10-Q 1 v093223_10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2007
or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 333-39629
 

KID CASTLE EDUCATIONAL CORPORATION
(Exact name of Registrant as specified in its charter)

Florida
59-2549529
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
 
8th Floor, No. 98 Min Chuan Road, Hsien Tien
Taipei, Taiwan ROC
(Address of principal executive offices)
011-886-22218 5996
(Registrant’s telephone number, including area code)
NONE
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer o    Accelerated Filer o   Non-accelerated filer x
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o   No x
 
As of September 30, 2007, there were 25,000,000 shares of the Registrant’s common stock outstanding.
 
 
FORM 10-Q
 
KID CASTLE EDUCATIONAL CORPORATION
 
TABLE OF CONTENTS

   
Page
     
PART I.
FINANCIAL INFORMATION
 
Item 1.
Unaudited Condensed Consolidated Financial Statements
2
   
a) Condensed Consolidated Balance Sheet as of September 30, 2007 and December 31, 2006
2
   
b) Condensed Consolidated Statements of Operations for the three months ended September 30, 2007 and September 30, 2006
4
   
c) Condensed Consolidated Statements of Operations for the nine months ended September 30, 2007 and September 30, 2006
5
   
d) Condensed Consolidated Statements of Stockholders’ Equity
6
   
e) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and September 30, 2006
7
   
f) Notes to Condensed Consolidated Financial Statements
9
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations 
21
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
26
 
Item 4.
Controls and Procedures
27
PART II.
OTHER INFORMATION
 
 
Item 1.
Legal Proceedings 
29
 
Item 1A
Risk Factors 
29
 
Item 2.
Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 
29
 
Item 3.
Defaults upon Senior Securities 
29
 
Item 4.
Submission of Matters to a Vote of Security Holders 
29
 
Item 5.
Other Information 
29
 
Item 6
Exhibits and Reports on Form 8-K 
29
SIGNATURES 
30

- 1 -
 
PART I. FINANCIAL INFORMATION
 
ITEM 1.    FINANCIAL STATEMENTS
 
Kid Castle Educational Corporation
Condensed Consolidated Balance Sheets
(Unaudited)
(Expressed in US Dollars)

 
  
September 30,
2007
  
December 31,
2006
  
ASSETS
          
Current assets
          
Cash and bank balances 
  
$
1,001,231
  
$
1,419,873
  
Bank fixed deposits – pledged (Note12) 
    
419,895
    
75,210
  
Notes and accounts receivable, net (Note 5) 
    
2,898,533
    
2,001,145
  
Inventories, net (Note 6) 
    
1,617,951
    
1,636,020
  
Other receivables (Notes 7) 
    
620,098
    
127,062
  
Prepayments and other current assets (Note 8) 
    
206,826
    
141,620
  
Pledged notes receivable (Note 12) 
    
645,660
    
430,415
  
Deferred income tax assets 
    
74,052
    
105,426
  
Total current assets 
    
7,484,246
    
5,936,771
  
Deferred income tax assets 
    
46,464
    
49,909
  
Prepayment of long-term investments 
    
287,351
    
—
  
Long-term investments (Note 9) 
    
86,409
    
33,295
  
Property and equipment, net  
    
2,228,950
    
1,755,992
  
Intangible assets, net of amortization (Note 11) 
    
409,463
    
538,638
  
Long-term notes receivable 
    
294,805
    
812,809
  
Pledged notes receivable (Note 12) 
    
227,004
    
13,851
  
Other assets 
    
238,032
    
231,958
  
Total assets 
  
$
11,302,724
  
$
9,373,223
  
LIABILITIES AND STOCKHOLDERS’ EQUITY
              
Current liabilities
              
Bank borrowings – short-term and maturing within one year (Note 12) 
  
$
1,478,460
  
$
808,037
  
Notes and accounts payable 
    
600,651
    
925,577
  
Accrued expenses 
    
789,285
    
975,396
  
Amounts due to stockholders/officers 
    
203,217
    
355,653
  
Other payables 
    
865,608
    
381,647
  
Deposits received 
    
862,893
    
752,597
  
Receipts in advance (Note 13) 
    
2,385,955
    
2,402,624
  
Income tax payable 
    
209,818
    
143,771
  
Total current liabilities 
    
7,395,887
    
6,745,302
  
Bank borrowings maturing after one year (Note 12)  
    
958,842
    
979,323
  
Receipts in advance (Note 13) 
    
1,155,162
    
1,275,638
  
Deposits received 
    
567,382
    
629,165
  
Deferred liability 
    
37,986
    
36,624
  
Accrued pension liabilities (Note 14) 
    
272,553
    
287,363
  
Total liabilities 
    
10,387,812
    
9,953,415
  
 
- 2 -
 
Kid Castle Educational Corporation

Condensed Consolidated Balance Sheets - Continued
(Unaudited)
(Expressed in US Dollars)

   
September 30,
2007
  
December 31,
2006
  
           
Commitments and contingencies (Note 16)
          
           
Minority interest 
    
153,155
    
54,561
  
               
Shareholders’ equity
              
Common stock, no par share:
              
25,000,000 shares authorized; issued and outstanding at September 30, 2007 and December 31, 2006 
    
8,592,138
    
8,592,138
  
Additional paid-in capital 
    
194,021
    
194,021
  
Legal reserve 
    
65,320
    
65,320
  
Accumulated deficit  
    
(7,362,734
)
  
(9,056,567
)
Accumulated other comprehensive loss 
    
(629,283
)
  
(330,713
)
Net loss not recognized as pension cost 
    
(97,705
)
  
(98,952
)
Total shareholders’ equity 
    
761,757
    
(634,753
)
Total liabilities and shareholders’ equity 
  
$
11,302,724
  
$
9,373,223
  

See accompanying notes to Condensed Consolidated Financial Statements.
 
- 3 -

Kid Castle Educational Corporation
 
Condensed Consolidated Statements of Operations (Unaudited)
 
(Expressed in US Dollars)
 
   
Three months ended September 30,
  
   
2007
  
2006
  
       
Operating Revenue
          
Sales of goods 
  
$
2,935,660
  
$
2,573,101
  
Franchising income 
    
552,254
    
831,805
  
Other operating revenue 
    
620,038
    
307,698
  
Total net operating revenue 
    
4,107,952
    
3,712,604
  
Operating costs
              
Cost of goods sold 
    
(1,264,881
)
  
(987,402
)
Cost of franchising 
    
(232,124
)
  
(83,107
)
Other operating costs 
    
(238,917
)
  
(527,095
)
Total operating costs 
    
(1,735,922
)
  
(1,597,604
)
Gross profit 
    
2,372,030
    
2,115,000
  
Advertising costs 
    
(2,842
)
  
(2,296
)
Other operating expenses 
    
(1,463,233
)
  
(1,379,880
)
Income from operations 
    
905,955
    
732,824
  
Interest expenses, net 
    
(18,161
)
  
(31,632
)
Share of income (loss) of investments 
    
39,253
    
(10,915
)
Other non-operating income (expenses), net 
    
(24,151
)
  
77,719
  
Income before income taxes 
    
902,896
    
767,996
  
Provision for taxes 
    
(150,545
)
  
(62,552
)
Income after income taxes 
    
752,351
    
705,444
  
Minority interest income 
    
(45,847
)
  
(41,731
)
Net income 
  
$
706,504
  
$
663,713
  
Earnings per share – basic and diluted 
  
$
0.03
  
$
0.03
  
Weighted-average shares used to compute earnings (loss) per share – basic and diluted 
    
25,000,000
    
18,999,703
  
 
See accompanying notes to Condensed Consolidated Financial Statements.
 
