UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31,June 30, 2005or
oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
Commission File Number: 333-61286
KID CASTLE EDUCATIONAL CORPORATION
(Exact name of Registrant as specified in its charter)
Florida
59-2549529
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
8th Floor, No. 98 Min Chuan Road, Hsien Tien
Taipei, Taiwan ROC
(Address of principal executive offices)
Registrant’s telephone number, including area code: 011-886-22218 5996
Securities registered pursuant to Section 12(b) of the Act:
Securities registered under Section 12(g) of the Act:
Title of class
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the last ninety days. Yes [X] No _
Yesþ Noo
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). [ ] Yes [X] No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
Yeso Noþ
As of May 10,August 19, 2005, there were 18,999,703 shares of the Registrant’s common stock outstanding.
#
Documents incorporated by reference: None.
FORM 10-Q
KID CASTLE EDUCATIONAL CORPORATION
TABLE OF CONTENTS
i
KID CASTLE EDUCATIONAL CORPORATION
UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS.
AS OF MARCH 31, 2005 AND DECEMBER 31, 2004ANDFOR THE THREE MONTHS ENDEDMARCH 31, 2005 AND 2004
KID CASTLE EDUCATIONAL CORPORATIONINDEX TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
-2-
Kid Castle Educational Corporation
Condensed Consolidated Balance Sheets
(Expressed in US Dollars)
March 31, | December 31, | |||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Current assets | ||||||||
Cash and bank balances | $ | 173,169 | $ | 213,564 | ||||
Bank fixed deposits – pledged (Note 12) | 354,416 | 294,331 | ||||||
Notes and accounts receivable, net (Notes 5 and 10) | 2,903,221 | 2,401,904 | ||||||
Inventories, net (Note 6) | 2,983,890 | 2,979,738 | ||||||
Other receivables (Notes 7 and 10) | 420,351 | 337,848 | ||||||
Prepayments and other current assets (Note 10) | 440,200 | 478,752 | ||||||
Pledged notes receivable (Note 12) | 1,220,482 | 1,218,356 | ||||||
Deferred income tax assets | 256,105 | 218,574 | ||||||
Total current assets | 8,751,834 | 8,143,067 | ||||||
Deferred income tax assets | 167,093 | 170,477 | ||||||
Prepaid interest in associates | — | 24,165 | ||||||
Interest in associates (Note 8) | 137,213 | 99,467 | ||||||
Property and equipment, net | 2,173,300 | 2,188,092 | ||||||
Intangible assets, net of amortization (Note 11) | 856,147 | 894,419 | ||||||
Long-term notes receivable | 224,185 | 240,971 | ||||||
Pledged notes receivable (Note 12) | 573,832 | 407,149 | ||||||
Other assets | 570,168 | 613,617 | ||||||
Total assets | $ | 13,453,772 | $ | 12,781,424 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities | ||||||||
Borrowings – short-term and maturing within one year (Note 12) | $ | 2,443,026 | $ | 2,632,982 | ||||
Notes and accounts payable (Note 10) | 1,574,181 | 1,506,543 | ||||||
Accrued expenses | 855,018 | 703,407 | ||||||
Other payables | 368,333 | 283,080 | ||||||
Deposits received | 668,432 | 498,266 | ||||||
Receipts in advance (Note 13) | 2,831,244 | 2,996,558 | ||||||
Income tax payable (Note 9) | 213,196 | 97,142 | ||||||
Obligation under capital leases due within one year | 27,572 | 8,659 | ||||||
Total current liabilities | 8,981,002 | 8,726,637 | ||||||
Borrowings maturing after one year (Note 12) | 1,877,956 | 1,651,825 | ||||||
Receipts in advance (Note 13) | 1,421,803 | 1,124,809 | ||||||
Obligation under capital leases | 27,280 | — | ||||||
Deposits received | 594,136 | 689,530 | ||||||
Accrued pension liabilities (Note 14) | 190,820 | 160,907 | ||||||
Total liabilities | 13,092,997 | 12,353,708 | ||||||
-3-
June 30, 2005
(Unaudited)
(Audited)
Current Assets:
Cash and bank balances
$
766,626
$
213,564
Bank fixed deposits – pledged
355,850
294,331
Notes and accounts receivable, net
4,570,800
2,401,904
Inventories
3,024,509
2,979,738
Other receivables
426,502
337,848
Prepayments and other currant assets
672,309
478,752
Pledged notes receivable
---
1,218,356
Deferred income tax assets
256,105
218,574
Total current assets
10,072,701
8,143,067
Deferred income tax assets
167,093
170,477
Prepaid interest in associates
---
24,165
Interest in associates
137,213
99,467
Property and equipment, net
2,189,853
2,188,092
Intangible assets, net of amortization
834,743
894,419
Long-term notes receivable
--
240,971
Pledged notes receivable
--
407,149
Other assets
620,127
613,617
Total Assets
$ 14,021,730
$ 12,781,424
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Borrowings – short-term and maturing
within one year
$ 2,177,097
$ 2,632,982
Notes and accounts payable
2,282,930
1,506,543
Accrued expenses
856,836
703,407
Other payables
511,361
283,080
Deposits received
350,801
498,266
Receipts in advance
4,316,920
2,996,558
Income tax payable
180,864
97,142
Obligation under capital leases due within one year
---
8,659
Total current liabilities
10,676,809
8,726,637
Borrowings maturing after one year
1,848,709
1,651,825
Receipts in advance
---
1,124,809
Obligation under capital leases
---
---
Deposits received
939,546
689,530
Accrued pension liabilities
219,917
160,907
Total liabilities
13,684,981
12,353,708
Minority Interests
53,139
33,791
Kid Castle Educational Corporation
Condensed Consolidated Balance Sheets - Continued
(cont.)
(Expressed in US Dollars)
March 31, | December 31, | |||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Commitments and contingencies (Note 16) | ||||||||
Minority interest | 33,950 | 33,791 | ||||||
Shareholders’ equity | ||||||||
Common stock, no par share: | ||||||||
25,000,000 shares authorized; 18,999,703 shares issued and outstanding at March 31, 2005 and December 31, 2004 | 7,669,308 | 7,669,308 | ||||||
Additional paid-in capital | 194,021 | 194,021 | ||||||
Legal reserve | 65,320 | 65,320 | ||||||
Accumulated deficit | (7,362,504 | ) | (7,312,074 | ) | ||||
Accumulated other comprehensive loss | (239,320 | ) | (222,650 | ) | ||||
Total shareholders’ equity | 26,825 | 393,925 | ||||||
Total liabilities and shareholders’ equity | $ | 13,453,772 | $ | 12,781,424 | ||||
(Unaudited)
June 30, 2005
December 31, 2004
(Unaudited)
(Audited)
Stockholders’ Equity:
Capital Stock
7,669,308
7,669,308
Additional paid in capital
194,021
194,021
Statutory reserve
65,320
65,320
Retained deficit
(7,570,531)
(7,312,074)
Accumulated other comprehensive
loss
(74,508)
(222,650 )
Total stockholders’ equity
283,610
393,925
Total Liabilities and Stockholders’ Equity
$
14,021,730
$
12,781,424
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
#
Kid Castle Educational Corporation
Condensed Consolidated Balance Sheets
(Expressed in US Dollars)
(Unaudited)
Six Month Periods Ended June 30,
2005
2004
Operating Revenue:
Sales of goods
$
3,549,331
$
3,216,779
Franchising income
1,308,046
1,192,740
Other operating revenue
306,348
203,914
Total net operating revenue
5,163,725
4,613,433
Operating costs:
Cost of goods sold
1,507,173
1,324,923
Cost of franchising
176,655
245,504
Other operating costs
177,271
135,739
Total operating costs
1,861,099
1,706,166
Gross profit
3,302,626
2,907,267
Advertising costs
(56,854)
( 454,492)
Other operating expenses
(3,250,544)
(3,430,104)
Loss from operations
(4,772)
(977,329)
Interest expenses, net
(115,983)
(64,936)
Share of income of investments
12,483
31,425
Other non-operating income, net
53,624
81,770
Loss before income taxes
and minority interest
(54,648)
(929,070)
Provision for taxes
( 184,750)
(1,222)
Loss before minority interest
(239,398)
(930,292)
Minority interest
in income
(19,059)
---
Net loss
$
(258,457)
$
(930,292)
Loss per share – basic and diluted
$ ( .01)
$ ( .05)
Weighted-average shares used to compute loss per share – basic and diluted
18,999,703
18,999,703
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
Kid Castle Educational Corporation
Condensed Consolidated Balance Sheets
(Expressed in US Dollars)
(Unaudited)
Three Month Periods Ended June 30,
2005
2004
Operating Revenue
Sales of goods
$
1,174,176
$
1,186,926
Franchising income
710,121
664,608
Other operating revenue
156,436
151,561
Total net operating revenue
2,040,733
2,003,095
Operating costs
Cost of goods sold
579,442
650,418
Cost of franchising
63,042
113,403
Other operating costs
103,075
78,544
Total operating costs
745,559
842,365
Gross profit
1,295,174
1,160,730
Advertising costs
(23,491)
(327,850)
Other operating expenses
(1,465,044 )
(1,413,680)
Loss from operations
(193,361)
(580,800)
Interest expenses, net
(56,730)
(43,171)
Share of loss of investments
---
(15,542)
Other non-operating (loss) income, net
102,563
38,097
Loss before income taxes and
minority interest income
(147,528)
(601,416)
Provision for taxes
(41,297)
( 1,222)
Loss before minority interest
(188,825)
(602,638)
Minority interest income
(19,202 )
---
Net loss
$ (208,027)
$
(602,638)
Loss per share – basic and diluted
$ ( .01)
$
( .03)
Weighted-average shares used to computer loss
per share-basic and diluted
18,999,703
18,999,703
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
-4-
#
Kid Castle Educational Corporation
Condensed Consolidated Statements of OperationsBalance Sheets
(Expressed in US Dollars)
Three months ended March 31, | ||||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Operating Revenue | ||||||||
Sales of goods | $ | 2,375,155 | $ | 2,029,853 | ||||
Franchising income | 597,925 | 528,132 | ||||||
Other operating revenue | 149,912 | 52,353 | ||||||
Total net operating revenue | 3,122,992 | 2,610,338 | ||||||
Operating costs | ||||||||
Cost of goods sold | (927,731 | ) | (674,505 | ) | ||||
Cost of franchising | (113,613 | ) | (132,101 | ) | ||||
Other operating costs | (74,196 | ) | (57,195 | ) | ||||
Total operating costs | (1,115,540 | ) | (863,801 | ) | ||||
Gross profit | 2,007,452 | 1,746,537 | ||||||
Advertising costs | (33,363 | ) | (126,642 | ) | ||||
Other operating expenses | (1,785,500 | ) | (2,016,424 | ) | ||||
Income (loss) from operations | 188,589 | (396,529 | ) | |||||
Interest expenses, net | (59,253 | ) | (21,765 | ) | ||||
