in 2014 and every three years thereafter. Class II directors shall face re-election at our annual general meeting of shareholders in 2015 and every three years thereafter. Class III directors shall face re-election at our annual general meeting of shareholders in 2016 and every three years thereafter.

 

If the number of directors changes, any increase or decrease will be apportioned among the classes so as to maintain the number of directors in each class as nearly as possible. Any additional directors of a class elected to fill a vacancy resulting from an increase in such class will hold office for a term that coincides with the remaining term of that class. Decreases in the number of directors will not shorten the term of any incumbent director. These board provisions could make it more difficult for third parties to gain control of the Company by making it difficult to replace members of our Board of Directors.

 

A director may vote in respect of any contract or transaction in which he is interested, provided, however, that the nature of the interest of any director in any such contract or transaction shall be disclosed by him at or prior to its consideration and any vote on that matter. A general notice or disclosure to the directors or otherwise contained in the minutes of a meeting or a written resolution of the directors or any committee thereof that a director is a shareholder of any specified firm or company and is to be regarded as interested in any transaction with such firm or company shall be sufficient disclosure and after such general notice it shall not be necessary to give special notice relating to any particular transaction.

There are no membership qualifications for directors. Further, there are no share ownership qualifications for directors unless so fixed by us in a general meeting.

 

The Board of Directors maintains a majority of independent directors who are deemed to be independent under the definition of independence provided by NASDAQ Stock Market Rule 4200(a)(15). Mr. Zhao, Mr. Wong, and Mr. Hu are our independent directors.

 

Mr. Yin Shenping currently holds both the positions of Chief Executive Officer and Chairman of the Board. These two positions have not been consolidated into one position; Mr. Yin simply holds both positions at this time. We do not have a lead independent director because of the foregoing reason and also because we believe our independent directors are encouraged to freely voice their opinions on a relatively small company board. We believe this leadership structure is appropriate because we are a smaller reporting company that recently became listed on a public exchange; as such we deem it appropriate to be able to benefit from the guidance of Mr. Yin as both our principal executive officer and Chairman of the Board.

 

Our Board of Directors plays a significant role in our risk oversight. The Board of Directors makes all relevant Company decisions. As such, it is important for us to have our Chief Executive Officer serve on the Board as he plays a key role in the risk oversight of the Company. As a smaller reporting company with a small board of directors, we believe it is appropriate to have the involvement and input of all of our directors in risk oversight matters.

 

Currently, three committees have been established under the board: the audit committee, the compensation committee and the nominating committee. All of these committees consist solely of independent directors.

 

The audit committee is responsible for overseeing the accounting and financial reporting processes of the Company and audits of the financial statements of the Company, including the appointment, compensation and oversight of the work of our independent auditors. Mr. Wong qualifies as the audit committee financial expert and serves as the chair of the audit committee.

 

The compensation committee of the board of directors reviews and makes recommendations to the board regarding our compensation policies for our officers and all forms of compensation, and also administers our incentive compensation plans and equity-based plans (but our board retains the authority to interpret those plans). Mr. Hu serves as the chair of the compensation committee.

 

The nominating committee of the board of directors is responsible for the assessment of the performance of the board, considering and making recommendations to the board with respect to the nominations or elections of directors and other governance issues. The nominating committee considers diversity of opinion and experience when nominating directors. Mr. Zhao serves as the chair of the nominating committee.

 

 

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There are no other arrangements or understandings pursuant to which our directors are selected or nominated.

 

Under Cayman Islands law, our directors have a fiduciary duty to the Company to act in good faith in their dealings with or on behalf of the Company and exercise their powers and fulfill the duties of their office honestly. This duty has four essential elements: