Friday, September 15, 2006 10:07:27 AM
Form 10-K for HARTCOURT COMPANIES INC
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15-Sep-2006
Annual Report
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Management discussion and analysis contains comparisons of the results of our operations for the twelve months ended May 31, 2006 and the twelve months ended May 31, 2005 (unaudited). The results for the 12 months ended May 31, 2005, include audited figures for the transitional five month period ended May 31, 2005, and the seven months ended December 31, 2004, which are not audited. The Company believes that the use of results of the 12 months ended May 31, 2005 in comparing against the results of operations for the twelve months ended May 31, 2006 represents a more meaningful analysis and better information for our investors than a comparison of the twelve months ended May 31, 2006 against the five months ended May 31, 2005.
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THE HARTCOURT COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal year Transition Fiscal year
ended period ended ended
May 31 May 31 May 31
(12 months) (five months) (12 months)
2005
2006 2005 (Unaudited)
Net sales $ 42,089,683 $ 19,677,794 $ 65,081,226
Cost of sales 40,598,971 18,440,692 63,737,326
Gross profit 1,490,712 1,237,102 1,343,900
Operating expenses:
Selling, general and administrative 1,384,950 862,216 1,531,645
Depreciation and amortization 48,157 29,764 64,754
Impairment on notes receivable 4,083,876
Total operating expenses 1,433,107 891,980 5,680,275
Income/(loss) from continuing operations
before other income/(expenses) 57,605 345,122 (4,336,375 )
Other income/(expense):
Interest expense (250,048 ) (199,566 ) (557,494 )
Interest income 140,232 46,756 195,863
Gain on disposal of fixed assets 312,401 - 97,888
Provision for investments - - (223,816 )
Other 71,039 94,476 82,351
Total other income/(expense) 273,624 (58,334 ) (405,208 )
Income from continuing operations before
minority interest and discontinued operations 331,229 286,788 (4,741,583 )
Less: Minority Interest (432,701 ) (138,453 ) 166,661
Loss before discontinued operations (101,472 ) 148,335 (4,908,244 )
Discontinued operations:
Loss from discontinued operations (596,353 ) - (186,038 )
Provision for assets pending for sales (1,827,990 ) - (5,914,848 )
Gain on disposal of discontinued operations - 53,125 (2,575,734 )
Gain/(loss) from discontinued operations (2,424,343 ) 53,125 (8,676,620 )
Income/(loss) before income tax (2,525,815 ) 201,460 (13,584,864 )
Income tax (309,145 ) (78,378 ) (211,287 )
NET INCOME/(LOSS) $ (2,834,960 ) $ 123,082 $ (13,796,151 )
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The following discussion contains forward-looking statements. . Forward looking statements are identified by words and phrases such as "anticipate", "intend", "expect" and words and phrases of similar import. We caution investors that forward-looking statements are only predictions based on our current expectations about future events and are not guarantees of future performance. Our actual results, performance or achievements could differ materially from those expressed or implied by the forward-looking statements due to risks, uncertainties and assumptions that are difficult to predict, including those set forth in Item 1A above. We encourage you to read those risk factors carefully along with the other information provided in this Report and in our other filings with the SEC before deciding to invest in our stock or to maintain or change your investment. We undertake no obligation to revise or update any forward-looking statement for any reason, except as required by law. You should read this MD&A in conjunction with the Consolidated Financial Statements and Related Notes in Item 8.
Critical Accounting Policies
In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our net revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Senior management has discussed the development and selection of these critical accounting policies and their disclosure in this Report with the Audit Committee of our Board of Directors. We believe the following critical accounting policies involve the most complex, difficult and subjective estimates and judgments: revenue recognition; allowance for doubtful accounts; income taxes; stock-based compensation; asset impairment.
Revenue Recognition
In accordance with generally accepted accounting principles ("GAAP") in the United States, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collection of the resulting receivable is reasonably assured. Noted below are brief descriptions of the product or service revenues that the Company recognizes in the financial statements contained herein.
Revenue from the trading of commodities is recognized as the cash is received. Such revenues are cash basis only, and are not accrued.
Revenue from service contracts associated with the investment portfolio is recognized as the cash is received. Such revenues carry significant credit risk, and accrued only when collection is reasonably assured. Payments received in advance are deferred until the service is provided.
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Amounts collected prior to satisfying the above revenue recognition criteria are included in advance from customers.