Share of loss of investments | 12,483 | 46,967 | ||||||
Other non-operating (loss) income, net | (48,939 | ) | 43,673 | |||||
Income (loss) before income taxes and minority interest income | 92,880 | (327,654 | ) | |||||
Provision for taxes | (143,453 | ) | — | |||||
Loss before minority interest income | (50,573 | ) | (327,654 | ) | ||||
Minority interest income | 143 | — | ||||||
Net loss | $ | (50,430 | ) | $ | (327,654 | ) | ||
Loss per share – basic and diluted | $ | (0.003 | ) | $ | (0.017 | ) | ||
Weighted-average shares used to compute (loss) earnings per share – basic and diluted | 18,999,703 | 18,999,703 | ||||||
(Unaudited)
Six Month Periods Ended June 30 ,
2005
2004
Cash flows from operating activities:
Net loss
$
(258,457)
$
(930,292)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization
223,862
188,553
Allowance for sales returns
92,463
(13,126)
Allowance for doubtful debts
110,063
130,866
Provision for (reversal of) allowance for loss
on inventory obsolescence and slow-moving items
95,147
34,970
Minority interest in income
19,059
---
Share of gain of investments
(12,483)
(31,425)
(Increase)/decrease in:
Notes and accounts receivable
(2,371,422)
402,524
Inventories
(139,918)
(185,880)
Other receivables
(88,654)
(202,283)
Prepayments and other current assets
(169,392)
9,484
Deferred income tax assets
(34,147)
3,306
Other assets
( 6,510)
(86,257)
Increase/(decrease) in:
Notes and accounts payable
776,387
219,374
Accrued expenses
153,429
( 36,063)
Other payables
228,281
205,497
Receipts in advance
195,553
(202,230)
Income taxes payable
83,722
(3,306)
Deposits received
102,551
99,576
Accrued pension liabilities
59,010
8,882
Net cash used in operating activities
(941,456)
(387,830)
Cash flows from investing activities
Purchases of property and equipment
(165,947)
( 47,371)
Proceeds from disposal of property and equipment
---
---
Bank fixed deposits – pledged
(61,519)
(111,678)
Pledged notes receivable
1,625,505
11,407
Collection of long term notes
240,971
---
Increase in interest in associates
( 24,977)
---
Acquisition of long term investments
---
(103,346)
Net cash used in investing activities
1,614,033
(250,988)
Kid Castle Educational Corporation
Condensed Consolidated Balance Sheets
(Expressed in US Dollars)
(Unaudited)
Six Months Periods Ended June 30 ,
2005
2004
Cash flows from financing activities
Proceeds from bank borrowings
795,968
2,865,929
Repayment of bank borrowings
(1,054,969)
(2,346,878)
Proceeds from capital leases
57,086
(13,933)
Repayment of capital leases
(65,748
---
Repayment of loan from officers/stockholders
----
(585,006)
Net cash consumed by financing activities
(267,657)
(79,888)
Net increase (decrease) in cash and cash equivalents
404,920
(718,706)
Effect of changes in exchange rate on cash and
148,142
(12,829)
cash equivalents
Cash and cash equivalents at beginning of period
213,564
1,273,723
Cash and cash equivalents at end of period
$ 766,626
$
542,188
Supplemental disclosure of cash flows information:
Cash payments for income taxes were $86,801for the 2005 period and $ 1,222 in the 2004 period. Cash payments for interest were $ 106,178 in the 2005 period and $ 64,936 in the 2004 period. None of the interest was capitalized.
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
-5-
#
Kid Castle Educational Corporation
Condensed Consolidated Statements of Stockholders’ Equity
(Expressed in US Dollars)
Common Stock | ||||||||||||||||||||||||||||
Accumulated | ||||||||||||||||||||||||||||
Additional | other | |||||||||||||||||||||||||||
Number of | paid-in | Legal | Accumulated | comprehensive | ||||||||||||||||||||||||
shares | Amount | capital | reserve | deficit | loss | Total | ||||||||||||||||||||||
Balance, December 31, 2003 | 18,999,703 | 7,669,308 | 194,021 | 65,320 | (6,057,482 | ) | (163,170 | ) | 1,707,997 | |||||||||||||||||||
Net loss for 2004 | — | — | — | — | (1,254,592 | ) | — | (1,254,592 | ) | |||||||||||||||||||
Cumulative translation adjustment | — | — | — | — | — | (59,480 | ) | (59,480 | ) | |||||||||||||||||||
Comprehensive loss | (1,314,072 | ) | ||||||||||||||||||||||||||
Balance, December 31, 2004 | 18,999,703 | $ | 7,669,308 | $ | 194,021 | $ | 65,320 | $ | (7,312,074 | ) | $ | (222,650 | ) | $ | 393,925 | |||||||||||||
Net loss for the three months ended March 31, 2005 (Unaudited) | — | — | — | — | (50,430 | ) | — | (50,430 | ) | |||||||||||||||||||
Cumulative translation adjustment (Unaudited) | — | — | — | — | — | (16,670 | ) | (16,670 | ) | |||||||||||||||||||
Comprehensive loss (Unaudited) | (67,100 | ) | ||||||||||||||||||||||||||
Balance, March 31, 2005 (Unaudited) | 18,999,703 | $ | 7,669,308 | $ | 194,021 | $ | 65,320 | $ | (7,362,504 | ) | $ | (239,320 | ) | $ | 326,825 | |||||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
-6-
Kid Castle Educational Corporation
Condensed Consolidated Statements of Cash Flows
(Expressed in US Dollars)
Three months ended March 31, | ||||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Cash flows from operating activities | ||||||||
Net loss | $ | (50,430 | ) | $ | (327,654 | ) | ||
Adjustments to reconcile net loss to net cash provided by (used in) operating activities | ||||||||
Depreciation of property and equipment | 66,681 | 52,266 | ||||||
Amortization of intangible assets | 42,835 | 40,509 | ||||||
Allowance for sales returns | 95,267 | 71,890 | ||||||
Allowance for doubtful debts | 284,537 | 156,221 | ||||||
Provision for (reversal of) allowance for loss on inventory obsolescence and slow-moving items | 6,452 | (69,180 | ) | |||||
Gain on disposal of property and equipment | (9,010 | ) | — | |||||
Minority interest income | (143 | ) | — | |||||
Share of gain of investments | (12,483 | ) | (46,967 | ) | ||||
(Increase)/decrease in: | ||||||||
Notes and accounts receivable | (775,674 | ) | 192,461 | |||||
Inventories | 4,514 | 204,320 | ||||||
Other receivables | (129,129 | ) | 72,016 | |||||
Prepayments and other current assets | 41,002 | (6,073 | ) | |||||
Deferred income tax assets | (32,194 | ) | 3,314 | |||||
Other assets | 46,591 | (31,084 | ) | |||||
Increase/(decrease) in: | ||||||||
Notes and accounts payable | 60,036 | 107,712 | ||||||
Accrued expenses | 148,876 | (46,463 | ) | |||||
Other payables | 124,933 | (76,311 | ) | |||||
Receipts in advance | (147,307 | ) | (261,384 | ) | ||||
Income taxes payable | 115,635 | (3,314 | ) | |||||
Deposits received | 67,207 | 29,413 | ||||||
Accrued pension liabilities | 29,115 | (16,266 | ) | |||||
Net cash provided by (used in) operating activities | (22,689 | ) | 45,426 | |||||
Cash flows from investing activities | ||||||||
Purchase of property and equipment | (104,562 | ) | — | |||||
Proceeds from disposal of property and equipment | 72,795 | — | ||||||
Bank fixed deposits – pledged | (58,629 | ) | (135,818 | ) | ||||
Pledged notes receivable | 29,990 | 30,129 | ||||||
Net cash used in investing activities | (60,406 | ) | (105,689 | ) | ||||
-7-
Kid Castle Educational Corporation
Condensed Consolidated Statements of Cash Flows – Continued
(Expressed in US Dollars)
Three months ended March 31, | ||||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Cash flows from financing activities | ||||||||
Proceeds from bank borrowings | $ | 795,968 | $ | 2,829,827 | ||||
Repayment of bank borrowings | (781,513 | ) | (2,169,859 | ) | ||||
Proceeds from capital leases | 57,089 | — | ||||||
Repayment of capital leases | (10,910 | ) | (5,662 | ) | ||||
Repayment of loan from officers/stockholders | — | (586,529 | ) | |||||
Net cash provided by financing activities | 60,634 | 67,777 | ||||||
Net increase (decrease) in cash and cash equivalents | (22,461 | ) | 7,514 | |||||
Effect of exchange rate changes on cash and cash equivalents | (17,934 | ) | (30,792 | ) | ||||
Cash and cash equivalents at beginning of period | 213,564 | 1,273,723 | ||||||
Cash and cash equivalents at end of period | $ | 173,169 | $ | 1,250,445 | ||||
Supplemental disclosure of significant non-cash transactions | ||||||||
Increase (decrease) of notes receivable and pledged notes receivable corresponding to the increase (decrease) in the following accounts: | ||||||||
Deposits received | $ | 1,586 | $ | (18,896 | ) | |||
Other payables | $ | 6,473 | $ | (10,112 | ) | |||
Receipts in advance | $ | 258,156 | $ | (123,465 | ) | |||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
-8-
Kid Castle Educational Corporation
Notes to Condensed Consolidated Financial StatementsBalance Sheets
(Expressed in US Dollars)
NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS(Unaudited)
Kid Castle Internet Technologies Limited (“KCIT”) was incorporated on December 17, 1999 under the provisions of the Company Law of the Republic of China (“ROC”) as a limited liability company. KCIT is engaged in the business of children’s education focusing on the English language. The business comprises publication, sales and distribution of related books, magazines, audio and videotapes and compact disc, franchising and sales of merchandises complementary to the business. KCIT commenced operations in April 2000 when it acquired the above business from a related company, Kid Castle Enterprises Limited (“KCE”), which was owned by two directors and stockholders of KCIT.
On March 9, 2001, KCIT formed a wholly-owned subsidiary, Premier Holding Investment Property Limited incorporated in the British Virgin Islands, which held the entire common stock of Higoal Developments Limited (“Higoal”) incorporated in the Cayman Islands on March 8, 2001. On September 10, 2001, Higoal established a wholly owned subsidiary, Kid Castle Educational Software Development Company Limited (“KCES”) in the People’s Republic of China (the “PRC”). The existing operations of Higoal are principally located in Taiwan and are being expanded in the PRC. In June 2002, after KCIT undertook a series of group restructurings, KCIT became the direct owner of the outstanding shares of Higoal. Premier Holding Investment Property Limited was then liquidated in June 2003.
