ITEM 1A.
RISK FACTORS
Risks Relating to Our Business
We have a history of operating losses and may have difficulty maintaining profitability.
Our ability to maintain a positive cash flow and maintain profitability depends on our ability to generate and maintain revenue while incurring reasonable expenses. This, in turn, depends, among other things, on the development of our business in Taiwan and the PRC. We may be unable to maintain profitability if we fail to do any of the following:
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maintain and improve our current products and services and develop or license new products on a timely basis;
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compete effectively with existing and potential competitors;
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further develop our business activities;
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manage expanding operations; or
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attract and retain qualified personnel.
Although the trend has reversed the last two years, we have incurred operating losses during most reporting periods since our inception. As a result, as of December 31, 2007, we had an accumulated deficit of $7,179,418. We incurred net losses of $1,698,282 and $46,211 for the years ended December 31, 2005 and 2006, respectively. We incurred net income of $1,877,149 for the years ended December 31, 2007. The net cash used in operation activities was $1,295,250 for years ended December 31, 2005. The net cash provided by operation activities were $1,773,267 and $1,507,860 for the year ended December 31, 2006 and 2007, respectively. The accumulated deficit has improved since Messrs. Pai and Yang have assumed their respective management roles, and we are optimistic that the trend will continue for the foreseeable future.
If we are unable to maintain profitability, it could impede implementation of our growth strategy, or cause the market price of our common stock to decrease.
We cannot predict whether demand for our products and services will continue to develop, particularly at the volume or prices that we need to maintain profitability in a competitive environment..
The market for English-language instruction and education is growing rapidly. We believe our success ultimately will depend upon, among other things, our ability to:
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increase awareness of our brand and the availability of our products and services;
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continue to attract and develop relationships with educational institutions and regulatory authorities in our targeted geographic markets; and
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continue to attract and retain customers.
Because our operating results are tied, in part, to the success of our franchises, the failure of our franchises could adversely affect our operating results.
Our revenues include licensing fees received from franchises of Kid Castle. Accordingly, our future revenues will be impacted by the gross revenues of Kid Castle franchises and the number of schools operating by these franchises. Although our revenues from Kid Castle franchise operations will vary directly with the gross revenues of our franchises, we are not directly dependent on the franchises’ profitability. We believe, however, that the profitability of existing franchises is key to our ability to attract new franchises and open new franchised schools. Therefore, factors that adversely affect the revenues and profitability of our franchises may have an adverse effect on our operating results.
There can be no assurance that our franchises will operate schools successfully. While no individual franchise represents more than 1% of our franchise revenues, a significant failure of our franchises to operate successfully could adversely affect our operating results. The resolution of certain franchise 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 potential claims by franchises that 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 market is new, rapidly evolving and highly competitive. We expect this competition to persist and intensify in the future. This increase in competition could impact our business as it leads to price reductions, increases in the Company’s overhead expenses, under-utilization of employees, and increases in operation costs.
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:
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branches and franchises of international language instruction companies;
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public institutions and private schools; and
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private tutors.
Because we face competition from established competitors, we cannot guarantee future profits.
Our primary competitors include Giraffe, Jordan, JEO, Gram and Hess in Taiwan; Onlyedu, DDDEO, New Oriental and English First in the PRC. Our primary competitors have significant financial, technical, and marketing resources, and established brand 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, in the ROC market, we need to improve our service quality or decrease our fees to maintain our customer level. In the PRC market, we have to assertively develop the market and further enhance our reputation as well as increase our market share. In performing the aforementioned in the respective markets, we may incur increased operational cost and or reduce our profit and therefore we cannot guarantee future profits.
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:
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our inability to adapt our products and services to local cultural traits and customs;
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our inability to locate qualified local employees, partners, and suppliers;
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difficulties managing foreign operations;
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the potential burdens of complying with a variety of foreign laws;
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trade standards and regulatory requirements;
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geopolitical risks, such as political and economic instability and changes in diplomatic and trade relationships;
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legal uncertainties or unanticipated changes regarding regulatory requirements, liability, export and import restrictions, tariffs, and other trade barriers;
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uncertainties of laws and enforcement relating to the protection of intellectual property;
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political, economic, and social conditions in the foreign countries where we conduct operations;
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currency risks and exchange controls;
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potential inflation in the applicable foreign economies; and
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foreign taxation of earnings and payments received by us from our franchises and affiliates.
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 guaranteed, 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 risks jeopardizing our competitive position. We may have to initiate litigation in order 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 and enforcement of those laws has been sporadic at best. Any further reduction in the legal protections granted to 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, these measures may not be adequate to prevent others from claiming that we violated their copyrights, 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 or modify our products.
We substantially rely on loans from shareholders and bank loans and our inability to obtain sufficient funding may adversely affect our liquidity and financial condition.
As of December 31, 2005, 2006 and 2007, our bank loans and loans from financial institutions were $3,157, 297, $1,787,360, and $2,965,310, respectively. Although we had an accumulated deficit, as of December 31, 2007, we had a positive cash flow from operations. Barring significant, unforeseen developments in the PRC, we believe we can decrease our reliance on loans from shareholders and banks to meet our funding requirements in the future. Despite our expectation to decrease reliance on loans, we may again be required to seek loans to meet our funding requirements and no assurances can be given that bank loans or loans from shareholders will be available in the future. If we are unable to secure sufficient financing, 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:
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our financial condition;
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general economic and capital market conditions;
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availability of credit from banks or lenders;
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conditions in the financial markets;
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investor confidence in us; and
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economic, political and other conditions in Taiwan and the PRC.
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 (“NT dollars”) and RMB, we are subject to risk from exchange rate fluctuations.
Our transactions with suppliers and customers are effected in NT dollars, the functional currency of our Taiwanese subsidiary, KCIT. As a result of our expansion in the PRC, our transactions are also effected in RMB, the functional currency of our PRC subsidiary, KCES and KCEI. Our financial statements are reported in U.S. dollars. As a result, fluctuations in the relative exchange rate among the U.S. dollar, the NT dollars, and the RMB will affect our reported shareholders’ equity from one period to the next. Such impacts could be material 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 companies formed under the laws of Taiwan and the People’s Republic of China, 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 both our business and our officers and directors are located outside the United States. As a result, it may be difficult for investors to affect service of process upon such persons, or to enforce court judgments obtained against such persons in United States courts when their claims are predicated upon the civil liability provisions of the Securities Act.
Our internal controls and management systems are currently not consistent with international practices, and we are in the process of improving these controls to enable us to certify their effectiveness in accordance with 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 meet 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 in 2005, our external auditors at the time 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 and related rules and regulations, we are required to evaluate our internal controls over financial reporting and to file an assessment of their effectiveness with the U.S. Securities and Exchange Commission. Our external auditors, within certain deadlines established by the SEC, are required to attest to such evaluation. 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, Mr. Min-Tan Yang, our Chief Executive Officer, and Mr. Suang-Yi Pai, our Chief Financial Officer. If these key officers 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 instructors and management, and 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 instructing personnel, or if we fail to continue to attract qualified personnel, our business could suffer considerable loss of profit.
“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 currently falls within the definition of penny stock and may 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 involving a penny stock, other than exempt transactions, 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 and current quotations for the securities to both the broker-dealer and the registered representative. 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.
Risks Relating to The People’s Republic of China
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, 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. Despite the fact that the exposure to this risk may decrease in the future as the Chinese economy globalizes and regulation relaxes, there is no assurance 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. (“KC Culture Media”) and 21st Century Kid Castle Language and Education Center (“KC Education Center”), and to establish a wholly-owned subsidiary, KCEI. KC Culture Media and KC Education Center primarily publish and distribute English-language education materials, enter into franchise and consulting relationships with kindergarten and language schools, and provide services to cooperative schools in China. KCEI has now commenced operation of directly managed schools in the PRC. We intend to use the direct management approach as one of our primary vehicles for our expansion into the PRC market. Although we received, on January 19, 2004, and October 31, 2003, respectively, licenses from the applicable government authorities to conduct the business of KC Culture Media and KC Education Center in the PRC, there exist various factors that render the regulatory environment volatile and uncertain.
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 certain laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation, and trade. However, PRC courts’ experience in implementing, interpreting, and enforcing these laws and regulations remain limited, and thus rendering any efforts that may be devoted to enforce commercial claims or to resolve commercial disputes being 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 2.
ITEM 2.
PROPERTIES
We lease many of our facilities, consisting principally of administrative office space, warehouse space, and sales offices. In addition, we lease housing accommodations for our employees in China. Our principal executive offices consist of 534 square meters of office space, which we own, located on the 8th Floor, No. 98, Min Chuan Road, Hsien Tien, Taipei, Taiwan, Republic of China. We believe that our current space is adequate for our needs for the foreseeable future.
The following table sets forth the location and size of the material facilities of our subsidiaries, KCIT and KCES:
KCIT
Nature
Location
Floor Space (m2 )
Registration area
No. 148, Jianguo Road, Hsien Tien,
Taipei, Taiwan, ROC
Administrative office
th Floor, No. 98, Min Chuan Road, Hsien
Tien, Taipei, Taiwan, ROC
Administrative office
8th Floor, No. 100, Min Chuan Road, Hsien
Tien, Taipei, Taiwan, R.O.C.
Administrative office
Room 5, 8th Floor, No. 251, Min Chuan 1st
Road, Kaohsiung, Taiwan, R.O.C.
Warehouse
No. 459, Sec. 2, Zhongshan Rd., Huatan
Shiang, Changhua County 503, Taiwan, ROC
5,000
KCES
Nature
Location
Floor Space (m2 )
Administration office
th Floor, No. 1277, Beijing West Road,
Shanghai, PRC
Warehouse
No. 305, Lane 2638, Hongmei South Road,
Shanghai, PRC
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
The Company is not a party to any legal proceedings of a material nature.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On May 4, 1998, our common stock was approved for quotation on the NASD Over-the-Counter Bulletin Board under the trading symbol “OMDO.” On June 28, 2002, the trading symbol was changed to “OMDR.” On August 22, 2002, the trading symbol was changed to “KDCE.” The high and low bid quotations for our common stock were as follows for the periods below (as reported by OTCBB).
The quotations below reflect inter-dealer prices without retail markup, markdown, or commission, and may not represent actual transactions:
As of December 31, 2007, the Company had approximately 2,400 shareholders of record. The Company has never paid any dividends on its common stock and does not have any plans to pay any dividends in the foreseeable future.
Recent Sale of Unregistered Securities; Use of Proceeds from Registered Securities
Not applicable.
Purchases of Equity Securities by Registrant and Affiliated Purchasers
Not applicable.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
Five-Year Selected Financial Data
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
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,” “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.
