Form 10-Q/A for HARTCOURT COMPANIES INC
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13-Nov-2006
Quarterly Report
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-looking Statements
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words "believes," "anticipates," "plans," "expects," "intends" and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in "Risk Factors Affecting Future Results" and "Liquidity and Capital Resources" below. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements. The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the accompanying notes contained in this quarterly report. Unless expressly stated or the context otherwise requires, the terms "we," "our," "us" and "Hartcourt" refer to The Hartcourt Companies, Inc. and its subsidiaries
Overview
We are a distributor of internationally well known brand named IT hardware products and related software and services. The main products are Samsung branded notebooks and monitors. Almost all of our revenue for the last two fiscal years and since the transition period ended May 31, 2005 was attributed to distribution revenues from sales of Samsung products in China. Our Samsung distribution business began in March 2003, through the acquisition of a Chinese company named Huaqin Shanghai, who was the distributor of Samsung monitors in the Eastern part of China. In August 2004, Huaqin Shanghai obtained additional distribution rights from Samsung for its notebook product line in the same geographic area. In February 2005, we acquired major assets from a Chinese company named Beijing Control Tech, who was the distributor of ClearOne audio products and Radvision video conference products and services in China. Control Tech's agreement with Radvision terminated on April 1, 2005. We have ceased distribution of Radvision Products during the first quarter of 2006, pending settlement discussions with Radvision to resolve the distributorship dispute.
Most international and domestic manufacturers of IT products in China rely on distributors, such as Hartcourt, to augment their sales and marketing operations. As a stocking, marketing, and financial intermediary, the distributor relieves manufacturers a portion of the costs and personnel associated with stocking and selling their products (including otherwise sizable investments in finished goods inventories, accounts receivables and distribution networks), while providing geographically dispersed selling, order processing, and delivery capabilities. At the same time, the distributor offers a broad range of customers the convenience of accessing from a single source with multiple products and rapid or scheduled deliveries, as well as other value-added services such as after sales service. The growth of the IT distribution industry in China has been fostered by many manufacturers who recognize that distributors are essential extensions of their marketing organizations. Most of our customers require delivery of the products they have ordered on schedules that are generally not available on direct purchases from manufacturers, and frequently their orders are of insufficient size to be placed directly with manufacturers.
Our sales organization is divided into two product lines, the monitor group and the notebook group. Zhou Jing Jing, our Vice President of Operations, who joined Hartcourt during the first quarter of fiscal 2006, is responsible for our sales organization. We have a centralized online Enterprise Resources Planning (ERP) system to support the daily operations, connecting order taking, inventory management, distribution, credit, accounting and other related functions.
We have authorized distribution rights with respect to Samsung monitors, notebooks and certain digital products covering the consumer and commercial product distribution channels in Shanghai, a metropolitan city with a population of 20 million people. The authorized distribution agreement signed between Huaqing Shanghai, a 51% owned subsidiary, and Samsung has a one-year term and is renewed on an annual basis. In exchange for this authorized distribution right, as well as purchase price protection and reimbursed advertising and promotion expenses from Samsung, we are required to achieve quarterly purchase targets set by Samsung and perform sales promotion and advertising activities under Samsung's direction, in addition to meeting other Samsung operational requirements. Almost all of our sales for the quarter ended February 28, 2006 were comprised of Samsung products, of which, monitors accounted for 81% of the revenue and notebooks accounted for 16% of revenue. Approximately 74% of our revenue derived from Sansung monitor sales and 26% from Samsung notebooks in fiscal 2005.
Excluding the Zhejiang Samsung market which we no longer service as of June 1, 2005, our Samsung sales in Shanghai decreased 4.7% compared to a year ago same period.
The markets in which we compete are dynamic and highly competitive. We expect competition to intensify in the future. Our current and potential competitors include the local distributors of Philip and LG monitors in the Shanghai region, as well as other distributors of notebooks made by multinational and leading Chinese notebook manufacturers.
