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CHINACAST EDUCATION CORP - 10-K/A - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Information Regarding Forward Looking Statements The following discussion of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and the notes to those financial statements set forth commencing on page F-1 of this annual report. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under "Forward Looking Statements" and "Risk Factors" and elsewhere in this registration statement, our actual results may differ materially from those anticipated in these forward-looking statements. Overview We are a leading post-secondary education and e-Learning services provider in China. We provide post-secondary degree and diploma programs through our three universities in China: The Foreign Trade and Business College of Chongqing Normal University, the Lijiang College of Guangxi Normal University and the Hubei Industrial University Business College. These universities offer fully accredited, career-oriented bachelor's degree and diploma programs in business, economics, law, IT/computer engineering, hospitality and tourism management, advertising, language studies, art and music. We provide its e-Learning services to post-secondary institutions, K-12 schools, government agencies and corporate enterprises via our nationwide satellite/fiber broadband network. These services include interactive distance learning applications, multimedia education content delivery and vocational training courses. We are subject to risks common to companies operating in China, including risks inherent in our distribution and commercialization efforts, uncertainty of foreign regulatory approvals and laws, the need for future capital and retention of key employees. We cannot provide assurance that we will generate revenues or achieve and sustain profitability in the future. Critical Accounting Policies We believe that the application of the following accounting policies, which are important to our financial position and results of operations, requires significant judgments and estimates on the part of management. For a summary of our significant accounting policies, see Note 2 of the consolidated financial statements appearing elsewhere in this Annual Report. Revenue Recognition. ChinaCast's principal sources of revenues are from provision of satellite bandwidth and network access services in distance learning and to a lesser extent, the provision of English training services sales of satellite communication related equipment and accessories. ChinaCast recognizes revenue when (1) there is persuasive evidence of an agreement with the customer, (2) product is shipped and title has passed, (3) the amount due from the customer is fixed and determinable, and (4) collectibility is reasonably assured. At the time of the transaction, ChinaCast assesses whether the amount due from the customer is fixed and determinable and collection of the resulting receivable is reasonably assured. ChinaCast assesses whether the amount due from the customer is fixed and determinable based on the terms of the agreement with the customer, including, but not limited to, the payment terms associated with the transaction. ChinaCast assesses collection based on a number of factors, including past transaction history with the customer and credit-worthiness of the customer. The revenues from provision of distance learning services via satellite bandwidth and network is recognized as the services are provided. Subscription fee received from the multimedia educational content broadcasting service is recognized as revenue over the subscription period during which the services are delivered. Revenues from bachelor degree and diploma program offerings, representing tuition fees and accommodation and catering service income, are recognized on a straight-line basis over the service period. The colleges' academic year is generally from September to August of the following year. All the admitted students need to register in September at the beginning of a semester. There are mainly two ways the tuitions are collected. A student either a) pays the tuition fee in cash at the beginning of each academic year when registering in September, or b) registers in September but uses student loans to pay the tuition fee later. The tuition fee would be collected once the student loan is processed by the bank. Revenue recognition is the same in both cases. Tuition received from degree and diploma programs is recognized proportionately over the relevant period attended by the students of the applicable program. The portion of tuition payments received from students but not earned is recorded as deferred revenue and is reflected as a current liability as such amounts represent revenue that the Company expects to earn within one year. 25 -------------------------------------------------------------------------------- Tuition refunds are provided to students if they decided to withdraw from school for the remaining service period, up to 90% of the tuition fee received. Tuition refunds have not been significant since the cancellation rate has been low. Revenues from satellite communication related equipment and accessories are recognized once the equipment and accessories are delivered and accepted by the customers. Useful lives and impairment of Property and equipment, and acquired intangible assets. Property and equipment and acquired intangible assets are amortized over their useful lives. Useful lives are based on management's estimates of the period that the assets will generate revenue. In particular, customer relationship (FTBC) acquired is amortized using the accelerated amortization method up to 41 months based on the estimated progression of the students through the respective courses, giving consideration to the revenue and cash flow associated. Customer relationship (LJC) acquired is amortized using the accelerated amortization method up to 47 months based on the estimated progression of the students through the respective courses, giving consideration to the revenue and cash flow associated. Affiliation agreement acquired is amortized on a straight-line basis up to 59 months. Customer relationship (HIUBC) acquired is amortized using the accelerated amortization method over 48 months based on the estimated progression of the students through the respective courses, giving consideration to the revenue and cash flow associated. Affiliation agreement acquired is amortized on a straight-line basis over 36 