- 4 -

Kid Castle Educational Corporation
 
Condensed Consolidated Statements of Operations (Unaudited)
 
(Expressed in US Dollars)
 
   
Nine months ended September 30,
  
   
2007
  
2006
  
       
Operating Revenue
          
   Sales of goods 
  
$
6,632,008
  
$
6,102,630
  
Franchising income 
    
1,642,432
    
2,026,493
  
Other operating revenue 
    
957,625
    
482,194
  
Total net operating revenue 
    
9,232,065
    
8,611,317
  
Operating costs
              
Cost of goods sold 
    
(2,795,509
)
  
(2,357,627
)
Cost of franchising 
    
(343,909
)
  
(254,474
)
Other operating costs 
    
(435,283
)
  
(608,672
)
Total operating costs 
    
(3,574,701
)
  
(3,220,773
)
Gross profit 
    
5,657,364
    
5,390,544
  
Advertising costs 
    
(21,015
)
  
(19,584
)
Other operating expenses 
    
(3,845,751
)
  
(4,224,520
)
Income from operations 
    
1,790,598
    
1,146,440
  
Interest expenses, net 
    
(60,778
)
  
(151,757
)
Share of income (loss) of investments 
    
55,242
    
(20,000
)
Other non-operating income, net 
    
347,078
    
78,894
  
Income before income taxes 
    
2,132,140
    
1,053,377
  
Provision for taxes 
    
(343,556
)
  
( 249,461
)
Income after income taxes 
    
1,788,584
    
804,116
  
Minority interest income 
    
(94,751
)
  
(55,323
)
Net income 
  
$
1,693,833
  
$
748,793
  
Earnings per share – basic and diluted 
  
$
0.07
  
$
0.04
  
Weighted-average shares used to compute earnings per share - basic and diluted 
    
25,000,000
    
18,999,703
  
 
See accompanying notes to Condensed Consolidated Financial Statements.

- 5 -

Kid Castle Educational Corporation
 
Condensed Consolidated Statements of Stockholders’ Equity
(Unaudited)
(Expressed in US Dollars)

   
Common Stock
                          
   
Number of
shares
  
Amount
  
Additional
paid-in
capital
  
Legal
reserve
  
Accumulated
deficit
  
Accumulated
other
comprehensive
loss
  
Net loss
not
recognized
as pension
cost
  
Total
  
                                   
Balance, December 31, 2005
    
18,999,703
  
$
7,669,308
  
$
194,021
  
$
65,320
  
$
(9,010,356
)
$
(244,864
)
  
—
  
$
(1,326,571
)
Net loss for 2006
    
—
    
—
    
—
    
—
    
(46,211
)
  
—
    
—
    
(46,211
)
Cumulative translation adjustment
    
—
    
—
    
—
    
—
    
—
    
(85,849
)
  
—
    
(85,849
)
Comprehensive loss
                                              
(132,060
)
Repayment of a liability by issuance of common stock
    
6,000,297
    
922,830
    
—
    
—
    
—
    
—
    
—
    
922,830
  
Net loss not recognized as pension cost
    
—
    
—
    
—
    
—
    
—
    
—
  
$
(98,952
)
  
(98,952
)
Balance, December 31, 2006
   
25,000,000
  
$
8,592,138
  
$
194,021
  
$
65,320
  
$
(9,056,567
)
$
(330,713
)
$
(98,952
)
$
(634,753
)
Net income for the nine months ended September 30, 2007 (Unaudited)
    
—
    
—
    
—
    
—
    
1,693,833
    
—
    
—
    
1,693,833
  
Cumulative translation adjustment (Unaudited)
    
—
    
—
    
—
    
—
    
—
    
(298,570
)
  
—
    
(298,570
)
Comprehensive income (Unaudited)
                                              
1,395,263
  
Net income not recognized as pension cost
    
—
    
—
    
—
    
—
    
—
    
—
  
$
1,247
    
1,247
  
                                                   
Balance, September 30, 2007 (Unaudited)
    
25,000,000
  
$
8,592,138
  
$
194,021
  
$
65,320
  
$
(7,362,734
)
$
(629,283
)
$
(97,705
)
$
761,757
  
 
See accompanying notes to Condensed Consolidated Financial Statements.
 
- 6 -

Kid Castle Educational Corporation
 
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Expressed in US Dollars)
 
   
Nine months ended September 30,
  
   
2007
  
2006
  
       
Cash flows from operating activities
          
Net income 
  
$
1,693,833
  
$
748,793
  
Adjustments to reconcile net income to net cash provided by operating activities 
              
Depreciation of property and equipment 
    
157,175
    
145,434
  
Amortization of intangible assets 
    
122,857
    
124,899
  
Allowance for sales returns 
    
64,379
    
82,415
  
Allowance for doubtful debts 
    
139,716
    
718,908
  
Provision (reversal) of allowance for loss on inventory obsolescence and slow-moving items 
    
(360,118
)
  
57,204
  
Loss on disposal of assets
    
2,666
    
—
  
Minority interests 
    
94,751
    
55,323
  
Share of loss (gain) of investments 
    
(55,242
)
  
20,000
  
(Increase)/decrease in:
              
Notes and accounts receivable 
    
(662,701
)
  
(2,255,781
)
Inventories 
    
372,793
    
654,177
  
Other receivables 
    
108,330
    
244,535
  
Prepayments and other current assets 
    
(45,000
)
  
115,420
  
Deferred income tax assets 
    
32,997
    
(61,755
)
Other assets 
    
76,081
    
349,901
  
Increase/(decrease) in:
              
Notes and accounts payable 
    
(191,414
)
  
(107,449
)
Accrued expenses 
    
(197,992
)
  
153,224
  
Other payables 
    
426,753
    
(135,059
)
Receipts in advance 
    
(125,205
)
  
566,707
  
Income taxes payable 
    
67,748
    
125,255
  
Deposits received 
    
64,777
    
528,489
  
Accrued pension liabilities 
    
(11,431
)
  
(3,793
)
               
Net cash provided by operating activities 
    
1,775,753
    
2,126,847
  
               
Cash flows from investing activities
              
Purchase of property and equipment 
    
(190,691
)
  
(49,928
)
Change in investments in associated company 
    
(222,872
)
  
—
  
Acquisition, net of cash acquired 
    
58,365
    
—
  
Proceeds from disposal of property and equipment 
    
118
    
—
  
Amount due from stockholder/director 
    
—
    
—
  
Prepayment of long-term investments 
    
—
    
—
  
Acquisition of long-term investments 
    
(854,123
)
  
—
  
Bank fixed deposits – pledged 
    
(345,622
)
  
34,023
  
Pledged notes receivable 
    
(433,690
)
  
695,875
  
               
Net cash provided by (used in ) investing activities 
    
(1,988,515
)
  
679,970
  

- 7 -

Kid Castle Educational Corporation

Condensed Consolidated Statements of Cash Flows – Continued
(Unaudited)
(Expressed in US Dollars)

   
Nine months ended September 30,
  
   
2007
  
2006
  
       
Cash flows from financing activities
          
Proceeds from bank borrowings 
  
$
1,114,717
  
$
213,903
  
Proceeds from loan from a stockholder 
    
4,748
    
—
  
Proceeds from capital leases
    
—
    
—
  
Repayment of bank borrowings 
    
(443,648
)
  
(1,466,062
)
Repayment of capital leases 
    
—
    
—
  
Repayment of loan from stockholders and transactions of related parties 
    
(601,004
)
  
(562,806
)
               
Net cash provided by (used in) financing activities 
    
74,813
    
(1,814,965
)
               
Net increase (decrease) in cash and cash equivalents 
    
(137,949
)
  
991,852
  
               
Effect of exchange rate changes on cash and cash equivalents 
    
(280,693
)
  
(45,463
)
               
Cash and cash equivalents at beginning of period 
    
1,419,873
    
613,391
  
               
Cash and cash equivalents at end of period 
  
$
1,001,231
  
$
1,559,780
  

See accompanying notes to Condensed Consolidated Financial Statements.
 
