10-Q 1 v132041_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, 2008
or

¨ 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)
 
011-886-2-2218 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 ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ¨
 
Accelerated filer ¨
 
 
 
Non-accelerated filer   ¨
 
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨     No x
 
As of September 30, 2008, 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.        Condensed Consolidated Financial Statements
 
2
 
a) Condensed Consolidated Balance Sheets as of September 30, 2008 (unaudited) and December 31, 2007
 
2-3
 
b) Condensed Consolidated Statements of Operations for the nine months ended September 30, 2008 and September 30, 2007 (unaudited)
 
4-5
 
c) Condensed Consolidated Statements of Stockholders’ Equity (unaudited)
 
6
 
d) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and September 30, 2007 (unaudited)
 
7-8
 
e) Notes to Condensed Consolidated Financial Statements
 
9
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
18
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
23
 
Item 4. Controls and Procedures
 
24
PART II.
OTHER INFORMATION
 
24
 
Item 1. Legal Proceedings
 
24
 
Item 1A Risk Factors  
 
24
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
25
 
Item 3. Defaults upon Senior Securities
 
25
 
Item 4. Submission of Matters to a Vote of Security Holders
 
25
 
Item 5. Other Information
 
25
 
Item 6 Exhibits and Reports on Form 8-K
 
25
SIGNATURES
 
26
 
-1-

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

 
  
(Unaudited)
September 30,
2008
  
December 31,
2007
  
 
  
 
  
 
  
ASSETS
          
Current assets
          
Cash and bank balances
  
$
1,742,176
  
$
1,238,212
  
Bank fixed deposits - pledged (Note11)
    
79,736
    
363,562
  
Notes and accounts receivable, net (Note 5)
    
3,194,618
    
2,453,868
  
Inventories, net (Note 6)
    
1,554,168
    
2,008,739
  
Other receivables (Note 7)
    
156,157
    
88,139
  
Prepayments and other current assets (Note 8)
    
810,823
    
542,794
  
Pledged notes receivable (Note 11)
    
384,903
    
557,983
  
Deferred income tax assets
    
46,201
    
42,335
  
Total current assets
    
7,968,782
    
7,295,632
  
Deferred income tax assets
    
51,370
    
50,481
  
Long-term investments (Note 9)
    
119,653
    
58,625
  
Property and equipment, net
    
2,475,860
    
2,312,065
  
Intangible assets, net of amortization (Note 10)
    
421,038
    
572,005
  
Long-term notes receivable
    
390,484
    
420,636
  
Pledged notes receivable (Note 11)
    
215,630
    
183,453
  
Other assets
    
356,048
    
268,388
  
Total assets
  
$
11,998,865
  
$
11,161,285
  
LIABILITIES AND STOCKHOLDERS’ EQUITY
          
Current liabilities
          
Bank borrowings - short-term and maturing within one year (Note 11)
  
$
219,044
  
$
1,212,534
  
Notes and accounts payable
    
931,401
    
389,639
  
Accrued expenses
    
1,177,992
    
985,764
  
Other payables
    
214,463
    
573,237
  
Deposits received
    
905,957
    
912,535
  
Receipts in advance (Note 12)
    
2,287,419
    
2,372,403
  
Income taxes payable
    
105,041
    
124,418
  
Total current liabilities
    
5,841,317
    
6,570,530
  
Bank borrowings maturing after one year (Note 11)
    
1,644,657
    
1,752,776
  
Receipts in advance (Note 12)
    
1,415,496
    
1,034,260
  
Deposits received
    
736,079
    
680,694
  
Deferred liability
    
41,810
    
38,787
  
Accrued pension liabilities (Note 13)
    
408,330
    
401,893
  
Total liabilities
    
10,087,689
    
10,478,940
  
 
-2-
Kid Castle Educational Corporation
  
Condensed Consolidated Balance Sheets - Continued
(Expressed in US Dollars)
  
 
  
(Unaudited)
September 30,
2008
  
 
December 31,
2007
  
 
  
 
  
 
  
Commitments and contingencies (Note 15)
          
 
          
Minority interest
    
224,465
    
162,343
  
 
          
Shareholders’ equity
          
Common stock, no par share :
          
60,000,000 shares authorized; 25,000,000 issued and outstanding at September 30, 2008 and December 31, 2007
    
8,592,138
    
8,592,138
  
Additional paid-in capital
    
194,021
    
194,021
  
Legal reserve
    
65,320
    
65,320
  
Accumulated deficit
    
(5,897,489
)
  
(7,179,418
)
Accumulated other comprehensive loss
    
(1,039,983
)
  
(932,027
)
Net loss not recognized as pension cost
    
(227,296
)
  
(220,032
)
Total shareholders’ equity
    
1,686,711
    
520,002
  
Total liabilities and shareholders’ equity
  
$
11,998,865
  
$
11,161,285
  
 
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,
  
 
  
2008
  
2007
  
 
  
 
  
Operating Revenue
          
Sales of goods
  
$
2,764,230
  
$
2,935,660
  
Franchising income
    
562,351
    
552,254
  
Other operating revenue
    
744,000
    
620,038
  
Total net operating revenue
    
4,070,581
    
4,107,952
  
Operating costs
          
Cost of goods sold
    
(1,123,317
)
  
(1,264,881
)
Cost of franchising
    
(73,496
)
  
(232,124
)
Other operating costs
    
(512,824
)
  
(238,917
)
Total operating costs
    
(1,709,637
)
  
(1,735,922
)
Gross profit
    
2,360,944
    
2,372,030
  
Advertising costs
    
(1,236
)
  