General
We are engaged in the business of child 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 business originally started in Taiwan, and, in 2001, we began expanding our business into the PRC. We officially launched our operations in Shanghai in April 2002. As in Taiwan, we offer advanced teaching materials and tools and monthly magazines to provide children ranging from two to twelve years of age a chance to learn exceptional English-language and computer skills.
Critical Accounting Policies, Judgment, 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 we believe 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, educational tools, and equipment as revenue when title of the product and risk of ownership are transferred to the customer. Title of the product and risk of ownership are transferred to the customer at the time of delivery or when the goods arrive at the customer’s designated location, and they may vary depending on the associated shipping terms. Additionally, we deliver products sold by our distributors directly to the distributors’ customers. We recognize the delivered goods 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 in revenues.
If market conditions were to decline, we may take actions to increase sales discounts, possibly resulting in an incremental reduction in 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. They could also result in an inability to recover the carrying value of the investments, an inability 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 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 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. We measure recoverability of assets to be held and used by comparing 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 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 December 31, 2007, the balance of our amortizable intangible assets was $538,638, including franchise-related intangible assets of $339,227 and copyrights of $199,411. The amortizable intangible assets are amortized on a straight-line basis over estimated useful lives of 10 years. As of December 31, 2007, the balance of goodwill was $197,043, which is amortized on a straight-line basis over estimated the useful lives of five 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 that 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 reliability. Actual results may differ significantly from management’s estimate.
Currency Exchange Risk.
Our transactions with suppliers and customers are primarily effected in NT dollars, which is the functional currency of our Taiwanese subsidiary, KCIT. As a result of our expansion in the PRC, we have increased transactions denominated in RMB, which is the functional currency of our PRC subsidiaries, KCES, KC Culture Media and Shanghai Kid Castle Educational Info Constitution Company Limited. Our financial statements are reported in U.S. dollars. As a result, fluctuations in the relative exchange rate among the U.S. dollar, the NT dollars, and the RMB will affect our reported financial results. Such impacts could be material and are independent of the underlying performance of the business. The market price of our securities could be significantly harmed based on unfavorable changes in exchange rates. We do not actively manage our exposure to the effects of such unfavorable changes in exchange rates.
Results of Operations
Comparison of Fiscal Years 2007 and 2006
Total Net Operating Revenue. Total net operating revenue consists of sales of goods, franchise income and other operating revenue. Total net operating revenues increased by $1,525,029, or 16%, to $11,236,612 for the year ended December 31, 2007 from $9,711,583 for the year ended December 31, 2006. The increase in revenue between the two years consisted of the increase in sales of goods of $897,132, franchise income of $125,117 and other operating revenues of $502,780.
Sales of goods. The increase in sales of goods, from $6,774,260 for fiscal year 2006 to $7,671,392 for fiscal year 2007, or 13%, was mainly due to the increase in net sales of goods generated from our PRC operations of $1,057,846, or 51%, to $3,136,881 for fiscal year 2007 from $2,079,035 for fiscal year 2006.
Franchise income. The increase in franchise income, from $2,080,551 for fiscal year 2006 to $2,205,668 for fiscal year 2007, or 6%, was mainly due to the increase in the number of our franchised schools established in the PRC. Franchise income for PRC increased by 219,121, or 31%, to $927,241 for fiscal year 2007 from $708,120 for fiscal year 2006.
Other operating revenue. Our other operating revenues represents revenue from other activities and services such as training of teachers, arranging for personal English-language tutors, organizing field trips and educational fairs, and collecting fees for designing the school layout of our franchised schools. Other operating revenue increased by $502,780, or 59%, to $1,359,552 for fiscal year 2007 from $856,772 for fiscal year 2006. The increase was mainly due to an increase in revenue generated from services rendered in connection with the construction and design layout of our franchised schools and sales of education-related equipment to our franchised schools in our Taiwan operations.
Gross Profit. Gross profit increased by $1,065,920, or 18%, to $7,138,765 for fiscal year 2007 from $6,072,845 for fiscal year 2006. The increase in gross profit was attributable to increase in operating revenue.
Total Operating Costs. Total operating costs increased by $459,109, or 13%, to $4,097,847 for fiscal year 2007 from $3,638,738 for fiscal year 2006. This increase was mainly due to costs associated with increased sales.
Other Operating Expenses. Other operating expenses decreased by $184,102, or 3%, to $5,342,216 for fiscal year 2007 from $5,526,318 for fiscal year 2006, principally due to decreases in expenditures to fund daily operations in our Taiwan operations.
Interest Expenses, Net. Net interest expenses decreased by $89,526, or 50%, to $90,299 for fiscal year from $179,825 for fiscal year 2006, primarily due to the reduction of loans due to officers and decreases in bank loans in 2007. Please refer to Note 13 in our Consolidated Financial Statements for more information.
Provision for Taxes. Provision for taxes for fiscal years 2007 and 2006 were $278,191 and $173,325, respectively. These provisions for income taxes mainly represent the use of net operating loss carry-forwards to offset the income generated for our operations in Taiwan and an increase in the valuation allowance charged against deferred tax assets generated from our PRC operations in order to reduce the deferred tax assets to the extent that the tax benefit is more likely than not to be realized.
Comparison of Fiscal Years 2006 and 2005
Total Net Operating Revenue. Total net operating revenue consists of sales of goods, franchise income and other operating revenue. Total net operating revenues decreased by $520,751, or 5%, to $9,711,583 for the year ended December 31, 2006 from $10,232,334 for the year ended December 31, 2005, including the decrease in sales of goods of $246,272 and franchise income of $209,104 and other operating revenues of $65,375.
Sales of goods. The decrease in sales of goods, from $7,020,532 for fiscal year 2005 to $6,774,260 for fiscal year 2006, or 4%, was mainly due to the decrease in net sales of goods generated from our Taiwan operations of $398,278, or 8% , to $4,695,786 for fiscal year 2006 from $5,094,064 for fiscal year 2005.
Franchise income. The decrease in franchise income, from $2,289,655 for fiscal year 2005 to $2,080,551 for fiscal year 2006, or 9%, was mainly due to the decrease in the number of our franchised schools in Taiwan and the decrease in franchise income in Shanghai operations despite an increase in the number of franchised schools. Franchise income for Taiwan decreased by $93,290 from $1,465,721 for fiscal year 2005 to $1,372,431 for fiscal year 2006 and for Shanghai decreased by $115,814 from $823,934 for fiscal year 2005 to $708,120 for fiscal year 2006.
Other operating revenue. Our other operating revenues represents revenue from other activities and services such as training of teachers, arranging for personal English-language tutors, organizing field trips and educational fairs, and collecting fees for designing the school layout of our franchised schools. Other operating revenue decreased by $65,375, or 7%, to $856,772 for fiscal year 2006 from $922,147 for fiscal year 2005. The decrease was mainly due to a decrease in revenue generated from services rendered in connection with the construction and design layout of our franchised schools and sales of education-related equipment to our franchised schools in our Taiwan operations.
Gross Profit. Gross profit decreased by $348,445, or 5%, to $6,072,845 for fiscal year 2006 from $6,421,290 for fiscal year 2005. The decrease in gross profit was attributable to decrease in operating revenue.
Total Operating Costs. Total operating costs decreased by $172,306, or 5%, to $3,638,738 for fiscal year from $3,811,044 for fiscal year 2005. This decrease was mainly due to decreases in operating revenue.
Other Operating Expenses. Other operating expenses decreased by $1,062,605, or 16%, to $5,526,318 for fiscal year 2006 from $6,588,923 for fiscal year 2005, principally due to decreases in salary expenditures resulting from a reduction in employee headcount in our Shanghai operations.
Interest Expenses, Net. Net interest expenses decreased by $57,063, or 24%, to $179,825 for fiscal year from $236,888 for fiscal year 2005, primarily due to the reduction of loans due to officers and decreases in bank loans in 2006. Please refer to Note 13 in our Consolidated Financial Statements for more information.
Provision for Taxes. Provision for taxes for fiscal years 2006 and 2005 were $173,325 and $477,297, respectively. These provisions for income taxes mainly represent the use of net operating loss carry-forwards to offset the income generated for our operations in Taiwan and an increase in the valuation allowance charged against deferred tax assets generated from our PRC operations in order to reduce the deferred tax assets to the extent that the tax benefit is more likely than not to be realized.
Liquidity and Capital Resources
Comparison of Fiscal Years 2007 and 2006
As of December 31, 2007, our principal sources of liquidity included cash and bank balances of $1,238,212, which decreased from $181,661 at December 31, 2006. The decrease in cash was mainly due to increase in new investment in our Shanghai operations.
Net cash provided by operating activities were $1,507,860 and $1,773,267 during fiscal year 2007 and 2006, respectively. Net cash provided by operating activities during fiscal year 2007 was primarily attributed to the increase in net income.
Net cash used in investing activities was $2,060,858 during fiscal years 2007 as compared to net cash provided by investing activities of $671,018 during fiscal years 2006. The $2,731,876 decrease is due to the acquisition of 100% interest in Jilin and Green Field, and a 55% interest in Lanbeisi in 2007.
Net cash provided by financing activities during fiscal year 2007 was $657,127 as compared to net cash used in financing activities of $1,583,939 during fiscal year 2006. The $2,241,066 increase was primarily attributable to proceeds from bank borrowings of $1,912,234 during fiscal year 2007, as compared to that of $213,357 during fiscal year 2006.
Comparison of Fiscal Years 2006 and 2005
As of December 31, 2006, our principal sources of liquidity included cash and bank balances of $1,419,873, which increased from $613,391 at December 31, 2005. The increase was mainly due to reductions in expenses in our Shanghai operations.
Net cash provided by operating activities was $1,773,267 during fiscal year 2006 and net cash used in operating activities was $1,295,250 during fiscal year 2005. Net cash provided by operating activities during fiscal year 2006 was primarily attributed to the decrease in net loss.
Net cash provided by investing activities was $671,018 and $1,514,264 during fiscal years 2006 and 2005, respectively. The $843,246 decrease is due to the change in the amount due from a shareholder/director of $977,838 during fiscal year 2005.
Net cash used in financing activities during fiscal year 2006 was $1,583,939 as compared to net cash provided by financing activities of $262,196 during fiscal year 2005. The $1,846,135 decrease was primarily attributable to proceeds from bank borrowings of $213,357 during fiscal year 2006, as compared to that of $3,067,111 during fiscal year 2005.
Off-Balance Sheet Arrangements
As of December 31, 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.
Contractual Obligations
The Company, Higoal and its subsidiaries are collectively referred to as the “Group.” The following table represents the Group’s contractual obligations:
Bank Borrowing. One of our financing sources is from bank borrowings. As of December 31, 2007 and December 31, 2006, the balances of bank borrowings, including current and non-current portions, were $2,965,310 and $1,787,360, respectively.