On September 18, 2002, Higoal issued 11,880,000 shares of common stock to the stockholders of KCIT in exchange for 100% of the outstanding common stock of KCIT. As a result of this reorganization, KCIT became a wholly owned subsidiary of Higoal. On October 1, 2002, Kid Castle Educational Corporation (the “Company”), formerly King Ball International Technology Limited Corporation entered into an exchange agreement with Higoal whereby the Company issued to the stockholders of Higoal 11,880,000 shares of common stock of the Company in exchange for 100% of the issued and fully paid up capital of Higoal.
As a result of the share exchange, the former stockholders of Higoal hold a majority of the Company’s outstanding capital stock. Generally accepted accounting principles require in certain circumstances that a company whose stockholders retain the majority voting interest in the combined business to be treated as the acquirer for financial reporting purposes. Accordingly, the acquisition has been accounted for as a “reverse acquisition” whereby Higoal is deemed to have purchased the Company. However, the Company remains the legal entity and the Registrant for Securities and Exchange Commission reporting purposes.
In July 2003, KCES entered into an agreement with 21st Century Publishing House to incorporate Jiangxi 21st Century Kid Castle Culture Media Co., Ltd (“Culture Media”). It was agreed that KCES and 21st Century Publishing House each owned 50% ownership and that each party contributed RMB$1 million for the incorporation. On July 2, 2004, KCES acquired additional 40% of ownership in Culture Media from 21st Century Publishing House. KCES now owns 90% of Culture Media.1.
-9-
The Company, Higoal and its subsidiaries collectively are referred to as the “Group”. The operations of the Group are principally located in Taiwan and the PRC.
NOTE 2 - BASIS OF PRESENTATION
The accompanyingunaudited interim condensed consolidated financial datastatements of Kid Castle Education Corporation (“the Company”) as of March 31,June 30, 2005, and for the six month and three monthsmonth periods ended March 31,June 30, 2005 and 2004, have been prepared by the Group, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of AmericaAmerica. In the opinion of management, such information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for such periods. The results of operations for the quarter ended June 30, 2005 are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2005.
Certain information and disclosures normally included in the notes to financial statements have been condensed or omitted pursuant to suchas permitted by the rules and regulations. However,regulations of the GroupSecurities and Exchange Commission, although the Company believes that the disclosures aredisclosure is adequate to make the information presented not misleading. TheseThe accompanying unaudited financial statements should be read in conjunction with the financial statements andof the notes theretoCompany included in the Group’s audited annual financial statementsreport on Form 10-K for the year ended December 31, 2004.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates.
The Group has incurred operating losses since inception and hence, as of March 31, 2005, the balance of accumulated deficit was $7,362,504. The Group plans to fund its working capital needs by obtaining new credit lines from financial institutions and raising capital through the sale of equity securities. If the Group is unable to meet its current operating plan, it will be required to obtain additional funding. Management believes such funding will be available, but there can be no assurances that such funding will be available, or if it is available, on terms acceptable to the Group. Management believes that if funding is not available, other actions can and will be taken to reduce costs. These actions may entail the Group to reduce headcount, sales and marketing, other expansion activities, which may affect the future growth of the Group’s operations.
NOTE 3 - SUMMARY OF IMPORTANT ACCOUNTING POLICIES
#
REVENUE RECOGNITION
Sales of books, magazines, audio and video tapes, compact disc and other merchandises are recognized as revenue on the transfer of risks and rewards of ownership, which generally coincides with the time when the goods are delivered to customers and title has passed. Provision is made for expected future sales returns and allowances when revenue is recognized.
Franchise fees are the annual licensing fees for franchisees to use the Group’s brand name and consulting services. Franchising income is recognized on a straight-line basis over the terms of the relevant franchise agreements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
An allowance for doubtful accounts is provided based on the evaluation of collectibility and aging analysis of notes and accounts receivables.
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INVENTORIES
Inventories are stated at the lower of cost or market. Cost includes all costs of purchase, cost of conversion and other costs incurred in bringing the inventories to their present location and condition, and is calculated using the weighted average method. Market value is determined by reference to the sales proceeds of items sold in the ordinary course of business after the balance sheet date or to management estimates based on prevailing market conditions.
PROPERTY AND EQUIPMENT AND DEPRECIATION
Property and equipment are stated at cost. Depreciation is computed using the straight-line method to allocate the cost of depreciable assets over the estimated useful lives of the assets as follows:
Maintenance, repairs and minor renewals are charged directly to the statement of operations as incurred. When assets are disposed of, the related cost and accumulated depreciation thereon are removed from the financial statements and any resulting gain or loss is included in the statement of operations.
LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. The Group does not perform a periodic assessment of assets for impairment in the absence of such information or indicators. Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used, or a significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable. For long-lived assets to be held and used, the Group measures fair value based on quoted market prices or based on discounted estimates of future cash flows.
INCOME TAXES
The Company and its subsidiaries accounts for income taxes in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109 “Accounting for Income Taxes”. Under SFAS No. 109, deferred tax liabilities or assets at the end of each period are determined using the tax rate expected to be in effect when taxes are actually paid or recovered. Valuation allowances are established when it is considered more likely than not that the deferred tax assets will not be realized.
INTANGIBLE ASSETS
Franchises and copyrights are stated at cost and amortized on the straight-line method over their estimated useful lives of 10 years.
COMPREHENSIVE INCOME (LOSS)
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Comprehensive income (loss) is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. Comprehensive income (loss) is disclosed in the condensed consolidated statement of stockholders’ equity.
NET EARNINGS (LOSS) PER COMMON SHARE
The Group computes net earnings (loss) per share in accordance with SFAS No. 128, “Earnings per Share.” Under the provisions of SFAS No. 128, basic net earnings (loss) per share is computed by dividing the net earnings (loss) available to common shareholders for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net earnings (loss) per share gives effect to common stock equivalents. For the three months ended March 31, 2005 and 2004, the Group did not have any potential common shares.
RECLASSIFICATION
The presentation of certain prior information has been reclassified to conform to current presentation.
NOTE 4 – RECENT ACCOUNTING PRONOUNCEMENTS
In September 2004, the EITF delayed the effective date for the recognition and measurement guidance previously discussed under EITF Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-01”) as included in paragraphs 10-20 of the proposed statement. The proposed statement will clarify the meaning of other-than-temporary impairment and its application to investments in debt and equity securities, in particular investments within the scope of FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investment accounted for under the cost method. The Group is currently evaluating the effect of this proposed statement on its financial position and results of operations.
In November 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 151,Inventory Costs, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not believe the adoption of SFAS No. 151 will have a material impact on our financial statements.
In December 2004, the FASB issued SFAS No. 153,Exchanges of Nonmonetary Assets, which eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS No. 153 will be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not believe the adoption of SFAS No. 153 will have a material impact on our financial statements.
NOTE 5 – NOTES AND ACCOUNTS RECEIVABLE
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March 31, | December 31, | |||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Notes and accounts receivable | ||||||||
– Third parties | $ | 3,198,682 | $ | 2,420,647 | ||||
– Related parties (NOTE 10) | 281,286 | 177,445 | ||||||
Total | 3,479,968 | 2,598,092 | ||||||
Allowance for doubtful accounts and sales returns | (576,747 | ) | (196,188 | ) | ||||
Notes and accounts receivable, net | $ | 2,903,221 | $ | 2,401,904 | ||||
NOTE 6 – INVENTORIES
March 31, | December 31, | |||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Work in process | $ | 106,262 | $ | 99,610 | ||||
Finished goods and other merchandises | 3,663,746 | 3,655,864 | ||||||
3,770,008 | 3,755,474 | |||||||
Less: Allowance for obsolete inventories and decline of market value | (786,118 | ) | (775,736 | ) | ||||
$ | 2,983,890 | $ | 2,979,738 | |||||
NOTE 7 – OTHER RECEIVABLES
March 31, | December 31, | |||||||
2005 | 2003 | |||||||
(Unaudited) | ||||||||
Other receivables – third parties: | ||||||||
Tax paid on behalf of landlord | $ | 973 | $ | 1,575 | ||||
Advances to staff | 84,856 | 74,396 | ||||||
Grants from Market Information Center | — | 29,959 | ||||||
Receivables from Shanghai Wonderland Educational Resources Co., Ltd. (“Shanghai Wonderland”) (Note (i)) | 169,538 | 87,082 | ||||||
Other receivables | 150,161 | 114,900 | ||||||
Sub-total | 405,528 | 307,912 | ||||||
Other receivables – related parties (NOTE 10) | 14,822 | 29,936 | ||||||
$ | 420,350 | $ | 337,848 | |||||
Note:
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NOTE 8 – INTEREST IN ASSOCIATES
March 31, | December 31, | |||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
21st Century Kid Castle Language and Education Center (“Education Center”) (Note (i)) | ||||||||
Investment cost | $ | 91,430 | $ | 90,620 | ||||
Share of loss | 18 | (32,752 | ) | |||||
$ | 91,448 | $ | 57,868 | |||||
Tianjin Kid Castle Educational Investment Consulting Co., Ltd. (“Tianjin Consulting”) (Note (ii)) | ||||||||
Investment cost | $ | 85,335 | $ | 60,413 | ||||
Share of loss | (56,890 | ) | (40,886 | ) | ||||
$ | 28,445 | $ | 19,527 | |||||
Lanbeisi Education &Culture Industrial Co., Ltd (“Lanbeisi”) (Note (iii)) | ||||||||
Investment cost | $ | 43,886 | $ | 43,498 | ||||
Share of loss | (26,566 | ) | (21,426 | ) | ||||
$ | 17,320 | $ | 22,072 | |||||
Total | $ | 137,213 | $ | 99,467 | ||||
Note:
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NOTE 9 – INCOME TAXES
The income taxes of the Group are substantially attributable to the operations in Taiwan and the PRC whose statutory tax rates are 25% and 15%, respectively. The principal differences between taxes on income computed at the applicable statutory income tax rates and recorded income tax expense are as follows:
Three months ended March 31, | ||||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Income taxes credit calculated on applicable statutory tax rates | $ | (99,849 | ) | $ | (432,789 | ) | ||
Higher/(lower) effective income tax rates of other countries | 16,296 | 33,955 | ||||||
Valuation allowance | 384,329 | 146,148 | ||||||
Non-taxable income | (57,694 | ) | (18,720 | ) | ||||
Non-deductible expenses | (129,302 | ) | 226,322 | |||||
Tax on undistributed earnings | 29,673 | 45,085 | ||||||
Income taxes expenses as recorded in statement of operations | $ | 143,453 | $ | — | ||||
At March 31, 2005, KCESD had net operating loss of approximately US$1,587,730, available to be carried forward to offset future taxable income which will expire in the period from 2006 to 2010. KCESD’s net operating loss carry-forwards to offset future taxable income is insignificant.