(2,842
)
Other operating expenses
   
(1,525,122
)
  
(1,463,233
)
Income from operations
    
834,586
    
905,955
  
Interest expense, net
    
(21,470
)
  
(18,161
)
Share of income of investments
    
25,429
    
39,253
  
Other non-operating income (loss), net
    
13,537
    
(24,151
)
Income before income taxes
    
852,082
    
902,896
  
Provision for taxes
    
(15,893
)
  
(150,545
)
Income after income taxes
    
836,189
    
752,351
  
Minority interest income
    
(19,713
)
  
(45,847
)
Net income
  
$
816,476
  
$
706,504
  
Earnings per share - basic and diluted
  
$
0.03
  
$
0.03
  
Weighted-average shares used to compute earnings per share - basic and diluted
    
25,000,000
    
25,000,000
  

See accompanying Notes to Condensed Consolidated Financial Statements.

-4-
 
Condensed Consolidated Statements of Operations (Unaudited)
 
(Expressed in US Dollars)
 
 
  
Nine months ended September 30,
  
 
  
2008
  
2007
  
 
  
 
  
Operating Revenue
          
Sales of goods
  
$
6,718,848
  
$
6,632,008
  
Franchising income
    
1,703,194
    
1,642,432
  
Other operating revenue
    
1,713,125
    
957,625
  
Total net operating revenue
    
10,135,167
    
9,232,065
  
Operating costs
          
Cost of goods sold
    
(2,844,771
)
  
(2,795,509
)
Cost of franchising
    
(260,292
)
  
(343,909
)
Other operating costs
    
(1,211,993
)
  
(435,283
)
Total operating costs
    
(4,317,056
)
  
(3,574,701
)
Gross profit
    
5,818,111
    
5,657,364
  
Advertising costs
    
(24,316
)
  
(21,015
)
Other operating expenses
    
(4,547,616
)
  
(3,845,751
)
Income from operations
    
1,246,179
    
1,790,598
  
Interest expense, net
    
(70,214
)
  
(60,778
)
Share of income of investments
    
55,216
    
55,242
  
Other non-operating income (loss), net
    
174,385
    
347,078
  
Income before income taxes
    
1,405,566
    
2,132,140
  
Provision for taxes
    
(75,258
)
  
(343,556
)
Income after income taxes
    
1,330,308
    
1,788,584
  
Minority interest income
    
(48,379
)
  
(94,751
)
Net income
  
$
1,281,929
  
$
1,693,833
  
Earnings per share - basic and diluted
  
$
0.05
  
$
0.07
  
Weighted-average shares used to compute earnings per share - basic and diluted
    
25,000,000
    
25,000,000
  

See accompanying Notes to Condensed Consolidated Financial Statements.

-5-

Kid Castle Educational Corporation
 
Condensed Consolidated Statements of Stockholders’ Equity
  (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, 2006
    
25,000,000
  
$
8,592,138
  
$
194,021
  
$
65,320
  
$
(9,056,567
)
$
(330,713
)
$
(98,952
)
$
(634,753
)
Net income for 2007
    
   
   
   
   
1,877,149
    
   
   
1,877,149
  
Cumulative translation adjustment
    
   
   
   
   
   
(601,314
)
  
   
(601,314
)
Comprehensive loss
    
   
   
   
   
   
   
   
1,275,835
  
Repayment of a liability by issuance of common stock_ 
    
   
   
   
   
   
   
   
 
Net loss not recognized as pension cost
    
 
   
 
   
 
   
 
   
 
   
 
 
$
(121,080
)
$
(121,080
)
Balance, December 31, 2007
    
25,000,000
  
$
8,592,138
  
$
194,021
  
$
65,320
  
$
(7,179,418
)
$
(932,027
)
$
(220,032
)
$
520,002
  
Net income for the nine months ended September 30, 2008 (Unaudited)
    
   
   
   
   
1,281,929
    
   
   
1,281,929
  
Cumulative translation adjustment (Unaudited)
    
   
   
   
   
   
(107,956
)
  
   
(107,956
)
Comprehensive loss (Unaudited)
    
   
   
   
   
   
   
   
1,173,973
  
Net loss not recognized as pension cost
    
 
   
 
   
 
   
 
   
 
   
 
 
$
(7,264
)
  
(7,264
)
 
    
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance, September 30, 2008 (Unaudited)
    
25,000,000
  
$
8,592,138
  
$
194,021
  
$
65,320
  
$
(5,897,489
)
$
(1,039,983
)
$
(227,296
)
$
1,686,711
  
 
See accompanying Notes to Condensed Consolidated Financial Statements.

-6-

K id Castle Educational Corporation
 
Condensed Consolidated Statements of Cash Flows
(Unaudited)
  (Expressed in US Dollars)
 
 
  
Nine months ended September 30,
  
 
  
2008
  
2007
  
 
  
 
  
Cash flows from operating activities
          
Net income
  
$
1,281,929
  
$
1,693,833
  
Adjustments to reconcile net income to net cash provided by operating activities
          
Depreciation of property and equipment
    
224,999
    
157,175
  
Impairment of goodwill
    
43,946
    
-
  
Amortization of intangible assets
    
130,486
    
122,857
  
Allowance for sales returns
    
80,455
    
64,379
  
Allowance for doubtful debts
    
74,760
    
139,716
  
Reversal of allowance for loss on inventory obsolescence and slow-moving items
    
(11,253
)
  
(360,118
)
Loss on disposal of PP&E
    
726
    
2,666
  
Minority interests
    
48,379
    
94,751
  
Share of income of investments
    
(55,216
)
  