months. Property and equipment and acquired intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Prepaid lease payments for land use rights. All land in the PRC is owned by the PRC government. The government in the PRC, according to the relevant PRC law, may grant the right to use the land for a specified period of time. Payments for acquiring land use rights represent prepayments of rentals over the periods the rights are granted and are stated at cost less accumulated amortization and any recognized impairment loss. Amortization is provided over the term of the land use right agreement on a straight-line basis. Prepaid lease payments which are to be amortized in the next twelve months or less are classified as current assets. Impairment of non-current advances. The non-current advances by the Company to CCL were for money spent on asset and expenses to build up the satellite business of CCL over the years. On December 31, 2010, CCTSH, CCLX and CCL entered into a Service Agreement (the "Service Agreement") under which CCL will assist CCLX to renew the inter-provincial value-added telecommunication service license (the "VSAT License") for the next ten years. The VSAT License is critical to the Company's E-learning and training services. Without the license, the Company is not allowed to conduct its business through satellite in China. Prior to December 31, 2010, the license was renewed each year with the assistance from CCL. In consideration of CCL's service in assisting the Company to obtain the renewal of the license, the Company shall pay an annual service fees to CCL in the amount of RMB 8.1million during the service term of the Service Agreement and RMB60 million remaining balance of the noncurrent advances, after deducting the purchase price of NCI in CCLX, will be used as a prepayment for this service. However, given that the annual renewal of VSAT license needs to be approved by a government agency and the result is not under the control of neither CCL nor CCLX, the Company believes that the fair value of the VSAT license renewal service to be provided by CCL cannot be reasonably estimated. In addition, CCLX undertakes to CCL in the Service Agreement that it will not take back nor to recover any amount of the prepayment even though it subsequently does not require the service of CCL during the entire service term. As a result, the Company decided to write off the RMB60 million for the prepayment for VSAT license renewal service. The impairment loss of RMB60 million is included in the operating income. Share-based compensation. The Company accounts for employee stock options under authoritative pronouncement issued by the FASB regarding share-based payment from the inception of the Company's stock compensation plans. Compensation cost related to employee share options or similar equity instruments is measured at the grant date based on the fair value of the award and is recognized on a straight-line basis over the requisite service period which is generally the vesting period, with a corresponding addition to paid-in capital. Purchase Price allocation in business combination. For business acquisition recorded using the purchase method of accounting, acquired assets and liabilities are recorded at their fair market value at the date of acquisition. The Company performs purchase price allocation based on such fair values. The valuation analyses utilize and consider generally accepted valuation methodologies such as income, market and cost approach. Inventory valuation. Inventories are valued at the lower of cost or market value and have been reduced by an allowance for excess and obsolete inventories. The estimated allowance is based on management's review of inventories on hand compared to estimated future usage and sales. Impairment of cost method investments. The Company periodically reviews the carrying value of the cost method investments for continued appropriateness. When there is an impairment indicator. This review is based upon the Company's projections of anticipated future cash flows. While the Company believes that the estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect the valuations. 26 -------------------------------------------------------------------------------- Income taxes. The Company has provided a full valuation reserve related to its substantial deferred tax assets. In the future, if sufficient evidence of the Company's ability to generate sufficient future taxable income in certain tax jurisdictions becomes apparent, the Company may be required to reduce its valuation allowances, resulting in income tax benefits in the Company's consolidated statement of operations. Management evaluates whether it is more likely than not that the deferred tax assets would be realized and assesses the need for valuation allowance. Effective on January 1, 2007, the Company adopted the authoritative pronouncement regarding uncertainty in income taxes . Under the guidance, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-that-not to be sustained upon audit by the relevant taxing authority based solely on technical merits of the associated tax position. If the Company ultimately determines that the payment of these liabilities will be unnecessary, the Company will reverse the liability and recognize a tax benefit during that period. Conversely, the Company records additional tax charges in a period in which it determines that a recorded tax liability is less than the expected ultimate assessment. The Company also elected the accounting policy that the interest and penalties recognized are classified as part of its income taxes. The unrecognized tax benefits, tax liabilities and accrued interest and penalties represent management's estimates under the provisions of the guidance. The three acquired universities have not paid any income tax so far. The Company provided provision of unrecognized tax benefits for the three acquired universities since significant judgments are required in determining whether such universities are qualified for the income tax exemption. The ultimate amount of tax liability may be uncertain as a result. As of December 31, 2010, the total unrecognized tax benefits was approximately RMB110 million. Impairment of Goodwill. The carrying value of goodwill as of December 31, 2010 by operating segments was as follows: 2010 2009 (RMB'000) (RMB'000) E-learning and training serve Group ("ELG") 1,618 1,614 Traditional University Group ("TUG"). 