Allowance for doubtful accounts
We maintain an allowance for doubtful accounts to reduce amounts to their estimated realizable value. A considerable amount of judgment is required when we assess the realization of accounts receivables, including assessing the probability of collection and the current credit-worthiness of each customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an additional provision for doubtful accounts could be required. We initially record a provision for doubtful accounts based on our historical experience, and then adjust this provision at the end of each reporting period based on a detailed assessment of our accounts receivable and allowance for doubtful accounts. In estimating the provision for doubtful accounts, we consider: (i) the aging of the accounts receivable; (ii) trends within and ratios involving the age of the accounts receivable; (iii) the customer mix in each of the aging categories and the nature of the receivable; (iv) our historical provision for doubtful accounts;
(v) the credit worthiness of the customer; and (vi) the economic conditions of the customer's industry as well as general economic conditions, among other factors.
Income taxes
We account for income taxes in accordance with SFAS No. 109, ACCOUNTING FOR INCOME TAXES. SFAS 109 prescribes the use of the liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we establish a valuation allowance. To the extent we establish a valuation allowance, or increase or decrease this allowance in a period, we increase or decrease our income tax provision in our statement of operations. If any of our estimates of our prior period taxable income or loss prove to be incorrect, material differences could impact the amount and timing of income tax benefits or payments for any period.
The Company operates in several countries. As a result, we are subject to numerous domestic and foreign tax jurisdictions and tax agreements and treaties among the various taxing authorities. Our operations in these jurisdictions are taxed on various bases: income before taxes, deemed profits and withholding taxes based on revenue. The calculation of our tax liabilities involves consideration of uncertainties in the application and interpretation of complex tax regulations in a multitude of jurisdictions across our global operations.
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We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. The tax liabilities are reflected net of realized tax loss carry forwards. We adjust these reserves upon specific events; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is different from our current estimate of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional charge to expense would result. If payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when the contingency has been resolved and the liabilities are no longer necessary.
Changes in tax laws, regulations, agreements and treaties, foreign currency exchange restrictions or our level of operations or profitability in each taxing jurisdiction could have an impact upon the amount of income taxes that we provide during any given year.
Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148 - ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND Disclosure. This statement amends SFAS No. 123 - ACCOUNTING FOR STOCK-BASED COMPENSATION, providing alternative methods of voluntarily transitioning to the fair market value based method of accounting for stock based employee compensation. FAS 148 also require disclosure of the method used to account for stock-based employee compensation and the effect of the method in both the annual and interim financial statements. The provisions of this statement related to transition methods are effective for fiscal years ending after December 15, 2002, while provisions related to disclosure requirements are effective in financial reports for interim periods beginning after December 31, 2002.
For stock options, we elected to continue to account for stock-based compensation plans using the intrinsic value-based method of accounting prescribed by APB No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Under the provisions of APB No. 25, compensation expense is measured at the grant date for the difference between the fair value of the stock and the exercise price.
For other items paid for by common stock, the value of the transaction is determined by the value of the goods or services received, measured at the time of the transaction. The corresponding stock value, used to determine the number of share to be issued, is the value of the average price for the 20 to 30 days prior to the transaction date.
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Asset Impairment
We periodically evaluate the carrying value of other long-lived assets, including, but not limited to, property and equipment and intangible assets, when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flows from such asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Significant estimates are utilized to calculate expected future cash flows utilized in impairment analyses. We also utilize judgment to determine other factors within fair value analyses, including the applicable discount rate.
Results of Operations
Our operations for the fiscal years ended May 31, 2006 consisted of operations of Huaqing (51% indirect ownership interest), Hartcourt Capital Inc. (100% ownership interest), Hartcourt China, Inc. (100% ownership interest), and Ai-Asia Inc. (100% ownership interest), and Hartcourt's investments in other entities located in Hong Kong and China. Our operations for the fiscal years ended May 31, 2005 consisted of operations of Huaqing (51% indirect ownership interest), Control Tech (90% indirect ownership interest), Hartcourt Capital Inc. (100% ownership interest), Hartcourt China, Inc. (100% ownership interest), and Ai-Asia Inc. (100% ownership interest), and Hartcourt's investments in other entities located in Hong Kong and China. While our operations for the five months transition period ended May 31, 2005 and for the fiscal year ended May 31, 2005 consisted of operations of Huaqing (51% indirect ownership interest), Control Tech (Consolidated from March 2005, 90% direct ownership interest), Hartcourt Capital Inc. (100% ownership interest), Hartcourt China, Inc. (100% ownership interest), and Ai-Asia Inc. (100% ownership interest), and Hartcourt's investments in other entities located in Hong Kong and China.
The following discussion and analysis are based on the historical figures and information and reflect only our IT business. As noted above, the Company plans to add to its traditional IT business by entering the growing Chinese vocational training marketplace. The business transformation from relying solely on the IT industry to include the education industry likely will materially change the Company's business operation, the operating revenue, selling, general and administrative expenses, the cash flows and other financial information in the future. As a result, any predictions of the future financial trends based on the discussion and analysis below are risky and the readers of this report shall caution about this factor.