(55,242
)
(Increase)/decrease in:
          
Notes and accounts receivable
    
(926,701
)
  
(662,701
)
Inventories
    
508,846
    
372,793
  
Other receivables
    
(113,487
)
  
108,330
  
Prepayments and other current assets
    
(267,809
)
  
(45,000
)
Deferred income tax assets
    
(3,519
)
  
32,997
  
Other assets
    
(86,244
)
  
76,081
  
Increase/(decrease) in:
          
Notes and accounts payable
    
551,797
    
(191,414
)
Accrued expenses
    
186,367
    
(197,992
)
Other payables
    
(334,131
)
  
424,960
  
Receipts in advance
    
253,755
    
(125,205
)
Income taxes payable
    
(21,786
)
  
67,748
  
Deferred liability
    
2,537
    
1,793
  
Deposits received
    
26,628
    
64,777
  
Accrued pension liabilities
    
671
    
(11,431
)
 
          
Net cash provided by operating activities
    
1,596,135
    
1,775,753
  
 
          
Cash flows from investing activities
          
Purchase of property and equipment
    
(362,284
)
  
(190,691
)
Change in investments in associated company
    
-
    
(222,872
)
Acquisition, net of cash acquired
    
-
    
58,365
  
Proceeds from disposal of property and equipment
    
2,236
    
118
  
Prepayment of long-term investments
    
-
    
-
  
Acquisition of long-term investments
    
-
    
(854,123
)
Bank fixed deposits-pledged
    
297,493
    
(345,622
)
Pledged notes receivable
    
155,998
    
(433,690
)
 
          
Net cash provided by (used in) investing activities
    
93,443
    
(1,988,515
)
 
-7-
K id Castle Educational Corporation

Condensed Consolidated Statements of Cash Flows – Continued
(Unaudited)
  (Expressed in US Dollars)
 
 
  
Nine months ended September 30,
  
 
  
2008
  
2007
  
 
  
 
  
Cash flows from financing activities
          
Proceeds from bank borrowings
    
-
    
1,114,717
  
Proceeds from loan from related parties
    
127,993
    
4,748
  
Repayment of bank borrowings
  
$
(1,177,680
)
$
(443,648
)
Repayment of loan from stockholders and transactions of related parties
    
(42,426
)
  
(601,004
)
 
          
Net cash provided by (used in) financing activities
    
(1,092,113
)
  
74,813
  
 
          
Net increase (decrease) in cash and cash equivalents
    
597,465
    
(137,949
)
 
          
Effect of exchange rate changes on cash and cash equivalents
    
(93,501
)
  
(280,693
)
 
          
Cash and cash equivalents at beginning of period
    
1,238,212
    
1,419,873
  
 
          
Cash and cash equivalents at end of period
  
$
1,742,176
  
$
1,001,231
  

See accompanying Notes to Condensed Consolidated Financial Statements.

-8-
K id 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”) 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 operations 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”), a company incorporated in the Cayman Islands on March 8, 2001. On September 10, 2001, Higoal established a wholly owned subsidiary, Kid Castle Educational Software Development Company Limited (“KCES”) in the People’s Republic of China (the “PRC”). The existing operations of Higoal are principally located in Taiwan and are being expanded in the PRC. In June 2002, after KCIT undertook a series of group restructurings, KCIT became the direct owner of the outstanding shares of Higoal. Premier Holding Investment Property Limited was then liquidated in June 2003.
 
On September 18, 2002, Higoal issued 11,880,000 shares of common stock to the stockholders of KCIT in exchange for 100% of the outstanding common stock of KCIT. As a result of this reorganization, KCIT became a wholly owned subsidiary of Higoal. On October 1, 2002, Kid Castle Educational Corporation (the “Company”), formerly King Ball International Technology Limited Corporation, entered into an exchange agreement with Higoal whereby the Company issued to the stockholders of Higoal 11,880,000 shares of common stock of the Company in exchange for 100% of the issued and fully paid up capital of Higoal.
 
As a result of the share exchange, the former stockholders of Higoal hold a majority of the Company’s outstanding capital stock. Generally accepted accounting principles require in certain circumstances that a company whose stockholders retain the majority voting interest in the combined business to be treated as the acquirer for financial reporting purposes. Accordingly, the acquisition has been accounted for as a “reverse acquisition” whereby Higoal is deemed to have purchased the Company. However, the Company remains the legal entity and the registrant for Securities and Exchange Commission (“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 (“Culture Media”). It was agreed that KCES and 21st Century Publishing House would each own 50% of 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 in the equity of Culture Media 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 PRC, with registered total capital of $153,778, in order to operate schools controlled by us in PRC. As of September 30, 2008, KCEI had total registered capital of $507,309.

-9-
The Company, Higoal and its subsidiaries are collectively 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, 2008 and for the nine months ended September 30, 2008 and 2007 have been prepared by the Group, without audit, pursuant to the rules and regulations of the SEC using generally accepted accounting principles in the United States. 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, 2007.
 
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.
 
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 collectability and on aging analysis of notes and accounts receivables. Under the aging analysis, 100% of any amount of overdue receivables in our ROC operations exceeding 365 days would be recognized as a doubtful account entry. Allowance for doubtful accounts in our PRC operations are recognized in two categories with varying percentages based on the number of days overdue. The categories are (1) overdue receivables between 181 and 365 days (based on an analysis of the financial strength of each customer, an allowance ranging between 10% and 80% is assigned) and (2) overdue receivables exceeding 365 days, so allowance of 100% is assigned.