772,465 502,157 774,083 503,771 Authoritative pronouncement issued by FASB regarding goodwill and others intangible assets, requires that the goodwill impairment assessment be performed at the reporting unit level. The guidance requires a two-step goodwill impairment test. The first step compares the fair values of each reporting unit to its carrying amount, including goodwill. If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit's goodwill. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill. We performed our annual goodwill impairment test at December 31, 2010. Our reporting units are consistent with our two operating segments. The goodwill allocated to our ELG segment arose in 2004 when we further purchased a portion of non-controlling interests of one subsidiary, CCT BVI, from three non-controlling shareholders. We note that prior to 2008 this was the only reporting unit and segment of the Company, and the market capitalization of the Company as of December 31, 2007 (RMB1,362.8 million) greatly exceeded the carrying amount of the ELG reporting unit, RMB804.6 million. Accordingly, we determined that the first step of the goodwill impairment test was passed, and that the goodwill of the ELG reporting unit was not impaired as of December 31, 2007. The assets and liabilities that make up the ELG reporting unit did not change significantly from 2007 to 2010. The ELG reporting unit is a relatively well established business. Revenue of this reporting unit has been growing steadily since 2004. Revenue grew 5% from 2007 to 2010, and we expect that the revenue of this reporting unit will continue to grow in the future. No significant negative events occurred and the likelihood that the fair value would be less than the carrying amount of the ELG reporting unit as of December 31, 2010 was remote. Therefore we determined that the fair value of the ELG reporting unit would be no less than the carrying amount of this reporting unit. The Company had one acquisition in 2008 which resulted in the addition of the TUG segment. The Company had another acquisition in 2009 and 2010, repectively, to further expand the TUG segment. For our TUG segment, we estimated the fair value of the reporting unit using the income approach. The income approach involves applying appropriate discount rates to estimated cash flows that are based on earnings of forecasts developed by us. The assumptions used in deriving the fair valuations are consistent with our business plan at the time of each valuation. These assumptions include: no material changes in the existing political, legal and economic conditions in China, no major changes in applicable tax rates and no material deviation in market conditions from our forecasts. The risks associated with achieving our forecasts were assessed in selecting the appropriate discount rate to apply to the estimated cash flows. 27 -------------------------------------------------------------------------------- In particular, the discounted cash flows for the TUG reporting unit were based on discrete five-year financial forecasts developed by management for planning purposes. Cash flows beyond the five-year discrete forecast were estimated using a terminal value calculation, which incorporated historical and forecasted financial trends for the reporting unit and considered long-term earnings growth rates for publicly traded peer companies. The key assumptions used in determining the fair value of the TUG reporting unit are: Key Assumptions Description Revenue growth rate The forecasted average annual growth rate of revenue is 3 - 19% from 2011 to 2015. This reflects the following assumptions: Student capacity of the campus is expected to grow upon completion of the planned construction projects; Demand for accredited degree program is expected to grow significantly in the PRC; and A long term growth rate into perpetuity has been determined to be 3% with reference to the birth rate, market penetration and other related factors. COGS growth rate Cost of goods sold ("COGS") are forecasted to grow by 0 to 10% from 2011 to 2015. Discount rate The discount rate applied to the cash flows is based on the weighted average cost of capital ("WACC") of the Company. WACC is the weighted average of the estimated rate of return required by equity and debt holders for an investment of this type. We used 16.0 to 19%. Publicly available information regarding our market capitalization was also considered in assessing the reasonableness of the cumulative fair values of our reporting units estimated using the discounted cash flow methodology. During the years ended December 31, 2008, 2009 and 2010, we determined that there had been no impairment of goodwill. Results of Operations For the purpose of the discussion and analysis of the results of CEC, the consolidated group is referred to as "the Group". CEC is sometimes referred to as the "Company". The satellite operating entity, ChinaCast Company Limited, is referred to as "CCL" and its registered branch in Beijing is referred to as "CCLBJ". The US dollar figures presented below were based on the historical exchange rate of 1USD = 6.6RMB at December 31, 2010 for 2010; 1USD = 6.8RMB at December 31, 2009 for 2009; and 1USD = 6.8RMB at December 31, 2008 for 2008. Since our acquisition of Hai Lai, we have been organized as two business divisions, the E-learning and training service Group (the "ELG"), encompassing all the Company's businesses before the acquisition, and the Traditional University Group (the "TUG"), offering bachelor and diploma programs to students in China. Year ended December 31, 2010 compared to year ended December 31, 2009 The revenue of the Company for 2010 amounted to RMB514.0 million (US$77.9 million) representing an increase of 48.3% compared to RMB346.5 million (US$51.0 million) in 2009. The increase was mainly due to the growth of the TUG. The results of LJC was consolidated for the whole year in 2010 whereas its result was consolidated for the period from October 5, 2009 to December 31, 2009 in 2009 after the acquisition of East Achieve. HIUBC also contributed to the growth after the acquisition of Wintown on August 23, 2010. Revenue of the ELG amounted to RMB208.1 million (US$31.5 million) for 2010 as compared to revenue of RMB196.3 million (US$28.9 million) for 2009. Service income, mainly of a recurring nature amounted to RMB189.9 million (US$28.8 million) for 2010 compared to RMB187.7 million (US$27.6 million) in 2009. Equipment sales, mainly project based, amounted to RMB18.2 million (US$2.8 million) against RMB8.6 million (US$1.3 million) last year. The following table provides