The principal competitive factors that affect the market for our business are available working capital to finance the revenue growth in terms of inventory and trade receivable; the ability to contain operating costs, as well as adding new product lines to our distribution list.
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Although Huaqin Shanghai has been the exclusive distributor for select Samsung IT products in the Shanghai region for the last 5 years, much of the services we provide can be performed by our competitors. In addition, there is a risk that Samsung may allow our competitors or new entrants to the market to take a portion of our Samsung distributor business which would have an adverse impact on our business and revenues.
We sell Samsung monitors, notebooks and digital devices to large regional retail stores and to second tier distributors who then resell to smaller retail stores. To promote Samsung's upscale product image, we also manage several Samsung image stores in Shanghai, selling a full range of Samsung consumer electronic products in Shanghai's downtown shopping districts in partnership with Samsung. For the Samsung products for which we have authorized distribution rights, we provide product warranty services to retail consumers on behalf of Samsung. In addition, we provide and charge for after-sales repair, maintenance and service. Our top customers for the quarter ended February 28, 2006 were Aiwei, a second-tier distributor, which accounted for approximately 11.7% of our revenue; Guowei, a major retailer and a distributor in Shanghai, which accounted for approximately 10.7% of our revenue; and Huahai, a distributor which accounted for approximately 6.0% of our revenue. During the quarter ended February 28, 2006 no other customer or distributor made up more than approximately 5% of our total sales. In fiscal 2005, Hangzhou Huaqin, a distributor in Zhejiang province, accounted for 13.5% of our revenue, Chenqin, a Shanghai distributor, accounted for approximately 7.1% of our revenue; and Wenzhou Huaqin, a distribution in Zhejiang province, accounted for 5.6% of our revenue. No other customers or distributors accounted for more than approximately 5% of our revenue for the quarter ended February 28, 2005.
We source our products from Samsung. As of February 28, 2006, approximately 74% of our Samsung inventory consisted of monitors and approximately 12% consisted of notebooks. It is the current practice of Samsung to protect its distributors, such as the Company, against the potential write-down of such inventories due to technological changes or Samsung's price reductions. Under the terms of the distributor agreement, and assuming the distributor complies with certain conditions, Samsung is required to credit us for inventory losses incurred through reductions in manufacturers' list prices of the items. Because most of our business is on an as-needed basis and varies slightly, we have no customer orders extending more than a week into the future.
We added audio/video equipment distribution business in March 2005, after acquiring major assets from Control Tech, a Chinese distribution company. Our distribution agreement with Radvision was terminated on April 1, 2005. Sales of Radvision products ceased during the first quarter of 2006. Control Tech is trying to amicably resolve the disputes with Radvision. Considering the market price drop, we made a provision on the Control Tech's inventory in the amount of $496,216 in this quarter. As Control Tech did not generate any revenue in this quarter, we made a full impairment for the goodwill arisen from acquiring of Control Tech of $1,079,009 as of February 28, 2006.
Results of Operations
The following table sets forth the consolidated statements of operations and the
percentage change for the three months and nine months ended February 28, 2006,
with the comparable reporting period in the preceding year.