- 8 -
 
Kid Castle Educational Corporation
 
Notes to Condensed 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” or “Taiwan”) as a limited liability company. KCIT is engaged in the business of children’s education focusing on the English language. The business comprises publication, sales and distribution of related books, magazines, audio and videotapes and compact disc, franchising and sales of merchandises complementary to the business. KCIT commenced operations in April 2000 when it acquired the above business from Kid Castle Enterprises Limited which was formerly owned by Mr. Kuo-An Wang and Mr. Yu-En Chiu. Kid Castle Enterprises Limited ceased operation on December 25, 2003.
 
On March 9, 2001, KCIT formed a wholly-owned subsidiary, Premier Holding Investment Property Limited incorporated in the British Virgin Islands, which held the entire common stock of Higoal Developments Limited (“Higoal”) incorporated in the Cayman Islands on March 8, 2001. On September 10, 2001, Higoal established a wholly owned subsidiary, Kid Castle Educational Software Development Company Limited (“KCES”) in the People’s Republic of China (the “PRC”). The existing operations of Higoal are principally located in Taiwan and are being expanded in the PRC. In June 2002, after KCIT undertook a series of group restructurings, KCIT became the direct owner of the outstanding shares of Higoal. Premier Holding Investment Property Limited was then liquidated in June 2003.
 
On September 18, 2002, Higoal issued 11,880,000 shares of common stock to the stockholders of KCIT in exchange for 100% of the outstanding common stock of KCIT. As a result of this reorganization, KCIT became a wholly owned subsidiary of Higoal. On October 1, 2002, Kid Castle Educational Corporation (the “Company”), formerly King Ball International Technology Limited Corporation, entered into an exchange agreement with Higoal whereby the Company issued to the stockholders of Higoal 11,880,000 shares of common stock of the Company in exchange for 100% of the issued and fully paid up capital of Higoal.
 
As a result of the share exchange, the former stockholders of Higoal hold a majority of the Company’s outstanding capital stock. Generally accepted accounting principles (“GAAP”) require in certain circumstances that a company whose stockholders retain the majority voting interest in the combined business 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 ( “SEC”) 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 (“KC Culture Media”). It was agreed that KCES and 21st Century Publishing House would each own 50% of KC Culture Media and that each party would contribute Renminbi (“RMB”) $1 million for its ownership interest. On July 2, 2004, KCES acquired an additional 40% of the equity of KC Culture Media from 21st Century Publishing House. KCES now owns 90% of KC Culture Media.
 
On December 27, 2006, KCES established a wholly-owned subsidiary, Shanghai Kid Castle Educational Info Constitution Company Limited (“KCEI”) in the PRC, with total registered capital of RMB$1,200,000, in order to operate schools controlled by us in PRC. As of September 30, 2007, KCEI had total registered capital of RMB$2,000,000.
 
- 9 -
 
The Company, Higoal and its subsidiaries are sometimes collectively are referred to as the “Group”. The operations of the Group are principally located in Taiwan and the PRC.
 
NOTE 2 - BASIS OF PRESENTATION
 
The accompanying financial data as of September 30, 2007 and for the nine months ended September 30, 2007 and 2006 have been prepared by the Group, without audit, pursuant to the rules and regulations of the SEC using United States (“U.S.”) GAAP. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Group believes that the disclosures are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Group’s audited annual financial statements for the year ended December 31, 2006.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates.
 
Although it has been profitable for the first 9 months of 2007, the Group has incurred operating losses in most periods since inception. As of September 30, 2007, the accumulated deficit was $7,362,734. The Group plans to fund its working capital needs by growth in sales and obtaining new credit lines from financial institutions. If the Group is unable to meet its current operating plan, it will be required to obtain additional funding. Management believes such funding will be available, but there can be no assurances that such funding will be available, or if it is available, on terms acceptable to the Group. Management believes that if funding is not available, other actions can and will be taken to reduce costs. These actions may entail the Group to reduce headcount, sales and marketing, other expansion activities, which may affect the future growth of the Group’s operations.
 
NOTE 3 - SUMMARY OF IMPORTANT ACCOUNTING POLICIES
 
Revenue Recognition
 
Sales of books, magazines, audio and video tapes, compact disc’ and other merchandises are recognized as revenue on the transfer of risks and rewards of ownership, which generally coincides with the time when the goods are delivered to customers and title has passed. Provision is made for expected future sales returns and allowances when revenue is recognized.
 
Franchise fees are the annual licensing fees for franchisees to use the Group’s brand name and consulting services. Franchising income is recognized on a straight-line basis over the terms of the relevant franchise agreements.
 
Allowance for Doubtful Accounts
 
An allowance for doubtful accounts is provided based on the evaluation of collectibility and aging analysis of notes and accounts receivables.
 
Inventories
 
Inventories are stated at the lower of cost or market value. 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.
 
- 10 -
 
Property and Equipment and Depreciation
 
Property and equipment are stated at cost. Depreciation is computed using the straight-line method to allocate the cost of depreciable assets over the estimated useful lives of the assets as follows:

   
Estimated useful life
(years)
  
Land
    
Indefinite
  
Buildings
    
50
  
Furniture and fixtures
    
3-10
  
Transportation equipment
    
2.5-5
  
Miscellaneous equipment
    
5-10
  
 
Maintenance, repairs and minor renewals are charged directly to the statement of operations as incurred. When assets are disposed of, the related cost and accumulated depreciation thereon are removed from the financial statements and any resulting gain or loss is included in the statement of operations.
 
Long-Lived Assets
 
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. The Group does not perform a periodic assessment of assets for impairment in the absence of such information or indicators. Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used, or a significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable. For long-lived assets to be held and used, the Group measures fair value based on quoted market prices or based on discounted estimates of future cash flows.
 
Income Taxes
 
The Company and its subsidiaries account 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 considered more likely than not that the deferred tax assets will not be realized.
 
Intangible Assets
 
Franchises and copyrights are stated at cost and amortized on the straight-line method over their estimated useful lives of ten years.
 
Comprehensive Income (Loss)
 
Comprehensive income (loss) is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. Comprehensive income (loss) is disclosed in the condensed consolidated statement of stockholders’ equity.
 