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Operating revenue:
We recorded operating revenue of US$42.1 million for the fiscal year ended May 31, 2006, compared to US$65.1 million for the same period in 2005, or a 35% decrease. The decrease is mainly due to the decline of sales revenue form Huaqing during this fiscal year. Two factors attribute to the decline of sales revenue from Huaqing. One factor is the Company faces more severe completions from its rivals and the other factor is that Huaqing focused on the more lucrative high-end products with higher margin. Our operating revenue for the five months transition period ended on May 31, 2005 was US$19.7 million. The sales revenue for the five months transition period and the fiscal year ended May 31, 2005 included US$ 1.2 million form Control Tech. Our sales during the fiscal years ended May 31 mainly represented revenues derived from sale of Samsung monitors and notebooks in Shanghai and sales of multimedia products in China. In the forthcoming fiscal year, the Company will try to focus more on those high margin products rather than add those thin margin products.
Our cost of sales amounted to US$40.6 million for the fiscal years ended May 31, 2006, compared to US$63.7 million for the same period in 2005 and US$18.4 million for the five months transition period ended May 31, 2005, excluding the discontinued operations. The decline of cost of sales is in line with the decline of sales revenue. The cost of sales for the five months transition period and the fiscal year ended May 31, 2005 included US$ 0.7 million from Control Tech.
Gross profit was US$1.5 million, or 3.5%, for the fiscal year ended May 31, 2006 compared to US$1.3 million, or 2.1%, for the same period in 2005, an increase of 11%, and the gross profit for the five months transition period ended May 31, 2005 was US$1.2 million. The gross profit for the five months transition period and the fiscal year ended May 31, 2005 included US$ 0.5 million from Control Tech. The increase of the gross margin is mainly contributed to the higher margin operation results of Huaqing, which is focused more on high-margin product, such as note books.
Selling, general and administrative expenses:
Our selling, general and administrative expenses were US$1,385 thousand for the fiscal year ended May 31, 2006 compared to US$1,532 thousand for the same periods in 2005, a decrease of US$147 thousand, or 10%. The expenses for five months transition period ended May 31, 2005 was US$ 862 thousand. The gross profit for the five months transition period and the fiscal year ended May 31, 2005included US$ 229 thousand from Control Tech. The selling, general and administrative expenses were slightly changed excluding the effects of Control Tech.
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Depreciation and amortization expenses:
Our depreciation and amortization expenses were US$48 thousand for the fiscal year ended May 31, 2006 compared to US$65 thousand for the same periods in 2005, a 26% decrease. The decrease was primarily due to our exclusion of the depreciation charges from Control Tech's business in this consolidated financial statement and the disposal of fixed assets during the fiscal year ended May 31, 2006. The depreciation and amortization expenses for five months transition period ended May 31, 2005 were US$ 30 thousand.
Interest income:
Interest income was US$140 thousand and US$196 thousand for the fiscal year ended May 31, 2006 and 2005. The US$56 thousand decrease was mainly due to lower cash balances. Interest income for five months transition period ended May 31, 2005 was US$ 47 thousand.
Interest expenses:
Interest expenses were US$250 thousand and US$557 thousand for the fiscal years ended May 31, 2006 and 2005. All the interest expenses were incurred by Huaqing, a 51% owned subsidiary, from short-term bank loans to finance the Samsung distribution business. The decrease of interest expenses was due to the decrease of short-term loan credit and note payable in the fiscal year 2006. Interest expenses for five months transition period ended May 31, 2005 were US$ 200 thousand.
Income( Loss) from Continuing Operations:
Income from continuing operations for the fiscal year ended May 31, 2006 was US$331 thousand, compared to a loss of US$4,742 thousand for the same period a year ago. The sharp decrease of the loss is mainly due to 4 million provisions on note receivable during the fiscal year ended 31 May 2005. Income from continuing operations for five months transition period ended May 31, 2005 were US$ 287 thousand.
Discontinued operations:
During the fiscal year ended May 31, 2006, the discontinued operations represent the provision and operation results of Control Tech, which was determined by the management to be disposed. During the fiscal year ended May 31, 2005, the discontinued operations represent the provision, disposal gain or loss and operation results of Guangzhou NewHuaSun Computer Co., Ltd, Shanghai GuoWei Since and Technology Co., Ltd, Wenzhou ZhongNan Group, Beijing Challenger Group and Hangzhou Huaqing Monitoring Technology Co., Ltd.