New Subsidiary Investment. On December 27, 2006, the Group established a wholly - owned subsidiary, Shanghai Kid Castle Educational Info Constitution Company Ltd. with registered total capital of RMB 1,200,000, in order to operate schools controlled by us in the PRC. As of December 31, 2007 KCEI had total registered capital of RMB2,000,000. We hope to increase the profit margin of the Group as a result of the formation of KCEI.
Pension Benefit. In accordance with the ROC Labor Standard Law, the Group maintains two different retirement plans: 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 whom were employed prior to June 2005. For further information, please refer to Note 16 to our 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 $44,010 and $64,703, respectively.
We also make defined contributions to a retirement benefits plan for our employees in the PRC in accordance with local regulations. 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 16 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 $44,010 and $64,703, 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 fiscal years 2007, 2006, and 2005 amounted to $56,095, $77,750 and $51,007, respectively.
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 Group will continue as a going concern. The Group has been aggressively expanding its business in the PRC, and the Shanghai operations were profitable as of December 31, 2006. We anticipate continued expansion of the market for its 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 its profit margin, the Group has operated direct-owned schools beginning since 2007. Due to the rapid expansion in Shanghai, the Group foresees additional need for funds in the near future to facilitate its expansion plans during 2008. As discussed in Note 13 to our Consolidated Financial Statements, the majority of the Group’s existing loans were guaranteed by two directors of the Group who have expressed their willingness to continue to support the Group until other sources of funds have been obtained. Moreover, 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 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 July 2007, 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, 2007, 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 2007, 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 is applied 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. The standard provides entities the ability, on an elective basis, to report most financial assets and financial liabilities at fair value, with corresponding gains and losses recognized in current earnings. We did not elect the fair value option under SFAS No. 159 as of January 1, 2008 for any of our financial assets and liabilities that were not already fair valued. We will consider applying the fair value option to future transactions as provided by the standard. We do not expect SFAS No. 159 to have a material impact on our financial statements.
In December 2007, the FASB released SFAS No. 141(R), “Business Combinations.” This standard revises and enhances the guidance set forth in SFAS No. 141 by establishing a definition for the “acquirer,” providing additional guidance on the recognition of acquired contingencies and non-controlling interests, and broadening the scope of the standard to include all transactions involving a transfer in control, irrespective of the consideration involved in the transfer. SFAS No. 141(R) is effective for business combinations for which the acquisition date occurs in a fiscal year beginning on or after December 15, 2008. Although the standard will not have any impact on our current Consolidated Financial Statements, application of the new guidance could be significant to the Company in the context of future merger and acquisition activity.
In December 2007, the FASB released SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements-an amendment of ARB No. 51.” This statement amends ARB 51 to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. We do not expect the standard to have a material impact on our Consolidated Financial Statements.
Non-GAAP Financial Measures
None.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, including changes in certain foreign currency exchange rates and interest rates. All of these market risks arise in the normal course of business, as we do not engage in speculative trading activities. We have not entered into derivative or hedging transactions to manage risk in connection with such fluctuations.
The following analysis provides quantitative information regarding our exposure to foreign currency exchange risk and interest rate risk.
Foreign currency exposure
We have operations in both Taiwan and the PRC. The functional currency of Higoal and its subsidiary, KCIT 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 KCES and its consolidated investee, KC Culture Media and Shanghai Kid Castle Educational Info Constitution Company 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.
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 fiscal year 2007, we have projected that, if interest rates were to increase by 1%, the result would be an annual increase in our interest expense of $21,438. This analysis does not take into consideration the effect of changes in the level of overall economic activity on interest rate fluctuations.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of Kid Castle and its subsidiaries including the notes thereto, together with the report thereon of Brock, Schechter & Polakoff, LLP, are presented beginning at page and are incorporated by reference herein.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On July 28, 2006, we engaged Brock, Schechter & Polakoff, LLP as our principal accountant and to audit our consolidated financial statements for the years ended December 31, 2005, 2006 and 2007.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Pursuant to Exchange Act Rule 13a-15(b) our management has performed an evaluation of the effectiveness of our disclosure controls and procedures. The term disclosure controls and procedures as defined in Exchange Act Rule Rule 13a-15(e) means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Based on deficiencies noted by our auditors, problems discovered relating to misuse of company funds by a company officer, and other issues noted in our management’s evaluation; we conclude that as of December 31, 2007 our disclosure controls and procedures were ineffective. We are taking measures to improve our disclosure controls and procedures, including instituting a new Enterprise Resource Planning (“ERP”) system and engaging an outside accounting firm to advise the Company with respect to setting up internal auditing and other controls and procedures. The ERP system is expected to complete its trial run period by the third fiscal quarter 2008 and become fully operational thereafter. The old system used by the Company will then be phased out. The phase-out period will involve the amalgamation of old data into the new ERP system, and training for staff on how to use the new ERP system. During the phase-out period, various functions and operations of the new ERP system will be operating in parallel with the old system.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the rules promulgated under the Securities Exchange Act of 1934. Under the supervision and with the participation of our management, including our principal executive and financial accounting officer, we have conducted an evaluation of the effectiveness of our internal control over financial reporting.
We have acknowledged that in the past our internal controls and procedures previously in place by the Company were inadequate and gave rise to misappropriation of funds as disclosed in our Current Report on Form 8-K filed on June 23, 2006. Among other improvements, we began implementing a comprehensive ERP system that will improve the Company’s internal controls. The ERP system has been fully installed and the system has been running in parallel with the old system since 2007. Since the trial-run in January 2007 to the filing date of this current report Form 10-K, we have encountered various obstacles that prevented the ERP system from independently operating on its own. The obstacles, included the proper training and familiarization of personnel with the ERP system and detecting enhancements that needed to be made in the ERP system and to resolve such enhancements and issues that are identified during the course of training and system trial-runs. As a result, Management now expects the ERP system to be fully operational in the third fiscal quarter of 2008. The operation of the old system is scheduled to be terminated by August 31, 2008. The Company believes that full implementation of its new ERP System will prevent misappropriation of funds by Company employees because the ERP system will perform the following functions:
·
Maintain detailed records and produce comprehensive financial statements on a periodic basis allowing management to review and detect irregular financial activities;
·
Place different check-points on the progression of ordinary monetary activities of the business; and
·
Delineate individual and/departmental responsibilities and effectively separate respective departmental transactions so as to prevent occurrence of intentional misappropriation of funds.
In addition to implementing a new ERP system, the following additional procedures have been implemented:
·
All departments requesting funds must obtain written approval from the Chief Executive Officer or the Chairman of the Board before the accounting department may commence processing payments;
·
All fund transfer applications must be approved by the applicable department supervisor before the application may be processed. No one can authorize their own application. This is applicable to all staff including staff at the managerial level;
·
Fund transfer applications in the PRC must additionally be approved by the headquarters in Taiwan;
·
All fund transfer applications must be accompanied by supporting documentation, such as a copy of the relevant contract copy of the relevant invoice or stock pre-payment statement;
·
Stock purchases require the approval of the supervisor or manager of the relevant department, the approval of the accounts department, and a stock receipt and suppliers’ certification. Finally the application must be approved by the Chairman of the Board before funds may be released; and
·
All pre-payments must be tracked by the fund applicant and the payments must be cleared within the month of payment or in accordance with the date stipulated in the relevant contract.
While we recognize that our internal controls and procedures were inadequate, we believe we have satisfactorily addressed these inadequacies by implementing the above changes, and now conclude that our internal control’s over financial reporting are effective
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this annual report.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Name
Age*
Position within the Company
Mr. Suang-Yi Pai
Chairman, Director and Acting Chief Financial Officer
Mr. Min-Tan Yang
Chief Executive Officer and Director
Mrs. Chin-Chen Huang
President of Shanghai Operations and Director
Mr. Ming-Tsung Shih
Director
Mr. Robert Theng
Director
*Age as at December 31, 2007.
Mr. Pai was elected to replace Mr. Kuo An Wang as the chairman of the board on November 2, 2005. Mr. Pai has served as a director of the company since October 2002. Since 1998, Mr. Pai has served as the general manager of Chin Yi Fung Enterprises Co., Ltd., a privately held company engaged in the manufacture of sandals.
Mr. Yang was elected by the board of directors to fill an existing vacancy and appointed chief executive officer on November 2, 2005. He has a master’s degree from the Department of Business Administration of Da-Yeh University. Mr. Yang has served as a director of Shanghai Taiwan Businessmen Elementary School since January 2005 and as a director of Global International Education Ltd since July 2001. In 2002, Mr. Yang was appointed as the chairman of two of the Company’s schools in Taiwan and, currently, he is the chairman of four of the Company schools.
Mrs. Huang has served as a director since October 2002 and as the President of Shanghai Operations since July 20, 2005. Prior to becoming the President of Shanghai operations, she was our Vice President of Taiwan operations.
Mr. Shih has served as a director since 2003. He is currently employed by Wuxi Paiho Textile Ltd. as a Financial Manager and part-time lecturer in Tunghai University.
Mr. Theng has served as a director since 2003, and he is currently a full-time professor at Dayeh University of Taiwan and the Vice President of Strategic Planning and Control of CV Sinar Jaya, Indonesia, a general contractor and real estate developer.
None of our directors are related to any of our other directors and none have any pending legal claims or litigation against them.
Section 16(a) Beneficial Reporting Compliance
None
Audit Committee Financial Expert
Mr. Shih qualifies as an audit committee financial expert according to the standard set forth in Regulation S-K, item 407. While the entire Board of Directors served as the Company’s Audit Committee and assumed responsibility for reviewing the Company’s financial statements with the Company’s auditors during the fiscal year ended December 31, 2007, the two independent directors, Messrs. Shih and Theng, had separate reviewing sessions with the Company’s auditors to discuss and ensure the accuracy and reliability of the Company’s financial statements in addition to those sessions conducted with the full Board of Directors.
Code of Ethics
We have adopted a corporate code of ethics. We believe our code of ethics is reasonably designed to deter wrongdoing and promote honest and ethical conduct; provide full, fair, accurate, timely and understandable disclosure in public reports; comply with applicable laws; ensure prompt internal reporting of code violations; and provide accountability for adherence to the code. Please refer to Exhibit 14 for a copy of our Code of Ethics (English translation). We will provide a copy of our Code of Ethics, without charge, to any person who requests in writing to our corporate secretary at our principal executive offices.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
Compensation Committee Interlocks and Insider Participation
As the Board of Directors does not have a Compensation Committee, the independent directors of the Board oversee the Company’s executive compensation program. Compensation for the CEO and the CFO has been approved by the Independent Directors of the Board. Compensation for other executive officers and senior management is determined by the CEO and CFO pursuant to the Board of Directors delegating to the CEO and CFO authority to do so. None of our executive officers serve as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our Board of Directors.