a summary of the ELG's revenue by business lines: 2010 2009 2008 (millions) RMB US$ RMB US$ RMB US$ Post secondary education distance learning 113.9 17.3 109.2 16.1 96.9 14.3 K-12 and content delivery 63.0 9.5 64.1 9.4 65.6 9.6 Vocational training, enterprise/government training and networking services 31.2 4.7 23.0 3.4 36.9 5.4 Total ELG revenue 208.1 31.5 196.3 28.9 199.4 29.3 28-------------------------------------------------------------------------------- Net revenue from post secondary education distance learning services increased from RMB109.2 million (US$16.1 million) in 2009 to RMB113.9 million (US$17.3 million) in 2010. The increase of 4.3% was mainly due to the increase in student enrollment and the increase in tuition fee. The total number of post-secondary students enrolled in courses using the Company's distance learning platforms increased to 143,000 from 138,000 at the end of 2009. The revenue from the K-12 and content delivery business decreased slightly by approximately 1.7% from RMB64.1 million (US$9.4 million) to RMB63.0 million (US$9.5 million). The number of subscribing schools for K-12 distance learning services has stabilized at 6,500. Net revenue from vocational and career training services and enterprise government training and networking services increased from RMB23.0 million (US$3.4 million) to RMB31.2 million (US$4.7 million). The decrease was mainly due to the increase in equipment sales, the nature of which is not recurring. TUG was established in the second quarter of 2008 after the acquisition of Hai Lai and was expanded to include LJC acquired in 2009 and the newly acquired HIUBC in 2010. TUG's revenue amounted to RMB150.3 million (US$22.1 million) in 2009 as compared to a revenue of RMB305.9 million (US$46.4 million) in 2010. The following table provides a summary of the TUG's revenue by universities: 2010 2009 2008 (millions) RMB US$ RMB US$ RMB US$ FTBC Group Tuition 123.4 18.7 110.3 16.2 70.9 10.4 Other 17.2 2.6 12.0 1.8 12.3 1.8 Sub-total 140.6 21.3 122.3 18.0 83.2 12.2 LJC Group Tuition 110.6 16.8 25.1 3.7 - - Other 12.3 1.9 2.9 0.4 - - Sub-total 122.9 18.7 28.0 4.1 - - HIUBC Group Tuition 38.2 5.8 - - - - Other 4.2 0.6 - - - - Sub-total 42.4 6.4 - - - - Total TUG revenue 305.9 46.4 150.3 22.1 83.2 12.2 FTBC had approximately 12,000 students and 12,600 students in 2009 and 2010, respectively, and generated RMB110.3 million (US$16.2 million) and RMB123.4 million (US$18.7 million) of tuition revenue in 2009 and 2010, respectively. The increase was due to an increase in tuition fees and the student enrollment. Other revenue of FTBC, which comprises mainly accommodation and catering revenue, amounted to RMB12.0 million (US$1.8 million) and RMB17.2 million (US$2.6 million) for 2009 and 2010, respectively. LJC had approximately 8,400 students and 9,200 students for 2009 and 2010, respectively. LJC generated RMB25.1 million (US$3.7 million) of tuition revenue in 2009 after the completion of its acquisition on October 5, 2009 and generated RMB110.6 million (US$16.8 million) of tuition revenue in 2010. Other revenue of LJC, which comprises mainly accommodation and catering revenue, amounted to RMB2.9 million (US$0.4 million) and RMB12.3 million (US$1.9 million) in 2009 and 2010, respectively. HIUBC had approximately 10,800 students for 2010 and generated RMB38.2 million (US$5.8 million) of tuition revenue in 2010 after the completion of its acquisition on August 23, 2010. Other revenue of HIUBC, which comprises mainly accommodation and catering revenue amounted to RMB4.2 million (US$0.6 million) Cost of sales of the Company increased by 81.3% from RMB147.5 million (US$21.7 million) in 2009 to RMB267.4 million (US$40.5 million) in 2010. The increase was mainly due to the expansion of the TUG. ELG's cost of materials increased from RMB8.5 million (US$1.2 million) for 2009 to RMB18.0 million (US$2.7 million) for 2010. The changes were mainly due to increase in equipment sales. The cost of service for the ELG decreased modestly from RMB34.9 million (US$5.1 million) for 2009 to RMB26.5 million (US$4.0 million) for 2010. The decrease was mainly due to the termination of the payment of satellite platform usage fee to CCLBJ effective from January 1, 2010. TUG's cost increased from RMB104.1 million (US$15.3 million) for 2009 to RMB222.9 million (US$33.8 million) for 2010. The main reason for the increase was that the result of LJC was consolidated for the whole year in 2010 whereas its result was consolidated for the period from October 5, 2009 to December 31, 2009 in 2009. The acquisition of HIUBC in August 2009 also contributed to the increase in TUG's cost. HIUBC's cost for the period from August 23, 2010 to December 31, 2010 amounted to RMB38.5 million (US$5.8 million). Amortization of intangible assets amounted to RMB39.5 million (US$6.0 million) for 2010 as compared to RMB20.2 million (US$2.9 million) for 2009. 29 -------------------------------------------------------------------------------- ELG's gross profit margin increased by 0.7 percentage points, from 77.9% in 2009 to 78.6% in 2010. The main reason for the increase was the termination of the payment of satellite platform usage fee to CCLBJ in 2010, which was partly offset by the increase in equipment sales, which has a low margin. TUG's gross profit margin decreased slightly by 3.6 percentage points, from 30.7% in 2009 to 27.1% in 2010. The decrease was mainly due to the lower margin of the newly acquired LJC and HIUBC, which had a higher revenue split to the parent university as compared to FTBC. In 2009, the Company received a service fee of RMB5.1 million (US$1.0 million), as compared to RMB6.5 million (US$1.0 million) in 2008. The service arose from various agreements with CCL that entitled the Company to the economic benefits of its Beijing Branch - CCLBJ. The management service fee was terminated effective from January 1, 2010. Selling and marketing expenses decreased by 35.6% to RMB3.0 million (US$0.5 million) in 2010 from RMB4.6 million (US$0.7 million) in 2009. The decrease was due to the drop in share option expense from RMB1.6 million (US$0.2 million) for 2009 to RMB0.4 million (US$0.06 million) for 2010. General and administrative expenses increased by 19.6% to RMB84.4 million (US$12.8 million) in 2010 from RMB69.6 million (US$10.2 million) in 2009. The reduction of share option expense from RMB14.6 million (US$2.1 million) for 2009 to RMB7.4 million (US$1.1 million) for 2010 was offset by the increase in general and administrative expenses of the LJC and HIUBC