NOTE 10 – RELATED PARTY TRANSACTIONS
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Three months ended March 31, | ||||||||||
2005 | 2004 | |||||||||
(Unaudited) | ||||||||||
(i) | Sales to: | |||||||||
- PKC Language | $ | 3,030 | $ | 3,979 | ||||||
- TCP PKC | 3,030 | 3,979 | ||||||||
- TCP Chevady | 7,614 | 5,191 | ||||||||
- TCP Chung-hua | 7,614 | 4,086 | ||||||||
- TCP Wonderland | 5,349 | 5,191 | ||||||||
- TCP Kid Castle | 4,996 | 4,949 | ||||||||
- English School | 6,034 | — | ||||||||
- Tianjin Consulting | 4,589 | — | ||||||||
- Lanbeisi | 26,793 | — | ||||||||
$ | 69,049 | $ | 27,375 | |||||||
(ii) | Rental income from: | |||||||||
- CCE | $ | 476 | $ | 450 | ||||||
$ | 476 | $ | 450 | |||||||
(iii) | Franchising income from: | |||||||||
- PKC Language | $ | 136 | $ | 129 | ||||||
- TCP PKC | 136 | 129 | ||||||||
- TCP Kid Castle | 1,854 | 2,014 | ||||||||
- TCP Chung-Hua | — | 214 | ||||||||
- TCP Chevady | 927 | 1,007 | ||||||||
- TCP Wonderland | 927 | 1,007 | ||||||||
$ | 3,980 | $ | 4,500 | |||||||
(iv) | Purchase from: | |||||||||
- Publishing House | $ | 319,640 | $ | — | ||||||
$ | 319,640 | $ | — | |||||||
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March 31, | December 31, | |||||||
Name of related parties | 2005 | 2004 | ||||||
(Unaudited) | ||||||||
- KCE | $ | 3,803 | $ | — | ||||
- PKC Language | 20,345 | 16,772 | ||||||
- TCP PKC | 20,345 | 16,772 | ||||||
- TCP Chung-hua | 39,353 | 27,506 | ||||||
- TCP Chevady | 40,505 | 24,431 | ||||||
- TCP Wonderland | 40,505 | 24,431 | ||||||
- TCP Kid Castle | 47,564 | 31,586 | ||||||
- Education Center | 57 | 726 | ||||||
- Tianjin Consulting | 15,439 | 15,746 | ||||||
- Lanbeisi | 53,370 | 19,475 | ||||||
$ | 281,286 | $ | 177,445 | |||||
March 31, | December 31, | |||||||
Name of related parties | 2005 | 2004 | ||||||
(Unaudited) | ||||||||
Amount due from Publishing House (Note 1) | $ | 5,408 | $ | 13,781 | ||||
Amount due from Education Center (Note 2) | 271 | 268 | ||||||
Amount due from Tianjin Consulting (Note 3) | — | 6,825 | ||||||
Amount due from Lanbeisi (Note 4) | 9,143 | 9,062 | ||||||
$ | 14,822 | $ | 29,936 | |||||
Note:
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March 31, | December 31, | |||||||
Name of related parties | 2005 | 2004 | ||||||
(Unaudited) | ||||||||
Prepayments to Publishing House | 168,026 | 265,223 | ||||||
$ | 168,026 | $ | 265,223 | |||||
Prepayments to Publishing House are mainly for inventory ordered by Culture Media. According to the purchase agreements signed with Publishing House, Culture Media has to prepay a certain percentage of inventories purchased upon the effectiveness of the contracts. The remaining payments are to be made three months after the initial payment.
March 31, | December 31, | |||||||
Name of related parties | 2005 | 2004 | ||||||
(Unaudited) | ||||||||
- Publishing House | $ | 391,397 | $ | 265,077 | ||||
$ | 391,397 | $ | 265,077 | |||||
NOTE 11 – INTANGIBLE ASSETS
March 31, | December 31, | |||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Gross carrying amount | ||||||||
Franchise | $ | 1,078,380 | $ | 1,072,939 | ||||
Copyrights | 633,914 | 630,716 | ||||||
1,712,294 | 1,703,655 | |||||||
Less: Accumulated amortization | ||||||||
Franchise | (539,190 | ) | (509,646 | ) | ||||
Copyrights | (316,957 | ) | (299,590 | ) | ||||
(856,147 | ) | (809,236 | ) | |||||
Net | $ | 856,147 | $ | 894,419 | ||||
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Amortization charged to operations was $42,835 and $40,509 for the three months ended March 31, 2005 and 2004, respectively.
The estimated aggregate amortization expenses for each of the five succeeding fiscal years are as follows:
2006 | $ | 171,340 | ||
2007 | 171,340 | |||
2008 | 171,340 | |||
2009 | 171,340 | |||
2010 | 171,340 | |||
$ | 856,700 | |||
NOTE 12 – BORROWINGS
March 31, | December 31, | |||||||||||
Notes | 2005 | 2004 | ||||||||||
(Unaudited) | ||||||||||||
Bank term loans | (i) | $ | 950,660 | $ | 945,932 | |||||||
Short-term unsecured bank loans | (ii) | 253,566 | 725,323 | |||||||||
Mid-term loan | (iii) | 958,809 | 1,130,827 | |||||||||
Mid-term secured bank loan | (iv) | 2,157,947 | 1,482,725 | |||||||||
4,320,982 | 4,284,807 | |||||||||||
Less: Balances maturing within one year included in current liabilities | ||||||||||||
Bank term loans | 728,627 | 721,896 | ||||||||||
Short-term unsecured bank loans | 253,566 | 725,323 | ||||||||||
Mid-term loan | 743,547 | 726,720 | ||||||||||
Mid-term secured bank loan | 717,286 | 459,043 | ||||||||||
2,443,026 | 2,632,982 | |||||||||||
Bank borrowings maturing after one year | $ | 1,877,956 | $ | 1,651,825 | ||||||||
Note:
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NOTE 13 – RECEIPTS IN ADVANCE
The balance comprises:
March 31, | December 31, | |||||||||||
Notes | 2005 | 2004 | ||||||||||
(Unaudited) | ||||||||||||
Current liabilities: | ||||||||||||
Sales deposits received | (i) | $ | 555,759 | $ | 565,053 | |||||||
Franchising feesreceived | (ii) | 1,756,352 | 1,906,286 | |||||||||
Subscription fees received | (iii) | 493,198 | 435,635 | |||||||||
Others | 25,935 | 89,584 | ||||||||||
2,831,244 | 2,996,558 | |||||||||||
Long-term liabilities: | ||||||||||||
Franchising feesreceived | (ii) | 1,421,803 | 1,124,809 | |||||||||
$ | 4,253,047 | $ | 4,121,367 | |||||||||
Note:
NOTE 14 – RETIREMENT PLANS
The Group has a defined benefit retirement plan (the “Plan”) covering all regular employees of KCIT, its ROC subsidiary in Taiwan. Under the funding policy of the Plan, commencing from September 2003, KCIT contributes monthly an amount equal to 2% of the employees’ total salaries and wages, to an independent retirement trust fund deposited with the Central Trust of China in accordance with the ROC Labor Standards Law in Taiwan. The retirement fund is not included in the Group’s
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financial statements. Net periodic pension cost is based on annual actuarial valuations which use the projected unit credit cost method of calculation and is charged to the consolidated statement of operations on a systematic basis over the average remaining service lives of current employees. Under the plan, the employees are entitled to receive retirement benefits upon retirement in the manner stipulated by the ROC Labor Standard Law in Taiwan. The benefits under the plan are based on various factors such as years of service and the final base salary preceding retirement.
The net periodic pension cost is as follows:
Three months ended March 31, | ||||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
Service cost | $ | 25,500 | $ | 15,424 | ||||
Interest cost | 4,884 | 1,732 | ||||||
Expected return on assets | (1,697 | ) | (367 | ) | ||||
Amortization of unrecognized loss | 428 | 322 | ||||||
Net periodic pension cost | $ | 29,115 | $ | 17,111 | ||||
The Group previously disclosed in its financial statements for the year ended December 31, 2004, that it expected to contribute $46,679 to the Plan in 2005. As of March 31, 2005 and 2004 contributions made by the Group amounted to $11,497 and $23,319, respectively.
NOTE 15 – GEOGRAPHICAL SEGMENTS
The Group is principally engaged in the business of child educational teaching materials and related services focusing on English language in Taiwan and the PRC. Accordingly, the Group has two reportable geographic segments: Taiwan and the PRC. The Group evaluates the performance of each geographic segment based on its net income or loss. The Group also accounts for inter-segment sales as if the sales were made to third parties. Information concerning the operations in these geographical segments is as follows:
Taiwan | The PRC | Total | Corporate | Eliminations | Consolidated | |||||||||||||||||||||||||||||||||||||||||||
Three months ended | Three months ended | Three months ended | Three months ended | Three months ended | Three months ended | Three months ended | Three months ended | Three months ended | Three months ended | Three months ended | Three months ended | |||||||||||||||||||||||||||||||||||||
March 31, | March 31, | March 31, | March 31, | March 31, | March 31, | March 31, | March 31, | March 31, | March 31, | March 31, | March 31, | |||||||||||||||||||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||||||||||||
Revenue | ||||||||||||||||||||||||||||||||||||||||||||||||
External revenue | $ | 2,313,293 | $ | 2,241,656 | $ | 805,513 | $ | 394,238 | $ | 3,118,806 | $ | 2,635,894 | $ | 4,186 | $ | — | $ | — | $ | — | $ | 3,122,992 | $ | 2,635,894 | ||||||||||||||||||||||||
Inter-segment revenue | 522 | 1,362 | — | — | 522 | 1,362 | — | — | (522 | ) | (1,362 | ) | — | — | ||||||||||||||||||||||||||||||||||
$ | 2,313,815 | $ | 2,243,018 | $ | 805,513 | $ | 394,238 | $ | 3,119,328 | $ | 2,637,256 | $ | 4,186 | $ | — | $ | (522 | ) | $ | (1,362 | ) | $ | 3,122,992 | $ | 2,635,894 | |||||||||||||||||||||||
Profit (loss) from Operations | $ | 452,556 | $ | (10,560 | ) | $ | (206,377 | ) | $ | (293,247 | ) | $ | 246,178 | $ | (303,807 | ) | $ | (57,590 | ) | $ | (69,395 | ) | $ | — | $ | 31,187 | $ | 188,589 | $ | (342,015 | ) | |||||||||||||||||
Capital expenditures | $ | 11,475 | $ | — | $ | 3,208 | $ | — | $ | 14,683 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 14,683 | $ | — | ||||||||||||||||||||||||
March 31, | December 31, | March 31, | December 31, | March 31, | December 31, | March 31, | December 31, | March 31, | December 31, | March 31, | December 31, | |||||||||||||||||||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||||||||||||
Total assets | $ | 10,869,782 | $ | 10,313,287 | $ | 2,909,664 | $ | 2,827,431 | $ | 13,779,446 | $ | 13,140,718 | $ | 30,341 | $ | 30,225 | $ | (356,015 | ) | $ | (389,519 | ) | $ | 13,453,772 | $ | 12,781,424 | ||||||||||||||||||||||
NOTE 16 – COMMITMENT AND CONTINGENCIES
A. Lease Commitment
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As of March 31, 2005, the Company’s future minimum lease payments under non-cancellable operating lease expiring in excess of one year are as follows:
Years ending December 31, | ||||
2005 | $ | 169,415 | ||
2006 | 247,935 | |||
2007 | 221,753 | |||
2008 | 207,540 | |||
2009 | 135,129 | |||
$ | 981,772 | |||
B. Going concern
The accompanying financial statements have been prepared assuming the Group will continue as a going concern. As the Group is aggressively expanding its business in the PRC and the Group’s PRC operation is still in an emerging stage and has not turned profitable, the Group has suffered recurring losses from operations and has a net capital deficiency. The above conditions raise substantial doubt about the Group’s ability to continue as a going concern, if the investment in the PRC will not gradually see returns. As discussed in Note 12, the majority of the Group’s existing loans were guaranteed by two directors of the Group who have expressed their continuous support to the Group until other sources of funds have been obtained. Moreover, the Group successfully obtained new bank facilities in the first quarter of 2005. Management believes that, with continuous growth in the sales in the PRC, the existing directors’ support and the new bank facilities, the Group will have sufficient funds for operations. The financial statements do no include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
This report contains certain
Forward Looking Statements.