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Minority interest:
Minority interest represented the profit shared by the minority shareholders of Huaqing (49%) during the fiscal year ended May 31, 2006, while minority interest during same period ended May 31, 2005 comprised of the profit shared by the minority shareholders of Huaqing (49%) and Control Tech (10%). The minority interest for the fiscal years ended May 31, 2006 and 2005 and the five months transition period ended May 31, 2005 were US$433 thousand of loss, US$167 thousand of profit and US$138 thousand of loss, respectively.
Income tax:
Overall, our subsidiaries and affiliates are continuing to pay taxes in China that are on average lower than the statutory rate of 33%. Certain of our subsidiaries and affiliates were granted special tax treatment by the local Chinese provincial tax authorities and are exempt from income tax.
Chinese local tax authorities had not yet conducted annual tax audits of our subsidiaries and affiliates in China for the 2005 tax year. Management believes that there are no outstanding tax issues or liabilities at the time of this transition period report. All tax liabilities, if any, prior to the acquisition by us of our various Chinese subsidiaries or affiliates are solely the responsibility of the selling shareholders, as stipulated in each acquisition agreement.
We made provision for PRC income taxes of US$309 thousand and US$211 thousand for the fiscal year ended May 31, 2006 and 2005, respectively. We made provision for PRC income taxes of US$78 thousand for the five months transition period ended May 31, 2005. This provision for taxes relates to the estimated amount of taxes that would be imposed by tax authorities in the PRC. None of our income is subject to taxation by any U.S. governmental authority.
Liquidity and Capital Resources:
As shown in our accompanying financial statements, we had a net loss of US$2.8 million for the fiscal year ended May 31, 2006 as compared to a net loss of US$13.8 million for the same periods in 2005. Loss from discontinued operations for the fiscal years ended May 31, 2006 and May 31, 2005 are US$2.4 million and US$8.7 million respectively. Our current assets exceeded our current liabilities by US$1.5 million as of May 31, 2006.
As disclosed in Item 1 Business of this 10K, the Company has decided to add to its existing IT business by expanding into the growing Chinese vocational training marketplace. This addition likely will have enormous demand on our capital resources in the near future.
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In addition to our working capital on hand, we intend to obtain required capital through a combination of bank loans, staff loans and the sale of our equity securities. However, there are no commitments or agreements on the part of anyone at this time to provide us with additional bank financing or purchase of securities.
If we are unable to raise the necessary additional working capital, our operations and financial condition may be adversely affected.
Operating activities:
During the fiscal year ended May 31, 2006, net cash used in operating activities was US$1.6 million, compared to net cash used by operating activities of US$10 million during the same period in 2005. The decrease in cash used from operating activities resulted mainly from net loss of $2.8 million, decrease of restricted cash $1.6 million, increase of accounts receivable of $0.4 million, increase of prepayment of $0.5 million, and decrease of advance from customers of $3.3 million, by netting off loss on discontinued operations of 0.6 million, provision on assets pending for sale of $1.8 million and decrease of advance to suppliers of $0.9 million. The net cash used in the operating activities was US$1.3 million during the five months transition period ended May 31, 2005.
Investing activities:
Net cash provided by investing activities during the fiscal year ended May 31, 2006, was US$0.9 million compared to net cash used in investing activities US$0.2 million for the same period in 2005. The cash provided by investment activities in the fiscal year ended May 31, 2006 was due to proceeds from disposal of property and equipment of $ 0.5 million and proceeds from notes receivable of $0.4 million. While the cash used in the fiscal year ended May 31 2005 is mainly resulted from the disposal of subsidiary of $3.5 million, by netting off (a) cash increased from acquiring new subsidiary of $2.0 million,
(b) cash proceeds on assets pending for sale of $1 million, and (c) cash proceeds on disposal of property of $0.3 million. The net cash provided in the investing activities was US$0.8 million during the five months transition period ended May 31, 2005.
Financing activities:
Net cash used by financing activities during the fiscal year ended May 31, 2006 equaled to US$0.4 million compared to cash provided by financing activities of US$8.1 million during the same period in 2005. Net cash used by financing activities during the fiscal year ended May 31, 2006 was primarily due to payments on notes payable of $1.6 million, netting of the net payment got from related party of $1 million and proceeds on loans or credit of $0.2 million. Net cash provided in year 2005 by financing activities was mostly due to the net effect of (a) payment of SEC judgment in the amount of US$1.1 million.(b) bank loans of US$5.5 million borrowed by Huaqing from local bank and (3) funds raised from private offering in the amount of US$2.4 million. The net cash provided in the financing activities was US$46 thousand during the five months transition period ended May 31, 2005.
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Research and Development
Presently the company is not undertaking any significant Research and Development efforts.