after their acquisition. The Company has foreign exchange losses of RMB1.0 million (US$0.1 million) in 2010 compared to RMB0.09 million (US$0.01 million) in 2009. The change was a result of the change in the RMB/US exchange rate. The last tranche of the consideration for acquiring East Achieve amounting to RMB20.5 million (US$3.1 million) was settled in the third quarter of 2010. The amount was less than the contingent consideration recorded by the Company resulting in a gain of RMB9.5 million (US$1.4 million) for 2010. The Company recorded an impairment loss of non-current advance amounting to RMB59.8 million (US$9.1 million) in 2010. In 2010, the Company disposed of its 17.85% stake in TCX, resulting in a gain of RMB2.1 million (US$0.3 million). Interest income increased from RMB8.3 million (US$1.2 million) in 2009 to RMB14.1 million (US$2.1 million) in 2010. The increase was due to a higher interest rate and a higher average term deposit holdings during the year. Interest expense increased from RMB8.0 million (US$1.2 million) in 2009 to RMB13.7 million (US$2.1 million) in 2010. The interest expense was generated from bank borrowings of FIBC, LJC and HIUBC. The result of LJC was consolidated for the whole year in 2010 whereas its result was consolidated for the period from October 5, 2009 to December 31, 2009 in 2009. The acquisition of HIUBC in 2010 also contributed to the increase in interest expense. Overall, profit before income tax and loss in equity investments decreased from RMB131.1 million (US$19.3 million) in 2009 to RMB110.7 million (US$16.8 million) in 2010, a decrease of 14.8%. The decrease was mainly due to the impairment loss of non-current advance amounting to RMB59.8 million (US$9.1 million) in 2010. The Group had an approximately RMB99.8 million non-current advance balance to CCL, of which RMB40 million was used by the Group to settle the acquisition of CCL's 90% equity interest in CCLX. The remaining RMB59.8 million was used as a prepayment for CCL's VSAT license renewal services to be provided to CCLX. However, since the annual renewal of the VSAT license needs to be approved by a government agency and the result is not under the control of either CCL nor CCLX, the Company believes that the fair value of the VSAT license renewal service to be provided by CCL cannot be reasonably estimated. In addition, CCLX agreed that it would not take back or recover any amount of the prepayment even though it would not subsequently require the services of CCL to renew the license. As a result, the Company decided to write off the RMB59.8 million prepayment of the VSAT license renewal service as an impairment loss. The Company recorded a loss in equity investments amounted to RMB0.1 million (US$0.02 million) in 2010 compared to RMB1.7 million (US$0.2 million) in 2009. Income taxes increased by 28.8% from RMB29.9 million (US$4.4 million) in 2009 to RMB38.6 million (US$5.8 million) in 2010. The higher income tax was due to the increase in business and the expansion in TUG, Gain from discontinued operations amounted to RMB1.2 million (US$0.2 million) in 2009 as compared to RMB1.3 million (US$0.2 million) in 2010, and the gain of 2009 arosed from the termination of the Company's stake in CLS while the gain of 2010 arosed from the disposal of Jiangsu English Training Technology Limited. Noncontrolling interest amounted to RMB1.5 million (US$0.2 million) in 2009 as compared to RMB7.3 million (US$1.1 million) in 2009. On September 18, 2009, the Company acquired the 20% minority stake in Hai Lai, which resulted in a reduction of the noncontrolling interest. 30 --------------------------------------------------------------------------------Net Income attributable to the Company amounted to RMB71.8 million (US$10.9 million) in 2010 compared to RMB92.1 million (US$13.5 million) in 2009. Year ended December 31, 2009 compared to year ended December 31, 2008 The revenue of the Company for 2009 amounted to RMB346.5 million (US$51.0 million) representing an increase of 22.6% compared to RMB282.6 million (US$41.6 million) in 2008. The increase was mainly due to the growth of the TUG. The results of FTBC was consolidated for the whole year in 2009 whereas its result was consolidated for the period from April 11, 2008 to December 31, 2008 in 2008 after the acquisition of Hai Lai. LJC also contributed to the growth after the acquisition of East Achieve on October 5, 2009. Revenue of the ELG amounted to RMB196.3 million (US$28.9 million) for 2009 as compared to revenue of RMB199.4 million (US$29.3 million) for 2008. Service income, mainly of a recurring nature amounted to RMB187.7 million (US$27.6 million) for 2009 compared to RMB170.5 million (US$25.1 million) in 2008. Equipment sales, mainly project based, amounted to RMB8.6 million (US$1.3 million) against RMB28.9 million (US$4.3 million) last year. Net revenue from post secondary education distance learning services increased from RMB96.9 million (US$14.3 million) in 2008 to RMB109.2 million (US$16.1 million) in 2009. The increase of 12.7% was due to the increase in student enrolment and the increase in tuition fee. The total number of post-secondary students enrolled in courses using the Company's distance learning platforms increased to 138,000 from 131,000 at the end of 2008. The revenue from the K-12 and content delivery business decreased slightly by approximately 2.3% from RMB65.6 million (US$9.6 million) to RMB64.1 million (US$9.4 million). The number of subscribing schools for K-12 distance learning services has stabilized at 6,500. Net revenue from vocational and career training services and enterprise government training and networking services decreased from RMB36.9 million (US$5.4 million) to RMB23.0 million (US$3.4 million). The decrease was mainly due to the drop in equipment sales, the nature of which is not recurring. TUG was established in the second quarter of 2008 after the acquisition of Hai Lai and was expanded to include the newly acquired LJC in 2009. TUG's revenue amounted to RMB83.2 million (US$12.2 million) in 2008 as compared to a revenue of RMB150.3 million (US$22.1 million) in 2009. FTBC had approximately 11,000 students and 12,000 students in 2008 and 2009, respectively, and generated RMB70.9 million (US$10.4 million) and RMB110.3 million (US$16.2 million) of tuition revenue in 2008 and 2009, respectively. The results of FTBC was consolidated for the whole year in 2009 whereas its result was consolidated for the period from April 11, 2008 to December 31, 2008 in 2008 after the acquisition