This
report contains certain forward-looking statements and information relating
to
us that are based on the beliefs and assumptions made by our Management as
well
as information currently available 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. Such
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, actual results may vary materially from those described herein as
anticipated, believed, estimated or expected. Certain of these risks and
uncertainties 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 SEC including, but not limited to our Annual
Report on Form 10-K/A for the year ended December 31, 2006. We do not
intend to update these forward-looking statements.
OVERVIEW
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, DVD, VCD 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 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 English language and computer skills, and to
provide a preschool 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
the U.S. GAAP. 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 liabilities
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
.
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.
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
.
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.
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
.
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
.
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
.
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 September 30, 2007, the balance of our amortizable intangible assets was
$409,463, including franchise-related intangible assets of $257,874 and
copyrights of $151,589. The amortizable intangible assets are amortized on
a
straight-line basis over estimated useful lives of ten 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
.
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 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
Three
Months Ended September 30, 2007 Compared to Three Months Ended September 30,
2006
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 $395,348, or 11%,
to $4,107,952 for the three months ended September 30, 2007 from $3,712,604
for
the three months ended September 30, 2006. This was comprised of increase in
other operating revenue of $312,340, increase in sales of goods of $362,559,
and
decrease in franchising income of $279,551.
Sales
of goods
.
The
increase in sales of goods, from $2,573,101 for the three months ended September
30, 2006 to $2,935,660 for the three months ended September 30, 2007, a 14%
increase, was mainly due to increases in sales in our Shanghai
operations.
Franchising
income
.
The
decrease in franchising income, from $831,805 for the three months ended
September 30, 2006 to $552,254 for the three months ended September 30, 2007,
a
34% increase, was mainly due to the decrease in franchising income in Taiwan
operations.
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, fees for designing the school layout of
our
franchised schools, and tuition from schools controlled by us. Other operating
revenue increased by $312,340, or 102%, to $620,038 for the three months ended
September 30, 2007 from $307,698 for the three months ended September 30, 2006,
mainly due to the increase in Shanghai operations.
Gross
Profit
.
Gross
profit increased by $257,030, or 12%, to $2,372,030 for the three months ended
September 30, 2007 from $2,115,000 for the three months ended September 30,
2006. The gross profit increase was mainly due to the increase in
revenue.
Total
Operating Expenses
.
Total
operating expenses increased by $83,899, or 6%, to $1,466,075 for the three
months ended September 30, 2007 from $1,382,176 for the three months ended
September 30, 2006, principally due to increases in daily expenditures in our
operations.
Other
Operating Expenses
.
Other
operating expenses increased by $83,353, or 6%, to $1,463,233 for the three
months ended September 30, 2007 from $1,379,880 for the three months ended
September 30, 2006, principally due to increases in expenditures to fund daily
operations.
Interest
Expenses, Net
.
Net
interest expenses decreased by $13,471, or 43%, to $18,161 for the three months
ended September 30, 2007 from $31,632 for the three months ended September
30,
2006, primarily due to the decrease of the borrowings during the three months
ended September 30, 2007 compared to the three months ended September 30, 2006.
Provision
for Taxes
.
Provision
for taxes for the three months ended September 30, 2007 and 2006 were $150,545
and $62,552, respectively. These provisions for income taxes relate to income
taxes resulting from our Taiwan operations.
Nine
Months Ended September 30, 2007 compared to Nine Months Ended September 30,
2006
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 $620,748, or 7%,
to
$9,232,065 for the nine months ended September 30, 2007 from $8,611,317 for
the
nine months ended September 30, 2006. This was comprised of the increase in
sales of goods of $529,378, an increase in other operating revenues of $475,431,
and a decrease in franchising income of $384,061.
Sales
of goods
.
The
increase in sales of goods by $529,378, or 9%, from $6,102,630 for the nine
months ended September 30, 2006 to $6,632,008 for the nine months ended
September 30, 2007, was mainly due to the increase in net sales of goods from
our Shanghai operations.