Certain of the statements contained in this Quarterly Report on Form 10-Q includes "forward looking statements". All statements other than statements of historical facts included in this Form 10-Q regarding the Company's financial position, business strategy, and plans and objectives of management for future operations and capital expenditures, and other matters, are forward looking statements. These forward-looking statements and information relating to us that are based onupon management's expectations of future events. Although we believe the beliefs and assumptions made by our management as well as information currently availableexpectations reflected in such forward looking statements are reasonable, there can be no assurances that such expectations will prove to the management. When used in this document, the words “anticipate,” “believe,” “estimate,” and “expect” and similar expressions, are intended to identify forward-looking statements. Suchbe correct. Additional statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect,concerning important factors that could cause actual results may varyto differ materially from those described herein as anticipated, believed, estimated or expected. Certain of these risks and uncertaintiesour expectations ("Cautionary Statements") are discussed under the caption “Factors That May Affect Our Future Results And Financial Condition” contained herein and other factors disclosed in our filings with the SecuritiesCautionary Statements section and Exchange Commission including, but not limited toelsewhere in our Annual Report on Form 10-K for the yearperiod ended December 31, 2004. We do not intend2 004. Readers are urged to updaterefer to the section entitled “Cautionary Statements” and elsewhere in our Form 10-K for a broader discussion of these forward-looking statements.statements, risks, and uncertainties. All written and oral forward looking statements attributable to us or persons acting on our behalf subsequent to the date of this Form 10-Q are expressly qualified in their entirety by the referenced Cautionary Statements.
GENERAL
We are engaged in the business of children’s education, focusing on the publication and sale of kindergarten language school and primary school teaching materials and magazines. We also provide management and consulting services to our franchised kindergarten and language schools. Our teaching materials include books, audio tapes, video tapes and compact discs. A major portion of our educational materials focuses on English language education. We also sell educational tools and equipment that are complementary to our business. Our major business originally started in Taiwan. In 2001, we started to expand our business in the People’s Republic of China (PRC). We officially launched our operations in Shanghai in April 2002. As in Taiwan, we offer advanced teaching materials and tools, and monthly and bi-weekly magazines to provide children ranging from 2 to 12 years of age a chance to learn exceptionalexceptio nal English language and computer skills, and to provide a pre-school education program.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to product returns, bad debts, inventories, equity investments, income taxes, financing operations, pensions, commitments and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilitiesli abilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.
Revenue Recognition.Recognition. We recognize sales of teaching materials and educational tools and equipment as revenue when title of the product and risk of ownership are transferred to the customer which occurs at the time of delivery, or when the goods arrive at the customer designated location, depending on the associated shipping terms. Additionally, we deliver products sold by our distributors directly to the distributors’ customers and as such the delivered goods are recognized as revenue in a similar way as sales to our direct customers. We estimate sales returns and discounts based on historical experience and record them as reductions to revenues.
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If market conditions were to decline, we may take actions to increase sales discounts, possibly resulting in an incremental reduction of revenue at the time when revenues are recognized.
Allowance for Doubtful Accounts.Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Allowance for Obsolete Inventories and Lower of Cost or Market.Market. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about inventory aging, future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
Investment Impairments.Impairments. We hold equity interests in companies having operations in areas within our strategic focus. We record an investment impairment charge when we believe an investment has experienced a decline in value that is not temporary. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future.
Fixed Assets and Depreciation.Depreciation. Our fixed assets are stated at cost. Major improvements and betterments to existing facilities and equipment are capitalized. Expenditures for maintenance and repairs that do not extend the life of the applicable asset are charged to expense as incurred. Buildings are depreciated over a 50-year term. Fixtures and equipment are depreciated using the straight-line method over their estimated useful lives, which range from two-and-a-half years to ten years.
Impairment of Long-Lived Assets.Assets. We review our fixed assets and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the asset over its remaining useful life. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. The estimate of fair value is generally based on quoted market prices or on the best available information, including prices for similar assets and the results of using other valuation techniques.
As of March 31, 2005, the balance of our amortizable intangible assets was $856,147, including franchise-related intangible assets of $539,190 and copyrights of $316,957. The amortizable intangible assets are amortized on a straight-line basis over estimated useful lives of 10 years. In determining the useful lives and recoverability of the intangibles, assumptions must be made regarding estimated future cash flows and other factors to determine the fair value of the assets, which may not represent the true fair value. If these estimates or their related assumptions change in the future, there may be significant impact on our results of operations in the period of the change incurred.
Income Taxes.Taxes. We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and tax loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income
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in the period that includes the enactment date. Deferred tax assets are subject to valuation allowances based upon management’s estimates of realizability. Actual results may differ significantly from management’s estimate.
RESULTS OF OPERATIONS
Comparison of The Three Months Ended March 31,June 30, 2005 and 2004
Total Net Operating Revenue.Total net operating revenue consistsis comprised of sales of goods, franchising income and other operating revenue. Total net operating revenues increased by $512,654,$37,638, or 20%1.9%, to $3,122,992$2,040,733 for the three months ended March 31,June 30, 2005 from $2,610,338$2,003,095 for the three months ended March 31, 2004, includingJune 30, 2004. The increase for the increase2005 period reflects a decrease in sales of goods of $345,302$12,750, and thean increase of franchising income of $69,793$45,513 and other operating revenues of $97,559$4,875, all from the amounts of the comparable prior period in 2004.
Sales of goods.The increasedecrease in sales of goods of $12,750 or 1.1%, from $2,029,853$1,186,926 for the three months ended March 31,June 30, 2004 to $2,375,155$1,174,176 for the three months ended March 31,June 30, 2005, or 17%, was mainly due to the temporary suspension of publishing of Kids Talk magazine in April, 2005 and the termination of an authorized direct marketing distributor in Taiwan.
Franchising income. The increase in net salesfranchising income of goods generated$45,513 or 6.8%, from our Shanghai operations of $301,144, or 101%, to $598,895$664,608 for the three months ended March 31, 2005 from $297,751June 30, 2004 to $710,121 for the three months ended March 31, 2004.
Franchising income.The increase in franchising income, from $528,132 for the three months ended March 31, 2004 to $597,925 for the three months ended March 31,June 30, 2005, or 13%, was mainly due to the increase in the number of our franchised schools in Shanghai. Franchising income for Shanghai increased by $110,039 from $96,488 for the three months ended March 31, 2004 to $206,527 for the three months ended March 31, 2005.
Other operating revenue.Our other operating revenues represent revenues from other activities and services such as training of teachers, arranging for personal English language tutors, organizing field trips and educational fairs, and fees for designing the school layout of our franchised schools. Other operating revenue increased by $97,559,$4,875, or 186%3.2%, to $149,912$156,436 for the three months ended March 31,June 30, 2005 from $52,353$151,561 for the three months ended March 31,June 30, 2004. The increase was mainly due to revenue generated from our services rendered in connection with the construction and design layout of our franchised schools and sales of education-related equipment to our franchised schools.
Gross Profit.Gross profit increased
Operating Costs. Operating costs are comprised o f cost of goods sold, cost of franchising and other operating costs. For the three month period ending June 30, 2005, total operating costs decreased by $260,915,$96,806 or 15%, to $2,007,45211.5% from $842,365 for the comparable period in 2004. The decrease for the 2005 period reflects a decrease of $70,976 in costs of goods sold, a decrease of $50,361 in costs of franchising, and increase of $24,531 in other operating costs, all from the amounts of the comparable prior period in 2004.
Cost of Goods Sold. The decrease of costs of goods sold of $70,976 or 10.9% from $650,418 for the three months ended March 31, 2005 from $1,746,537June 30, 2004 to $579,442 for the for the three months ended March 31,June 30, 2005 is due mainly to decrease in sales of goods.
Costs of Franchising. The decrease in the costs of franchising of $50,361 or 44.4% from $113,403 for the three months ended June 30, 2004 to $ 63,042 for the three months ended June 30, 2005 is due mainly to cost control in our Shanghai operation.
Other Operating costs. The increase in other operating costs of $24,531 or 31.2% from $78,544 for the three months ended June 30, 2004 to $103,075 for the three months ended June 30, 2005 is due mainly to increase in other operating revenue.
Gross Profit. Gross profit increased by $134,444, or 11.6%, to $1,295,174 for the three months ended June 30, 2005 from $1,160,730 for the three months ended June 30, 2004. The increase in gross profit was attributable to the fact that the rate of increase in Franchise income and decrease in our franchising costs and other operating costs from March 31, 2004 to March 31, 2005 was lower than the rate of increase in our franchising income and other operating income for the same period. In addition, the gross margin
Advertising Costs. Advertising costs decreased from 67%by $304,359, or 92.8%, to $23,491 for the three months ended March 31, 2004 to 61%June 30, 2005 from $327,850 for the three months ended March 31, 2005, primarily because of the consolidation of Culture Media that has a lower gross margin than KCIT and KCESD. Culture Media’s gross margin for the three months ended March 31, 2005 was approximately 50%.
