KID CASTLE EDUCATIONAL CORP - Quarter Report: 2004 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

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, 2004

or

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

Commission File Number: 333-61286

KID CASTLE EDUCATIONAL CORPORATION

8th Floor, No. 98 Min Chuan Road, Hsien Tien
Taipei, Taiwan ROC
(Address of principal executive offices)

Registrant’s telephone number, including area code:                                                      011-886-22218 5996

Securities registered pursuant to Section 12(b) of the Act:

Securities registered under Section 12(g) of the Act:

Title of class
None

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the last ninety days.

Yes x  No  o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes o  No x

o

As of November 10, 2004, there were 18,999,703 shares of the Registrant’s common stock outstanding.

Documents incorporated by reference: None.

FORM 10-Q

KID CASTLE EDUCATIONAL CORPORATION

TABLE OF CONTENTS

i

KID CASTLE EDUCATIONAL CORPORATION

UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
AND
FOR THE THREE MONTHS AND NINE MONTHS ENDED
SEPTEMBER 30, 2004 AND 2003

KID CASTLE EDUCATIONAL CORPORATION

-2-

Kid Castle Educational Corporation

Condensed Consolidated Balance Sheets

(Expressed in US Dollars)

-3-

Kid Castle Educational Corporation

Condensed Consolidated Balance Sheets - Continued

(Expressed in US Dollars)

     The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

-4-

Kid Castle Educational Corporation

Condensed Consolidated Statements of Operations

(Expressed in US Dollars)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

-5-

Kid Castle Educational Corporation

Condensed Consolidated Statements of Stockholders’ Equity

(Expressed in US Dollars)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

-6-

Kid Castle Educational Corporation

Condensed Consolidated Statements of Cash Flows

(Expressed in US Dollars)

-7-

Kid Castle Educational Corporation

Condensed Consolidated Statements of Cash Flows – Continued

(Expressed in US Dollars)

-8-

Kid Castle Educational Corporation

Condensed Consolidated Statements of Cash Flows – Continued

(Expressed in US Dollars)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

-9-

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”) as a limited liability company. KCIT is engaged in the business of children’s education focusing on the English language. The business comprises publication, sales and distribution of related books, magazines, audio and videotapes and compact disc, franchising and sales of merchandises complementary to the business. KCIT commenced operations in April 2000 when it acquired the above business from a related company, Kid Castle Enterprises Limited (“KCE”), which was owned by two directors and stockholders of KCIT.

On March 9, 2001, KCIT formed a wholly-owned subsidiary, Premier Holding Investment Property Limited incorporated in the British Virgin Islands, which held the entire common stock of Higoal Developments Limited (“Higoal”) incorporated in the Cayman Islands on March 8, 2001. On September 10, 2001, Higoal established a wholly owned subsidiary, Kid Castle Educational Software Development Company Limited (“KCES”) in the People’s Republic of China (the “PRC”). The existing operations of Higoal are principally located in Taiwan and are being expanded in the PRC. In June 2002, after KCIT undertook a series of group restructurings, KCIT became the direct owner of the outstanding shares of Higoal. Premier Holding Investment Property Limited was then liquidated in June 2003.

On September 18, 2002, Higoal issued 11,880,000 shares of common stock to the stockholders of KCIT in exchange for 100% of the outstanding common stock of KCIT. As a result of this reorganization, KCIT became a wholly owned subsidiary of Higoal. On October 1, 2002, Kid Castle Educational Corporation (the “Company”), formerly King Ball International Technology Limited Corporation entered into an exchange agreement with Higoal whereby the Company issued to the stockholders of Higoal 11,880,000 shares of common stock of the Company in exchange for 100% of the issued and fully paid up capital of Higoal.

As a result of the share exchange, the former stockholders of Higoal hold a majority of the Company’s outstanding capital stock. Generally accepted accounting principles require in certain circumstances that a company whose stockholders retain the majority voting interest in the combined business to be treated as the acquirer for financial reporting purposes. Accordingly, the acquisition has been accounted for as a “reverse acquisition” whereby Higoal is deemed to have purchased the Company. However, the Company remains the legal entity and the Registrant for Securities and Exchange Commission reporting purposes.

In July 2003, KCES entered into an agreement with 21^st Century Publishing House to incorporate Jiangxi 21^st Century Kid Castle Culture Media Co., Ltd (“Culture Media”). It was agreed that KCES and 21^st Century Publishing House each owned 50% ownership and that each party contributed RMB$1 million for the incorporation. On July 2, 2004, KCES acquired additional 40% of ownership in Culture Media from 21^st Century Publishing House. As of September 30, 2004, the Group owns 90% of Culture Media, which became a consolidated entity.

-10-

The Company, Higoal and its subsidiaries collectively are referred to as the “Group”. The operations of the Group are principally located in Taiwan and the PRC.

NOTE 2 - BASIS OF PRESENTATION

The accompanying financial data as of September 30, 2004 and for the nine months and three months ended September 30, 2004 and 2003 have been prepared by the Group, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America 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, 2003.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates.