- 11 -
 
Net Earnings (Loss) Per Common Share
 
The Group computes net earnings (loss) per share in accordance with SFAS No. 128, “Earnings per Share”. Under the provisions of SFAS No. 128, basic net earnings (loss) per share is computed by dividing the net earnings (loss) available to common shareholders for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net earnings (loss) per share gives effect to common stock equivalents. For the nine months ended September 30, 2007 and 2006, the Group did not have any potential common stock shares.
 
Reclassification
 
The presentation of certain prior information has been reclassified to conform to current presentation.

NOTE 4 – 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. This standard applies when other accounting pronouncements require fair value measurements; it does not require new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. We are currently evaluating the effect of the guidance contained in this standard and do not expect the implementation to have a material impact on our financial statements
 
In February 2007, the FASB released SFAS No.159, “The Fair Value Option for Financial Assets and Financial Liabilities”. The standard is effective for fiscal years beginning after November 15, 2007, with early adoption permitted as of the beginning of a fiscal year that begins on or before the aforementioned date. We did not elect to adopt SFAS No. 159 early.
 
NOTE 5 – NOTES AND ACCOUNTS RECEIVABLE
 
   
September 30,
2007
  
December 31,
2006
  
   
(Unaudited)
      
           
Notes and accounts receivable
          
– Third parties 
  
$
4,159,637
  
$
2,995,538
  
– Related parties 
    
66,529
    
113,928
  
               
Total 
    
4,226,166
    
3,109,466
  
Allowance for doubtful accounts and sales returns 
    
(1,327,633
)
  
(1,108,321
)
               
Notes and accounts receivable, net 
  
$
2,898,533
  
$
2,001,145
  

- 12 -
 
NOTE 6 – INVENTORIES
 
   
September 30,
2007
  
December 31,
2006
  
   
(Unaudited)
      
           
Work in process 
  
$
178,419
  
$
145,110
  
Finished goods and other merchandises 
    
1,848,018
    
2,268,608
  
               
     
2,026,437
    
2,413,718
  
Less: Allowance for obsolete inventories and decline of market value 
    
(408,486
)
  
(777,698
)
               
   
$
1,617,951
  
$
1,636,020
  
 
NOTE 7 – OTHER RECEIVABLES

   
September 30,
2007
  
December 31,
2006
  
   
(Unaudited)
      
Other receivables – third parties:
          
Tax paid on behalf of landlord
  
$
—
  
$
—
  
Advances to staff
    
96,920
    
55,438
  
Grants from Market Information Center
    
—
    
—
  
Receivables from Shanghai Wonderland Educational
Resources Co., Ltd.(i) (“Shanghai Wonderland”)
    
395,266
    
381,092
  
Other receivables
    
500,880
    
42,480
  
Less : Allowance for doubtful accounts
    
(395,266
)
  
(381,092
)
               
Sub-total
    
597,800
    
97,918
  
               
Other receivables – related parties
    
22,298
    
29,144
  
   
$
620,098
  
$
127,062
  

Note:
 
(i)
Shanghai Wonderland was a distributor for the Group. The Group loaned Shanghai Wonderland RMB$450,000 (approximately $54,000), RMB$500,000 (approximately $62,000) and RMB$2,500,000 (approximately $310,000) for operations in December 2003, July 2004 and August 2005, respectively. The identified loans were unsecured and bore no interest. Shanghai Wonderland has fully repaid the loan of RMB$450,000 in December 2004 and January 2005. As of September 30, 2007, Shanghai Wonderland still owes the Group a balance of RMB$3,000,000 (approximately $395,266). Such sum has now been itemized and recorded as “Allowance for doubtful accounts” compared to its prior recognition as “Other receivables”.
 
- 13 -
 
NOTE 8 – PREPAYMENTS AND OTHER CURRENT ASSETS
 
   
September 30,
2007
  
December 31,
2006
  
   
(Unaudited)
      
           
Prepayments
  
$
173,662
  
$
139,582
  
Temporary payments
    
25,311
    
1,084
  
Tax recoverable
    
—
    
—
  
Prepaid interest
    
7,253
    
54
  
Others
    
600
    
900
  
               
   
$
206,826
 
$
141,620
  

NOTE 9– INTEREST IN ASSOCIATES

   
September 30,
2007
  
December 31,
2006
  
   
(Unaudited)
      
           
21st Century Kid Castle Language and Education Center(i)
(“Education Center”)
         
Investment cost
  
$
99,686
  
$
96,111
  
Share of loss
    
(3,427
)
  
(52,091
)
               
   
$
96,259
  
$
44,020
  
               
Tianjin Kid Castle Educational Investment Consulting Co., Ltd.(ii)
(“Tianjin Consulting”)
              
Investment cost
  
$
93,039
  
$
89,704
  
Share of loss
    
(102,889
)
  
(104,693
)
               
   
$
(9,850
)
$
(14,989
)
               
Sichuan Lanbeisi Kid Castle Education Development Co., Ltd
(“Lanbeisi”) (Note (iii))
              
Investment cost
  
$
-
  
$
46,133
  
Share of loss
    
-
    
(41,869
)
               
 
  
$
 -  
$
4,264
  
               
Total
  
$
86,409
  
$
33,295
  

 
Notes:
 
(i)
In October 2003, the Group obtained the PRC government’s approval to co-found Education Center with 21st Century Publishing House in the PRC. In 2004, Education Center registered the total capital as RMB$1,500,000, and KCES and 21st Century Publishing House each owns 50% of the company.. It has been determined that the Group has significant influence and should therefore account for its investment in Education Center on the equity method.
 
For the three months ended September 30, 2007 and 2006, the Group recognized investment income accounted for under the equity method in Education Center of $50,601 and $1,996, respectively.
 
- 14 -
 
(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 Consulting. It has been determined that the Group has significant influence and should therefore account for its investee on the equity method.
   
  For the three months ended September 30, 2007 and 2006, the Group recognized an investment revenue of $5,698 and an investment loss of $14,708 respectively, these amounts are 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. It has been determined that the Group has significant influence and should therefore account for its investee using the equity method.
   
  As of September 30, 2007, the Group acquired 100% interests in Sichuan Lanbeisi Kid Castle Education Development Co., Ltd, which became a consolidated entity. (Please refer to Note 10 to our condensed consolidated financial statements for more information.)
 
NOTE 10 – 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% interests in Jilin KCEI from the third parties for the purchase price of $550,196 (RMB$4,200,000). The Group’s Management believes that the book value of the existing assets and liabilities of Jilin KCEI approximate the fair value of the assets and liabilities from which the purchase price was determined for the purpose of applying purchase accounting. 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 $569,894.

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 (“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 $43,741 (RMB$320,000). Pursuant to this equity transfer agreement, the Group and Sichuan Province Education Institutional Service Center in Sichuan Province, PRC own, respectively, 90% and 10% interests in 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 $13,669 (RMB$80,000). Pursuant to this equity transfer agreement the Group acquired 100% interests in Lanbeisi. The Group’s Management believes that the acquisition is beneficial to our expansion development in Sichuan Province, PRC. As of September 30, 2007, the Group owns 100% of Lanbeisi, which became a consolidated entity. The fair value of Lanbeisi’s net liabilities as of August 1, 2007 are $36,756.
 
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 $314,724 (RMB$2,500,000). The fair value of Xian Yanta Green Field Preschool’s net assets as of August 1, 2007 are $244,200. The Group’s Management believe that the acquisition enables the Group to expand its business into the Xian Province, PRC.
 