-10-
INVENTORIES
 
Inventories are stated at the lower of cost or market. Cost includes all costs of purchase, cost of conversion and other costs incurred in bringing the inventories to their present location and condition, and is calculated using the weighted average method. Market value is determined by reference to the sales proceeds of items sold in the ordinary course of business after the balance sheet date or to management estimates based on prevailing market conditions.
PROPERTY AND EQUIPMENT AND DEPRECIATION
 
Property and equipment are stated at cost. Depreciation is computed using the straight-line method to allocate the cost of depreciable assets over the estimated useful lives of the assets as follows:
 
 
 
Estimated useful life
(in 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 10 years, the goodwill is tested for impairment on a recurring basis.
 
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, 2008 and 2007, 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 March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133.” SFAS No. 161 gives financial statement users better information about the reporting entity's hedges by providing for qualitative disclosures about the objectives and strategies for using derivatives, quantitative data about the fair value of and gains and losses on derivative contracts, and details of credit-risk-related contingent features in their hedged positions. SFAS No. 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008 and interim periods within those years. The Group does not expect the adoption of SFAS No. 161 to have a material effect on the Group’s Consolidated Financial Statements.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed by management to have a material impact on the Group’s present or future Consolidated 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.

-12-
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 accounted for at fair value. We will consider applying the fair value option to future transactions as provided by the standard.
 
NOTE 5 - NOTES AND ACCOUNTS RECEIVABLE

 
  
September 30, 
2008
  
December 31,
2007
  
 
  
(Unaudited)
  
 
  
 
  
 
  
 
  
Notes and accounts receivable
          
- Third parties
  
$
3,686,733
  
$
2,757,425
  
- Related parties
    
72,143
    
150,363
  
 
          
Total
    
3,758,876
    
2,907,788
  
Allowance for doubtful accounts and sales returns
    
(564,258
)
  
(453,920
)
 
          
Notes and accounts receivable, net
  
$
3,194,618
  
$
2,453,868
  
NOTE 6 - INVENTORIES

 
  
September 30, 
2008
  
December 31,
2007
  
 
  
(Unaudited)
  
 
  
 
  
 
  
 
  
Work in process
  
$
111,983
  
$
180,985
  
Finished goods and other merchandises
    
1,760,126
    
2,151,962
  
 
          
 
    
1,872,109
    
2,332,947
  
Less: Allowance for obsolete inventories and decline of market value
    
(317,941
)
  
(324,208
)
 
          
 
  
$
1,554,168
  
$
2,008,739
  
NOTE 7 - OTHER RECEIVABLES  

 
  
September 30, 
2008
  
December 31,
2007
  
 
  
(Unaudited)
  
 
  
Other receivables - third parties:
          
Tax paid on behalf of landlord
  
$ 
    
$
 
  
Advances to staff
    
109,125
    
87,188
  
Grants from Market Information Center
          
Other receivables
    
45,967
    
633
  
 
          
Sub-total
    
155,092
    
87,821
  
Other receivables - related parties
    
1,065
    
318
  
 
  
$
156,157
  
$
88,139
  
 
-13-
NOTE 8 - PREPAYMENTS AND OTHER CURRENT ASSETS
 
 
  
September 30,
2008
  
December 31,
2007
  
 
  
(Unaudited)
  
 
  
 
  
 
  
 
  
Prepayments
  
$
810,741
  
$
523,199
  
Temporary payments
    
82
    
15,598
  
Prepaid interest
    
-
    
2,713
  
Others
    
-
    
1,284
  
 
          
 
  
$
810,823
  
$
542,794
  
NOTE 9- INTEREST IN ASSOCIATES
 
 
  
September 30, 
2008
  
December 31,
2007
  
 
  
(Unaudited)
  
 
  
 
  
 
  
 
  
21 st Century Kid Castle Language and Education Center (“Education Center”) (Note (i))
          
Investment cost
  
$
109,720
  
$
101,787
  
Share of loss
    
8,494
    
(39,641
)
 
          
 
  
$
118,214
  
$
62,146
  
 
          
Tianjin Kid Castle Educational Investment Consulting Co., Ltd. (“Tianjin Consulting”) (Note (ii))
          
Investment cost
  
$
102,405
  
$
95,000
  
Share of loss
    
(100,966
)
  
(98,521
)
 
          
 
  
$
1,439
  
$
(3,521
)
 
          
Total
  
$
119,653
  
$
58,625
  
 
Note:
 
(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 investee. It has been determined that the Group has significant influence and should therefore account for its investee on the equity method.
 
-14-
For the nine months ended September 30, 2008 and 2007, the Group recognized investment income accounted for under the equity method in Education Center of $50,097 and $ 50,601, respectively.
 
(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 and should therefore account for its investee on the equity method.
 
For the nine months ended September 30, 2008 and 2007, the Group recognized an investment revenue of $5,119 and $5,698, respectively, accounted for under the equity method, in Tianjin Consulting.

NOTE 10 - INTANGIBLE ASSETS
 
 
  
September 30, 
2008
  
December 31,
2007
  
 
  
(Unaudited)
  
 
  
 
  
 
  
 
  
Gross carrying amount
          
Franchise
  
$
1,064,646
  
$
1,049,538
  
Copyrights
    
625,841
    
616,960
  
Goodwill
    
235,236
    
218,227
  
 
          
Less: Accumulated amortization
          
Franchise
    
(904,949
)
  
(813,392
)
Copyrights
    
(531,965
)
  
(478,144
)
     
(1,436,914
)
  
(1,291,536
)
Less: Impairment of goodwill
              
Goodwill
    
(67,771
)
  
(21,184
)
 
          
Net
  
$
421,038
  
$
572,005
  
 
Amortization charged to operations was $130,486 and $122,857 for the nine months ended September 30, 2008 and 2007, respectively. The impairment of goodwill was $43,946 for the nine months ended September 30, 2008.
 