The Group has incurred operating losses since inception and hence, as of September 30, 2004, the balance of accumulated deficit was $6,842,653. The Group plans to fund its working capital needs by obtaining new credit lines from financial institutions and raising capital through the sale of equity securities. If the Group is unable to meet its current operating plan, it will be required to obtain additional funding. Management believes such funding will be available, but there can be no assurances that such funding will be available, or if it is available, on terms acceptable to the Group. Management believes that if funding is not available, other actions can and will be taken to reduce costs. These actions may entail the Group to reduce headcount, sales and marketing, other expansion activities, which may affect the future growth of the Group’s operations.

NOTE 3 - SUMMARY OF IMPORTANT ACCOUNTING POLICIES

REVENUE RECOGNITION

Sales of books, magazines, audio and video tapes, compact disc and other merchandises are recognised 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.

-11-

INVENTORIES

Inventories are stated at the lower of cost or market. Cost includes all costs of purchase, cost of conversion and other costs incurred in bringing the inventories to their present location and condition, and is calculated using the weighted average method. Market value is determined by reference to the sales proceeds of items sold in the ordinary course of business after the balance sheet date or to management estimates based on prevailing market conditions.

PROPERTY AND EQUIPMENT AND DEPRECIATION

Property and equipment are stated at cost. Depreciation is computed using the straight-line method to allocate the cost of depreciable assets over the estimated useful lives of the assets as follows:

Maintenance, repairs and minor renewals are charged directly to the statement of operations as incurred. When assets are disposed of, the related cost and accumulated depreciation thereon are removed from the financial statements and any resulting gain or loss is included in the statement of operations.

LONG-LIVED ASSETS

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. The Group does not perform a periodic assessment of assets for impairment in the absence of such information or indicators. Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used, or a significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable. For long-lived assets to be held and used, the Group measures fair value based on quoted market prices or based on discounted estimates of future cash flows.

INCOME TAXES

The Company and its subsidiaries accounts for income taxes in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109 “Accounting for Income Taxes”. Under SFAS No. 109, deferred tax liabilities or assets at the end of each period are determined using the tax rate expected to be in effect when taxes are actually paid or recovered. Valuation allowances are established when it is considered more likely than not that the deferred tax assets will not be realized.

INTANGIBLE ASSETS

Franchises and copyrights are stated at cost and amortized on the straight-line method over their estimated useful lives of 10 years.

COMPREHENSIVE INCOME (LOSS)

-12-

Comprehensive income (loss) is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. Comprehensive income (loss) is disclosed in the condensed consolidated statement of stockholders’ equity.

NET EARNINGS (LOSS) PER COMMON SHARE

The Group computes net earnings (loss) per share in accordance with SFAS No. 128, “Earnings per Share”. Under the provisions of SFAS No. 128, basic net earnings (loss) per share is computed by dividing the net earnings (loss) available to common shareholders for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net earnings (loss) per share gives effect to common stock equivalents. For the nine months ended September 30, 2004 and 2003, 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 January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No.46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”). FIN 46 clarifies when a company should consolidate in its financial statements the assets, liabilities and activities of a variable interest entity. FIN 46 provides general guidance as to the definition of a variable interest entity and requires a variable interest entity to be consolidated if a company absorbs the majority of the variable interest entity’s expected losses, or is entitled to receive a majority of the variable interest entity’s residual returns, or both. In December 2003, the FASB issued a revised interpretation of FIN 46 (“FIN 46-R”), which supercedes FIN 46 and clarifies and expands current accounting guidance for variable interest entities. FIN 46 and FIN 46-R are effective immediately for all variable interest entities created after January 31, 2003, and for variable interest entities created prior to February 1, 2003, no later than the end of the first reporting period after March 15, 2004. We have performed a review of all entities created prior to and subsequent to January 31, 2003, and determined the adoption of FIN 46 and FIN 46-R did not have a material impact on the Group’s financial reporting and disclosures.

On April 30, 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”(“SFAS No. 149”) SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The new guidance amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group (“DIG”) process that effectively required amendments to SFAS No. 133, and decisions made in connection with other FASB projects dealing with financial instruments and in connection with implementation issues raised in relation to the application of the definition of a derivative and characteristics of a derivative that contains financing components. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Group does not expect SFAS No. 149 to have a material impact on the Group’s consolidated financial statements upon adoption.

-13-

In May 2003, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 150”). SFAS No. 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS No. 150 is effective for all financial instruments created or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Group does not expect SFAS No. 150 to have a material impact on the Group’s consolidated financial statements upon adoption.

In December 2003, the Staff of the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which supercedes SAB 101, “Revenue Recognition in Financial Statements.” SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements and revises the SEC’s “Revenue Recognition in Financial Statements Frequently Asked Questions and Answers” that have been codified in Topic 13. SAB 104 was effective immediately and did not have a material impact on the Group’s financial reporting and disclosures.