- 15 -

NOTE 11 – INTANGIBLE ASSETS
 
   
September 30,
2007
  
December 31,
2006
  
   
(Unaudited)
      
           
Gross carrying amount
          
Franchise 
  
$
1,031,496
  
$
1,043,775
  
Copyrights 
    
606,355
    
613,572
  
               
     
1,637,851
    
1,657,347
  
Less: Accumulated amortization
              
Franchise 
    
(773,622
)
  
(704,548
)
Copyrights 
    
(454,766
)
  
(414,161
)
               
     
(1,228,388
)
  
(1,118,709
)
               
Net 
  
$
409,463
  
$
538,638
  
 
Amortization charged to operations were $122,857 and $124,899 for the nine months ended September 30, 2007 and 2006, respectively.
 
The estimated aggregate amortization expenses for each of the three succeeding fiscal years are as follows:
 
2008 
  
$
163,785
  
2009 
    
163,785
  
2010 
    
40,965
  
         
   
$
368,535
  

NOTE 12 – BANK BORROWINGS
 
   
September 30,
2007
  
December 31,
2006
  
   
(Unaudited)
      
           
Bank term loans(i) 
  
$
594,716
  
$
108,922
  
Short-term unsecured bank loans(ii) 
    
813,975
    
446,086
  
Mid-term secured bank loan(iii) 
    
1,028,611
    
1,232,352
  
               
     
2,437,302
    
1,787,360
  
Less: Balances maturing within one year included in current liabilities
              
Bank term loans 
    
499,952
    
103,523
  
Short-term unsecured bank loans 
    
813,975
    
446,086
  
Mid-term secured bank loan 
    
164,533
    
258,428
  
               
     
1,478,460
    
808,037
  
               
Bank borrowings maturing after one year 
  
$
958,842
  
$
979,323
  
 
- 16 -
 
Notes:
 
(i)
This line item represents bank loans that have been secured by a pledge of post-dated checks amounting to $789,218 and $261,142 that we have received from franchisees and the Group’s bank deposits of $18,402 and $1,963 as of September 30, 2007 and December 31, 2006, respectively, for the purpose of financing operations. The repayment dates of the loans coincided with the maturity dates of the corresponding pledged post-dated checks, and was extended on October 18, 2006. The weighted average interest rates were 5.37% and 6.055% per annum as of September 30, 2007 and 2006, respectively.
 
For the nine months ended September 30, 2007 and 2006, the interest expense charged to operations amounted to $4,438 and $16,092, respectively.
 
(ii)
In August 2005, KCIT obtained an unsecured short-term loan to finance the Group’s operations in the amount of $304,553, which was collateralized by KCIT’s refundable deposits of $60,911, notes receivables approximating 30% of the loan balance and guaranteed by two directors and stockholders of the Group. The loan bears interest at the lending bank’s basic fixed deposit rate plus 3.29% per annum. The short-term loan was extended in February 2007 and is due on February 2008. A portion of the principal of the loan amounting to $146,186 is repayable in 12 equal monthly installments and the remaining principal amount of $158,367 will be repayable at maturity. The applicable interest rate is approximately 5.51% and 5% per annum as of September 30, 2007 and 2006, respectively.
 
In March 2005, KCIT obtained an unsecured short-term loan to finance the Group’s operations in the amount of $304,553, which was extended on October 18, 2006. The loan was guaranteed by two directors and stockholders of the Group and bears interest at the Taiwan basic borrowing rate plus 1.3% per annum. The short-term loan is repayable in 36 equal monthly installments. The last installment will be due on March 19, 2008.
 
In May 2007, KCES obtained an unsecured short-term loan to finance the Group’s operations in the amount of $327,498, which was guaranteed by Director Mr. Yang and KCIT, and KCIT’s refundable deposits of $340,000. The loan bears interest at the PRC basic borrowing rate per annum, and is due in April 2008.
 
For the nine months ended September 30, 2007 and 2006, the interest expense charged to operations from the above three unsecured short-term loans amounted to $31,008 and $8,219 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 is personally guaranteed by two directors of the Group. The loan bears interest at the lending bank’s basic fixed deposit rate plus 0.69% per annum for the two-year period from 2005 to 2007, plus 1.69% per annum for the year 2008.  On August 10, 2005, the bank extended the term of the loan and it is now repayable in 84 equal monthly installments starting on August 10, 2012. As of September 30, 2007, the applicable interest rate is approximately 2.7% and the Group has repaid $108,487.
 
- 17 -
 
In February 2005, KCIT obtained a 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. The loan was collateralized by notes receivables approximating 30% of the loan balance, and guaranteed by two directors of the Group. As of September 30, 2007, the Group has repaid $386,677.
 
In August 2005, KCIT obtained a new bank loan of $213,187, which bears interest at 4.1% and 3.7% per annum as of September 30, 2007 and December 31, 2006, respectively, and is repayable in 60 equal monthly installments. The last installment will be due on August 10, 2010, and guaranteed by two directors of the Group. As of September 30, 2007, the Group has repaid $83,493.
 
For the nine months ended September 30, 2007 and 2006, the interest expense charged to operations amounted to $28,559 and $37,828, respectively.
NOTE 13 – RECEIPTS IN ADVANCE
 
The balance comprises:
 
   
September 30,
2007
  
December 31,
2006
  
   
(Unaudited)
      
           
Current liabilities:
          
Sales deposits received(i) 
  
$
500,940
  
$
481,334
  
Franchising income received(ii) 
    
1,425,412
    
1,608,066
  
Subscription fees received(iii) 
    
447,061
    
285,531
  
               
Related Parties
     -     566  
Others 
    
12,542
    
27,127
  
     
2,385,955
    
2,402,624
  
               
Long-term liabilities:
              
Franchising income received(ii) 
    
1,155,162
    
1,275,638
  
               
   
$
3,541,117
  
$
3,678,262
  

Notes:
 
(i)
The balance represents receipts in advance from customers for goods sold to them.
 
(ii)
The balance mainly represents franchising income received in advance which is attributable to the periods after the respective period end dates. 
 
(iii)
The balance represents subscription fees received in advance for subscription of magazines published by the Group.
 