The estimated aggregate amortization expenses for each of the two succeeding fiscal years are as follows:
2009
  
$
169,048
  
2010
    
42,263
  
 
      
 
  
$
211,311
  
NOTE 11 - BANK BORROWINGS
 
 
  
Notes
  
September 30, 
2008
  
December 31,
2007
  
 
  
 
  
(Unaudited)
  
 
  
 
  
 
  
 
  
 
  
Bank term loans
    
(i)
 
$
455,559
  
$
580,553
  
Short-term unsecured bank loans
    
(ii)
 
  
31,292
    
1,027,446
  
Mid-term secured bank loan
    
(iii)
 
  
1,376,849
    
1,357,311
  
 
              
 
        
1,863,700
    
2,965,310
  
Less: Balances maturing within one year included in current liabilities
              
Bank term loans
        
—
    
185,088
  
Short-term unsecured bank loans
        
31,292
    
1,027,446
  
Mid-term secured bank loan
        
187,752
    
—
  
 
              
 
        
219,044
    
1,212,534
  
 
              
Bank borrowings maturing after one year
      
$
1,644,656
  
$
1,752,776
  
 
Note:
 
(i)  
This line item represents bank loans that have been secured by a pledge of post-dated checks amounting to $904,682 and $753,962 that we have received from franchisees and the Group’s bank deposits of $27,752 and $22,053 as of September 30, 2008 and December 31, 2007, 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, which were extended on October 1, 2008 and will be due on September 30, 2009. The weighted average interest rates were 5.86% and 5.85% per annum as of September 30, 2008 and 2007, respectively.
 
For the nine months ended September 30, 2008 and 2007, interest expense charged to operations in respect of bank loans was $25,134 and $4,438, 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 and notes receivables approximating 30% of the loan balance, and guaranteed by two directors and stockholders of the Group. The loan bore interest at the lending bank’s basic fixed deposit rate plus 3.29% per annum, which was extended in February 2007 and was due in February 2008. Of the principal, $146,186 is repayable in 12 equal monthly installments. The loan was fully repaid on November 28, 2007.
  
-15-
In May 2007, KCES obtained a $339,287 short-term loan to finance the Group’s operations. The loan was guaranteed by Director Min Tan Yang and KCIT, and was collateralized by $340,000 of KCIT deposits. It was due in April 2008. The loan bore interest at the PRC basic borrowing rate per annum. The loan was fully repaid on April 10, 2008.

For the nine months ended September 30, 2008 and 2007, interest expense charged to operations in respect of the above unsecured short-term loans was $421 and $31,008, respectively.
 
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 was secured by the Group’s land and buildings and personal guarantees provide by two directors of the Group. The loan bore interest at the lending bank’s basic fixed deposit rate plus 0.69% per annum for the years 2005 to 2007, and plus 1.69% per annum for the year 2008.  On August 10, 2005, the bank extended the term of the loan and it was repayable in 84 equal monthly installments starting on August 10, 2012. The loan was fully repaid on November 28, 2007.
 
In February 2005, KCIT obtained a new bank loan of $456,830, which bore interest at 6% per annum and was repayable in 36 equal monthly installments. The last installment was due on February 2, 2008 and the loan was fully repaid on January 9, 2008.
 
In August 2005, KCIT obtained a new bank loan of $213,187, which was repayable in 60 equal monthly installments. The last installment was due on August 10, 2010, however, the loan was fully repaid on November 28, 2007.

In November 28, 2007, KCIT obtained a new bank loan of $1,542,401. The loan is secured by the Group’s land and buildings and is personally guaranteed by two directors of the Group. It bears interest at the lending bank’s basic fixed deposit rate plus 1.45% per annum. Of the principal, $370,176 is repayable in 24 equal monthly installments. A final balloon payment of $1,172,225 is due on November 28, 2009. The applicable interest rate was approximately 3.6% per annum as of September 2008 and December 2007.
 
For the nine months ended September 30, 2008 and 2007, interest expense charged to operations amounted to $42,592 and $28,559, respectively.
NOTE 12 - RECEIPTS IN ADVANCE
 
The balance comprises:

 
  
Notes
  
September 30, 
2008
  
December 31,
2007
  
 
  
 
  
(Unaudited)
  
 
  
 
  
 
  
 
  
 
  
Current liabilities:
              
Sales deposits received
    
(i)
 
$
635,625
  
$
303,258
  
Franchising income received
    
(ii)
 
  
1,196,966
    
1,456,267
  
Subscription fees received
    
(iii)
 
  
433,446
    
516,136
  
Others
        
20,728
    
96,742
  
Related parties
          
654
    
—
  
 
        
2,287,419
    
2,372,403
  
 
              
Long-term liabilities:
              
Franchising income received
    
(ii)
 
  
1,415,496
    
1,034,260
  
 
              
 
      
$
3,702,915
  
$
3,406,663
  
 
-16-
Note:
 
(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.
 