Total Operating Expenses.Total operating expenses decreased by $324,203, or 15%, to $1,818,863 for the three months ended March 31, 2005 from $2,143,066 for the three months ended March 31, 2004. Advertising costs decreased by $93,279, or 74%, to $33,363 for the three months ended March 31, 2005 from $126,642 for the three months ended March 31,June 30, 2004. This decrease was mainly due to additional expenses in connection with promotion of the allocation of our adverting budget for 2005. We do most of our advertisingCompany’s new products during the summer vacation period rather than winter vacation period, and therefore incur most of our advertising expenses in the second and third quarters.three months ended June 30, 2004.
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Other Operating Expenses.Other operating expenses decreasedwhich reflects general and administrative and selling expenses increased by $230,924,$51,364, or 11%3.6%, to $1,785,500$1,465,044 for the three months ended March 31,June 30, 2005 from $2,016,424$1,413,680 for the three months ended March 31,June 30, 2004 due to office
i mprovements for our Shanghai office and move of a warehouse for our Shanghai operation.
Loss From Operations. Loss from operations decreased $387,439 or 66.7% from $580,800 for the three months ended June 30, 2004 to $193,361 for the three months ended June 30, 2005 for the reasons discussed above.
Interest Expenses, Net. Net interest expenses increased by $13,559, or 31.4%, to $56,730 for the three months ended June 30, 2005 from $43,171 for the three months ended June 30, 2004, primarily due to the increase in bank borrowings that occurred during the three months ended June 30, 2005.
Other non-operating income (net) which reflects changes in valuation of asset due to changes in exchange rate, lease income and penalty received from customers was $38,097 for the 2004 period compared with $102,563 mainly due to changes in exchange rate in favor of the Company.
Provision for Taxes. Provision for taxes for the three months ended June 30, 2005 and 2004 were $41,297 and $1,222, respectively. These provisions for income taxes relate to income taxes resulting from our operations in Taiwan.
Net Loss. As a result of the matters described above, we incurred a net loss of $208,027, or $(0.01) per diluted common share, for the three months ended June 30, 2005 as compared to a net loss of $602,638, or $(0.03) per diluted common share, for the three months ended June 30, 2004.
Comparison of The Six Months Ended June 30, 2005 and 2004
Total Net Operating Revenue. Total net operating revenue consists of sales of goods, franchising income and other operating revenue. Total net operating revenues increased by $550,292, or 11.9%, to $5,163,725 for the six months ended June 30, 2005 from $4,613,433 for the six months ended June 30, 2004. The increase for the 2005 period reflects increases in sales of goods of $332,552, franchising income of $115,306, and other operating revenues of $102,434 all from the amounts of the comparable prior period in 2004.
Sales of goods. The increase in sales of goods, from $3,216,779 for the six months ended June 30, 2004 to $3,549,331 for the six months ended June 30, 2005, or 10.3%, was mainly due to the increase in net sales of goods generated from our Shanghai operations offset by a small decrease in sales of good generated from our Taiwan operations.
Franchising income. The increase in franchising income, from $1,192,740 for the six months ended June 30, 2004 to $1,308,046 for the six months ended June 30, 2005, or 9.7%, was mainly due to the increase in the number of our franchised schools in Shanghai.
Other operating revenue. Our other operating revenues represent revenues from other activities and services such as training of teachers, arranging for personal English language tutors, organizing field trips and educational fairs, and fees for designing the school layout of our franchised schools. Other operating revenue increased by $102,434, or 50.2%, to $306,348 for the six months ended June 30, 2005 from $203,914 for the six months ended June 30, 2004. The increase was mainly due to revenue generated from our services rendered in connection with the construction and design layout of our franchised schools and sales of education-related equipment to our franchised schools.
Operating Costs. Operating costs are comprised o f cost of goods sold, cost of franchising and other operating costs. For the six month period ending June 30, 2005, total operating costs increased by $154,933 or 9.1 from $1,706,166 for the comparable period in 2004. The increase for the 2005 period reflects an increase of $182,250 in costs of goods sold, a decrease of $68,849 in costs of franchising, and increase of $41,532 in other operating costs, all from the amounts of the comparable prior period in 2004.
Cost of Goods Sold. The increase of costs of goods sold of $182,250 or 13.8% from $1,324,923 for the six months ended June 30, 2004 to $1,507,173 for the for the six months ended June 30, 2005 is due mainly to the sales of new versions of educational materials.
Costs of Franchising. The decrease in the costs of franchising of $ 68,849 or 28% from $ 245,504 for the six months ended June 30, 2004 to $ 176,655 for the six months ended June 30, 2005 is due mainly to cost control in our Shanghai operation.
Other Operating costs. The increase in other operating costs of $ 41,532 or 30.6% from $ 135,739 for the six months ended June 30, 2004 to $ 177,271 for the six months ended June 30, 2005 is due mainly to increase in other operating revenue.
Gross Profit. Gross profit increased by $395,359, or 13.6%, to $3,302,626 for the six months ended June 30, 2005 from $2,907,267 for the six months ended June 30, 2004. The increase in gross profit was attributable to increase in franchising income and decrease in our franchising costs for the same period.
Advertising Costs. Advertising costs decreased by $397,638, or 87.5%, to $56,854 for the six months ended June 30, 2005 from $454,492 for the six months ended June 30, 2004. This decrease was mainly due to additional expenses in connection with promotion of the Company’s new products during the three months ended June 30, 2004.
Other Operating Expenses. Other operating expenses which reflects general and administrative and selling expenses decreased by $179,560, or 5.2%, to $3,250,544 for the six months ended June 30, 2005 from $3,430,104 for the six months ended June 30, 2004, principally due to decreases in salary expenses resulting from a reduction in employee headcount in our Taiwan operations.
Loss From Operations. Loss from operations decreased $972,557 or 99.5% from $977,329 for the six months ended June 30, 2004 to $4,772 for the six months ended June 30, 2005 for the reasons discussed above.
Interest Expenses, Net.Net interest expenses increased by $37,488,$51,047, or 172%78.6%, to $59,253$115,983 for the threesix months ended March 31,June 30, 2005 from $21,765$64,936 for the threesix months ended March 31,June 30, 2004, primarily due to the increase of thein bank borrowings during the threesix months ended March 31,June 30, 2005 comparing to the threesix months ended March 31,June 30, 2004.
Other non-operating income (net) which reflects changes in valuation of asset due to changes in exchange rate, lease income and penalty received from customers was $81,770 for the 2004 (please referperiod compared with $53,624 due to Note 12 to our Condensed Consolidated Financial Statements for more information).changes in exchange rate not in favor of the Company.
Provision for Taxes.Provision for taxes for the threesix months ended March 31,June 30, 2005 and 2004 were $143,453$184,750 and $0,$1,222, respectively. These provisions for income taxes relate to income taxes resulting from our operations in Taiwan.
Net Loss. As a result of the matters described above, we incurred a net loss of $258,457, or $(0.01) per diluted common share, for the six months ended June 30, 2005 as compared to a net loss of $930,292, or $(0.05) per diluted common share, for the six months ended June 30, 2004.
LIQUIDITY AND CAPITAL RESOURCES
Comparison of Fiscal Years 2004 and 2003
As of March 31,June 30, 2005, our principal sources of liquidity included cash and bank balances of $173,169$766,626 which decreasedincreased from $213,564 at December 31, 2004.2004, an increase of 553,062. The decrease was mainly due to the expenditures to fund the daily operations.increase is results of investment in operations in PRC operations occurred during 2004.
Net cash (used in) provided by operating activities was ($22,689) and $45,426 during the three months ended March 31, 2005 and 2004, respectively.
Net cash used in operating activities was $941,456 and $387,830 during the threesix months ended March 31,June, 2005 and 2004, respectively. The increase during the six months ended June, 2005 was primarily attributed to net loss.increase in Prepayments and other current assets.
Net cash used inprovided by (used in) investing activities were $60,406$1,614,033 and $105,689$(250,988) during the threesix months ended March 31,June 30, 2005 and 2004, respectively. The $45,283 differencechanges was primarily attributable to cash usedchanges in purchasepledged notes receivable and collection of property and equipment of $104,562 during the three months ended March 31, 2005 and the increase of pledged bank fixed deposits by 58,629 during the three months ended March 31, 2005, compared to increase of $135,818 during the three months ended March 31, 2004.long term notes.
Net cash providedconsumed by financing activities during the threesix months ended March 31,June, 2005 was $60,634$267,657 as compared to $67,777$79,888 during the threesix months ended March 31,June 30, 2004. The $7,143 difference was primarily attributable to the decrease of net proceeds from bank borrowings of 645,512, and the repaymentno Repayment of loans fromto officers/shareholders. The Repayment of loans to officers/shareholders of $586,529was $585,006 during the threesix months ended March 31,June 30, 2004.
Off-Balance Sheet Arrangements
As of March 31,June 30, 2005, we did not engage in any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K promulgated by the SEC under the Securities Exchange Act of 1934.
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Contractual Obligations
The Company, Higoal and its subsidiaries are collectively referred to as the “Group.” The following table represents the Group’s contractual obligations:
Payments Due by Period | ||||||||||||||||||||||||||||
Total | 2005 | 2006 | 2007 | 2008 | 2009 | Thereafter | ||||||||||||||||||||||
(Thousand dollars) | ||||||||||||||||||||||||||||
Contractual obligations | ||||||||||||||||||||||||||||
Bank borrowing | 4,321 | 2,474 | 780 | 366 | 89 | 89 | 523 | |||||||||||||||||||||
Pension benefit | 29 | — | — | — | — | — | 29 | |||||||||||||||||||||
Operating leases | 1,508 | 169 | 248 | 222 | 208 | 135 | 526 | |||||||||||||||||||||
Total | 5,858 | 2,643 | 1,028 | 588 | 297 | 224 | 1,078 | |||||||||||||||||||||
Bank Borrowing
One of our financing sources is from bank borrowings. As of March 31,June 30, 2005 and 2004, the balances of bank borrowings including current and non-current portions, were $4,320,982 and $3,217,258, respectively.$4,025,806.
Equity Investments in Joint Ventures
On May 28, 2004, the Groupwe signed a joint venture agreement with Zhangjhou Yu Hua Educational Investment Co., Ltd. in Henan Province, PRC to establish a company, Henan Kid Castle Education Development Co., Ltd. with registered capital of RMB$300,000. Pursuant to this joint venture agreement, the Groupwe and Zhangjhou Yu Hua Educational Investment Co., Ltd. own 65% and 35% interests in Henan Kid Castle Education Development Co., Ltd., respectively. No capital contribution has yet been made for the joint venture as of March 31,June 30, 2005.