Three Months Ended Nine Months Ended
February 28, Percentage February 28, Percentage
2006 Change February 28, 2005 2006 Change February 28, 2005
Net revenue $ 9,427,749 -28.05 % $ 13,103,965 $ 32,133,061 -38.09 % $ 51,903,530
Cost of revenue 9,194,641 -24.14 12,120,909 30,696,442 -38.08 49,573,787
Gross profit 233,108 -76.29 983,056 1,436,619 -38.34 2,329,743
Operating expenses
Sales and marketing 123,623 -66.93 373,848 194,983 -77.49 866,029
General and administrative 1,703,929 -66.91 5,148,620 2,448,541 -58.89 5,956,249
Total operating expenses 1,827,552 -66.91 5,522,468 2,643,524 -61.25 6,822,278
Interest income/(expenses)-net (54,550 ) -33.90 (82,521 ) (71,320 ) 55.81 (45,773 )
Other income/(expenses)-net 142,897 -128.48 (501,771 ) 650,555 -623.95 (124,164 )
Minority Interest expense 5,852 -97.95 285,215 (522,072 ) 211.50 (167,601 )
Discontinued operations
expenses, net - -100.00 (7,588,920 ) (6,028 ) -99.94 (10,419,538 )
Income before income taxes (1,500,245 ) -87.93 (12,427,409 ) (1,155,770 ) -92.42 (15,249,611 )
Provision for income taxes 209 - - 208,460 - 15,978
Net loss $ (1,500,454 ) -87.93 % $ (12,427,409 ) $ (1,364,230 ) -91.06 % $ (15,265,589 )
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The following table sets forth the condensed consolidated statements of operations, expressed as a percentage of net revenue, for the periods indicated:
Three Months Ended Nine Months Ended
February 28, February 28, February 28, February 28,
2006 2005 2006 2005
Net revenue 100.00 % 100.00 % 100.00 % 100.00 %
Cost of revenue 97.53 92.50 95.53 95.51
Gross margin 2.47 7.50 4.47 4.49
Operating expenses 0.00 0.00 0.00 0.00
Sales and marketing 1.31 2.85 0.61 1.67
General and administrative 18.07 39.29 7.62 11.48
Total operating expenses 19.38 42.14 8.23 13.14
Interest income -0.58 -0.63 -0.22 -0.09
Other income 1.52 -3.83 2.02 -0.24
Provision for income taxes 0.00 -57.91 -0.02 -20.07
Income before income taxes -15.91 -94.84 -3.60 -29.38
Provision for income taxes 0.00 -? 0.65 -?
Net income -15.92 % -94.84 % -4.25 % -29.41 %
Three Months and Nine Months Ended February 28, 2006 Compared to Three Months and Nine Months Ended February 28, 2005.
Net Revenue
We recorded net sales of $9,427,749 for the three months ended February 28, 2006, compared to $13,103,965 for the same period in 2005, excluding the discontinued operations. Lower sales are due to our exit of the Zhejiang province market on the Samsung product as a result of Samsung distribution channel re-arrangement. Excluding the sales in the Zhejiang region in 2005, Samsung product sales in Shanghai decreased by 4.7% for the three months ended February 28, 2006 compared to the prior year period. For the nine moths ended February 28, 2006, we recorded net sales of $32,133,061, compared to $51,903,530 in the prior year period. Excluding the sales to Zhejiang region, revenue decreased 3.8% compared to the prior year period.
Cost of Revenue and Gross Margin
Cost of Goods Sold amounted to $9,194,641 for the three months ended February 28, 2006, compared to $12,120,909 for the comparable period in 2005, excluding discontinued operations. Cost of Goods Sold amounted to $30,696,442 for the nine months ended February 28, 2006, compared to $49,573,787 for the comparable period in 2005, excluding discontinued operations. Almost all of the cost of sales for the three months and nine months ended February 28, 2006 and 2005 represented the cost of Samsung products.
Gross margin was $233,108, or 2.47%, for the three months ended February 28, 2006 compared to $983,056 or 7.50%, for the comparable period in 2005. Gross margin was $1,436,619, or 4.47%, for the nine months ended February 28, 2006 compared to $2,329,743, or 4.49%, for the comparable period in 2005. The decrease in gross margin was due to the consulting service and better product mix for the three months ended February 28, 2005 compared to the comparable period in 2006.
Selling, general and administrative expenses: Our selling, general and administrative expenses were $235,474 for the three months ended February 28, 2006 compared to $1,420,294 for the comparable period in 2005, representing a decrease of $1,184,820, or 83%, due to lower advertising and promotion expenses as well as legal expenses. Selling, general and administrative expenses were $1,012,313 for the nine months period ended February 28, 2006 compared to $2,691,364 for the comparable period in 2005, representing a decrease of $1,679,051 or 63%, due to lower advertising and promotion expenses as well as legal expenses.