In December 2003, the FASB revised SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” This Statement revises employers’ disclosures about pension plans and other postretirement benefit plans. It requires additional disclosures to those in the original SFAS No. 132 about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The required information should be provided separately for pension plans and for other postretirement benefit plans. This Statement, which also requires new disclosures for interim periods beginning after December 15, 2003, is effective for fiscal years ended after December 15, 2003. The Group has adopted this Statement since the year ended December 31, 2003.

In September 2004, the EITF delayed the effective date for the recognition and measurement guidance previously discussed under EITF Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-01”) as included in paragraphs 10-20 of the proposed statement. The proposed statement will clarify the meaning of other-than-temporary impairment and its application to investments in debt and equity securities, in particular investments within the scope of FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investment accounted for under the cost method. The Group is currently evaluating the effect of this proposed statement on its financial position and results of operations.

NOTE 5 – NOTES AND ACCOUNTS RECEIVABLE

-14-

NOTE 6 – INVENTORIES

NOTE 7 – OTHER RECEIVABLES

Note:

-15-

NOTE 8 – LONG-TERM INVESTMENTS

Note:

-16-

NOTE 9 – ACQUISITION

In July 2003, the Group entered into an agreement with 21^st Century Publishing House to incorporate Culture Media. It was agreed that KCES, the Group’s wholly owned PRC subsidiary, and 21^st Century Publishing House each had 50% ownership and that each party contributed RMB$1 million for the incorporation. On July 2, 2004, the Group acquired additional 40% of the ownership in Culture Media from 21^st Century Publishing House for a purchase price of approximately $121,000 (RMB $1 million). The Group’s management believed that the book value of the existing assets and liabilities of Culture Media approximated the fair value of these assets and liabilities, based on which the purchase price was determined for the purpose of applying purchase accounting. The acquisition expands the Group’s current sales and services in Shanghai and is expected to increase the Group’s competitive position in China. As of September 30, 2004, the Group owns 90% of Culture Media, which became a consolidated entity.

The fair values of Culture Media’s assets and liabilities as at July 2, 2004 are presented below:

-17-

The result of operations of Culture Media during the period since July 2, 2004, the date that the respective acquisition was completed, to September 30, 2004 has been included in the Group’s condensed consolidated statements of operations. The following unaudited pro forma information presents a summary of the results of operations of the Group assuming the acquisition of Culture Media occurred on January 1, 2004. And as Culture Media has not commenced its operation until October 2003, the information presented for the preceding year does not include the result of operations of Culture Media.

NOTE 10 – RELATED PARTY TRANSACTIONS

A. Names of related parties and relationship with the Group are as follows:

-18-

B. Significant transactions and balances with related parties are as follows:

-19-

Note:

-20-

Prepayments to Publishing House are mainly for inventory ordered by Culture Media. According to each contract signed with Publishing House, Culture Media has to prepay a certain percentage of inventories purchased upon the effectiveness of the contracts. The remaining payments will be made three months after the initial payment.

(ix) Amount due to officers:

Note:

-21-

NOTE 11 – INTANGIBLE ASSETS

Amortization charged to operations was $120,515 and $117,271 for the nine months ended September 30, 2004 and 2003, respectively.

The estimated aggregate amortization expenses for each of the five succeeding fiscal years are as follows:

NOTE 12 – BANK BORROWINGS

-22-

Note:

-23-

NOTE 13 – RECEIPTS IN ADVANCE

The balance comprises:

Note:

-24-

NOTE 14 – RETIREMENT PLANS

The Group has a defined benefit retirement plan (the “Plan”) covering all regular employees of KCIT, its ROC subsidiary in Taiwan. Under the funding policy of the Plan, commencing from September 2003, KCIT contributes monthly an amount equal to 2% of the employees’ total salaries and wages, to an independent retirement trust fund deposited with the Central Trust of China in accordance with the ROC Labor Standards Law in Taiwan. The retirement fund is not included in the Group’s financial statements. Net periodic pension cost is based on annual actuarial valuations which use the projected unit credit cost method of calculation and is charged to the consolidated statement of operations on a systematic basis over the average remaining service lives of current employees. Under the plan, the employees are entitled to receive retirement benefits upon retirement in the manner stipulated by the ROC Labor Standard Law in Taiwan. The benefits under the plan are based on various factors such as years of service and the final base salary preceding retirement.

The net periodic pension cost is as follows:

The Group previously disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $54,355 to the Plan in 2004. As of September 30, 2004, $35,580 of contributions had been made. The Group presently anticipates contributing an additional $18,775 to fund the Plan in 2004 for a total of $54,355.

-25-

NOTE 15 – GEOGRAPHICAL SEGMENTS

The Group is principally engaged in the business of child educational teaching materials and related services focusing on English language in Taiwan and the PRC. Accordingly, the Group has two reportable geographic segments: Taiwan and the PRC. The Group evaluates the performance of each geographic segment based on its net income or loss. The Group also accounts for inter-segment sales as if the sales were made to third parties. Information concerning the operations in these geographical segments is as follows:

[Continued from above table, first column(s) repeated]