Franchising
income
.
The
decrease in franchising income, from $2,026,493 for the nine months ended
September 30, 2006 to $1,642,432 for the nine months ended September 30, 2007,
a
19% decrease, was mainly due to the decrease in franchising income from our
operations.
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, fees for designing the school layout of
our
franchised schools and tuition from schools controlled by us. Other operating
revenue increased by $475,431, or 99%, to $957,625 for the nine months ended
September 30, 2007 from $482,194 for the nine months ended September 30, 2006.
The increase was mainly due to increase in revenues from our Shanghai
operations.
Gross
Profit
.
Gross
profit increased by $266,820, or 5%, to $5,657,364 for the nine months ended
September 30, 2007 from $5,390,544 for the nine months ended September 30,
2006.
The increase in Gross Profit was principally due to the increase in our
operating revenue.
Total
Operating Expenses
.
Total
operating expenses decreased by $377,338, or 9%, to $3,866,766 for the nine
months ended September 30, 2007, from $4,224,520 for the nine months ended
September 30, 2006. The decrease in total operating expenses was principally
due
to decreases in bad debt allowance in Taiwan operations.
Other
Operating Expenses
.
Other
operating expenses decreased by $378,769, or 9%, to $3,845,751 for the nine
months ended September 30, 2007, from $4,224,520 for the nine months ended
September 30, 2006, principally due to decreases in reserved for additional
bad
debt allowance in Taiwan operations.
Interest
Expenses, Net
.
Net
interest expenses decreased by $90,979, or 60%, to $60,778 for the nine months
ended September 30, 2007, from $151,757 for the nine months ended September
30,
2006, primarily due to the decrease of borrowings during the nine months ended
September 30, 2007 compared to the nine months ended September 30, 2006. (Please
refer to Note 12 of Condensed Consolidated Financial Statements for more
information.)
Other
Non-operating Income, Net
.
Net
other non-operating income increased by $268,184, to $347,078 for the nine
months ended September 30, 2007, from $78,894 for the nine months ended
September 30, 2006. The increases in net other non-operating income was
principally due to gains in the value of recovered inventory of
$360,118.
Provision
for Taxes
.
Provision
for taxes for the nine months ended September 30, 2007 and 2006 were $343,556
and $249,461, respectively. These provisions for income taxes relate to income
taxes resulting from our operations in Taiwan.
LIQUIDITY
AND CAPITAL RESOURCES
As
of September 30, 2007, our principal sources of liquidity included cash and
bank
balances of $1,001,231 which decreased from $1,419,873 at December 31,
2006. The decrease was mainly due to decreased expenditures to fund daily
operations.
We
have
aggressively expanded business in the PRC. Shanghai operations have turned
profitable in 2006, and the Group has turned profitable in the first nine months
of 2007. We anticipate continued expansion of the market for our learning
materials and an increase in the number of franchise schools. Furthermore,
we
foresee better utilization of capital and funds as we identify and implement
alternatives for restructuring and refinancing in order to increase our profit
margin. We began to set up schools controlled by us in 2007. Based on our
internal historical records and growing market demand, Management believes
that
by directly operating our schools we can increase our profit margin. In 2007,
Management expects that in the initial stage of the direct school operating
business, we need to invest additional funds to acquire control of schools
that
will become profitable in 2008. Because of the rapid expansion in Shanghai,
we
expect that additional funds will be required in the near future to facilitate
the expansion plans for our Shanghai operations in 2008. Management expects
that
the Group still requires approximately US$1 million for the next twelve months
to invest in business development. We will rely on short-term loans from
financial institutions as a source for additional funding. As discussed in
Note
12 of Condensed Consolidated Financial Statements, the majority of the Group’s
existing loans were guaranteed by two of our directors who have expressed their
willingness to continue to support us until other sources of funds have been
obtained. Management believes that, with continuous growth of sales in the
PRC,
the existing directors’ support, and the new bank facilities, we will have
sufficient funds for operations over the foreseeable future. Management expects
that the Group will be able to repay the loans from our directors by the end
of
2007.