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Depreciation and amortization expenses: Our depreciation and amortization expenses were $16,853 for the three months ended February 28, 2006 compared to $18,298 for the comparable period in 2005. The decrease was primarily due to the disposal of property and equipment. Depreciation and amortization expenses were $55,986 for the nine months ended February 28, 2006 compared to $47,038 for the comparable period in 2005. The increase was primarily due to the purchase of property and equipment.
Interest income: Interest income was $2,174 and $76,649, respectively, for the three months ended February 28, 2006 and 2005. The decrease was due to lower fixed deposit in the bank as security of bank loans. Interest income was $75,616 and $164,928, respectively, for the nine months ended February 28, 2006 and 2005. The decrease was due to lower fixed deposit in the bank as security of bank loans.
Interest expenses: Interest expenses were $56,724 and $159,170, respectively, for the three months February 28, 2006 and 2005. The decrease of $102,446, or 64%, was primarily due to the decrease of short-term borrowing. For the nine months ended February 28, 2006 and 2005, interest expenses were $146,936 and $210,701, respectively. The decrease of $63,765 was due to a decrease of short term borrowing.
Income from Continuing Operations: Loss from continuing operations for the three months ended February 28, 2006 was $1,594,444, compared to a loss of $4,539,412 in the prior year period, primarily as the result of lower operating expenses and lower impairment or provision costs. For the nine months period ended February 28, 2006 and 2005, loss from continuing operation was $1,206,905 and $4,492,535 respectively. The decrease was mainly due to lower operating expenses and lower impairment or provision costs in the quarter ended February 28, 2006.
Minority interest: Minority interest represented the profit shared by the minority shareholders of Huaqing (49%) and Control Tech (10%) for the three month and nine month periods ended February 28, 2006. For the three month and nine month periods ended February 28, 2005, minority interest represented the profit shared by the minority shareholders of Huaqing (49%) only.
Income tax: We made provision for PRC income taxes of $209 and $208,460 for the three months and nine month ended February 28, 2006, respectively. 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 U.S. taxes.
Liquidity and Capital Resources:
Our principal capital requirements during the quarter ended on February 28, 2006 have been primarily funded by Chinese short term bank loans.
As shown in our accompanying financial statements, we had a net loss of $1,500,454 for the three months ended February 28, 2006 compared to a net loss of $12,427,409 for the comparable period in 2005 due to lower operating expenses, various rebates from the vendor and the one-time charge of 7,642,039 from discontinued operations. Our current assets exceeded our current liabilities by $3,082,372 as of February 28, 2006.
As of February 28, 2006, we had working capital of $3,082,372. In addition to our working capital on hand, we intend to obtain needed capital through a combination of bank loans and 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 nine months ended February 28, 2006, net cash used in operating activities increased to $1,592,527, compared to $1,347,937 during the comparable period in 2005. The increase in cash used in operating activities resulted mainly from clearance of other liabilities of Huaqing.
Investing activities: Net cash provided by investing activities during the nine months ended February 28, 2006, was $985,324 compared to $5,498,004 for the comparable period in 2005. The cash provided by investment activities in the nine months ended February 28, 2006 was mostly due to $522,116 proceeds from disposed property and recovery of notes in the amount of $486,603.
Financing activities: Net cash used in financing activities during the nine months ended February 28, 2006 equaled to $8,245 compared to $4,542,021 during the comparable period in 2005. Net cash used in financing activities in the nine months ended February 28, 2006 and 2005 mainly represents the repayment of balance due to related parties.
As a result of the above activities, we experienced a net decrease in cash of $565,020 for the nine months ended February 28, 2006.
Contractual Obligations
As of the three months ended February 28, 2006, we do not have any contractual obligation other than the facility leases described in Note 13 (b) of financial statements.
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Off-Balance Sheet Arrangements
During the quarter ended February 28, 2006, the Company did not engage in any off-balance sheet arrangements as defined in Item 303(a)(4) of the SEC's Regulation S-K.
Critical Accounting Policies and Estimates
For a description of what we believe to be the critical accounting policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements, refer to our Annual Report on Form 10-K for the 5-month transition period ended May