In light of the financial distress of the Company in 2005, the Company’s CEO, Mr. Yang, and CFO, Mr. Pai, volunteered to receive nominal salary from the Company. In 2006, Messrs Yang’s and Pai’s annual base salaries were $18,509 and $18,190, respectively, which were substantially lower than the compensation paid to executives in similar positions at peer companies. In 2007, Messrs Yang’s and Pai’s annual base salaries were $72,524 and $54,225, respectively.
Elements to Executive Compensation
The Company’s executive compensation program is designed to attract and retain executives responsible for the Company’s long-term success, to reward executives for achieving both financial and strategic company goals and to provide a compensation package that recognizes individual contributions as well as overall business results. The Company’s executive compensation program also takes into account the compensation practices of companies with whom Kid Castle competes for executive talent.
The two components of the Company’s executive compensation program are base salary and annual discretionary bonuses. Overall compensation is intended to be competitive for comparable positions at peer companies.
Objectives. The objectives of the Company’s executive compensation policies are to attract and retain highly qualified executives by designing the total compensation package to motivate executives to provide excellent leadership and achieve Company goals; to align the interests of executives, employees, and stockholders by establishing cohesive management, financial, operation and marketing goals that reflect the Company’s strategic growth plan; and to provide executives with reasonable security, through retirement plan and annual discretionary bonuses that motivate them to continue employment with the Company and achieve goals that will make the Company thrive and remain competitive in the long-run.
Linkage between compensation programs and Company objective and values. We link executive compensation closely with the Company objectives, which we believe are dependent on the level of employee engagement, operational excellence, cost management and profitability achieved. Currently, the primary quantifiable measurement of operational excellence for the Company is the achievement of profitability, which is directly related to increasing annual revenue. Executives’ annual performance evaluations are based in part on their achievement of the aforementioned goals and in part on revenue targets that may be established by the Board of Directors at the beginning of each fiscal year. The Board of Directors has not set a specific revenue goal for the award of bonuses for fiscal 2008. The Company currently does not have a defined non-equity incentive plan in place for its named executives. Instead, the disinterested members of the Board of Directors determine if any annual discretionary bonuses should be awarded to named executives in conjunction with the named executives’ annual performance evaluations. As indicated in the table below, during the last three fiscal years, the Board of Directors has not elected to award any annual discretionary bonuses to any named executives.
The roles of various elements of compensation. Executive compensation includes base salary, annual discretionary bonuses awarded by the Board of Directors in conjunction with named executives’ annual performance evaluations and other annual compensation granted under the noncontributory defined benefit retirement plan. Collectively, the Board’s objective is to ensure a total pay package that is appropriate given the performance of both the Company and the individual named executive.
Governance practices concerning compensation. The Board of Directors has implemented a number of procedures that the Board follows to ensure good governance concerning compensation. These include setting CEO and CFO salaries, authorizing the CEO or the CFO to determine the salaries of presidents and vice presidents, including Mrs. Huang, President of Shanghai operations, establishing annual goals for the Company, reviewing proposals for stock incentive plans, exercising fiduciary responsibilities over retirement plans, overseeing management development and succession planning, and keeping adequate records of its activities.
Base Salary
Each executive’s base salary is initially determined with reference to competitive pay practices of peer companies (where such information is publicly available) and is dependent upon the executive’s level of responsibility and experience. The Board uses its discretion, rather than a formal weighting system, to evaluate these factors and to determine individual base salary levels. Thereafter, base salaries are reviewed periodically, and increases are made based on the Board of Director’s subjective assessment of individual performance, as well as the factors discussed above. In light of the financial distress of the Company in 2005, Mr. Pai and Yang volunteered to receive no salary payments from the Company. In 2006, Messrs Yang and Pai were awarded $18,509 and $18,190 annual salary packages, respectively. Ms. Huang, President of Shanghai Operations, is subject to a conditional payment arrangement for her base salary for fiscal year 2007. Under this arrangement, 20 percent of her base salary is withheld and paid only if the Company is able to maintain or exceed its revenue at the fiscal year 2006 level. In 2007, Messrs Yang and Pai have received annual base salaries in the amounts of $72,524 and $54,225, respectively.
To ensure that its overall compensation is competitive, the Company reviews executive compensation, including both base salary and variable compensation, with a range of peer companies that offer tuition services in the children education industry and have physical presence in the PRC and ROC. The data gathered on these business entities is publicly available information from industry specific resources and the World Wide Web. Please note, however, many of the Company’s peers are not publicly-traded companies and, as a result, only limited information regarding executive compensation is available. The English-language teaching and educational services industry in Asia is highly fragmented, varying significantly among different geographic locations and types of consumers. Our main competitors in Taiwan include Giraffe Language School, Joy Enterprise Organization, Jordan’s Language School, Gram English, and Hess Educational Organization. Our main competitors in the PRC include English First, New Oriental Educational & Technology Group, DD Dragon Education Organization and Only Education Group. More information regarding our main competitors in the PRC and ROC regions can be found under the heading “Competition” in Item 1, above.
Based on review of available information, our Board of Directors estimates that the range of salaries for chief executive officers of our peer companies is $90,000 to $144,000 annually.
Annual Discretionary Bonuses
In past years we have paid variable incentive compensation to our executives, however, due to the our overall performance in 2007, our executive officers were not awarded bonuses.
Summary Compensation Table
The following table sets forth information about the compensation paid or accrued by our chief executive officer, chief financial officer, and one other most highly compensated executive officer (our “named officers”) for the last three completed fiscal years:
Notes:
(i)
Estimated annual retirement benefits of Mr. Yang under the Company’s non-contributory defined benefit retirement plan, includes health, accident, and labor insurance premiums in the aggregate amount of $380, and accrued retirement benefits under the Company’s non-contributory defined benefit retirement plan in the amount of $901.
(ii)
Estimated annual retirement benefits of Mrs. Huang under the Company’s non-contributory defined benefit retirement plan, includes health, accident, and labor insurance premiums in the aggregate amount of $1,528, and accrued retirement benefits under the Company’s non-contributory defined benefit retirement plan in the amount of $1,763.
(iii)
Estimated annual retirement benefits of Mrs. Huang under the Company’s non-contributory defined benefit retirement plan, includes health, accident, and labor insurance premiums in the aggregate amount of $2,160, and accrued retirement benefits under the Company’s non-contributory defined benefit retirement plan in the amount of $1,586.
(iv)
Estimated annual retirement benefits of Mrs. Huang under the Company’s non-contributory defined benefit retirement plan, includes health, accident, and labor insurance premiums in the aggregate amount of $3,582, and accrued retirement benefits under the Company’s non-contributory defined benefit retirement plan in the amount of $1,923.
Stock Option Grants in the Last Fiscal Year; Exercises of Stock Options
There were no grants of stock options during the fiscal year ended December 31, 2007. The Company has never granted any stock options.
Pension Plans
The Group maintains tax-qualified defined contribution and benefit retirement plan for its employees in accordance with ROC Labor Standard Law. As a result, the Group currently maintains two different retirement plans with contribution and benefit calculation formulas. On July 1, 2005, the Bureau of National Health Insurance issued New Labor Retirement pension regulations in Taiwan. The Group has defined the new contribution retirement plan (the “New Plan”) covering all regular employees in KCIT, and KCIT contributes monthly an amount equal to 6% of its employees’ basic salaries and wages to the Bureau of National Health Insurance. The Group still maintains the benefit retirement plan (the “Old Plan”), which commenced in September 2003 and only applies to the employees of KCIT who were employed prior to June 30, 2005, and KCIT contributes monthly an amount equal to 2% of its 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 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. Contribution amounts are determined in accordance with the advice of professionally qualified actuaries in Taiwan. Under the plan, the employees are entitled to receive retirement benefits upon retirement in the manner stipulated by the relevant labor laws in Taiwan. The benefits under the plan are based on various factors such as years of service and the final base salary preceding retirement.
PENSION BENEFITS
Notes:
(i)
The calculation of pension benefits under the Old Plan is applied prior to July 1, 2005 and calculation of pension benefits under the New Plan is applied after July 1, 2005.
Compensation Committee Report
As we do not have a compensation committee, the entire board of directors reviewed and discussed the Compensation Discussion and Analysis set forth above and agrees to its inclusion in this annual report on form 10-K.
Suang-Yi Pai
Min-Tan Yang
Chin-Chen Huang
Ming-Tsung Shih
Robert Theng
Director Compensation
The Company’s Bylaws provide that the Company’s directors may be paid their expenses and a fixed sum for attendance at meetings of the Board of Directors, may be paid a stated salary as a director, and no such payment shall preclude any director from serving the Company in any other capacity and receiving compensation therefore. Currently, each independent director is paid $609 (NT$20,000) for his attendance at each regular Board meeting.
DIRECTOR COMPENSATION
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth the beneficial ownership of shares of our common stock by (i) each person who is known to us to be the beneficial owner of more than 5% of our common stock; (ii) each director and named executive officer (defined above) individually; and (iii) all directors and executive officers as a group. Beneficial ownership of common stock has been determined for this purpose in accordance with Rules 13d-3 and 13d-5 of the Securities and Exchange Commission, under the Securities Exchange Act of 1934, as amended. These rules provide, among other things, that a person is deemed to be the beneficial owner of common stock if such person, directly or indirectly, has or shares voting power or investment power with respect to the common stock or has the right to acquire such ownership within sixty days after the date of this registration statement.
Notes:
(1) Based on 25,000,000 shares of common stock outstanding as at December 31, 2007.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
In late 2005, our company experienced financial difficulties and was incapable of generating cash flows sufficient to sustain our operations. At the time, our board of directors approached Messrs. Pai and Yang for financial aid and management support. Mr. Pai, a director of the Company, was elected Chairman on November 2, 2005 and subsequently procured short-term loans for the Company from two third parties, Olympic Well International Ltd. (“ Olympic ”) and Chen-Chen Shih ("Shih"), payable in three months in the amount of approximately U.S.$690,000 and $60,000 respectively, with a 7% annual interest rate. Mr. Yang, who was elected as a director of the Company on November 2, 2005, loaned us approximately U.S.$1.05 million with a 7% annual interest rate. As of July 31, 2006, the remaining debt owed by the Company to Olympic and Shih was assigned to Mr. Pai pursuant to an Assignment Agreement dated as of August 1, 2006. On December 28, 2006, pursuant to the loan settlement and conversion agreement, the parties agreed to convert a portion of the loans to stock at a conversion price of $0.15 per share and to issue promissory notes to the remaining amount. The promissory notes are due in one year and have an annual interest rate of 7%. These transactions are summarized in the following table:
As of December 31, 2007, the remaining outstanding principal and accrued interest on the notes $374,715 was fully repaid in cash.