Off-Balance Sheet Arrangements
During the fiscal year ended on May 31, 2006, the Company did not engage in any off-balance sheet arrangements
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15-Sep-2006
Annual Report
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Management discussion and analysis contains comparisons of the results of our operations for the twelve months ended May 31, 2006 and the twelve months ended May 31, 2005 (unaudited). The results for the 12 months ended May 31, 2005, include audited figures for the transitional five month period ended May 31, 2005, and the seven months ended December 31, 2004, which are not audited. The Company believes that the use of results of the 12 months ended May 31, 2005 in comparing against the results of operations for the twelve months ended May 31, 2006 represents a more meaningful analysis and better information for our investors than a comparison of the twelve months ended May 31, 2006 against the five months ended May 31, 2005.
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THE HARTCOURT COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal year Transition Fiscal year
ended period ended ended
May 31 May 31 May 31
(12 months) (five months) (12 months)
2005
2006 2005 (Unaudited)
Net sales $ 42,089,683 $ 19,677,794 $ 65,081,226
Cost of sales 40,598,971 18,440,692 63,737,326
Gross profit 1,490,712 1,237,102 1,343,900
Operating expenses:
Selling, general and administrative 1,384,950 862,216 1,531,645
Depreciation and amortization 48,157 29,764 64,754
Impairment on notes receivable 4,083,876
Total operating expenses 1,433,107 891,980 5,680,275
Income/(loss) from continuing operations
before other income/(expenses) 57,605 345,122 (4,336,375 )
Other income/(expense):
Interest expense (250,048 ) (199,566 ) (557,494 )
Interest income 140,232 46,756 195,863
Gain on disposal of fixed assets 312,401 - 97,888
Provision for investments - - (223,816 )
Other 71,039 94,476 82,351
Total other income/(expense) 273,624 (58,334 ) (405,208 )
Income from continuing operations before
minority interest and discontinued operations 331,229 286,788 (4,741,583 )
Less: Minority Interest (432,701 ) (138,453 ) 166,661
Loss before discontinued operations (101,472 ) 148,335 (4,908,244 )
Discontinued operations:
Loss from discontinued operations (596,353 ) - (186,038 )
Provision for assets pending for sales (1,827,990 ) - (5,914,848 )
Gain on disposal of discontinued operations - 53,125 (2,575,734 )
Gain/(loss) from discontinued operations (2,424,343 ) 53,125 (8,676,620 )
Income/(loss) before income tax (2,525,815 ) 201,460 (13,584,864 )
Income tax (309,145 ) (78,378 ) (211,287 )
NET INCOME/(LOSS) $ (2,834,960 ) $ 123,082 $ (13,796,151 )
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The following discussion contains forward-looking statements. . Forward looking statements are identified by words and phrases such as "anticipate", "intend", "expect" and words and phrases of similar import. We caution investors that forward-looking statements are only predictions based on our current expectations about future events and are not guarantees of future performance. Our actual results, performance or achievements could differ materially from those expressed or implied by the forward-looking statements due to risks, uncertainties and assumptions that are difficult to predict, including those set forth in Item 1A above. We encourage you to read those risk factors carefully along with the other information provided in this Report and in our other filings with the SEC before deciding to invest in our stock or to maintain or change your investment. We undertake no obligation to revise or update any forward-looking statement for any reason, except as required by law. You should read this MD&A in conjunction with the Consolidated Financial Statements and Related Notes in Item 8.
Critical Accounting Policies
In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our net revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Senior management has discussed the development and selection of these critical accounting policies and their disclosure in this Report with the Audit Committee of our Board of Directors. We believe the following critical accounting policies involve the most complex, difficult and subjective estimates and judgments: revenue recognition; allowance for doubtful accounts; income taxes; stock-based compensation; asset impairment.
Revenue Recognition
In accordance with generally accepted accounting principles ("GAAP") in the United States, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collection of the resulting receivable is reasonably assured. Noted below are brief descriptions of the product or service revenues that the Company recognizes in the financial statements contained herein.
Revenue from the trading of commodities is recognized as the cash is received. Such revenues are cash basis only, and are not accrued.
Revenue from service contracts associated with the investment portfolio is recognized as the cash is received. Such revenues carry significant credit risk, and accrued only when collection is reasonably assured. Payments received in advance are deferred until the service is provided.
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Amounts collected prior to satisfying the above revenue recognition criteria are included in advance from customers.