NOTE 13 - RETIREMENT PLANS 

      The Group maintains tax-qualified defined contribution and benefit retirement plans for its employees in accordance with the 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 a new defined contribution retirement plan (the “New Plan”) covering all regular employees of KCIT. KCIT contributes monthly an amount equal to 6% of the employees’ base salaries and wages to the Bureau of National Health Insurance. The Group still maintains the former 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. 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. Under the Old Plan, the employees are entitled to receive retirement benefits upon retirement in the manner stipulated by the ROC Labor Standard Law in Taiwan. The benefits under the 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,  
  
 
  
  2008  
  
   2007 
  
 
  
  (Unaudited)  
  
Service cost
  
$
    
$
 
  
Interest cost
    
9,684
    
9,162
  
Expected return on assets
    
(1,569
)
  
(1,818
)
Amortization of unrecognized loss
    
2,424
    
2,217
  
 
          
Net periodic pension cost
  
$
10,539
  
$
9,561
  
 
-17-
NOTE 14 - GEOGRAPHICAL SEGMENTS
 
The Group is principally engaged in the business of child educational teaching materials and related services focusing on English language in Taiwan and the PRC. Accordingly, the Group has two reportable geographic segments: Taiwan and the PRC. The Group evaluates the performance of each geographic segment based on its net income or loss. The Group also accounts for inter-segment sales as if the sales were made to third parties. Information concerning the operations in these geographical segments is as follows:

 
  
Taiwan
  
The PRC
  
Total
  
Corporate
  
Eliminations
  
Consolidated
  
 
  
Nine months
ended
September 30,
2008
  
Nine months 
ended
September 30,
2007
  
Nine months 
ended
September 30,
2008
  
Nine months 
ended
September 30,
2007
  
Nine months 
ended
September 30,
2008
  
Nine months 
ended
September 30,
2007
  
Nine months 
ended
September 30,
2008
  
Nine months 
ended
September 30,
2007
  
Nine months 
ended
September 30,
2008
  
Nine months 
ended
September 30,
2007
  
Nine months 
ended
September 30,
2008
  
Nine months 
ended
September 30,
2007
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
Revenue
    
   
   
   
   
   
   
   
   
   
   
   
 
External revenue
  
$
5,193,759
  
$
5,287,849
  
$
4,941,408
  
$
3,944,216
  
$
10,135,167
  
$
9,232,065
  
$
—
  
$
—
  
$
—
  
$
—
  
$
10,135,167
  
$
9,232,065
  
Inter-segment revenue
    
—
    
—
    
—
    
—
    
—
    
—
    
—
    
—
    
—
    
—
    
—
    
—
  
 
    
   
   
   
   
   
   
   
   
   
   
   
 
 
  
$
5,193,759
  
$
5,287,849
  
$
4,941,408
  
$
3,944,216
  
$
10,135,167
  
$
9,232,065
  
$
—
  
$
—
  
$
—
  
$
—
  
$
10,135,167
  
$
9,232,065
  
 
    
   
   
   
   
   
   
   
   
   
   
   
 
Profit from
Operations
  
$
673,668
  
$
946,475
  
$
683,818
  
$
973,485
  
$
1,357,486
  
$
1,919,960
  
$
(111,307
)
$
(129,362
)
$
—
  
$
—
  
$
1,246,179
  
$
1,790,598
  
 
    
   
   
   
   
   
   
   
   
   
   
   
 
Capital expenditures
  
$
75,863
  
$
35,359
  
$
207,126
  
$
41,408
  
$
282,989
  
$
76,767
  
$
—
  
$
—
  
$
—
  
$
—
  
$
282,989
  
$
76,767
  
 
  
September 30,
2008
  
December 31,
2007
  
September 30,
2008
  
December 31,
2007
  
September 30,
2008
  
December 31,
2007
  
September 30,
2008
  
December 31,
2007
  
September 30,
2008
  
December 31,
2007
  
September 30,
2008
  
December 31,
2007
  
Total assets
  
$
7,417,665
  
$
7,495,418
  
$
5,023,622
  
$
4,063,399
  
$
12,441,287
  
$
11,558,817
  
$
2,901
  
$
2,597
  
$
(445,323
)
$
(400,129
)
$
11,998,865
  
$
11,161,285
  
 
NOTE 15 - COMMITMENT AND CONTINGENCIES 

A. Lease Commitment 

      As of September 30, 2008, the Company’s future minimum lease payments under a non-cancelable operating lease expiring in excess of one year are as follows:
 
     
2009    
  
$
484,012
  
2010    
    
276,513
  
2011    
    
342,970
  
2012    
    
712,496
  
Years 2013 to 2017    
    
1,264,272
  
     
      
     
  
$
3,080,263
  

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 within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended, 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. 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 for the year ended December 31, 2007. We do not intend to update these forward-looking statements.

-18-
OVERVIEW
 
      We are a leading provider in the PRC and Taiwan of English-language instruction and educational services to children for whom Chinese is the primary language. Our focus is on children between two and twelve years old. In 2007 we taught or provided educational materials for approximately 1,300,000 students at over 7,430 locations through our franchise and cooperative school operations.

We commenced operations in 1986 as an English-language school, and since then we have expanded our franchise operations to provide bilingual kindergarten instruction, computer training, and tutorial services. In September 1999, we began offering a variety of multimedia, including educational videos, textbooks, workbooks, and educational software, authored by us as fully functional, stand-alone products or as supplements to our classroom-based and Internet-based instruction.

We have incurred operating losses during most of our operating history. However, we have been profitable since 2007. The accumulated deficit has improved since Messrs. Pai and Yang have assumed their respective management roles, and as of September 30, 2008, the balance of accumulated deficit was $5,897,489. Although we still have an accumulated deficit, we have 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 additional financing 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 need to seek a more expensive source of funding to finance our operations.
 