- 18 -
 
NOTE 14 – RETIREMENT PLANS 

The Group maintains tax-qualified defined contribution and benefit retirement plans for its employees in accordance with the ROC Labor Standard Law in Taiwan. As a result, the Group currently maintains two different retirement plans with contribution and benefit calculation formulae. On July 1, 2005, the Bureau of National Health Insurance issued new labor retirement pension regulations in Taiwan. The Group has a new defined contribution retirement plan (the “New Plan”) covering all regular employees of KCIT. KCIT contributes monthly amounts equivalent to 6% of the employees’ base 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, which only applies to the regular employees of KCIT who were employed prior to June 2005. KCIT contributes monthly amounts equivalent 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. 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. Under the Old Plan, the employees are entitled to receive retirement benefits upon retirement in the manner stipulated by the ROC Labor Standard Law. The benefits under the Old 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:

   
Nine months ended September 30,
  
   
2007
  
2006
  
   
(Unaudited)
  
Service cost
  
$
—
  
$
—
  
Interest cost
    
9,162
    
9,204
  
Expected return on assets
    
(1,818
)
  
(1,827
)
Amortization of unrecognized loss
    
2,217
    
2,227
  
 
              
Net periodic pension cost
  
$
9,561
  
$
9,604
  

NOTE 15 – GEOGRAPHIC SEGMENTS
 
The Group is principally engaged in the business of child educational teaching materials and related services focusing on English language in Taiwan and the PRC. Accordingly, the Group has two reportable geographic segments: Taiwan and the PRC. The Group evaluates the performance of each geographic segment based on its net income or loss. The Group also accounts for inter-segment sales as if the sales were made to third parties. Information concerning the operations in these geographic segments is as follows:
 
- 19 -
 
   
Taiwan
  
The PRC
  
Total
  
   
Nine months
ended
September 30,
2007
  
Nine months
ended
September 30,
2006
  
Nine months
ended
September 30,
2007
  
Nine months
ended
September 30,
2006
  
Nine months
ended
September 30,
2007
  
Nine months
ended
September 30,
2006
  
                           
Revenue
                          
External revenue
  
$
5,287,849
  
$
5,716,524
  
$
3,944,216
  
$
2,895,355
  
$
9,232,065
  
$
8,611,879
  
Inter-segment revenue
    
—
    
(562
)
  
—
    
—
    
—
    
(562
)
                                       
   
$
5,287,849
  
$
5,715,962
  
$
3,944,216
  
$
2,895,355
  
$
9,232,065
  
$
8,611,317
  
                                       
Profit (loss) from Operations
  
$
946,474
  
$
666,032
  
$
973,485
  
$
682,815
  
$
1,919,960
  
$
1,348,847
  
                                       
Capital expenditures
  
$
35,359
  
$
32,863
  
$
41,408
  
$
16,077
  
$
76,767
  
$
48,940
  
 
   
September 30,
2007
  
December 31,
2006
  
September 30,
2007
  
December 31,
2006
  
September 30,
2007
  
December 31,
2006
  
                           
Total assets
  
$
7,459,199
  
$
7,409,359
  
$
4,009,428
  
$
1,960,446
  
$
11,468,627
  
$
9,369,805
  
 
   
Corporate
  
Eliminations
  
Consolidated
  
   
Nine months
ended
September 30,
2007
  
Nine months
ended
September 30,
2006
  
Nine months
ended
September 30,
2007
  
Nine months
ended
September 30,
2006
  
Nine months
ended
September 30,
2007
  
Nine months
ended
September 30,
2006
  
                           
Revenue
                          
External revenue
  
$
—
  
$
—
  
$
—
  
$
—
  
$
9,232,065
  
$
8,611,879
  
Inter-segment revenue
    
—
    
—
    
—
    
—
    
—
    
(562
)
                                       
 
   $
—
  
$
—
  
$
—
  
$
—
  
$
9,232,065
  
$
8,611,317
  
                                       
Profit (loss) from Operations
  
$
(129,362
)
$
(202,407
)
$
—
  
$
—
  
$
1,790,598
  
$
1,146,440
  
                                       
Capital expenditures
  
$
—
  
$
—
  
$
—
  
$
—
  
$
76,767
  
$
48,940
  
 
   
September 30,
2007
  
December 31,
2006
  
September 30,
2007
  
December 31,
2006
  
September 30,
2007
  
December 31,
2006
  
                           
Total assets
  
$
3,130
  
$
359,772
  
$
(169,033
)
$
(356,354
)
$
11,302,724
  
$
9,373,223
  

NOTE 16 – COMMITMENT AND CONTINGENCIES
 
A. Lease Commitment 

As of September 30, 2007, the Company’s future minimum lease payments under a non-cancelable operating lease expiring in excess of one year are as follows:

Years ending December 31,
  
 
  
2008
  
$
193,760
  
2009
    
53,443
  
2010
    
—
  
2011
    
—
  
2012
    
—
  
 
      
   
$
247,203
  
 
 
- 20 -
 
B. Going concern 

     The accompanying financial statements have been prepared assuming the Group will continue as a going concern. 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.

 
     This report contains certain forward-looking statements and information relating to us that are based on the beliefs and assumptions made by our Management as well as information currently available to the Management. When used in this document, the words “anticipate,” “believe,” “estimate,” and “expect” and similar expressions, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected. Certain of these risks and uncertainties are discussed under the caption “Factors That May Affect Our Future Results And Financial Condition” contained herein and other factors disclosed in our filings with the SEC including, but not limited to our Annual Report on Form 10-K/A for the year ended December 31, 2006. We do not intend to update these forward-looking statements.

OVERVIEW
 
     We are engaged in the business of children’s education, focusing on the publication and sale of kindergarten language school and primary school teaching materials and magazines. We also provide management and consulting services to our franchised kindergarten and language schools. Our teaching materials include books, audio tapes, DVD, VCD and compact discs. A major portion of our educational materials focuses on English language education. We also sell educational tools and equipment that are complementary to our business. Our major business originally started in Taiwan. In 2001, we started to expand our business in the PRC. We officially launched our operations in Shanghai in April 2002. As in Taiwan, we offer advanced teaching materials and tools, and monthly and bi-weekly magazines to provide children ranging from 2 to 12 years of age a chance to learn English language and computer skills, and to provide a preschool education program.

CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES 

     Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with the U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to product returns, bad debts, inventories, equity investments, income taxes, financing operations, pensions, commitments and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

     Revenue Recognition. We recognize sales of teaching materials and educational tools and equipment as revenue when title of the product and risk of ownership are transferred to the customer, which occurs at the time of delivery, or when the goods arrive at the customer designated location, depending on the associated shipping terms. Additionally, we deliver products sold by our distributors directly to the distributors’ customers and as such the delivered goods are recognized as revenue in a similar way as sales to our direct customers. We estimate sales returns and discounts based on historical experience and record them as reductions to revenues. If market conditions were to decline, we may take actions to increase sales discounts, possibly resulting in an incremental reduction of revenue at the time when revenues are recognized.
 
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     Allowance for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

     Allowance for Obsolete Inventories and Lower of Cost or Market. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about inventory aging, future demand and market conditions. If actual market conditions are less favorable than those projected by Management, additional inventory write-downs may be required.

     Investment Impairments. We hold equity interests in companies having operations in areas within our strategic focus. We record an investment impairment charge when we believe an investment has experienced a decline in value that is not temporary. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future.

     Fixed Assets and Depreciation. Our fixed assets are stated at cost. Major improvements and betterments to existing facilities and equipment are capitalized. Expenditures for maintenance and repairs that do not extend the life of the applicable asset are charged to expense as incurred. Buildings are depreciated over a 50-year term. Fixtures and equipment are depreciated using the straight-line method over their estimated useful lives, which range from two-and-a-half years to ten years.

     Impairment of Long-Lived Assets. We review our fixed assets and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the asset over its remaining useful life. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. The estimate of fair value is generally based on quoted market prices or on the best available information, including prices for similar assets and the results of using other valuation techniques.

     As of September 30, 2007, the balance of our amortizable intangible assets was $409,463, including franchise-related intangible assets of $257,874 and copyrights of $151,589. The amortizable intangible assets are amortized on a straight-line basis over estimated useful lives of ten years. In determining the useful lives and recoverability of the intangibles, assumptions must be made regarding estimated future cash flows and other factors to determine the fair value of the assets, which may not represent the true fair value. If these estimates or their related assumptions change in the future, there may be significant impact on our results of operations in the period of the change incurred.