Allowance for doubtful accounts
We maintain an allowance for doubtful accounts to reduce amounts to their estimated realizable value. A considerable amount of judgment is required when we assess the realization of accounts receivables, including assessing the probability of collection and the current credit-worthiness of each customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an additional provision for doubtful accounts could be required. We initially record a provision for doubtful accounts based on our historical experience, and then adjust this provision at the end of each reporting period based on a detailed assessment of our accounts receivable and allowance for doubtful accounts. In estimating the provision for doubtful accounts, we consider: (i) the aging of the accounts receivable; (ii) trends within and ratios involving the age of the accounts receivable; (iii) the customer mix in each of the aging categories and the nature of the receivable; (iv) our historical provision for doubtful accounts;
(v) the credit worthiness of the customer; and (vi) the economic conditions of the customer's industry as well as general economic conditions, among other factors.
Income taxes
We account for income taxes in accordance with SFAS No. 109, ACCOUNTING FOR INCOME TAXES. SFAS 109 prescribes the use of the liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we establish a valuation allowance. To the extent we establish a valuation allowance, or increase or decrease this allowance in a period, we increase or decrease our income tax provision in our statement of operations. If any of our estimates of our prior period taxable income or loss prove to be incorrect, material differences could impact the amount and timing of income tax benefits or payments for any period.
The Company operates in several countries. As a result, we are subject to numerous domestic and foreign tax jurisdictions and tax agreements and treaties among the various taxing authorities. Our operations in these jurisdictions are taxed on various bases: income before taxes, deemed profits and withholding taxes based on revenue. The calculation of our tax liabilities involves consideration of uncertainties in the application and interpretation of complex tax regulations in a multitude of jurisdictions across our global operations.
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We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. The tax liabilities are reflected net of realized tax loss carry forwards. We adjust these reserves upon specific events; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is different from our current estimate of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional charge to expense would result. If payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when the contingency has been resolved and the liabilities are no longer necessary.
Changes in tax laws, regulations, agreements and treaties, foreign currency exchange restrictions or our level of operations or profitability in each taxing jurisdiction could have an impact upon the amount of income taxes that we provide during any given year.
Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148 - ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND Disclosure. This statement amends SFAS No. 123 - ACCOUNTING FOR STOCK-BASED COMPENSATION, providing alternative methods of voluntarily transitioning to the fair market value based method of accounting for stock based employee compensation. FAS 148 also require disclosure of the method used to account for stock-based employee compensation and the effect of the method in both the annual and interim financial statements. The provisions of this statement related to transition methods are effective for fiscal years ending after December 15, 2002, while provisions related to disclosure requirements are effective in financial reports for interim periods beginning after December 31, 2002.
For stock options, we elected to continue to account for stock-based compensation plans using the intrinsic value-based method of accounting prescribed by APB No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Under the provisions of APB No. 25, compensation expense is measured at the grant date for the difference between the fair value of the stock and the exercise price.
For other items paid for by common stock, the value of the transaction is determined by the value of the goods or services received, measured at the time of the transaction. The corresponding stock value, used to determine the number of share to be issued, is the value of the average price for the 20 to 30 days prior to the transaction date.
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Asset Impairment
We periodically evaluate the carrying value of other long-lived assets, including, but not limited to, property and equipment and intangible assets, when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flows from such asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Significant estimates are utilized to calculate expected future cash flows utilized in impairment analyses. We also utilize judgment to determine other factors within fair value analyses, including the applicable discount rate.
Results of Operations
Our operations for the fiscal years ended May 31, 2006 consisted of operations of Huaqing (51% indirect ownership interest), Hartcourt Capital Inc. (100% ownership interest), Hartcourt China, Inc. (100% ownership interest), and Ai-Asia Inc. (100% ownership interest), and Hartcourt's investments in other entities located in Hong Kong and China. Our operations for the fiscal years ended May 31, 2005 consisted of operations of Huaqing (51% indirect ownership interest), Control Tech (90% indirect ownership interest), Hartcourt Capital Inc. (100% ownership interest), Hartcourt China, Inc. (100% ownership interest), and Ai-Asia Inc. (100% ownership interest), and Hartcourt's investments in other entities located in Hong Kong and China. While our operations for the five months transition period ended May 31, 2005 and for the fiscal year ended May 31, 2005 consisted of operations of Huaqing (51% indirect ownership interest), Control Tech (Consolidated from March 2005, 90% direct ownership interest), Hartcourt Capital Inc. (100% ownership interest), Hartcourt China, Inc. (100% ownership interest), and Ai-Asia Inc. (100% ownership interest), and Hartcourt's investments in other entities located in Hong Kong and China.
The following discussion and analysis are based on the historical figures and information and reflect only our IT business. As noted above, the Company plans to add to its traditional IT business by entering the growing Chinese vocational training marketplace. The business transformation from relying solely on the IT industry to include the education industry likely will materially change the Company's business operation, the operating revenue, selling, general and administrative expenses, the cash flows and other financial information in the future. As a result, any predictions of the future financial trends based on the discussion and analysis below are risky and the readers of this report shall caution about this factor.