Policy and Procedures with Respect to Related Person Transactions
We recognize that Related Person Transactions (defined as transactions, arrangements or relationships in which we were, are or will be a participant and the amount involved exceeds $10,000, and in which any Related Person (defined below) had, has or will have a direct or indirect interest) may raise questions among shareholders as to whether those transactions are consistent with the best interests of the Company and its shareholders. It is our policy to enter into or ratify Related Person Transactions only when the Board of Directors determines that the Related Person Transaction in question is in, or is not inconsistent with, the best interests of the Company and its shareholders, including but not limited to situations where we may obtain products or services of a nature, quantity or quality, or on other terms, that are not readily available from alternative sources or when we provide products or services to Related Persons on an arm’s length basis on terms comparable to those provided to unrelated third parties or on terms comparable to those provided to employees generally.
“Related Person” is defined as follows:
1.
any person who is, or at any time since the beginning of the Company’s last fiscal year was, a director or executive officer of the Company or a nominee to become a director of the Company;
2.
any person who is known to be the beneficial owner of more than 5% of any class of the Company’s voting securities;
3.
any immediate family member of any of the foregoing persons, which means any child, stepchild, parent, stepparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law of the director, executive officer, nominee or more than 5% beneficial owner, and any person (other than a tenant or employee) sharing the household of such director, executive officer, nominee or more than 5% beneficial owner; and
4.
any firm, corporation or other entity in which any of the foregoing persons is employed or is a general partner or principal or in a similar position or in which such person has a 5% or greater beneficial ownership interest.
Directors and executive officers are required to submit to the Board of Directors, acting in its role as audit committee, a list of immediate family members and a description of any current or proposed Related Person Transactions on an annual basis and provide updates during the year.
In our review of any Related Person Transactions, the Board of Directors must consider all of the relevant facts and circumstances available to it, including (if applicable) but not limited to: the benefits to the Company; the impact on a director’s independence in the event the Related Person is a director, an immediately family member of a director or an entity in which a director is a partner, shareholder or executive officer; the availability of other sources for comparable products or services; the terms of the transaction; and the terms available to unrelated third parties or to employees generally. No member of the Board of Directors may participate in any review, consideration or approval of any Related Person Transaction with respect to which such member or any of his or her immediate family members is the Related Person. The Board of Directors will approve or ratify only those Related Person Transactions that are in, or are not inconsistent with, the best interests of the Company and its shareholders, as the Board of Directors determines in good faith. The Board of Directors will convey the decision to the Chief Executive Officer or the Chief Financial Officer, who will convey the decision to the appropriate persons within the Company.
Director Independence
Based on the standard for director independence set forth in the American Stock Exchange, Company Guide, Messrs. Shih and Theng are independent directors. Messrs. Pai, Yang, and Huang are not independent directors.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
The total audit fees incurred for years 2006 and 2007 amounted to $136,325 and $121,026, respectively.
Audit-Related Fees
No audit-related fees were incurred in 2006 or 2007.
Tax Fees
The fees incurred for engaging tax advisors for years 2006 and 2007 amounted to US$13,000 and $15,000, respectively.
All Other Fees
None
Approval of Audit Services
The Board of Directors, in its audit committee function, approves all audit and non-audit services by its registered accountant. The Board does not engage such services pursuant to pre-approval policies.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) List of documents filed.
(1) Consolidated Financial Statements
The consolidated financial statements of Kid Castle Educational Corporation and its subsidiaries including the notes thereto, together with the report thereon of Brock, Schechter & Polakoff, LLP, are presented beginning at page .
(2) Summary of Quarterly Results
(3) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
Accounts receivable
Allowance for doubtful accounts and sales returns
Inventory
Provision for loss on inventory obsolescence and slow-moving items
Deferred income tax assets
Valuation allowance for deferred income tax assets - current
Valuation allowance for deferred income tax assets - non current
(b) Exhibits.
The exhibits filed with this annual report on Form 10-K are listed in the Exhibit Index that follows the signatures.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Min-Tan Yang
Min-Tan Yang
Director and President
(Principal Executive Officer)
March 31, 2008
/s/ Suang-Yi Pai
Suang-Yi Pai
Director, Chief Financial Officer and
Chairman (Principal Financial and
Accounting Officer)
March 31, 2008
/s/ Chin-Chen Huang
Chin-Chen Huang
Director
March 31, 2008
/s/ Ming-Tsung Shih
Ming-Tsung Shih
Director
March 31, 2008
/s/ Robert Theng
Robert Theng
Director
March 31, 2008
Exhibit Index
Exhibit
Number
Description
Incorporated by
Reference from
Document
Exhibit No.
in Referenced
Document
3.1
Articles of Incorporation
Form 10-K filed March 8, 2007
3.1
3.2
Bylaws
Form 10-Q/A filed August 17, 2004
3.1
10.1
Complete translation of Approval notification from Chang Hwa Bank Co., Ltd., for loan extension on October 18, 2007
10.2
Guarantee agreement by and among Chang Hwa Bank Co., Ltd., Kid Castle Internet Technology Corporation (Borrower), Min-Tan Yang (Guarantor) and Suang-Yi Pai (Guarantor) on April 13, 2006
10.3
Acknowledgement of loan, Loan Agreement by and between First Sino Bank and Kid Castle Educational Software Development Co., Ltd and guarantee by Kid Castle Internet Technology Corporation (Guarantor) and Min-Tan Yang (Guarantor) on April 20, 2007
10.4
Acknowledgement of loan, loan Agreement by and between Union Bank of Taiwan and Kid Castle Internet Technology Corporation and guarantee by Min-Tan Yang (Guarantor) and Suang-Yi Pai (Guarantor) on November 26, 2007
10.5
Equity Transfer Agreement, by and between Sichuan Province Education Institutional Service Center (Transferor) and Shanghai Kid Castle Educational Info Constitution Co., Ltd (Transferee) on June, 30,
10.6
Equity Transfer Agreement, by and between LANBEISI Education & Culture Industrial Co., Ltd (Transferor) and Shanghai Kid Castle Educational Info Constitution Co., Ltd (Transferee) on May 10, 2007
10.7
Equity Transfer Agreement, by and among Ai-Tung Sun (Transferor), Ying-Ji Lu (Transferor), Shanghai Kid Castle Educational Info Constitution Co., Ltd (Transferee) and Kid Castle Educational Software Development Co., Ltd (Transferee) on April 2, 2007
10.8
Equity Transfer Agreement, by and between Hsin-Pei Sheng (Transferor) and Shanghai Kid Castle Educational Info Constitution Co., Ltd (Transferee) on June 1, 2007
Code of Ethics
Form 10-K filed April 15, 2005
Subsidiaries of the Company
Form 10-KSB filed March 30, 2004
31.1
Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934
31.2
Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934
32.1
Certifications of Principal Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Kid Castle Educational Corporation
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Shareholders
Kid Castle Educational Corporation
Taipei, Taiwan ROC
We have audited the accompanying consolidated balance sheets of Kid Castle Educational Corporation and its Subsidiaries (the “Company”) as of December 31, 2007 and December 31, 2006 and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2007 and December 31, 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
Our audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule appearing under Item 15(a)(2) on page 37 is presented for purposes of additional analysis and is not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 17 to the financial statements, the Company has suffered previous losses from operations and has a small capital equity that raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 17. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/Brock, Schechter & Polakoff, LLP
Buffalo, New York
March 28,
Kid Castle Educational Corporation
Consolidated Balance Sheets
See accompanying notes to Consolidated Financial Statements.
Kid Castle Educational Corporation
Consolidated Statements of Operations
See accompanying notes to Consolidated Financial Statements.
Kid Castle Educational Corporation
Consolidated Statements of Shareholders’ Equity
See accompanying notes to Consolidated Financial Statements.
Kid Castle Educational Corporation
Consolidated Statements of Cash Flows
Kid Castle Educational Corporation
Consolidated Statements of Cash Flows - (Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
Kid Castle Educational Corporation
Notes To Consolidated Financial Statements
(Expressed in US Dollars)
NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS
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 is comprised of publication, sales and distribution of books, magazines, audiotapes, videotapes and compact discs, and the franchising and sales of merchandises complementary to the business of teaching children the English language. 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 shareholders 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 Ltd. (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 shareholders 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 shareholders 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 shareholders of Higoal hold a majority of the Company’s outstanding capital stock. Generally accepted accounting principles require in certain circumstances that a company whose shareholders 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 would own 50% ownership and that each party would contribute RMB1 million for the incorporation. On July 2, 2004, KCES acquired an additional 40% of Culture Media’s ownership from 21st Century Publishing House. KCES now owns 90% of Culture Media.
On December 27, 2006, KCES established a wholly-owned subsidiary, Shanghai Kid Castle Educational Info Constitution Company Limited (‘KCEI”) in the People’s Republic of China (the PRC), with registered total capital of RMB1,200,000, in order to operate schools controlled by us in the PRC. As of December 31, 2007, KCEI had total registered capital of RMB2,000,000.
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 - SUMMARY OF IMPORTANT ACCOUNTING POLICIES
Basis of Accounting and Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. The preparation of financial statements in accordance with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Kid Castle Educational Corporation
Notes To Consolidated Financial Statements - (Continued)
Foreign Currency Translation and Transactions
The functional currency of the Company is U.S. dollars and the financial records are maintained and the financial statements are prepared in U.S. dollars. The functional currency of Higoal and its subsidiary, KCIT, is New Taiwan Dollars (“NT$”) and the financial records are maintained and the financial statements are prepared in NT$. The functional currency of KCES, Culture Media and KCEI is Renminbi (“RMB”) and the financial records are maintained and the financial statements are prepared in RMB.
For the Company, foreign currency transactions during the year are translated into US$ at the exchange rates existing on the transaction dates. Gain and loss resulting from foreign currency transactions are included in the consolidated statement of operations. Assets and liabilities denominated in foreign currencies at the balance sheet date are translated into US$ at year-end exchange rates. All exchange differences are dealt with in the statement of operations.
For Higoal and KCIT, foreign currency transactions during the year are translated into NT$ at the exchange rates existing on the transaction dates. Gain and loss resulting from foreign currency transactions are included in the statement of operations. Assets and liabilities denominated in foreign currencies at the balance sheet date are translated into NT$ at year end exchange rates. All exchange differences are dealt with in the statement of operations.
For KCES, Culture Media and KCEI, foreign currency transactions during the year are translated into RMB at the exchange rates existing on the transaction dates. Gain and loss resulting from foreign currency transactions are included in the statement of operations. Assets and liabilities denominated in foreign currencies at the balance sheet date are translated into RMB at year end exchange rates. All exchange differences are dealt with in the statement of operations.
For the purpose of preparing the Group’s consolidated financial statements, the statement of operations of KCES prepared in RMB has been translated at the average exchange rates of NT$4.318 = RMB1.00 (2006: NT$4.045 = RMB1.00; 2005:NT$3.926 RMB1.00) and the balance sheet expressed in RMB has been translated at the exchange rate of NT$4.399 = RMB 1.00 (December 31, 2006: NT$4.177 = RMB1.00; December 31, 2005:NT$4.069=RMB1:00) existing on December 31, 2007. Translation adjustments are included as a component of shareholders’ equity.