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES 

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

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

-19-

      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, 2008, the balance of our amortizable intangible assets was $421,038, including franchise-related intangible assets of $159,697 and copyrights of $93,876. The amortizable intangible assets are amortized on a straight-line basis over estimated useful lives of 10 years. The balance of goodwill was $167,465, which is tested for impairment on a recurring basis. In determining the useful lives and recoverability of the intangibles, assumptions must be made regarding estimated future cash flows and other factors to determine the fair value of the assets, which may not represent the true fair value. If these estimates or their related assumptions change in the future, there may be significant impact on our results of operations in the period of the change incurred.

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

RESULTS OF OPERATIONS 

Three Months Ended September 30, 2008 compared to Three Months Ended September 30, 2007 

 Total Net Operating Revenue. Total net operating revenue consists of sales of goods, franchising income and other operating revenue. Total net operating revenues decreased by $37,371, or 1%, to $4,070,581 for the three months ended September 30, 2008 from $4,107,952 for the three months ended September 30, 2007. The decrease in total net operating revenue in third quarter 2008 consisted of the decrease in sales of goods of $171,430, increase in the franchising income of $10,097, and increase in other operating revenue of $123,962.

     Sales of goods. The decrease in sales of goods, from $2,935,660 for the three months ended September 30, 2007 to $2,764,230 for the three months ended September 30, 2008, a decrease of $171,430 or 6%, was mainly due to decrease of sales in our Taiwan operations.

     Franchising income. The increase in franchising income, from $552,254 for the three months ended September 30, 2007 to $562,351 for the three months ended September 30, 2008, or 2%, was mainly due to the increase in franchising income in our Shanghai 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 school controlled by us. Other operating revenue increased by $123,962, to $744,000 for the three months ended September 30, 2008 from $620,038 for the three months ended September 30, 2007. The increase was mainly due to revenues derived from operating schools controlled by us in the PRC and Taiwan.

     Gross Profit. Gross profit decreased by $11,086, or 0.5%, to $2,360,944 for the three months ended September 30, 2008 from $2,372,030 for the three months ended September 30, 2007. This was mainly due to increase in other operating costs from our operations of schools controlled by us in the PRC and Taiwan.

     Total Operating Expenses. Total operating expenses increased by $60,283, or 4%, to $1,526,358 for the three months ended September 30, 2008 from $1,466,075 for the three months ended September 30, 2007, principally due to increases in expenditures to fund daily operations in our Shanghai operations.

     Other Operating Expenses. Other operating expenses increased by $61,889, or 4%, to $1,525,122 for the three months ended September 30, 2008 from $1,463,233 for the three months ended September 30, 2007, principally due to increases in daily expenditures in our Shanghai operations.

     Interest Expenses, Net. Net interest expenses increased by $3,309, or 18%, to $21,470 for the three months ended September 30, 2008 from $18,161 for the three months ended September 30, 2007, primarily due to the increase of the borrowings during the three months ended September 30, 2008 compared to the three months ended September 30, 2007.

     Provision for Taxes. Provision for taxes for the three months ended September 30, 2008 and 2007 were $15,893 and $150,545, respectively. These provisions for income taxes relate to income taxes resulting from our operations in Taiwan.

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  Nine Months Ended September 30, 2008 compared to Nine Months Ended September 30, 2007

 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 $903,102, or 10%, to $10,135,167 for the nine months ended September 30, 2008 from $9,232,065 for the nine months ended September 30, 2007. This was mainly due to the increase in sales of goods of $86,840, franchising income of $60,762, and other operating revenues of $755,500.

      Sales of goods. The increase in sales of goods, from $6,632,008 for the nine months ended September 30, 2007 to $6,718,848, for the nine months ended September 30, 2008 (a 1% increase), was mainly due to the increase in net sales of goods in Shanghai operations.

      Franchising income. The 4% increase in franchising income, from $1,642,432 for the nine months ended September 30, 2007 to $1,703,194, for the nine months ended September 30, 2008, was mainly due to the increase in franchising income from our Shanghai 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 the tuition from schools. Other operating revenue increased by $755,500, or 79%, to $1,713,125 for the nine months ended September 30, 2008 from $957,625 for the nine months ended September 30, 2007. A major portion of the increase was due to increases in operating revenue from schools controlled by us in the PRC and Taiwan.

      Gross Profit. Gross profit increased by $160,747, or 3%, to $5,818,111 for the nine months ended September 30, 2008, from $5,657,364 for the nine months ended September 30, 2007. The increase in Gross Profit was mainly due to the increase in revenue from our Shanghai operations.

      Total Operating Expenses. Total operating expenses increased by $705,166, or 18%, to $4,571,932 for the nine months ended September 30, 2008, from $3,866,766 for the nine months ended September 30, 2007. The increase in total operating expenses was mainly due to increases in expenditures to fund daily operations in our Shanghai operations.

      Other Operating Expenses. Other operating expenses increased by $701,865, or 18%, to $4,547,616 for the nine months ended September 30, 2008, from $3,845,751 for the nine months ended September 30, 2007.The increase in operating expenses was mainly due to increases in expenditures to fund daily operations in our Shanghai operations.

      Interest Expenses, Net. Net interest expenses increased by $9,436, or 16%, to $70,214 for the nine months ended September 30, 2008 from $60,778 for the nine months ended September 30, 2007. The increase in net interest expenses was mainly due to the increase of the borrowings during the nine months ended September 30, 2008, compared to the nine months ended September 30, 2007. (See Note 11 to our Condensed Consolidated Financial Statements for more information.)