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Operating revenue:
We recorded operating revenue of US$42.1 million for the fiscal year ended May 31, 2006, compared to US$65.1 million for the same period in 2005, or a 35% decrease. The decrease is mainly due to the decline of sales revenue form Huaqing during this fiscal year. Two factors attribute to the decline of sales revenue from Huaqing. One factor is the Company faces more severe completions from its rivals and the other factor is that Huaqing focused on the more lucrative high-end products with higher margin. Our operating revenue for the five months transition period ended on May 31, 2005 was US$19.7 million. The sales revenue for the five months transition period and the fiscal year ended May 31, 2005 included US$ 1.2 million form Control Tech. Our sales during the fiscal years ended May 31 mainly represented revenues derived from sale of Samsung monitors and notebooks in Shanghai and sales of multimedia products in China. In the forthcoming fiscal year, the Company will try to focus more on those high margin products rather than add those thin margin products.
Our cost of sales amounted to US$40.6 million for the fiscal years ended May 31, 2006, compared to US$63.7 million for the same period in 2005 and US$18.4 million for the five months transition period ended May 31, 2005, excluding the discontinued operations. The decline of cost of sales is in line with the decline of sales revenue. The cost of sales for the five months transition period and the fiscal year ended May 31, 2005 included US$ 0.7 million from Control Tech.
Gross profit was US$1.5 million, or 3.5%, for the fiscal year ended May 31, 2006 compared to US$1.3 million, or 2.1%, for the same period in 2005, an increase of 11%, and the gross profit for the five months transition period ended May 31, 2005 was US$1.2 million. The gross profit for the five months transition period and the fiscal year ended May 31, 2005 included US$ 0.5 million from Control Tech. The increase of the gross margin is mainly contributed to the higher margin operation results of Huaqing, which is focused more on high-margin product, such as note books.
Selling, general and administrative expenses:
Our selling, general and administrative expenses were US$1,385 thousand for the fiscal year ended May 31, 2006 compared to US$1,532 thousand for the same periods in 2005, a decrease of US$147 thousand, or 10%. The expenses for five months transition period ended May 31, 2005 was US$ 862 thousand. The gross profit for the five months transition period and the fiscal year ended May 31, 2005included US$ 229 thousand from Control Tech. The selling, general and administrative expenses were slightly changed excluding the effects of Control Tech.
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Depreciation and amortization expenses:
Our depreciation and amortization expenses were US$48 thousand for the fiscal year ended May 31, 2006 compared to US$65 thousand for the same periods in 2005, a 26% decrease. The decrease was primarily due to our exclusion of the depreciation charges from Control Tech's business in this consolidated financial statement and the disposal of fixed assets during the fiscal year ended May 31, 2006. The depreciation and amortization expenses for five months transition period ended May 31, 2005 were US$ 30 thousand.
Interest income:
Interest income was US$140 thousand and US$196 thousand for the fiscal year ended May 31, 2006 and 2005. The US$56 thousand decrease was mainly due to lower cash balances. Interest income for five months transition period ended May 31, 2005 was US$ 47 thousand.
Interest expenses:
Interest expenses were US$250 thousand and US$557 thousand for the fiscal years ended May 31, 2006 and 2005. All the interest expenses were incurred by Huaqing, a 51% owned subsidiary, from short-term bank loans to finance the Samsung distribution business. The decrease of interest expenses was due to the decrease of short-term loan credit and note payable in the fiscal year 2006. Interest expenses for five months transition period ended May 31, 2005 were US$ 200 thousand.
Income( Loss) from Continuing Operations:
Income from continuing operations for the fiscal year ended May 31, 2006 was US$331 thousand, compared to a loss of US$4,742 thousand for the same period a year ago. The sharp decrease of the loss is mainly due to 4 million provisions on note receivable during the fiscal year ended 31 May 2005. Income from continuing operations for five months transition period ended May 31, 2005 were US$ 287 thousand.
Discontinued operations:
During the fiscal year ended May 31, 2006, the discontinued operations represent the provision and operation results of Control Tech, which was determined by the management to be disposed. During the fiscal year ended May 31, 2005, the discontinued operations represent the provision, disposal gain or loss and operation results of Guangzhou NewHuaSun Computer Co., Ltd, Shanghai GuoWei Since and Technology Co., Ltd, Wenzhou ZhongNan Group, Beijing Challenger Group and Hangzhou Huaqing Monitoring Technology Co., Ltd.