For presentation of the Group’s consolidated financial statements, the consolidated statement of operations and consolidated statement of cash flows of Higoal prepared in NT$ have been translated at the average exchange rate of US$1.00 = NT$32.8427 (2006: US$1.00 = NT$32.523; 2005:US$1:00 = NT$32.167; 2004: US$1.00 = NT$33.42) and the consolidated balance sheet of Higoal expressed in NT$ have been translated at the exchange rate of US$1.00 = NT$32.417 (December 31, 2006: US$1.00 =NT$32.596; December 31, 2005:US$1:00 = NT$32.835. Translation adjustments are included as a component of shareholders’ equity.
Revenue Recognition
Sales of books, magazines, audiotapes, video tapes, compact discs and other merchandise 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 discounts when revenue is recognized.
Franchise income is recognized on a straight-line basis over the terms of the relevant franchise agreements.
Kid Castle Educational Corporation
Notes To Consolidated Financial Statements - (Continued)
Allowance for Doubtful Accounts
An allowance for doubtful accounts is provided based on the evaluation of collectibility and aging analysis of note receivable, accounts receivable and other receivables.
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. An allowance for loss on obsolescence and decline in market value is provided, when necessary.
Cash Equivalents
Cash equivalents include all highly liquid investments with an original maturity of three months or less when purchased.
Investments in Associates
Investments in other companies in which, through ownership and other factors, the Company has significant influence, but less than a majority of the voting common stock are accounted for under the equity method. Under the equity method the Company includes its share of the investee’s income or loss in its results of operations. The Company reviews its investments on a regular basis and considers factors including the operating results, available evidence of the market value and economic outlook of the relevant industry sector. When the Company concludes that an investment has suffered impairment that is other-than-temporary, the impairment is written off against earnings.
Fair Values of Financial Instruments
The carrying amounts of certain financial instruments approximate their fair values as of December 31, 2007, 2006, and 2005 because of the relatively short-term maturity of these instruments.
Property, 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.
Kid Castle Educational Corporation
Notes To Consolidated Financial Statements - (Continued)
Intangible Assets
Franchises and copyrights are stated at cost and amortized on the straight-line method over their estimated useful lives of 10 years.
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 Company 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 Company measures fair value based on quoted market prices or based on discounted estimates of future cash flows.
Advertising Costs
All advertising costs incurred in the promotion of the Company’s products and services are expensed as incurred.
Income Taxes
The Group 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 currently enacted tax rate. Valuation allowances are established when it is not considered more likely than not that the deferred tax assets will be realized.
Net Earnings (Loss) Per Share
The Company 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 potential common shares. For the years ended December 31, 2007, 2006, and 2005, the Group did not have any potential common shares.
Reclassification
The presentation of certain prior information has been reclassified to conform to current presentation.
Recent 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. The expanded disclosures include a requirement to disclose fair value measurements according to a hierachy, segregating measurements using quoted prices in active markets for identical assets and liabilities, significant other observable inputs, and significant unobservable inputs. 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. This standard will affect our fair value disclosures, however it is not expected to have a material impact on our financial condition or results of operations
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. The standard provides entities the ability, on an elective basis, to report most financial assets and financial liablities at fair value, with corresponding gains and losses recognized in current earnings. We did not elect the fair value option under SFAS No. 159 as of January 1, 2008 for any of our financial assets and liabilities that were not already accounted for at fair value. We will consider applying the fair value option to future transactions as provided by the standard. We do not expect SFAS No. 159 to have a material impact on our financial statements.
In December 2007, the FASB released SFAS No. 141(R), “Business Combinations.” This standard revises and enhances the guidance set forth in SFAS No. 141 by establishing a definition for the “acquirer,” providing additional guidance on the recognition of acquired contingencies and noncontrolling interests, and broadening the scope of the standard to include all transactions involving a transfer in control, irrespective of the consideration involved in the transfer. SFAS No. 141(R) is effective for business combinations for which the acquisition date occurs in a fiscal year beginning on or after December 15, 2008. Although the standard will not have any impact on our current Consolidated Financial Statements, application of the new guidance could be significant to the Company in the context of future merger and acquisition activity.
In December 2007, the FASB released SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51.” This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. We do not expect the standard to have a material impact on our Consolidated Financial Statements.
NOTE 3 - NOTES AND ACCOUNTS RECEIVABLE
Note: The total allowance for doubtful accounts and sales returns for the year ended December 31, 2007 amounted to US$453,920. Of this total, the allowance for sales returns was US$10,299, and allowance for doubtful accounts was US$443,621. The allowance for sales returns in the amount of US$10,299 is calculated based on historical operations in the ROC and allowance for doubtful accounts in the amount of US$443,621 is attributable to other debtors of the Company. The estimate of allowance for doubtful debt is made based on a percentage ageing analysis, whereby 100% of overdue receivables in our ROC operations exceeding 365 days are recognized as a doubtful account. Allowance for doubtful accounts in our operations in the PRC region are recognized in two categories with varying percentages based on the number of days overdue. The categories are (1) overdue between 181 and 365 days (based on an analysis of the financial strength of each customer, a discount ranging between 10% and 80% is assigned) and (2) overdue exceeding 365 days , which are revised at 100%.
NOTE 4 -INVENTORIES
NOTE 5 -OTHER RECEIVABLES
Note:
(i)
Shanghai Wonderland was a distributor of the Group. The Group loaned Shanghai Wonderland RMB450,000 (approximately $54,000), RMB500,000 (approximately $60,000), and RMB2,500,000 (approximately $310,000) for operations in December 2003, July 2005 and August 2005, respectively. The identified loans were unsecured and bore no interest. Shanghai Wonderland has fully repaid the loan of RMB450,000 in December 2004 and January 2005. As of December 31, 2007, Shanghai Wonderland still owes the Group a balance of RMB3,000,000 (approximately $403,595). This amount has been written off in 2007.
NOTE 6 - PREPAYMENTS AND OTHER CURRENT ASSETS
NOTE 7 -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 rate in Taiwan and recorded income tax (benefit) expense are as follows:
Significant components of the estimated deferred income tax assets as of December 31, 2007 and 2006 are as follows:
At December 31, 2005, KCES had net operating losses of approximately US$997,982, available to be carried forward to offset future taxable income which will expire in 2010.
The Company’s net operating loss carry forwards to offset future taxable income is insignificant.
NOTE 8 -INTEREST IN ASSOCIATES
Notes:
(i)
In October 2003, the Group obtained the government’s approval to co-found Education Center with 21 st Century Publishing House in the PRC. In 2004, Education Center registered the total capital as RMB1,500,000, and KCES and 21 st Century Publishing House each owns 5 0 % of the investee. It has been determined that the Group has significant influence and should therefore account for its investee on the equity method.
For the year ended December 31, 2007, the Group recognized investment income of $15,040 and recognized an investment loss of $9,759 for the year ended December 31, 2006, accounted for under the equity method, in Education Center.
(ii)
On April 1, 2004, the Group signed a joint venture agreement with Tianjin Foreign Enterprises & Experts Service Corp., in Tianjin City, PRC. Pursuant to this joint venture agreement, the Group and Tianjin Foreign Enterprises & Experts Service Corp. each owns a 50% interest in Tianjin Kid Castle Educational Investment Consulting Co., Ltd. It has been determined that the Group has significant influence over its investee and accordingly the investment is accounted for under the equity method. For the year ended December 31, 2007, the Group recognized investment income of $11,967 and recognized an investment loss of $21,164 for the year ended December 31, 2006, accounted for under the equity method, in Tianjin Consulting.
(iii)
On April 28, 2004, the Group signed a joint venture agreement with Lanbeisi Education & Culture Industrial Co., Ltd. in Sichuan Province, PRC and Sichuan Province Education Institutional Service Center in Sichuan Province, PRC. Pursuant to this joint venture agreement, the Group, Lanbeisi Education & Culture Industrial Co., Ltd and Sichuan Province Education Institutional Service Center own, respectively, 45 %, 45 % and 10 % interests in Sichuan Lanbeisi Kid Castle Education Development Co., Ltd. On May 10, 2007 and June 30, 2007, the Group signed a equity transfer agreement with Lanbeisi Education & Culture Industrial Co., Ltd and Sichuan Province Education Institutional Service Center, respectively, to acquire their interests of 45% and 10% in Lanbeisi, respectively.
As of December 31, 2007, the Group acquired 100% of Sichuan Lanbeisi Kid Castle Education Development Co., Ltd, which became a consolidated entity. (Please refer to Note 9 to our condensed consolidated financial statements for more information.)
NOTE 9 - ACQUISITION
Jilin Kid Castle Educational Investment Development Ltd (“Jilin KCEI”) was established in September 2002. In March 2007, the Group entered into an equity transfer agreement with third parties to acquire 100% ownership in Jilin KCEI. In May 2007, pursuant to this equity transfer agreement, KCES and KCEI, the Group’s wholly owned PRC subsidiaries, acquired, respectively, 49% and 51% of Jilin KCEI from the third parties for the purchase price of $570,003 (RMB4,200,000). The acquisition is expected to increase the Group’s profit margin and competitive position in the PRC. As of September 30, 2007, the Group owns 100% of Jilin KCEI, which became a consolidated entity. The fair value of Jilin KCEI’s net assets as of May 1, 2007 are $510,038. The difference between the purchase price and the fair value of Jilin KCEI’s net assets was $59,965, which was accounted for as goodwill.
On April 28, 2004, the Group signed a joint venture agreement with Lanbeisi Education & Culture Industrial Co., Ltd in Sichuan Province, PRC and Sichuan Province Education Institutional Service Center in Sichuan Province, PRC. Pursuant to this joint venture agreement, the Group, Lanbeisi Education & Culture Industrial Co., Ltd and Sichuan Province Education Institutional Service Center own, respectively, 45%, 45% and 10% of Sichuan Lanbeisi Kid Castle Education Development Co., Ltd (“Lanbeisi”). On May 10, 2007, the Group signed an equity transfer agreement with Lanbeisi Education & Culture Industrial Co., Ltd in Sichuan Province, PRC to acquire it’s interests of 45% in Lanbeisi for the purchase price of $43,429 (RMB320,000). Pursuant to this equity transfer agreement, the Group and Sichuan Province Education Institutional Service Center in Sichuan Province, PRC own, respectively, 90% and 10% of Lanbeisi. On June 30, 2007, the Group signed an equity transfer agreement with Sichuan Province Education Institutional Service Center in Sichuan Province, PRC for the purchase price of $10,857 (RMB80,000). Pursuant to this equity transfer agreement the Group acquired 100% of Lanbeisi. The Group’s Management believes that the acquisition is beneficial to our expansion development in Sichuan Province, PRC. As of December 31, 2007, the Group owns 100% of Lanbeisi, which became a consolidated entity. The fair value of Lanbeisi’s net liabilities as of July 31, 2007 was $37,011. The difference between the purchase price and the fair value of Lanbeisi’s net assets was $74,642, which was accounted for as goodwill.