Other Non-operating Income, Net. Net other non-operating income decreased by $172,693, or 50%, to $174,385 for the nine months ended September 30, 2008, from $347,078 for the nine months ended September 30, 2007. The decrease in net other non-operating income was mainly due to the reduction in the allowance for obsolete inventory from $360,118 for the nine months ended September 30, 2007 to $11,253 for the nine months ended September 30, 2008.

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      Provision for Taxes. Provision for taxes for the nine months ended September 30, 2008 and 2007 were $75,258 and $343,556, respectively. These provisions for income taxes relate to income taxes resulting from our operations in Taiwan.

LIQUIDITY AND CAPITAL RESOURCES 

     As of September 30, 2008, our principal sources of liquidity included cash and bank balances of $1,742,176, which increased $503,964 from the balance of $1,238,212 at December 31, 2007. The increase was mainly due to continuing profitability of our operations.

We have assertively expanded our business in the PRC. The Shanghai operations have turned profitable in 2006, and the Group has turned profitable in the first quarter of 2007. We anticipate continued expansion of the demand for 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 since 2007. Due to the rapid expansion in our Shanghai operations, the Group foresees additional need for funds in the near future to facilitate its expansion plans during 2008. As discussed in Note 11 to our Condensed Consolidated Financial Statements, the majority of the Group’s existing loans are 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.

     Net cash provided by operating activities was $1,596,135 and $1,775,753 during the nine months ended September 30, 2008 and 2007, respectively. The $179,618 difference was primarily attributed to (i) an increase in net income of $1,281,929 during the nine months ended September 30, 2008, compared to an increase of net income of $1,693,833 during the nine months ended September 30, 2007, (ii) an increase in notes and accounts receivable of $926,701 during the nine months ended September 30, 2008, compared to an increase of notes and accounts receivable of $662,701 during the nine months ended September 30, 2007 and (iii) a decrease of reversal of allowance for loss on inventory obsolescence and slow-moving items in the amounts of $11,253 during the nine months ended September 30, 2008, compared to a decrease of reversal of allowance for loss on inventory obsolescence and slow-moving items in the amounts of $360,118 during the nine months ended September 30, 2007.

     Net cash provided by investing activities was $93,443 during the nine months ended September 30, 2008 and net cash used in investing activities was $1,988,515 during the nine months ended September 30, 2007. The $2,081,958 difference was primarily attributable to an acquisition during the nine months ended September 30, 2007.

     Net cash used in financing activities during the nine months ended September 30, 2008 was $1,092,113, compared to net cash provided by financing activities of $74,813 during the nine months ended September 30, 2007. The $1,166,926 difference was primarily attributable to (i)$1,177,680 in cash used in repayment of bank borrowings during the nine months ended September 30, 2008, compared to $443,648 used for the same purpose during the nine months ended September 30, 2007 and (ii) proceeds from bank borrowings of $1,114,717 during the nine months ended September 30, 2007.

Off-Balance Sheet Arrangements 

     As of September 30, 2008, 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 from bank borrowings. As of September 30, 2008 and 2007, the balances of bank borrowings, including current and non-current portions, were $1,863,701 and $2,437,302, 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 covering all regular employees of KCIT, our subsidiary in Taiwan, and the benefit retirement plan which commenced in September 2003, and only applies to the regular employees of KCIT who were employed prior to June 2005, as described in Note14 to our Condensed Consolidated Financial Statements. The benefits expected to be paid in each of the next five fiscal years, and in the aggregate for the five fiscal years thereafter are $0 and $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 the nine months ended September 30, 2008 and 2007 amounted to $41,865, and $39,611, respectively.

  New Accounting Pronouncements

See Note 4 to the Consolidated Financial Statements

Non-GAAP Financial Measures

      None.
 

     We are exposed to market risk, 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.

     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 2008, we have projected that, if interest rates were to increase by one percent, the result would be an annual increase in our interest expense of $21,413. 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 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, of its consolidated investee, Culture Media, and of 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.

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ITEM 4. 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 our conclusion is that as of September 30, 2008 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, when fully operational, will enable the centralization of all information required to be disclosed pursuant to the Exchange Act to be digitally recorded, processed, summarized and reported in a timely and secured manner. During the last phase of ERP system integration, certain difficulties were encountered that have prevented the ERP system to be satisfactorily declared effective and independently operational by the management. In addition to that, the original dates scheduled to conduct certain assessments has also been interfered since the company hired to assist the implementation of the new ERP system unexpectedly ceased its operation in September 2008. The Company is assertively seeking to engage a new system consulting company to continue the integration process. It is anticipated by management that the new system will become fully operational in the fourth fiscal quarter 2009. The old system used by the Company will then be phased out.
 
The Company recognizes that the disclosure controls and procedures were inadequate; it is assertively attending to the inadequacy and believes that implementation of ERP will significantly strengthen the Company’s disclosure controls and procedures.

Changes in Internal Control Over Financial Reporting  
 
There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

During the last quarter, we have continued to implement a comprehensive ERP system that, when fully operational, will enhance our internal controls over financial reporting. The ERP system has been fully installed and the system has been running in parallel with the old system since 2007. The system is expected to be fully operational in the fourth fiscal quarter 2009. 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.
 

      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 for the year ended December 31, 2007, 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 facts 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, 2008 from the risk factors disclosed in the above-mentioned Form 10-K for the year ended December 31, 2007.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 

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 13, 2008

By:  
 /s/ Suang-Yi Pai
 
Name:  
Suang-Yi Pai     
 
Title:  
Chief Financial Officer