One year ago today. Well worth a re-read........
Dear Fellow Shareholders:
Normally, the development of the annual report each year starts from articulating the performance of the past year and followed by a strategy that will guide the future operations. Unfortunately, Hartcourt has no historical luxury in Fiscal 2006 (ended May 31, 2006) to show off, and I am definitely not the right person to summarize the past. Fiscal 2006 was a year of puzzling for Hartcourt as the Company had stalled in its business development and operation. We, however, only have a theme that is unique for the years at our hands. This theme, represented by change, value and opportunity, will best describe the Hartcourt in transition happening over last three months and should define our performance in Fiscal 2007 and beyond.
FISCAL 2006 AND THE TRANSITION IN REVIEW
Certainly Fiscal 2006 was a lousy year for Hartcourt, as it was shown by its share price, continuously touching the historical lows. Shareholders indeed always have smart eyes. Hartcourt had acquired many IT product distribution companies and tried to be one of the biggest IT product players in China. But, when these acquired companies demonstrated their incapability to deliver the expected performance, Hartcourt started to rescind the acquisition agreements. Sales revenue of the Company had been reduced sharply and the bottom line profit had gone. IT product dealing is a commodity business and it has sharp thin margin, if any!
As a result, in Fiscal 2006, Hartcourt was still busy in cleaning its backyard. The rescinding of the acquisitions meant to return the acquired targets to the former owners and to collect back the Hartcourt stocks that were used as the acquisition payments. Some of the rescindings were not even completed until the Fiscal 2007 began. Unbelievably, it took more than two years to do the rescindings. Fortunately, we have ended the nightmare, although we are still looking for buyers for two more subsidiaries.
The above said aggressive acquisition of IT companies also resulted in reporting deficiencies. A certain transaction and presentation in the financial statements had not been accounted for properly in the Company's financial statements in 2003. SEC required re-statements and re-filing of the financial statements to reflect the true dealings. Again, it took the former management more than a year to try to fix the deficiency, but, without success. The current management team, since their appointment, spent all the efforts to make the re-filing in accordance with the SEC rules, although it happened in the Fiscal 2007.
Not only the legal reporting with the SEC was stained, but the communication with the market (shareholders) was also stopped. There were reasons to be shy or even to be nervous upon the significant downsizing of the company, but the communication with the shareholders was still important. The new management decided to go back to the real world (not hiding from the reality) and talked to the shareholder representatives in New York and San Francisco in late July and early August 2006.
Fiscal 2006 and years before also saw frequent changes of the Company executives. Some of those executives were also members of the Board of Directors, the Company's central engine. Imagine the car engine was stalled while running on the New Jersey Turnpike. Changing is good if we are confident at our strategy, vision, mission and goals, otherwise, we will lose our direction like the car has no steering system. At the beginning of Fiscal 2007, we quickly installed the Board and its governing committees, or the engine, and the execution team, or the powered steering. These are the important components of the turnaround strategy. We want the corporate governance back in track and prepare for the change, our change, for which we have a solid plan.
Hartcourt originally made an exciting and sound move by focusing its business in China and in 2002 it moved its operation headquarters to Shanghai. However, successful China operations require the management team to have an executable business plan and to possess local knowledge. To be a commercial success in China, a company must work with local business partners, politicians and professionals, as parts of the business plan. Unfortunately, we don't see the existence of such a plan in Fiscal 2006. That's why even before I was hired to the new management team I started to work on such a workable plan. With the plan in place and with the strong credentials in combining both Chinese and international business knowledge, we believe that it is half done for the Hartcourt's turn-around maneuver.
If the treatment of the past by this management team was "reactive" as some people may pointed out, the transition itself and the new business plan was designed for Hartcourt to move permanently into the "proactive" stage and remain there. I am glad that we made the transition, fixed the historical deficiencies and laid down the necessary platform for the future development (all three steps at the same time) within three months. We of course foresee the tough time ahead since Hartcourt is like a new born baby or a patient just coming out the operation room, but we now see some light at the end of the tunnel.