On June 1, 2007, the Group entered into an equity transfer agreement with a third party to acquire 100% ownership in Xian Yanta Green Field Preschool for the purchase price of $339,287(RMB2,500,000). The fair value of Xian Yanta Green Field Preschool’s net assets as of July 31, 2007 was $255,667. The difference between the purchase price and the fair value of Xian Yanta Green Field Preschool’s net assets was $83,620, which was accounted for as goodwill. The Group’s Management believe that the acquisition enables the Group to expand its business into the Xian Province, PRC.
NOTE 10 -PROPERTY AND EQUIPMENT
The land and buildings at 8th floor, No. 98 Min Chuan Road, Hsin-Tien City, Taipei City, Taiwan, with carrying cost of $1,492,131 and $1,483,937 as of December 31, and 2006, respectively, purchased from a director are pledged to a bank to secure a bank loan (Note 13(iii)) granted in December 2003.
Depreciation charged to the operations was $253,620, $215,249 and $299,884 for the years ended December 31, 2007, 2006, and 2005, respectively.
NOTE 11 - INTANGIBLE ASSETS
Amortization charged to operations was $164,488, $166,106 and $167,945 for the years ended December 31, 2007, 2006, and 2005, respectively and the write-off of goodwill charged to operations was $21,184 for the year ended December 31, 2007.
The estimated aggregate amortization expenses and write-off of goodwill for each of the five succeeding fiscal years are as follows:
Goodwill should not be amortized but evaluated on an annual basis as to its value.
NOTE 12 -ACCRUED EXPENSES
NOTE 13 -BORROWINGS
Notes:
(i)
The balance represents discounting notes receivable loans with the bank using post-dated checks totaling $753,962 and $261,142 received from franchises and also collateralized by the Group’s bank deposits of $8,067 and $1,963 as of December 31, 2007 and 2006, respectively. The repayment dates of the loans coincided with the maturity dates of the corresponding pledged post-dated checks, and was extended on October 18, 2007. The weighted average interest rates were 5.85 % and 5.37 % per annum as of December 31, 2007 and 2006, respectively.
For the years ended December 31, 2007 and 2006, the interest expense charged to operations amounted to $22,053and $17,995, respectively.
(ii)
In March 2005, KCIT obtained an unsecured short-term loan in the amount of $304,553, which is guaranteed by two directors and shareholders of the Group. The loan bears interest at the Taiwan basic borrowing rate plus 1.3% per annum and was extended on April 11, 2007 and October 18, 2007. The short-term loan is repayable in 36 equal monthly installments. The last installment will be due on March 19, 2008. The applicable interest rate is approximately 5.85% and 5.37% per annum as of December 31, and 2006, respectively.
In August 2005, KCIT obtained an unsecured short-term loan in the amount of $304,553, which was collateralized by the KCIT’s refundable deposits of $60,911 and notes receivables approximating 30% of loan balance, and guaranteed by two directors and shareholders of the Group. The loan bears interest at the lending back’s basic fixed deposit rate plus 3.29 % per annum, which was extended in February 2007 and is due on February 2008. A portion of the principal of the loan amounting to $153,457 is repayable in 12 equal monthly installments and remaining principal amount of $151,096 will be repayable at maturity. The applicable interest rate is approximately 5.78% and 5.31% per annum as of December 31, 2007 and 2006, respectively, and was fully settled on November 28, 2007.
In May 2007, KCES obtained a short-term loan to finance the Group’s operations in the amount of $339,287, which was guaranteed by Director Mr. Yang and KCIT, and was collateralized by KCIT’s deposits of $340,000. It is due in April 2008. The loan bears interest at the PRC basic borrowing rate per annum, and the Group has repaid $6,836.
In November 28, 2007, KCIT obtained a new bank loan in the principal amount of $1,542,401. The loan is secured by the Group’s land and buildings and personal guarantees provided by two directors of the Group. The loan bears interest at the lending bank’s basic fixed deposit plus 1.45% per annum, A portion of the principal of the loan amount of $370,176 is repayable in 24 equal monthly installments and remaining principal amount of $1,172,225 will be repayable at maturity. The applicable interest rate is approximately 3.6% per annum as of December 2007 and is due on November 28, 2009.
For the years ended December 31, 2007 and 2006, the interest expense charged to operations from the above unsecured short-term loans amounted to $31,336 and $27,473, respectively.
(iii)
In August 2005, KCIT obtained a bank loan in the principal amount of $944,115 to repay its mortgage loan that was originally granted by a bank on August 10, 2003 and to finance its operations. The loan is secured by the Group’s land and buildings and personal guarantees provided by two directors of the Group. The loan bears interest at the lending bank’s basic fixed deposit rate plus 0.69%, per annum. On August 10, 2005, the bank extended the term of the loan and the Group agreed to repay the loan, which was repayable in 84 equal monthly installments starting August 10, 2012. As of December 31, 2007, the applicable per annum interest rate is approximately 2.7 % and was fully settled in advance by the Company on November 28, 2007.
In February 2005, KCIT obtained a new bank loan of $456,830, which bears interest at 6 % per annum and is repayable in 36 equal monthly installments. The last installment will be due on February 2, 2008, was collateralized by notes receivables approximating 30% of the loan balance, and guaranteed by two directors of the Group. As of December 31, 2007, the Group repaid $429,138.
In August 2005, KCIT obtained a new bank loan of $213,187, which bears interest at 3.7 % per annum, and was repayable in 60 equal monthly installments. The last installment was to be due on August 10, 2010, and guaranteed by two directors of the Group and was fully settled in advance by the Company on November 28, 2007.
For the years ended December 31, 2007 and 2006, the interest expense charged to operations from the aforementioned loans amounted to $34,510 and $47,837, respectively.
NOTE 14 - DEPOSITS RECEIVED
The balance represents deposits received from franchises for their due performance under the franchise agreements. The deposits are refundable to franchises upon expiration of the franchise agreements, usually within a three-year period for operations in Taiwan and within five-year period for operations in the PRC.
NOTE 15 -RECEIPTS IN ADVANCE
Notes:
(i) The balance represents receipts in advance from customers for goods to be sold to them.
(ii) The balance represents franchise income received in advance which is attributable to the periods after the respective year end date in which the Group is obliged to provide training to teachers of the franchises and marketing material and to sell course material at the agreed price in the franchise agreements.
(iii) The balance represents subscription fees received in advance for subscription of magazines published by the Group.
NOTE 16 - RETIREMENT PLANS
The Group maintains tax-qualified defined contribution and benefit retirement plan for its employees in accordance with ROC Labor Standard Law. As a result, the Group currently maintains two different retirement plans with contribution and benefit calculation formulas. On July 1, 2005, the Bureau of National Health Insurance issued New Labor Retirement pension regulations in Taiwan. The Group has defined the new contribution retirement plan (the ‘New Plan”) covering all regular employees in KCIT, and KCIT contributes monthly an amount equals 6% of the employees’ basic salaries and wages to the Bureau of National Health Insurance. The Group still maintains the benefit retirement plan (the “Old Plan”), which commenced in September 2003 and only applies to the employees of KCIT who were employed before June 30, 2005. 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 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. Contribution amounts are determined in accordance with the advice of professionally qualified actuaries in Taiwan. Under the plan, the employees are entitled to receive retirement benefits upon retirement in the manner stipulated by the relevant labor laws 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:
The net pension amount recognized in the consolidated balance sheet as at December 31, 2007, and 2006, the measurement dates, is as follows:
Changes in plan assets are as follows:
As of December 31, 2007 and 2006, the asset category of the plan assets consisted of cash contributions deposited with Central Trust of China.
Actuarial assumptions used:
Under the Plan, 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 as follow:
The Group also makes defined contributions to a retirement benefits plan for its employees in the PRC in accordance with local regulations. The contributions made by the Company for the years ended December 31, 2007, 2006, and 2005 amounted to $56,095, $77,750, and $51,007, respectively.
NOTE 17 -COMMITMENTS AND CONTINGENCIES
A. Lease Commitment
During the years ended December 31, 2007, 2006, and 2005, the Company incurred lease expenses amounting to $449,501, $404,405, and $491,909, respectively. As of December 31, 2007, the Company’s future minimum lease payments under non-cancelable operating leases expiring in excess of one year are as follows:
B. Going Concern
The accompanying financial statements have been prepared assuming the Group will continue as a going concern. Although the Group in the last two years has reversed a long trend of recurring net losses, it still has a significant accumulated deficit. Management expects net income in 2008, although the realization of net income is uncertain. 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.
NOTE 18 -COMMON STOCK
Pursuant to an exchange agreement effective on October 1, 2002, the Company issued to the shareholders of Higoal 11,880,000 authorized but unissued shares of common stock of the Company in exchange for 100% of the issued and fully paid up capital of Higoal.
The issued and outstanding common stock of the Company immediately prior to the above share exchange was 3,120,829 shares. All shares and per share data prior to October 1, 2002 have been restated to reflect the stock issuance as a recapitalization of Higoal.
On October 2, 2002, the Company issued 73,500 shares of common stock to a shareholder, Halter Capital Corporation, pursuant to certain anti-dilution terms set forth in a stock exchange agreement dated June 6, 2002.
Pursuant to a special Board resolution passed on April 2, 2003, the Company resolved to issue 6,000,000 shares of common stock at a subscription price of $0.70 per share to investors in reliance on Regulation S under the Securities Act. Subsequent to the resolution and before December 31, 2003, the Company issued 3,592,040 shares for cash and received net proceeds of $2,514,428. Additionally, pursuant to an agreement entered into in November 2003, the Company issued 333,334 shares to ACE Capital Investment Ltd. to repay the liability of $500,000 as required by the original creditor.
On November 4, 2003, the Company submitted “Common Stock Listing Application” with American Stock Exchange LLC (“AMEX”) for the listing of its issued and outstanding shares of common stock. On November 29, 2004, as the Company had not received approval for the listing application from AMEX, management withdrew the application.
On December 28, 2006, the Company issued 6,000,297 shares of common stock for a purchase price of $0.15 to Suang-Yi Pai, our Chairman of the Board, and Min-Tan Yang, our Chief Executive Officer, pursuant to the Loan Settlement and Conversion Agreement relating to settlement certain loans made by Messrs. Pai and Yang to the Company. (For further information please refer to Form 8-K/A filed on January 24, 2007.)
As of December 31, 2007, the Company was authorized to issue 60,000,000 shares of common stock with no par value. And as of December 31, 2007, 2006, and 2005, the total issued and outstanding shares were 25,000,000, 25,000,000, and 18,999,703 shares, respectively.