     Income Taxes. We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and tax loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are subject to valuation allowances based upon Management’s estimates of realizability. Actual results may differ significantly from Management’s estimate.
 
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RESULTS OF OPERATIONS 

Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006 

      Total Net Operating Revenue. Total net operating revenue consists of sales of goods, franchising income and other operating revenue. Total net operating revenues increased by $395,348, or 11%, to $4,107,952 for the three months ended September 30, 2007 from $3,712,604 for the three months ended September 30, 2006. This was comprised of increase in other operating revenue of $312,340, increase in sales of goods of $362,559, and decrease in franchising income of $279,551.

     Sales of goods. The increase in sales of goods, from $2,573,101 for the three months ended September 30, 2006 to $2,935,660 for the three months ended September 30, 2007, a 14% increase, was mainly due to increases in sales in our Shanghai operations.

     Franchising income. The decrease in franchising income, from $831,805 for the three months ended September 30, 2006 to $552,254 for the three months ended September 30, 2007, a 34% increase, was mainly due to the decrease in franchising income in Taiwan operations.

     Other operating revenue. Our other operating revenues represent revenues from other activities and services such as training of teachers, arranging for personal English language tutors, organizing field trips and educational fairs, fees for designing the school layout of our franchised schools, and tuition from schools controlled by us. Other operating revenue increased by $312,340, or 102%, to $620,038 for the three months ended September 30, 2007 from $307,698 for the three months ended September 30, 2006, mainly due to the increase in Shanghai operations.

     Gross Profit. Gross profit increased by $257,030, or 12%, to $2,372,030 for the three months ended September 30, 2007 from $2,115,000 for the three months ended September 30, 2006. The gross profit increase was mainly due to the increase in revenue.

     Total Operating Expenses. Total operating expenses increased by $83,899, or 6%, to $1,466,075 for the three months ended September 30, 2007 from $1,382,176 for the three months ended September 30, 2006, principally due to increases in daily expenditures in our operations.

     Other Operating Expenses. Other operating expenses increased by $83,353, or 6%, to $1,463,233 for the three months ended September 30, 2007 from $1,379,880 for the three months ended September 30, 2006, principally due to increases in expenditures to fund daily operations.

     Interest Expenses, Net. Net interest expenses decreased by $13,471, or 43%, to $18,161 for the three months ended September 30, 2007 from $31,632 for the three months ended September 30, 2006, primarily due to the decrease of the borrowings during the three months ended September 30, 2007 compared to the three months ended September 30, 2006.

     Provision for Taxes. Provision for taxes for the three months ended September 30, 2007 and 2006 were $150,545 and $62,552, respectively. These provisions for income taxes relate to income taxes resulting from our Taiwan operations.
 
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Nine Months Ended September 30, 2007 compared to Nine Months Ended September 30, 2006 

     Total Net Operating Revenue. Total net operating revenue consists of sales of goods, franchising income and other operating revenue. Total net operating revenues increased by $620,748, or 7%, to $9,232,065 for the nine months ended September 30, 2007 from $8,611,317 for the nine months ended September 30, 2006. This was comprised of the increase in sales of goods of $529,378, an increase in other operating revenues of $475,431, and a decrease in franchising income of $384,061.

     Sales of goods. The increase in sales of goods by $529,378, or 9%, from $6,102,630 for the nine months ended September 30, 2006 to $6,632,008 for the nine months ended September 30, 2007, was mainly due to the increase in net sales of goods from our Shanghai operations.

     Franchising income. The decrease in franchising income, from $2,026,493 for the nine months ended September 30, 2006 to $1,642,432 for the nine months ended September 30, 2007, a 19% decrease, was mainly due to the decrease in franchising income from our operations.

     Other operating revenue. Our other operating revenues represent revenues from other activities and services such as training of teachers, arranging for personal English language tutors, organizing field trips and educational fairs, fees for designing the school layout of our franchised schools and tuition from schools controlled by us. Other operating revenue increased by $475,431, or 99%, to $957,625 for the nine months ended September 30, 2007 from $482,194 for the nine months ended September 30, 2006. The increase was mainly due to increase in revenues from our Shanghai operations.

     Gross Profit. Gross profit increased by $266,820, or 5%, to $5,657,364 for the nine months ended September 30, 2007 from $5,390,544 for the nine months ended September 30, 2006. The increase in Gross Profit was principally due to the increase in our operating revenue.

     Total Operating Expenses. Total operating expenses decreased by $377,338, or 9%, to $3,866,766 for the nine months ended September 30, 2007, from $4,224,520 for the nine months ended September 30, 2006. The decrease in total operating expenses was principally due to decreases in bad debt allowance in Taiwan operations.

     Other Operating Expenses. Other operating expenses decreased by $378,769, or 9%, to $3,845,751 for the nine months ended September 30, 2007, from $4,224,520 for the nine months ended September 30, 2006, principally due to decreases in reserved for additional bad debt allowance in Taiwan operations.

     Interest Expenses, Net. Net interest expenses decreased by $90,979, or 60%, to $60,778 for the nine months ended September 30, 2007, from $151,757 for the nine months ended September 30, 2006, primarily due to the decrease of borrowings during the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006. (Please refer to Note 12 of Condensed Consolidated Financial Statements for more information.)

Other Non-operating Income, Net. Net other non-operating income increased by $268,184, to $347,078 for the nine months ended September 30, 2007, from $78,894 for the nine months ended September 30, 2006. The increases in net other non-operating income was principally due to gains in the value of recovered inventory of $360,118.

     Provision for Taxes. Provision for taxes for the nine months ended September 30, 2007 and 2006 were $343,556 and $249,461, respectively. These provisions for income taxes relate to income taxes resulting from our operations in Taiwan.
 
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LIQUIDITY AND CAPITAL RESOURCES 

     As of September 30, 2007, our principal sources of liquidity included cash and bank balances of $1,001,231 which decreased from $1,419,873 at December 31, 2006. The decrease was mainly due to decreased expenditures to fund daily operations.

We have aggressively expanded business in the PRC. Shanghai operations have turned profitable in 2006, and the Group has turned profitable in the first nine months of 2007. We anticipate continued expansion of the market for our learning materials and an increase in the number of franchise schools. Furthermore, we foresee better utilization of capital and funds as we identify and implement alternatives for restructuring and refinancing in order to increase our profit margin. We began to set up schools controlled by us in 2007. Based on our internal historical records and growing market demand, Management believes that by directly operating our schools we can increase our profit margin. In 2007, Management expects that in the initial stage of the direct school operating business, we need to invest additional funds to acquire control of schools that will become profitable in 2008. Because of the rapid expansion in Shanghai, we expect that additional funds will be required in the near future to facilitate the expansion plans for our Shanghai operations in 2008. Management expects that the Group still requires approximately US$1 million for the next twelve months to invest in business development. We will rely on short-term loans from financial institutions as a source for additional funding. As discussed in Note 12 of Condensed Consolidated Financial Statements, the majority of the Group’s existing loans were guaranteed by two of our directors who have expressed their willingness to continue to support us until other sources of funds have been obtained. Management believes that, with continuous growth of sales in the PRC, the existing directors’ support, and the new bank facilities, we will have sufficient funds for operations over the foreseeable future. Management expects that the Group will be able to repay the loans from our directors by the end of 2007.