of Hai Lai. Other revenue of FTBC, which comprises mainly accommodation and catering revenue amounted to RMB12.3 million (US$1.8 million) and RMB12.0 million (US$1.8 million) for 2008 and 2009, respectively. LJC had approximately 8,400 students and generated RMB25.1 million (US$3.7 million) of tuition revenue in 2009 after the completion of its acquisition on October 5, 2009. Other revenue of LJC, which comprises mainly accommodation and catering revenue amounted to RMB2.9 million (US$0.4 million) in 2009. Cost of sales of the Company increased by 16.2% from RMB126.9 million (US$18.7 million) in 2008 to RMB147.5 million (US$21.7 million) in 2009. The increase was mainly due to the expansion of the TUG. ELG's cost of materials decreased from RMB29.1 million (US$4.3 million) for 2008 to RMB8.5 million (US$1.2 million) for 2009. The changes were mainly due to drop in equipment sales. The cost of service for the ELG decreased modestly from RMB40.2 million (US$5.9 million) for 2008 to RMB34.9 million (US$5.1 million) for 2009. The decrease was mainly due to the reduction in transponder fee from RMB7.5m (US$1.1 milion ) for 2008 to RMB3.5 million (US$0.5 million) for 2009 after renegotiating with the service providers as a result of the reduced bandwidth. TUG's cost increased from RMB57.5 million (US$8.5 million) for 2008 to RMB104.1 million (US$15.3 million) for 2009. The main reason for the increase was that the results of FTBC was consolidated for the whole year in 2009 whereas its result was consolidated for the period from April 11, 2008 to December 31, 2008 in 2008. The acquisition of LJC in the fourth quarter of 2009 also contributed to the increase in TUG's cost. LJC's cost in the fourth quarter of 2009 amounted to RMB26.9 million (US$4.0 million). Amortization of intangible assets amounted to RMB20.0 million (US$2.9 million) for 2009 as compared to RMB14.0 million (US$2.1 million) for 2008. ELG's gross profit margin increased by 12.7 percentage points, from 65.2% in 2008 to 77.9% in 2009. The main reason for the increase was the reduction in equipment sales, which has a low marginTUG's gross profit margin decreased slightly by 0.1 percentage points, from 30.8% in 2008 to 30.7% in 2009. 31 -------------------------------------------------------------------------------- In 2009, the Company received a service fee of RMB5.1 million (US$1.0 million), as compared to RMB6.5 million (US$1.0 million) in 2008. The service arose from various agreements with CCL that entitled the Company to the economic benefits of its Beijing Branch - CCLBJ. CCLBJ is in the process of transferring all its outstanding businesses, mainly in post secondary education distance learning, to the Company, which led to the reduction in management service fee. Selling and marketing expenses decreased by 19.4% to RMB4.6 million (US$0.7 million) in 2009 from RMB5.7 million (US$0.8 million) in 2008. The reduction was due to the lower sales and marketing activities associated with the enterprise training business line and the Tongji project. General and administrative expenses increased slightly by 2.9% to RMB69.6 million (US$10.2 million) in 2009 from RMB67.7 million (US$10.0 million) in 2008. The increase due to the acquisition and expansion in TUG was offset by the reduction in professional expenses and office rental of the ELG in 2009. Professional expenses of the ELG for 2009 and 2008 was RMB13.4 million (US$2.0 million) and RMB17.0 million (US$2.5 million) respectively. Office rental of the ELG for 2009 and 2008 was RMB2.4 million (US$0.4 million) and RMB4.3 million (US$0.6 million) respectively. Payroll of the ELG also decreased to RMB14.8 million (US$2.2 million) for 2009 from RMB16.5 million (US$2.4 million) for 2008. The Company has foreign exchange losses of RMB0.09 million (US$0.01 million) in 2009 compared to RMB1.2 million (US$0.2 million) in 2008. The decrease was a result of the stable trend of the exchange rate of the RMB against US dollars in 2009 while the exchange rate was volatile in 2008. As a result of the deterioration of the operating profitability of TCX, an investment impairment loss of RMB8.5 million (US$1.3 million) was recorded in 2008 in relation to TCX. A further investment impairment loss of RMB0.4 million (US$0.06 million) was recorded in 2009 in relation to TCX that reduced the balance of cost method investment in TCX to zero. Interest income decreased from RMB19.5 million (US$2.9 million) in 2008 to RMB8.3 million (US$1.2 million) in 2009. The decrease was due to a lower interest rate and a lower average term deposit holdings during the year as a result of the settlement of the acquisition consideration in 2008 and 2009. Interest expense increased from RMB2.6 million (US$0.4 million) in 2008 to RMB8.0 million (US$1.2 million) in 2009. The interest expense was generated from bank borrowings of FIBC and LJC. The result of FTBC was consolidated for the whole year in 2009 whereas its result was consolidated for the period from April 11, 2008 to December 31, 2008 in 2008. The acquisition of LJC in 2009 also contributed to the increase in interest expense. Overall, profit before income tax increased from RMB96.0 million (US$14.1 million) in 2008 to RMB131.1 million (US$19.3 million) in 2009, an increase of 36.5%. The increase was mainly due to the drop in investment impairment loss; the reduction in professional expenses and rental expense as well as the expansion of the TUG. The Company's share of net investment losses from various equity method investments amounted to RMB1.7 million (US$0.2 million) in 2009 compared to RMB0.4 million (US$0.06 million) in 2008. Income taxes increased by 22.8% from RMB24.4 million (US$3.6 million) in 2008 to RMB29.9 million (US$4.4 million) in 2009. The higher income tax was due to the increase in business and the expansion in TUG. Gain from discontinued operations amounted to RMB1.2 million (US$0.02 million) in 2009 as compared to loss amounted to RMB21.0 million (US$3.1 million) in 2008. The gain of 2009 arose from disposal the Company's stake in CLS amounting to RMB1.2 million (US$0.2 million); and the loss from discontinued operations in 2008 was mainly due to an impairment loss on brand name usage right amounting to RMB14.5 million (US$2.1 million). Net income attributable to non-controlling shareholders amounted to RMB7.3 million (US$1.1 million) in 2009 as compared to RMB7.5 million (US$1.1 million) in 2008. Net Income attributable to the Company amounted to RMB92.1 million (US$13.5 million) in 2009 compared to RMB42.7 million (US$6.3 million) in 2008. Liquidity and Capital Resources Cash and bank balances together with term deposits increased from RMB834.6 million (US$122.8 million) at December 31, 2009, to RMB948.4 million (US$143.7 million) at December 31, 2010. The increase of approximately 13.6% was because of the proceeds from the issuance of shares of the Company in 2010. 