On June 29, 2004, the Groupwe signed a joint venture agreement with Li Kai and Zhang Wuen Shou in the PRC to establish a company, Shanxi Kid Castle Education Development Co., Ltd. with registered capital of RMB$500,000. Pursuant to this joint venture agreement, the Group,we , Li Kai and Zhang Wuen Shou own, respectively, 51%, 30% and 19% interests in Shanxi Kid Castle Education Development Co., Ltd. No capital contribution has yet been made for the joint venture as of March 31,June 30, 2005.
Pension Benefit
We have a non-contributory and funded defined benefit retirement plan (the “Plan”) covering all regular employees of KCIT, our subsidiary in Taiwan, as described in Note 14 to our Condensed Consolidated Financial Statements. The benefits expected to be paid in each of the next five fiscal years, and in the aggregate for the five fiscal years thereafter are $0 and $28,845, respectively. We also make defined contributions to a retirement benefits plan for our employees in the PRC in accordance with local regulations. The contributions made by us for the three months ended March 31, 2005 and 2004 amounted to $11,497, and $23,319, respectively.
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Operating Leases
We have entered into several non-cancelable lease arrangements for administrative office space, warehouse space and sales offices for various lengths of time.
Going Concern
The accompanying financial statements have been prepared assuming the Groupwe will continue as a going concern. As the Group iswe are aggressively expanding its business in the PRC and the Group’sour PRC operation is still in an emerging stage and has not turned profitable, the Group haswe ha ve suffered recurring losses from operations and has a net capital deficiency.operations. The above conditions raise substantial doubt about the Group’sour ability to continue as a going concern, if the investment in the PRC does not gradually see returns. As discussed in Note 12 to our Condensed Consolidated Financial Statements, theThe majority of the Group’sour existing loans were guaranteed by two directors of the Group who have expressed their continuous support to the Groupus until other sources of funds have been obtained. Moreover, the Group successfully obtained new bank facilities in the first quarter of 2005 (please refer to Note 12 to our Condensed Consolidated Financial Statements for more information). Management believes that, with continuous growth in the sales in the PRC, the existing directors’ support and the new bank facilities, the Groupwe will have sufficient funds for operations. The financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
NEW ACCOUNTING PRONOUNCEMENTS
In September 2004, the EITF delayed the effective date for the recognition and measurement guidance previously discussed under EITF Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-01”) as included in paragraphs 10-20 of the proposed statement until further guidance is issued for its application. The proposed statement will clarify the meaning of
other-than-temporary impairment and its application to investments in debt and equity securities, in particular investments within the scope of FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investment accounted for under the cost method. The Group is currently evaluating the effect of this proposed statement on its financial position and results of operations.
In November 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 151,Inventory Costs,, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not believe the adoption of SFAS No. 151 will have a material impact on our financial statements.
In December 2004, the FASB issued SFAS No. 153,Exchanges of Nonmonetary Assets,, which eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS No. 153 will be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not believe the adoption of SFAS No. 153 will have a material impact on our financial statements.
Non-GAAP Financial Measures
None.
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Risks Relating to Our Business
We have a history of operating losses and we anticipate losses and negative cash flow to continue for the foreseeable future, and unless we are able to generate profits and positive cash flow on a consistent basis we may not be able to continue operations.
Our ability to attain a positive cash flow and become profitable depends on our ability to generate and maintain greater revenue while incurring reasonable expenses. This, in turn, depends, among other things, on the development of our business of child educational teaching materials and related services focusing on English language in Taiwan and the PRC. We may be unable to achieve and maintain profitability if we fail to do any of the following:
We have incurred operating losses since inception. As a result, as of March 31, 2005, we had an accumulated deficit of $7,342,858. We incurred net losses of $1,906,996, $1,940,591, and $1,254,592 for the years ended December 31, 2002, 2003 and 2004, respectively, and had cash flow from operations of $33,886, ($2,689,688) and $(1,544,902) for the years ended December 31, 2002, 2003 and 2004, respectively. If we are unable to achieve and maintain a positive cash flow and profitability, we may be unable to continue our operations. Even if we do achieve a positive cash flow and profitability, we cannot be certain that we will be able to sustain or increase them on a quarterly or annual basis in the future.
Our inability to achieve or maintain profitability or positive cash flow could result in disappointing financial results, impede implementation of our growth strategy or cause the market price of our common stock to decrease. Specifically, if we cannot effectively maintain, improve and develop our products and services, we may not be able to recover our fixed costs or otherwise turn profitable. We may not be able to develop and introduce new products, services and enhancements that respond to technological changes, evolving education industry standards or customer needs and trends on a timely basis. We may experience difficulties that could delay or prevent the successful development, introduction or marketing of new products, services or service enhancements. These new products, services and service enhancements may not achieve market acceptance or our competitors may develop alternative technologies and methods that gain broader market acceptance than our products and services. Accordingly, we cannot assure you that we will be able to generate the cash flow and profits necessary to sustain our business expectations, which makes our ability to successfully implement our business plan uncertain.
We cannot predict whether demand for our products and services will continue to develop, particularly at the volume or prices that we need to become profitable.
Although the market for English language instruction and education is growing rapidly, we cannot be certain that this growth will continue at its present rate, or at all. We believe our success ultimately will
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depend upon, among other things, our ability to:
Because our operating results are tied, in part, to the success of our franchisees, the failure of our franchisees could adversely affect our operating results.
Our revenues include licensing fees received from franchisees of Kid Castle. Accordingly, our future revenues will be impacted by the gross revenues of Kid Castle franchisees and the number of schools operating by these franchisees. Although our revenues from Kid Castle franchise operations will vary directly with the gross revenues of our franchisees, we are not directly dependent on the franchisees’ profitability. We believe, however, that the profitability of existing franchisees is key to our ability to attract new franchisees and open new franchised schools. Therefore, factors that adversely affect the revenues and profitability of our franchisees may have an adverse effect on our operating results.
There can be no assurance that our franchisees will operate schools successfully. While no individual franchisee represents more than 1% of our franchise revenues, a significant failure of our franchisees to operate successfully could adversely affect our operating results. The resolution of certain franchisee financial difficulties may cause us to incur additional costs, due to uncollectible accounts receivable related to franchise and license fees, the purchase of teaching and learning materials and/or potential claims by franchisees and could have a material adverse effect on our results of operations.
An increase in market competition could have a negative impact on our business.
Our markets are new, rapidly evolving and highly competitive, and we expect this competition to persist and intensify in the future. This increase in competition could lead to price reductions, decreased sales-volume, under-utilization of employees, reduced operating margins and loss of market share. There can be no assurance that we will be able to successfully compete for customers in our targeted markets.
Our failure to maintain and enhance our competitive position could seriously harm our business and operating results. We encounter current or potential competition from a number of sources, including:
Because we face competition from established competitors, we may be unable to maintain the market share.
Our primary competitors, including Giraffe Language School in Taiwan, Ladder Digital Education Corp. in Taiwan and the PRC, and Joy Enterprises Organization in Taiwan and the PRC, have significant financial, technical and marketing resources, and/or name recognition. Some of these competitors have a longer operating history and greater overall resources than we do. These companies also have established customer support and professional services organizations. As a result, our competitors may be able to adapt more quickly to changes in customer needs, offer products and services at lower prices than we do, and devote greater resources than we do to the development and sale of teaching/learning products and services, which could result in reducing our market share.
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Because we intend to expand internationally, we will be subject to risks of conducting business in foreign countries.
As we expand our operations outside of Taiwan, we will be subject to the risks of conducting business in foreign countries, including:
We cannot be certain that the risks associated with our anticipated foreign operations will not negatively affect our operating results or prospects, particularly as these operations expand in scope, scale and significance.
Because we may not be able to protect our proprietary rights on a global basis, we may incur substantial costs to defend or protect our business and intellectual property.
We strategically pursue the registration of our intellectual property rights. However, effective patent, trademark, service mark, copyright and trade secret protection may not always be available and the steps we have taken may be inadequate to protect our intellectual property. In addition, there can be no assurance that competitors will not independently develop similar intellectual property. If others are able to copy and use our products and delivery systems, we may not be able to maintain our competitive position. If we fail to protect our intellectual property, we may be exposed to expensive litigation or risk jeopardizing our competitive position. We may have to litigate to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. This litigation could result in substantial costs and the diversion of our management and technical resources, which could harm our business.
In addition, laws in the PRC have traditionally been less protective of intellectual property rights
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and enforcement relating to the protection of intellectual property in the PRC has been sporadic at best. Deterioration in compliance with existing legal protections or reductions in the legal protection for intellectual property rights in the PRC could adversely affect our revenue as we continue to expand into the PRC market.
Because we may not be able to avoid claims that we infringed the proprietary rights of others, we may incur substantial costs to defend or protect our business and intellectual property.
Although we have taken steps to avoid infringement claims from others, these measures may not be adequate to prevent others from claiming that we violated their copyrights, other trademarks or other proprietary rights. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract our management from our business. A party making a claim could secure a judgment that requires us to pay substantial damages or we may lose the rights to use our products or to modify them.
We rely substantially on bank loans and our inability to obtain sufficient funding may adversely affect our liquidity and financial condition.
We rely substantially on bank loans to satisfy our funding requirements. As of December 31, 2002, 2003 and 2004, our bank loans and loans from financial institutions were $4,284,807, $2,484,471 and $1,982,019 respectively. Although, in our experience, our bank loans and loans from financial institutions have been, in the past, a stable source of funding, no assurances can be given that this will continue to be the case. If we are unable to secure sufficient borrowings, our liquidity position would be adversely affected, and we may be required to seek more expensive sources of funding to finance our operations.
Implementing our strategies may require substantial capital expenditures. To the extent these expenditures exceed our cash resources, we will be required to seek additional debt or equity financing. Our ability to obtain sufficient financing and the cost of such financing will depend on numerous factors, some of which are beyond our control, including:
If we are unable to obtain sufficient funding for our operations or development plans on commercially acceptable terms, or at all, our liquidity and financial condition may be adversely affected.
Because we conduct operations in New Taiwan Dollars and Renminbi (RMB), we are subject to risk from exchange rate fluctuations.
Our transactions with suppliers and customers are effected in New Taiwan dollars, the functional currency of our Taiwanese subsidiary, Kid Castle Internet Technologies Limited (KCIT), and, as a result of our expansion in the PRC, increasingly in RMB, the functional currency of our PRC subsidiary, Kid Castle Educational Software Development Company Limited (KCES). Our financial statements are reported in U.S. dollars. As a result, fluctuations in the relative exchange rate among the U.S. dollar, the
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New Taiwan dollar and the RMB will affect our reported shareholders’ equity from one period to the next. Such impacts could be meaningful and are independent of the underlying performance of our business. The market price of our securities could be significantly affected by unfavorable changes in exchange rates. We do not actively manage our exposure to such unfavorable changes in exchange rates.