Net
cash provided by operating activities was $1,775,753 and $2,126,847 during
the
nine months ended September 30, 2007 and 2006, respectively. The $351,094
difference was primarily attributed to (i) reversal of allowance for loss on
inventory obsolescence and slow-moving items of $360,118 during the nine months
ended September 30, 2007, compared to provision of $57,204 during the nine
months ended September 30, 2006, (ii) a decrease of accrued expense of $197,992
during the nine months ended September 30, 2007, compared to an increase of
$153,224 during the nine months ended September 30, 2006, and (iii) decrease
of
receipts in advance of $125,205 during the nine months ended September 30,
2007,
compared to an increase of $566,707 during the nine months ended September
30,
2006.
Net
cash used in investing activities was $1,988,515 during the nine months ended
September 30, 2007 and net cash provided by investing activities was $679,970
during the nine months ended September 30, 2006. The $2,668,185 difference
was
primarily attributable to acquisition and a decrease of pledged notes receivable
in the amount of $433,690 during the nine months ended September 30, 2007,
compared to an increase of $695,875 during the nine months ended September
30,
2006.
Net
cash provided by financing activities during the nine months ended September
30,
2007 amounted to an increase of $74,813, as compared to a decrease of $1,814,965
during the nine months ended September 30, 2006. The $1,889,778 difference
was
primarily attributable to (i) an increase of $900,814 in cash provided by bank
borrowings, (ii) a decrease of $1,022,414 in cash used in repayment of bank
borrowings, and (iii) an increase of $38,198 in cash used to repay loans from
related parties.
Off-Balance
Sheet Arrangements
As
of September 30, 2007, 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.
Bank
Borrowing
One
of our financing sources is bank borrowings. As of September 30, 2007 and 2006,
the balances of bank borrowings, including current and non-current portions,
were $2,437,302 and $1,904,828, respectively.
Pension
Benefit
As
of July 1, 2005, the Group maintains two different retirement plans, according
to the ROC Labor Standard Law, a non-contributory and funded defined
contribution retirement plan (the “New Plan”) covering all regular employees of
KCIT, our subsidiary in Taiwan, and the benefit retirement plan (the “Old Plan”)
which commenced in September 2003, and only applies to the regular employees
of
KCIT who were employed prior to June 2005. (See Note 14 of Condensed
Consolidated Financial Statements.) The benefits under both plans 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 $16,735, 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 PRC
employees for the nine months ended September 30, 2007 and 2006 amounted to
$39,611, and $26,326, respectively.
NEW
ACCOUNTING PRONOUNCEMENTS
In
July 2006, the Financial Accounting Standards Board (the “FASB”) released
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an
Interpretation of FASB Statement 109.” Effective for fiscal years beginning
after December 15, 2006, this interpretation provides guidance on the financial
statement recognition and measurement for income tax positions that we have
taken or expect to take in our income tax returns. It also provides related
guidance on derecognition, classification, interest and penalties, accounting
in
interim periods, disclosure, and transition. We have adopted this standard
as of
January 1, 2007. The adoption did not have a significant impact on our financial
statements.
In
September 2006, the FASB released SFAS No. 157, “Fair Value Measurements” which
defines fair value, establishes a framework for measuring fair value in GAAP,
and enhances disclosures about fair value measurements. This standard applies
when other accounting pronouncements require fair value measurements; it does
not require new fair value measurements. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those years. We are currently evaluating the effect
of
the guidance contained in this standard and do not expect the implementation
to
have a material impact on our financial statements.
In
February 2007, the FASB released SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.” The standard is effective for
fiscal years beginning after November 15, 2007, with early adoption permitted
as
of the beginning of a fiscal year that begins on or before the aforementioned
date. We did not elect to adopt SFAS No. 159 early.
Non-GAAP
Financial Measures
None.