32 -------------------------------------------------------------------------------- Net cash generated from operating activities was RMB352.6 million (US$53.4 million) in 2010 as compared to RMB135.1 million (US$19.9 million) in 2009. Mainly, it is due to the net cash generated from operating activities for 2009 was depressed because after the acquisition of LJC on October 5, 2009, there was a payment of RMB27.3 million (US$4.0 million) to Guangxi Normal University as fee payment under the affiliation agreement for revenue received before October 5, 2009. The revenue received before October 5, 2009 was not consolidated into the operating cash flow of the Company, but the fee payment under the affiliation agreement payment after October 5, 2009 was included in the operating cash outflow. As such, the operating cash flow would be reduced accordingly. Net cash used in investment activities in 2010 was RMB637.6 million (US$96.6 million), mainly reflecting settlement of acquisition consideration in relation to HIUBC of RMB340.1 million (US$51.5 million). The Company also paid RMB100.4 million (US$15.2 million) for acquiring property and equipment mainly for TUG. There was also a transfer to fixed deposit of RMB197.0 million (US$29.8 million). Net cash used in investment activities in 2009 was RMB385.5 million (US$56.7 million), mainly reflecting settlement of acquisition consideration in relation to LJC of RMB221.9 million (US$32.6 million). Net cash provided by financing activities in 2010 was RMB199.0 million (US$30.1 million), mainly reflecting the proceeds from issue of shares and net repayment of bank borrowing amounting to RMB32.4 million (US$4.9 million). Net cash provided by financing activities in 2009 was RMB327.6 million (US$48.2 million), mainly reflecting the proceeds from issue of shares in a secondary offerings and RMB70 million (US$10.3 million) bank borrowing raised. On December 1, 2009, the Company entered into an underwriting agreement (the "Underwriting Agreement") with Roth Capital Partners, LLC (the "Underwriter"), pursuant to which the Company agreed to issue and sell 5,930,000 shares of the Company's common stock, par value $0.0001 per share, to the Underwriter at an offering price per share of $6.85. In addition, the Company also granted the Underwriter an option to purchase up to an additional 889,500 shares to cover overallotments, if any, at the same price of US$6.85 per share. The sale of the 5,930,000 shares of common stock was consummated on December 7, 2009 and the sale of up to an additional 889,500 shares to cover overallotments was consummated on December 16, 2009. Net proceeds to the Company from the offering, after deducting underwriting discounts and commissions and estimated offering expenses, were approximately US$43.6 million. On January 5, 2010, the Company issued 692,520 restricted shares of our common stock to Thriving Blue Limited, a British Virgin Islands company that is 100% owned by Ron Chan Tze Ngon, the Company's Chief Executive Officer ("Thriving Blue") pursuant to a Subscription Agreement dated December 21, 2009 between the Company and Thriving Blue for a purchase price of US$7.22 per share or an aggregate purchase price of US$4,999,994.40. The shares are beneficially held on behalf of Ron Chan Tze Ngon, Michael Santos, and Antonio Sena. On April 29, 2010, the Company entered into a Stock Purchase Agreement with Wu Shi Xin, the sole stockholder of Wintown Enterprises Limited, a British Virgin Islands company ("Wintown"), pursuant to which Mr. Wu purchased 3,735,734 shares of our common stock for a purchase price of US$7.85 per share, or an aggregate purchase price of US$29.3 million. Wintown is the holding company of HIUBC. The Company believes that its cash and cash equivalents balances, together with its access to financing sources, will continue to be sufficient to meet the working capital needs associated with its current operations on an ongoing basis, although that cannot be assured. Also, it is possible that the Company's cash flow requirements could increase as a result of a number of factors, including unfavorable timing of cash flow events, the decision to increase investment in marketing and development activities or the use of cash for acquisitions to accelerate its growth. Total assets at the end of 2010 amounted to RMB2,894.2 million (US$438.5 million). In 2009, total assets was RMB2,273.9 million (US$334.4 million), an increase of 27.3%. Total current assets increased by 16.1% to RMB1,067.4 million (US$161.7 million). Accounts receivable increased from RMB53.8 million (US$7.9 million) as at December 31, 2009 to RMB59.4 million (US$9.0 million) at the end of 2010. Most of the business partners are long term customers and settle their accounts promptly. All accounts receivable are reviewed regularly and provisions have been made for any balances that are disputed or doubtful. Inventory, mainly made up of satellite transmission and receiving equipment, amounted to RMB1.0 million (US$0.2 million) and RMB1.4 million (US$0.2 million) as at December 31, 2010 and December 31, 2009 respectively. Prepaid expenses and other current assets increased from RMB19.2 million (US$2.9 million) as at December 31, 2009 to RMB48.2 million (US$7.3 million). The increase was mainly due to the increase in deposits and prepayments for construction projects paid by LJC. The Company had bank borrowings amounting to RMB260.0 million (US$39.4 million) at December 31, 2010, to finance the construction projects and campus capacity expansion in TUG. 33-------------------------------------------------------------------------------- Payment Due by Period Within 2014 and Total 1 Year 2012 2013 beyond Other (RMB (RMB (RMB (RMB (RMB (RMB '000) '000) '000) '000) '000) '000) Long-term debt obligation Principal 260,000 170,000 55,000 30,000 5,000 - Interest 22,672 14,628 5,603 2,345 96 - Operating lease commitments 3,680 1,617 2,063 FIN48 obligation 109,933 109,933Lease obligation for information usage and satellite platform usage 12,136 12,136 Total contractual obligations 408,421 198,381 62,666 32,345 5,096 109,933 Equivalent US$ '000. 