Because our officers and directors are not U.S. persons, and our operating subsidiaries are Taiwan and People’s Republic of China companies, you may be unable to enforce judgments under the Securities Act.
Our operating subsidiaries are a Taiwanese company and a PRC company and our officers and directors are residents of various jurisdictions outside the United States. All or a substantial portion of the assets of our business and of such persons are located outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon such persons or to enforce court judgments in the United States obtained against such persons in the United States courts and predicated upon the civil liability provisions of the Securities Act.
Our internal controls and management systems are not currently consistent with international practices in certain respects and we are in the process of improving these controls to enable us to certify the effectiveness of our internal controls under the Sarbanes-Oxley Act of 2002. Our failure to timely and successfully upgrade these controls and systems could subject us to regulatory actions and harm the price of our stock.
Our internal control and management systems were designed to meet the standards generally adopted by private Taiwan companies and the internal control and management systems of our PRC subsidiaries were designed to the standards generally adopted by companies in China. These standards are different from the standards and best practices adopted by companies in the United States. We have identified areas in which our current control and management systems do not meet international standards and practices. In addition, during their audit, our external auditors brought to our attention a number of areas in which our current internal controls and management systems do not reduce undetected material errors or fraud to a relatively low level of risk, which could adversely affect our ability to accurately and timely record, process, summarize and report financial data. Pursuant to the Sarbanes-Oxley Act of 2002 and the various rules and regulations adopted pursuant thereto or in conjunction therewith, we are required, for fiscal year 2005, to perform an evaluation of our internal controls over financial reporting and file an assessment of its effectiveness with the U.S. Securities and Exchange Commission. Unless we successfully upgrade our controls and systems, we will not be able to satisfactorily comply with our obligation under the Sarbanes-Oxley Act of 2002 and our external auditors will be unable to provide a satisfactory certification. We have prepared an internal plan of action for compliance, which includes a schedule of activities to address our need to meet these standards and best practices. If we fail to successfully complete the improvements we have scheduled on a timely basis, or if the activities fail to raise our internal controls and management systems to the levels required by international standards or legal requirements, or if we fail to implement new or improved controls, then we may fail to meet our reporting obligations and our auditors may be unable to certify the management’s assertion of the effectiveness of our internal controls as required under the Sarbanes-Oxley Act of 2002. This could subject us to regulatory scrutiny and result in a loss of public confidence in our management, which could, among other things, adversely affect our stock price.
If we lose key management or other personnel, we may experience delays in our product development and other negative effects on our business.
Our success is dependent upon the personal efforts and abilities of our executive officers, Kuo-An Wang, our Chief Executive Officer, and Yu-En Chui, our Chief Financial Officer. If these key officers
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cease employment with us before we find qualified replacements, it would have a significant negative impact on our operations. We do not have employment agreements with any of our executive officers.
Moreover, our growth and success depend on our ability to attract, hire and retain additional highly qualified management, educators, technical, marketing and sales personnel. These individuals are in high demand and we may not be able to attract the staff we need. The hiring process is intensely competitive, time consuming and may divert the attention of our management from our operations. Competitors and others have in the past, and may in the future, attempt to recruit our employees. If we lose the services of any of our senior management or key education personnel, or if we fail to continue to attract qualified personnel, our business could suffer.
“Penny Stock” regulations may impose certain restrictions on marketability of our common stock.
The SEC has adopted regulations which generally define “penny stock” to be an equity security that has a market price of less than $5.00 per share. Our common stock may fall within the definition of penny stock and be subject to rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally those with assets in excess of $1,000,000, or annual incomes exceeding $200,000 or $300,000, together with their spouses).
For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of such securities and have received the purchaser’s prior written consent to the transaction. Additionally, for any transaction, other than exempt transactions, involving a penny stock, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer’s presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the “penny stock” rules may restrict the ability of broker-dealers to sell our common stock and may affect the ability of investors to sell our common stock in the secondary market.
An outbreak of Severe Acute Respiratory Syndrome (SARS) may adversely affect our results of operations.
In March 2003, Guangdong Province of the PRC, Hong Kong, Singapore, Taiwan and several other Asian countries encountered an outbreak of SARS, a highly contagious form of atypical pneumonia. In the future, if any of our employees or students is suspected to have contracted SARS, under certain circumstances such employees, students and affected areas of our premises may have to be quarantined. As a result, we may have to temporarily suspend all or part of our operations. Furthermore, a future outbreak of SARS may negatively impact our ability to attract foreign teachers, who may be less inclined to come to Taiwan, and to attract and retain students, whose parents may choose to have them taught at home by individual tutors or forego supplemental English learning altogether. Although the World Health Organization removed all of the above regions from its list of areas affected by SARS by the summer of 2003, and there have been only a relatively small number of confirmed cases of SARS since that time, we cannot rule out the possibility of a future outbreak or predict the effect any such future outbreak could have on our company.
Risks Relating to The People’s Republic of China
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Our operations in the PRC are subject to political, regulatory and economic uncertainties.
Our operations and assets in the PRC are subject to significant political, regulatory and economic uncertainties. Changes in laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply, restrictions on the manner of operating educational institutions or disseminating educational materials, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business, results of operations and financial condition. Under its current leadership, the PRC government has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the PRC government will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.
In addition, in July 2003, our subsidiary, KCES, entered into agreements with a local Chinese party, 21st Century Publishing House, in Jiangxi Province to establish two joint ventures, Jiangxi 21st Century Kid Castle Culture Media Co., Ltd. (Culture Media) and 21st Century Kid Castle Language and Education Center (Education Center). Culture Media and Education Center are established to engage primarily in the publication and distribution of English language education materials, enter into franchise and consulting relationships with kindergarten and language schools, and provide services to cooperative schools in China. We intend to use them as one of our primary vehicles for our expansion into the PRC market. Although we received, on January 19, 2004 and October 31, 2003, licenses from the applicable government authorities to conduct the business of Culture Media and Education Center in the PRC, the regulations with respect to operation of businesses by foreign-owned entities are still in flux. There is no assurance that the licenses will not be challenged by the PRC authorities.
The lack of remedies and impartiality under the PRC’s legal system could negatively impact us.
Unlike the United States, the PRC has a civil law system based on written statutes in which judicial decisions have little precedential value. The PRC government has enacted some laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable. These matters may be subject to the exercise of considerable discretion by agencies of the PRC government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, including from changes in certaininterest rates and foreign currency exchange rates that may adversely affect our results of operations and interest rates. All of these marketfinancial position. In seeking to minimize the risks arise in the normal course of business, as we do not engage in speculative trading activities. We have not entered into derivative and/or hedging transactions to manage risk in connectioncosts associated with such fluctuations.
The following analysis provides quantitative information regarding ouractivities, we manage exposure to changes in interest rates and foreign currency exchange riskrates through our regular operating and financing activities.
We do not presently use derivative instruments to adjust our interest rate risk.risk profile. We do not utilize financial instruments for trading or speculative purposes, nor do we utilize leveraged financial instruments.
Interest rate exposure
We are exposed to fluctuating interest rates related to variable rate bank borrowings. In analyzing the effect of interest rate fluctuations based on the average balances of our outstanding bank borrowings for
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the three months ended March 31, 2005, we have projected that, if interest rates were to increase by 1%, the result would be an annual increase in our interest expense of $43,030. This analysis does not take into consideration the effect of changes in the level of overall economic activity on interest rate fluctuations.
Foreign currency exposure
We have operations in both Taiwan and the PRC. The functional currency of Higoal Development Ltd. and its subsidiary, Kid Castle Internet Technologies Ltd. is NT Dollars and the financial records are maintained and the financial statements are prepared for these entities in NT Dollars. The functional currency of Kid Castle Educational Software Development Company Ltd. and its consolidated investee, Jiangsi 21th Century Kid Castle Culture Media Co. Ltd. is RMB and the financial records are maintained and the financial statements are prepared for these entities in RMB. In the normal course of business, these operations are not exposed to fluctuations in currency values. We do not generally enter into derivative financial instruments in the normal course of business, nor do we use such instruments for speculative purposes. The translation from the applicable local currency assets and liabilities to the U.S. Dollar is performed using exchange rates in effect at the balance sheet date except for shareholders’ equity, which is translated at historical exchange rates. Revenue and expense accounts are translated using average exchange rates during the period. Gains and losses resulting from such translations are recorded as a cumulative translation adjustment, a separate component of shareholders’ equity.
ITEM 4. CONTROLS AND PROCEDURES
We are in the process of identifying, developing and implementing measures to improve the effectiveness of our disclosure controls and procedures, and, in particular, internal controls, including plans to enhance our resources, systems and training with respect to our financial reporting and disclosure responsibilities, and to review our actions with the audit committee and independent auditors. Since April 2004, we have been in the process of implementing a system with respect to internal control over financial reporting. In May 2004, we began installing a new ERP system through an application service provider, and we expect the installation to be completed in the fourth quarter of 2005. Our CEO and our CFO believe that such measures will help improve our disclosure controls and procedures. Based on this information, as of March 31,June 30, 2005, our CEO and our CFO believe that, subject to the limitations noted above, our disclosuredisclosu re controls and procedures are effective in ensuring that material information required to be included in Kid Castle’s SEC reports is made known to them on a timely basis.
In May 2005, our accounting manager, who assisted our CFO with our internal control over financial reporting, resigned. We are in the process of searching for a candidate to hire as an accounting manager to handle our internal control over financial reporting. Although this personnel change caused a temporary interruption of our internal control over financial reporting, we believe that the ongoing implementation of our new system with respect to internal control over financial reporting and the installation of our ERP system have minimized any adverse effect that may have been caused by such resignation.
PART II
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OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We have no material pending legal proceedings.
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ITEM 2. CHANGES IN SECURITIES
Pursuant to a stock purchase agreement dated August 18, 2003, Globe Wisdom Investments Limited (“GWIL”), a Samoan international business company, subscribed for 175,500 shares of our common stock at an aggregate purchase price of $122,850 in a private offering. As of March 31, 2005, we had not yet issued any shares to GWIL pursuant to the August 18, 2003 stock purchase agreement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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A. Exhibits
registrant, pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Yu-En Chiu, Chief Financial Officer of the registrant, pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification s of Kuo-An Wang, Chief Executive Officer and Yu-En Chiu, Chief Financial Officer of the
registrant, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
B. Reports on Form 8-K
On April 15, 2005, we filed a Form 8-K reporting the resignation of Yuanchau Liour as a member of our board of directors and from our Audit Committee which occurred on April 12, 2005.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Dated: May 20,August 22, 2005
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By: /s/ Kuo-An Wang
Name: Kuo-An Wang
Title: Chief Executive Officer
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