     Net cash provided by operating activities was $1,775,753 and $2,126,847 during the nine months ended September 30, 2007 and 2006, respectively. The $351,094 difference was primarily attributed to (i) reversal of allowance for loss on inventory obsolescence and slow-moving items of $360,118 during the nine months ended September 30, 2007, compared to provision of $57,204 during the nine months ended September 30, 2006, (ii) a decrease of accrued expense of $197,992 during the nine months ended September 30, 2007, compared to an increase of $153,224 during the nine months ended September 30, 2006, and (iii) decrease of receipts in advance of $125,205 during the nine months ended September 30, 2007, compared to an increase of $566,707 during the nine months ended September 30, 2006.

     Net cash used in investing activities was $1,988,515 during the nine months ended September 30, 2007 and net cash provided by investing activities was $679,970 during the nine months ended September 30, 2006. The $2,668,185 difference was primarily attributable to acquisition and a decrease of pledged notes receivable in the amount of $433,690 during the nine months ended September 30, 2007, compared to an increase of $695,875 during the nine months ended September 30, 2006.

     Net cash provided by financing activities during the nine months ended September 30, 2007 amounted to an increase of $74,813, as compared to a decrease of $1,814,965 during the nine months ended September 30, 2006. The $1,889,778 difference was primarily attributable to (i) an increase of $900,814 in cash provided by bank borrowings, (ii) a decrease of $1,022,414 in cash used in repayment of bank borrowings, and (iii) an increase of $38,198 in cash used to repay loans from related parties.

Off-Balance Sheet Arrangements 

     As of September 30, 2007, we did not engage in any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K promulgated by the SEC under the Securities Exchange Act of 1934.
 
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Bank Borrowing 

     One of our financing sources is bank borrowings. As of September 30, 2007 and 2006, the balances of bank borrowings, including current and non-current portions, were $2,437,302 and $1,904,828, respectively.

Pension Benefit

     As of July 1, 2005, the Group maintains two different retirement plans, according to the ROC Labor Standard Law, a non-contributory and funded defined contribution retirement plan (the “New Plan”) covering all regular employees of KCIT, our subsidiary in Taiwan, and the benefit retirement plan (the “Old Plan”) which commenced in September 2003, and only applies to the regular employees of KCIT who were employed prior to June 2005. (See Note 14 of Condensed Consolidated Financial Statements.) The benefits under both plans expected to be paid in each of the next five fiscal years, and in the aggregate for the five fiscal years thereafter are $0 and $16,735, respectively. We also make defined contributions to a retirement benefits plan for our employees in the PRC in accordance with local regulations. The contributions made by us for PRC employees for the nine months ended September 30, 2007 and 2006 amounted to $39,611, and $26,326, respectively.
 
NEW ACCOUNTING PRONOUNCEMENTS 

     In July 2006, the Financial Accounting Standards Board (the “FASB”) released Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement 109.” Effective for fiscal years beginning after December 15, 2006, this interpretation provides guidance on the financial statement recognition and measurement for income tax positions that we have taken or expect to take in our income tax returns. It also provides related guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We have adopted this standard as of January 1, 2007. The adoption did not have a significant impact on our financial statements.
 
     In September 2006, the FASB released SFAS No. 157, “Fair Value Measurements” which defines fair value, establishes a framework for measuring fair value in GAAP, and enhances disclosures about fair value measurements. This standard applies when other accounting pronouncements require fair value measurements; it does not require new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. We are currently evaluating the effect of the guidance contained in this standard and do not expect the implementation to have a material impact on our financial statements.
 
     In February 2007, the FASB released SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” The standard is effective for fiscal years beginning after November 15, 2007, with early adoption permitted as of the beginning of a fiscal year that begins on or before the aforementioned date. We did not elect to adopt SFAS No. 159 early. 

Non-GAAP Financial Measures

     None.


     We are exposed to market risks, including from 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.
 
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     The following analysis provides quantitative information regarding our exposure to foreign currency exchange risk and interest rate risk.

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 2006, we have projected that, if interest rates were to increase by 1 percent, the result would be an annual increase in our interest expense of $18,991. This analysis does not take into consideration the effect of changes in the level of overall economic activity on interest rate fluctuations.

Foreign currency exposure 

     We have operations in both Taiwan and the PRC. The functional currency of Higoal and its subsidiary, KCIT is New Taiwan dollars (“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 KCEI 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.

 
 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 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 September 30, 2007 our disclosure controls and procedures were ineffective. We are taking steps to improve our disclosure controls and procedures, 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 was launched into its trial run period beginning in 2007 and our Management evaluated that it will be extended to the fourth fiscal quarter 2007 to verify its functionality. The old system currently in use by the Company will be phased out after the new ERP completes its trial run period. During the phase out period, certain functions and operations will run in parallel on the old and new systems, data will be migrated to the new ERP system, and staff will be trained in its use.
 
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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 recognize that the internal controls and procedures adopted by the Company were inadequate and gave rise to misappropriation of funds as disclosed in our Form 8-K filed with the SEC on June 23, 2006. During the third quarter of 2007 we have continued to make changes that have materially affected, or are reasonably likely to affect, our internal control over financial reporting in a positive way. Among other improvements, we began implementing a comprehensive ERP system that would improve the Company’s internal controls. The ERP system is currently at a trial run stage. The required software and hardware input have been fully installed and the system is now running to detect bugs that may reside in the system. The system is expected to be fully operational in first fiscal quarter of 2008. The Company believes that full implementation of its new ERP System will will perform the following functions that will improve internal control over financial reporting:

·  
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.
 
·  
Delineate individual unit/departmental responsibilities and effectively separate respective departmental transactions so as to avoid intentional misappropriation of funds from taking place.

In addition to implementing a new ERP system, the following additional procedures have been implemented to improve internal control over financial reporting:

·  
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, a copy of the relevant invoice, or a 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, and finally, approval by the Chairman of the Board before funds may be released.

·  
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.
 
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The Company recognizes that its internal controls and procedures have been inadequate; it is assertively attending to the inadequacy and believes that implementation of all of the foregoing procedures will significantly strengthen the Company’s internal financial controls and procedures.

 

     We have no material pending legal proceedings.

ITEM 1A.     RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K/A for the year ended December 31, 2006, which could materially affect our business, financial condition or future results. We caution the reader that these risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors emerge from time to time. Management cannot predict such new risk factors, nor can we assess the impact, if any, of such new risk factors on our business or the extent to which any factor, or combination of factors, may impact our business. There have not been any material changes during the quarter ended September 30, 2007 from the risk factors disclosed in the above-mentioned Form 10-K/A for the year ended December 31, 2006, filed with the SEC on November 13, 2007.

 
     None.

 
     None.

 
     None.

 
     None.


A.
  
Exhibits
31.1
 
Rule 13a-14(a) Certification of Principal Executive Officer
31.2
  
Rule 13a-14(a) Certification of Principal Financial Officer
32.1
 
Section 1350 Certification of Principal Executive Officer and Principal Financial Officer
 
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In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


Dated: November 12, 2007
     
     
  By:  
/s/ Suang-Yi Pai
 
  Name:  Suang-Yi Pai
  Title:    Chief Financial Officer
 
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