61,882 30,058 9,495 4,901 772 16,657 Contractual Obligations and Commercial Commitments. The Company has various contractual obligations that will affect its liquidity. The following table sets forth the contractual obligations of the Company as of December 31, 2010: The following table presents the contractual obligations in USD solely for the convenience of readers. The exchange rate of RMB 6.6 was applied as of December 31, 2010. Within 1 2014 and Total year 2012 2013 beyond Other (USD'000) (USD'000) (USD'000) (USD'000) (USD'000) (USD'000) Long-term debt obligation Principal 39,394 25,758 8,333 4,545 758 Interest 3,435 2,216 849 355 15 Operating lease commitments 558 245 313 FIN48 obligation 16,657 16,657 Lease obligation for information usage and satellite platform usage 1,839 1,839 Total contractual obligations 61,882 30,058 9,495 4,901 772 16,657 Operating Leases. The Company leases certain office premises under non-cancelable leases. Rent expense under operating leases for the years ended December 31, 2008, 2009, and 2010 were RMB6.7 million, RMB3.0 million and RMB2.7 million (US$0.4 million), respectively. The Company has entered into certain operating lease arrangements relating to the information usage and satellite platform usage services. Rental expense related to these operating lease arrangement for the years ended December 2008, 2009 and 2010 were RMB17.5 million, RMB17.4 million and RMB12.1 million (US$1.8 million), respectively. The Company had no fixed commitment on information usage and satellite platform usage fee. The satellite platform usage fee was payable to the CCLBJ calculated at 10% of revenue generated by a subsidiary of the Company for 2008 and 2009. As of December 31, 2010, future minimum capital commitments under the non-cancelable construction premises was RMB nil million due in 2010. The Company has not entered any financial guarantees or other commitments to guarantee the payment obligations of any third parties. Accounting Pronouncements Recent Accounting Pronouncement In June 2009, the FASB issued an authoritative pronouncement to amend the accounting rules for variable interest entities. The amendments effectively replace the quantitative-based risks-and-rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which reporting entity has (1) the power to direct the activities of a variable interest entity that most significantly affect the entity's economic performance and (2) the obligation to absorb losses of, or the right to receive benefits from, the entity. Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity's economic performance. The new guidance also requires additional disclosures about a reporting entity's involvement with variable interest entities and about any significant changes in risk exposure as a result of that involvement. 34--------------------------------------------------------------------------------The new guidance is effective at the start of a reporting entity's first fiscal year beginning after November 15, 2009, and all interim and annual periods thereafter. The Company has had one consolidated variable interest entity under the authoritative literature prior to the amendment discussed above because it was the primary beneficiary of the entity. Because the Company, through its wholly owned subsidiary, has (1) the power to direct the activities of the variable interest entity that most significantly affect the entity's economic performance and (2) the right to receive benefits from the variable interest entity. This new guidance has been adopted by the company on January 1, 2010. The Company continues to consolidate the variable interest entity upon the adoption of the new guidance which therefore has no impact on the Company's financial condition or results of operations, except for the additional disclosures on the face of and in the notes to the consolidated financial statements. In April 2010, the FASB issued an authoritative pronouncement on effect of denominating the exercise price of a share-based payment award in the currency of the market in which the underlying equity securities trades and that currency is different from (1) entity's functional currency, (2) functional currency of the foreign operation for which the employee provides services, and (3) payroll currency of the employee. The guidance clarifies that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition, and therefore should be considered an equity award assuming all other criteria for equity classification are met. The pronouncement is for interim and annual periods beginning on or after December 15, 2010, and will be applied prospectively. Affected entities will be required to record a cumulative catch-up adjustment for all awards outstanding as of the beginning of the annual period in which the guidance is adopted. In December 2010, the FASB issued an authoritative pronouncement on when to perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts. The amendments in this update modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the guidance is effective for impairment tests performed during entities' fiscal years (and interim periods within those years) that begin after December 15, 2010. Early adoption will not be permitted. For nonpublic entities, the guidance is effective for impairment tests performed during entities' fiscal years (and interim periods within those years) that begin after December 15, 2011. Early application for nonpublic entities is permitted; nonpublic entities that elect early application will use the same effective date as that for public entities. In December 2010, the FASB issued an authoritative pronouncement on disclosure of supplementary pro forma information for business combinations. The objective of this guidance is to address diversity in practice regarding the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable t the business combination included in the reported pro forma revenue and earnings. The amendments affect any public entity as defined by Topic 805 that enters into business combinations that are material on an individual or aggregate basis. The amendments will be effective for business combinations consummated in periods beginning after December 15, 2010, and should be applied prospectively as of the date of adoption. Early adoption is permitted. For most calendar-year-end companies, companies should evaluate and disclose the impact, if any, this guidance will have on its consolidated financial statements starting from January 1, 2011. 35-------------------------------------------------------------------------------- |