HARTCOURT'S BUSINESS STRATEGY AND VOCATIONAL EDUCATION FOCUS
Hartcourt's business strategy is easy to understand. We conduct our business as a holding company for China's providers of vocational education and technical training services. Hartcourt structures itself so that its portfolio of companies and affiliates can operate well-recognized institutions with dominant positions within their regions and sectors. We plan to grow onshore in China through acquisitions and building the expansion upon them, we will regionally consolidate to achieve economies of scale, we will focus exclusively on designing practical vocational courses and attracting students to take them and we will work proactively to maximize the economic value of the Hartcourt group. By executing this strategy effectively, we believe Hartcourt will become one of the China's top education groups and the economic results will enhance Hartcourt's shareholder value.
In order to understand the simplicity of our business strategy (I personally don't do any business that common senses can't tell the model or source/size of the profit margin), education business (in China) resembles oil drilling in the way it collects (tuition) cash after it establishs its reputation and proves the quality of the products. The difficult part of the business is to develop and build the school with necessary community (including government) recognition. Then the tuition the school collects will represent the key revenue sources and faculty compensation will be the key operation expenses, hence the profit margin. Hartcourt will find and acquire the target schools after evaluating the courses and the market, just like acquiring the drilled oil wells, and put together strong faculty teams, incentive plans and strategic expansion programs.
We are repositing the company to pursue our business strategy based on the following beliefs about the China vocational education industry beyond the year 2006:
China will need more than 25 million middle vocational graduates and 11 million high vocational graduates over 2006-2010 and this represents USD50 billion tuition revunues for next five years;
Despite the above-mentioned growing demand, the total number of vocational schools is decreasing because the industry starts to go through a massive consolidation process in which a substantial number of low quality vocational schools will be shut down or acquired by good ones;
Students (and their parents) are more picky since only quality school graduates can find good jobs while attending lousy schools will waste their money and they have to go to better schools for "continuous" education again for better jobs and life. There were frequent reports that many college (degree) graduates went to vocational schools in order to find decent jobs;
Although government allows private and foreign capital to participate in the vocational education, money capital only is not sufficient and will not be encouraged (approved) by educators or governmental agencies. What the China courterparts are seeking for is money plus education resources.
These trends became evident when we studied China's recent development of the vocational education industry. Accordingly, we decided that Hartcourt should position itself to be a first mover to take advantage of this opportunity. To that end, we are adopting four objectives:
acquire the existing vocational schools that we evaluate to be good;
build a comprehensive nexus of all acquired institutions, with core themes and distribution schemes;
hire local experienced educators and put together sound operation plans;
develop the solid relationship with the corporate world to improve the employment rate of our graduates.
Hartcourt has changed in many aspects, as I think the changes are so critical for the Company's future development. Many people may not be aware of the good side of the changes and their importance, because the lack of communication of the Company with the shareholders in Fiscal 2006 and before made the comparison difficult, if not impossible. Nevertheless, we changed, for good, for creating more value for shareholders by identifying and creating opportunities.
LOOKING FORWARD
As I conclude this letter and reflect with a sense of self-criticism on Hartcourt's performance in Fsical 2006 and of exposure of our changes over last three months, I remain very optimistic about the future success of the Company and our ability to deliver value to our shareholders. We have the commitment and talents, an engaged and insightful Board, a well-researched business strategy and a value-added execution program. Hartcourt also offers an entrepreneurial and experienced management team that has proven itself capable of creating value through identifying and solving problematic situations, making and executing solid business plans.
We are very focused on driving improved performance in our business. Our management reward programs are designed to align their interests with those of our shareholders. With the major hinderance behind us and aggressive restructuring and acquisition under way, we believe Hartcourt can lead the way in delivering exceptional growth, value and opportunity to our shareholders in Fiscal 2007 and beyond.
Best regards,
Yungeng Hu
President and Chief Financial Officer
Also on behalf of
Billy Wang Victor Zhou
Chairman of the Board of Directors Chief Executive Officer
August 31, 2006
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