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Minority interest:
Minority interest represented the profit shared by the minority shareholders of Huaqing (49%) during the fiscal year ended May 31, 2006, while minority interest during same period ended May 31, 2005 comprised of the profit shared by the minority shareholders of Huaqing (49%) and Control Tech (10%). The minority interest for the fiscal years ended May 31, 2006 and 2005 and the five months transition period ended May 31, 2005 were US$433 thousand of loss, US$167 thousand of profit and US$138 thousand of loss, respectively.
Income tax:
Overall, our subsidiaries and affiliates are continuing to pay taxes in China that are on average lower than the statutory rate of 33%. Certain of our subsidiaries and affiliates were granted special tax treatment by the local Chinese provincial tax authorities and are exempt from income tax.
Chinese local tax authorities had not yet conducted annual tax audits of our subsidiaries and affiliates in China for the 2005 tax year. Management believes that there are no outstanding tax issues or liabilities at the time of this transition period report. All tax liabilities, if any, prior to the acquisition by us of our various Chinese subsidiaries or affiliates are solely the responsibility of the selling shareholders, as stipulated in each acquisition agreement.
We made provision for PRC income taxes of US$309 thousand and US$211 thousand for the fiscal year ended May 31, 2006 and 2005, respectively. We made provision for PRC income taxes of US$78 thousand for the five months transition period ended May 31, 2005. This provision for taxes relates to the estimated amount of taxes that would be imposed by tax authorities in the PRC. None of our income is subject to taxation by any U.S. governmental authority.
Liquidity and Capital Resources:
As shown in our accompanying financial statements, we had a net loss of US$2.8 million for the fiscal year ended May 31, 2006 as compared to a net loss of US$13.8 million for the same periods in 2005. Loss from discontinued operations for the fiscal years ended May 31, 2006 and May 31, 2005 are US$2.4 million and US$8.7 million respectively. Our current assets exceeded our current liabilities by US$1.5 million as of May 31, 2006.
As disclosed in Item 1 Business of this 10K, the Company has decided to add to its existing IT business by expanding into the growing Chinese vocational training marketplace. This addition likely will have enormous demand on our capital resources in the near future.
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In addition to our working capital on hand, we intend to obtain required capital through a combination of bank loans, staff loans and the sale of our equity securities. However, there are no commitments or agreements on the part of anyone at this time to provide us with additional bank financing or purchase of securities.
If we are unable to raise the necessary additional working capital, our operations and financial condition may be adversely affected.
Operating activities:
During the fiscal year ended May 31, 2006, net cash used in operating activities was US$1.6 million, compared to net cash used by operating activities of US$10 million during the same period in 2005. The decrease in cash used from operating activities resulted mainly from net loss of $2.8 million, decrease of restricted cash $1.6 million, increase of accounts receivable of $0.4 million, increase of prepayment of $0.5 million, and decrease of advance from customers of $3.3 million, by netting off loss on discontinued operations of 0.6 million, provision on assets pending for sale of $1.8 million and decrease of advance to suppliers of $0.9 million. The net cash used in the operating activities was US$1.3 million during the five months transition period ended May 31, 2005.
Investing activities:
Net cash provided by investing activities during the fiscal year ended May 31, 2006, was US$0.9 million compared to net cash used in investing activities US$0.2 million for the same period in 2005. The cash provided by investment activities in the fiscal year ended May 31, 2006 was due to proceeds from disposal of property and equipment of $ 0.5 million and proceeds from notes receivable of $0.4 million. While the cash used in the fiscal year ended May 31 2005 is mainly resulted from the disposal of subsidiary of $3.5 million, by netting off (a) cash increased from acquiring new subsidiary of $2.0 million,
(b) cash proceeds on assets pending for sale of $1 million, and (c) cash proceeds on disposal of property of $0.3 million. The net cash provided in the investing activities was US$0.8 million during the five months transition period ended May 31, 2005.
Financing activities:
Net cash used by financing activities during the fiscal year ended May 31, 2006 equaled to US$0.4 million compared to cash provided by financing activities of US$8.1 million during the same period in 2005. Net cash used by financing activities during the fiscal year ended May 31, 2006 was primarily due to payments on notes payable of $1.6 million, netting of the net payment got from related party of $1 million and proceeds on loans or credit of $0.2 million. Net cash provided in year 2005 by financing activities was mostly due to the net effect of (a) payment of SEC judgment in the amount of US$1.1 million.(b) bank loans of US$5.5 million borrowed by Huaqing from local bank and (3) funds raised from private offering in the amount of US$2.4 million. The net cash provided in the financing activities was US$46 thousand during the five months transition period ended May 31, 2005.
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Research and Development
Presently the company is not undertaking any significant Research and Development efforts.
Off-Balance Sheet Arrangements
During the fiscal year ended on May 31, 2006, the Company did not engage in any off-balance sheet arrangements
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