NOTE 19 - RESTRICTIONS ON RETAINED EARNINGS
In accordance with the regulations of the countries where KCIT, KCES, Culture Media and KCEI, the Group’s wholly-owned subsidiaries, were incorporated, certain restrictions on these subsidiaries’ retained earnings are described as follows:
A. KCIT
Legal reserve
According to the Taiwan Company Law, the annual net income should be used initially to cover any accumulated deficit; thereafter 10% of the annual net income should be set aside as a legal reserve until the reserve has reached 100 % of contributed capital. Under the Taiwan Company Law, the legal reserve shall be exclusively used to cover accumulated deficit or, if the balance of reserve exceeds 50% of contributed capital, to increase capital not exceeding 50% of reserve balance and shall not be used for any other purpose.
As of December 31, 2007, 2006, and 2005, the balance of legal reserve as shown on the consolidated statement of shareholders’ equity was $65,320, $65,320, and $65,320, respectively, based on the local statutory financial statements of the subsidiary.
Undistributed earnings
In accordance with KCIT’s articles of incorporation , the annual net income should be used initially to cover income tax and any accumulated deficit; 10% o f the annual net income should be set aside as legal reserve. Thereafter, the board of directors may propose and the shareholders may approve the distribution of the remaining earnings.
B. KCES, Culture Media and KCEI
The laws and regulations of the PRC require KCES, Culture Media and KCEI to provide certain statutory funds, namely, a reserve fund, an enterprise expansion fund, and a staff and workers’ bonus and welfare fund, which are appropriated from net profit (based on the subsidiaries’ statutory accounts) after offsetting any prior years’ losses but before dividend distribution. These funds are created for specific purposes and appropriations to these funds are at the discretion of the directors. The reserve fund can only be used, upon approval by the relevant authority, to offset accumulated losses or increase capital. The enterprise expansion fund can only be used to increase capital upon approval by the relevant authority. The staff and workers’ bonus and welfare fund can only be used for special bonuses or collective welfare of the subsidiaries’ employees, and assets acquired through this fund shall not be taken as the subsidiaries’ assets.
NOTE 20 - RELATED PARTY TRANSACTIONS
A.
Names of related parties and relationship with the Company are as follows:
Names of related parties
Relationship with the Company
Mr. Min-Tan Yang
Director and chief executive officer of the Company since November 2, 2005.
Mr. Suang-Yi Pai
Director of the board of directors and appointed as chairman of the board since November 2, 2005.
Kid Castle Enterprises Limited (“KCE”)
Its two directors and shareholders are Mr. Kuo-An Wang and Mr. Yu-En Chiu.
Chevady Culture Enterprise Limited (‘CCE”)
Its chairman of the board of directors is Mr. Kuo-An Wang
Private Kid Castle Short Term Language Cram School (“PKC Language”)
Its chairman of the board of directors is Mr. Yu-En Chiu.
Taipei Country Private Kid Castle Short Term Language Cram School (“TCP PKC”)
Its chairman of the board of directors is Mr. Yu-En Chiu.
Taipei Country Private Chevady Preschool (“TCP Chevady”)
Its chairman of the board of directors is Mr. Yu-En Chiu.
Taipei Country Private Chung-hua Preschool (“TCP Chung-hua”)
Its chairman of the board of directors is Mr. Yu-En Chiu.
Taipei Country Private Wonderland Preschool (“TCP Wonderland”)
Its chairman of the board of directors is Mr. Yu-En Chiu.
Taipei City Private Kid Castle Preschool (“TCP Kid Castle”)
Its chairman of the board of directors is Mr. Yu-En Chiu.
Taipei Country Private Kid’s Castle Yin Cyun Preschool (“TCP Yin Cyun”)
Its chairman of the board of directors is Mr. Min-Tan Yang.
Yin Cyun Language & Computer School ("Yin Cyun Language")
Its chairman of the board of directors is Mr. Min-Tan Yang.
Taipei Country Private Yin Tzu Preschool (“TCP Yin Tzu”)
Its chairman of the board of directors is Mr. Min-Tan Yang.
Private Kuan Lung Short Term Language Cram School (“Kuan Lung Language”)
Its chairman of the board of directors is Mr. Min-Tan Yang.
Taipei City Private Chu Sheng Preschool (“TCP Chu Sheng”)
Its chairman of the board of directors is Mr. Min-Tan Yang.
Taipei Country Private Chu Yao Preschool (“TCP Chu Yao”)
Its chairman of the board of directors is Mr. Min-Tan Yang.
Private Liang Yu Language & Computer School ("Liang Yu Language")
Its chairman of the board of directors is Mr. Min-Tan Yang.
st Century Publishing House (“Publishing House”)
A joint venture partner (third-party after July 2004).
Jiangxi 21 st Century Kid Castle Culture Media Co., Ltd (“Culture Media”)
An investment accounted for under the equity method before July 2, 2004. It has become a consolidated entity after July 2, 2004.
st Century Kid Castle Language and Education Center (“Education Center”)
An investment accounted for under the equity method.
Tianjin Kid Castle Educational Investment Consulting Co., Ltd. (“Tianjin Consulting”)
An investment accounted for under the equity method.
Sichuan Lanbeisi Kid Castle Education Development Co., Ltd. (“Lanbeisi”)
An investment accounted for under the equity method before August 1, 2007. Since August 1, 2007. It has become a consolidated entity.
B.
Significant transactions and balances with related parties are as follows:
(vi)
The two directors, Mr. Suang Yi Pai and Min Tan Yang, have personally guaranteed certain bank loans and borrowings. Please see the details as described in Note 13 - Borrowings.
The management of the Group is of the opinion that the above transactions were carried out in the normal course of business at agreed upon terms.
(v)
Accounts and notes receivable - related parties:
(vi)
Other receivables - related parties:
Notes:
1.
Education Center was founded in October 2003. The amount due from this related party is mainly inventory purchases paid by the Group on behalf of Education Center. The amount due has no fixed repayment term and bears no interest.
2.
Tianjin Consulting was incorporated in April 2004. The Group paid certain pre-operating costs on behalf of Tianjin Consulting. The amount due from this related party has no fixed repayment term and bears no interest.
3.
Lanbeisi was incorporated in April 2004. The Group paid pre-operating costs of RMB75,000 (approximately $9,000) on behalf of Lanbeisi. The amount due from this related party has no fixed repayment term and bears no interest.
(vii)
Notes payable - related parties:
(viii) Other payables - related parties:
(ix) Receipts in advance:
(x) Significant transactions and balances with related parties are as follows:
1. Amount due to officers/directors:
Note 1.
In the fourth quarter of 2005, Mr. Yang loaned $1,050,000 to the Company, and third parties, Olympic Well International Ltd. (“Olympic”) and Chen-Chen Shih (“Shih”), investors introduced to the Company by Mr. Pai, loaned $690,000 and $60,089, respectively. The loans were treated as short-term loans, due in three months, with a per annum interest rate of 7%. A portion of the loan made by Olympic in the amount of US$342,364 was assigned to Mr. Pai on or about December 30, 2005. That amount, along with $209,211 which was owed Mr. Yang, were forgiven in exchange for the Company’s forgiveness of Mr. Chiu’s debt to the Company of $551,575 (NT$18,500,000 based on the exchange rate prevailing at the time of the loans). Effective December 28, 2006 we entered into a loan settlement and conversion agreement with Messrs. Pai and Yang related to settlement of the above loans to the Company. Pursuant to the loan settlement and conversion agreement, the parties agreed to convert a portion of the loans to stock at the conversion price $0.15 per share and to issue promissory notes for the remaining amount. The promissory notes had a term of one year and had an annual interest rate of 7%. The amount of residual promissory notes for Messrs. Pai and Yang were $107,680 and $240,789, respectively, and as of December 31, 2006, accumulated interest on the notes was $2,346 and $4,838, payable for Messrs. Pai and Yang respectively. For further information, please refer to the Company’s Form 8-K/A filed on January 24, 2007.
As of December 31, 2007, the promissory notes held by Mr. Pai and Mr. Yang were fully repaid.
In July 2007, Mr. Yang loaned $40,713 (RMB300,000) to KCEI. The loan bears interest at 6% per annum and is due in March 2008.
Note 2.
Amount due from ex-CFO:
During the year ended December 31, 2004, certain improper withdrawals and subsequent repayments by the Company ’ s then Chief Financial Officer Yu-En Chiu have been recognized in the Consolidated Statements of Cash Flows as short term non-interest bearing advances to Mr. Chiu. Mr. Chiu made cash repayments and withdrawals to and from the Company on an intermittent basis during the year. During the year ended December 31, 2004, the highest balance of the advances to Mr. Yu-En Chiu was $328,546. As of December 31, 2004, Mr. Yu-En Chiu had repaid all outstanding advances to the Company. However, Mr. Chiu initiated further withdrawals on January 13, 2005. During 2005, the total amount of withdrawals were NT$95,000,000($2,953,337), and as of December 31, 2005, the highest balance of the deemed loan to Mr. Chiu at any time was NT$21,660,000 ($673,361). Mr. Chiu has repaid all such withdrawals to the Company and the amount due from officers was nil. The circumstances surrounding Mr. Chiu’s fund misappropriation is more fully described in our June 23, 2006 Form 8-K. (The currency in 8-K’s disclosure have been translated from New Taiwan Dollars to US dollars based on an exchange rate of US$1 = NT$33.42.)
On June 1, 2006 Mr. Yu-En Chiu resigned as Chief Financial Officer and a Director of the Company following events that lead to the identification by current management of these improper cash advances and repayments. Mr. Chiu was temporarily reassigned to act as the chairman of the Company’s PRC operations, and on December 29, 2006, the Company notified Mr. Chiu that the termination of his employment with the Company was effective at February 28, 2007.
NOTE 21 - CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Group to significant concentrations of credit risk consist principally of cash, trade notes receivable and accounts receivable. The Group’s cash are deposited with various financial institutions in the ROC and the PRC. The Group offers credit terms on the sale of its products to certain customers. The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateral from its customers.
The Company maintains an allowance for uncollectible notes receivable and accounts receivable based upon the expected collectability of all notes receivable and accounts receivable.
In addition to cash, notes receivable and accounts receivable, the Company’s financial instruments include notes payable and accounts payable, which are carried at cost, which approximates the fair value because of the short-term maturity of these instruments.
No individual customer of the Group accounted for more than 10% of operating revenues for the years ended December 31, 2007, 2006, and 2005. However, one major customer accounted for approximately 23% of notes (including current and long-term notes receivable) and accounts receivable as of December 31, 2007 and 2006.
NOTE 22 - GEOGRAPHIC SEGMENTS
The Group is principally engaged in the business of child education, 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:
A.
For the year ended December 31,
B.
For the year ended December 31,
C. For the year ended December 31, 2005
NOTE 23 - SUBSEQUENT EVENT
None.