##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: March 31, 2005
or o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 333-61286   KID CASTLE EDUCATIONAL CORPORATION  Florida
(State or other jurisdiction of
incorporation or organization)
    
    59-2549529
(IRS Employer
Identification No.)
 8th Floor, No. 98 Min Chuan Road, Hsien Tien
Taipei, Taiwan ROC
(Address of principal executive offices) Registrants telephone number, including area code:  011-886-22218 5996 Securities registered pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registeredCommon Stock
    
    N/A
 Securities registered under Section 12(g) of the Act: Title of class None
 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the last ninety days. Yes þ      No o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yes o     No þ As of May 10, 2005, there were 18,999,703 shares of the Registrants common stock outstanding. Documents incorporated by reference: None.




---



##### Table of Contents



FORM 10-Q KID CASTLE EDUCATIONAL CORPORATION TABLE OF CONTENTS PagePART I
    
    FINANCIAL INFORMATION
    
    
    2Item 1.
    
    Unaudited Condensed Consolidated Financial Statements.
    
    
    2Item 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations.
    
    
    24Item 3.
    
    Quantitative and Qualitative Disclosures About Market
Risk
    
    
    36Item 4.
    
    Controls and Procedures.
    
    
    37PART II.
    
    OTHER INFORMATION
    
    
    37Item 1.
    
    Legal Proceedings.
    
    
    37Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities.
    
    
    38Item 3.
    
    Defaults upon Senior Securities.
    
    
    38Item 4.
    
    Submission of Matters to a Vote of Security Holders.
    
    
    38Item 5.
    
    Other Information.
    
    
    38Item 6
    
    Exhibits and Reports on Form 8-K.
    
    
    38SIGNATURES
    
    
    39
 i




---



##### Table of Contents



KID CASTLE EDUCATIONAL CORPORATION UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS AS OF MARCH 31, 2005 AND DECEMBER 31, 2004
AND
FOR THE THREE MONTHS ENDED
MARCH 31, 2005 AND 2004 KID CASTLE EDUCATIONAL CORPORATION
INDEX TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS PagesCondensed Consolidated Balance Sheet
    
    2  3Condensed Consolidated Statements of Operations
    
    4Condensed Consolidated Statements of Stockholders Equity
    
    5Condensed Consolidated Statements of Cash Flows
    
    6  8Notes to Condensed Consolidated Financial Statements
    
    9  26EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  -2-




---



##### Table of Contents



Kid Castle Educational Corporation 
 Condensed Consolidated Balance Sheets (Expressed in US Dollars) March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)ASSETSCurrent assetsCash and bank balances
    
    $
    173,169
    
    
    $
    213,564Bank fixed deposits  pledged (Note 12)
    
    
    354,416
    
    
    
    294,331Notes and accounts receivable, net (Notes 5 and 10)
    
    
    2,903,221
    
    
    
    2,401,904Inventories, net (Note 6)
    
    
    2,983,890
    
    
    
    2,979,738Other receivables (Notes 7 and 10)
    
    
    420,351
    
    
    
    337,848Prepayments and other current assets (Note 10)
    
    
    440,200
    
    
    
    478,752Pledged notes receivable (Note 12)
    
    
    1,220,482
    
    
    
    1,218,356Deferred income tax assets
    
    
    256,105
    
    
    
    218,574Total current assets
    
    
    8,751,834
    
    
    
    8,143,067Deferred income tax assets
    
    
    167,093
    
    
    
    170,477Prepaid interest in associates
    
    
    
    
    
    
    24,165Interest in associates (Note 8)
    
    
    137,213
    
    
    
    99,467Property and equipment, net
    
    
    2,173,300
    
    
    
    2,188,092Intangible assets, net of amortization (Note 11)
    
    
    856,147
    
    
    
    894,419Long-term notes receivable
    
    
    224,185
    
    
    
    240,971Pledged notes receivable (Note 12)
    
    
    573,832
    
    
    
    407,149Other assets
    
    
    570,168
    
    
    
    613,617Total assets
    
    $
    13,453,772
    
    
    $
    12,781,424LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesBorrowings  short-term and maturing within
one year (Note 12)
    
    $
    2,443,026
    
    
    $
    2,632,982Notes and accounts payable (Note 10)
    
    
    1,574,181
    
    
    
    1,506,543Accrued expenses
    
    
    855,018
    
    
    
    703,407Other payables
    
    
    368,333
    
    
    
    283,080Deposits received
    
    
    668,432
    
    
    
    498,266Receipts in advance (Note 13)
    
    
    2,831,244
    
    
    
    2,996,558Income tax payable (Note 9)
    
    
    213,196
    
    
    
    97,142Obligation under capital leases due within one year
    
    
    27,572
    
    
    
    8,659Total current liabilities
    
    
    8,981,002
    
    
    
    8,726,637Borrowings maturing after one year (Note 12)
    
    
    1,877,956
    
    
    
    1,651,825Receipts in advance (Note 13)
    
    
    1,421,803
    
    
    
    1,124,809Obligation under capital leases
    
    
    27,280
    
    
    
    Deposits received
    
    
    594,136
    
    
    
    689,530Accrued pension liabilities (Note 14)
    
    
    190,820
    
    
    
    160,907Total liabilities
    
    
    13,092,997
    
    
    
    12,353,708
 -3-




---



##### Table of Contents



Kid Castle Educational Corporation Condensed Consolidated
Balance Sheets - Continued (Expressed in US Dollars) March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)Commitments and contingencies (Note 16)Minority interest
    
    
    33,950
    
    
    
    33,791Shareholders equityCommon stock, no par share:25,000,000 shares authorized; 18,999,703 shares
issued and outstanding at March 31, 2005 and
December 31, 2004
    
    
    7,669,308
    
    
    
    7,669,308Additional paid-in capital
    
    
    194,021
    
    
    
    194,021Legal reserve
    
    
    65,320
    
    
    
    65,320Accumulated deficit
    
    
    (7,362,504
    )
    
    
    (7,312,074
    )Accumulated other comprehensive loss
    
    
    (239,320
    )
    
    
    (222,650
    )Total shareholders equity
    
    
    26,825
    
    
    
    393,925Total liabilities and shareholders equity
    
    $
    13,453,772
    
    
    $
    12,781,424
 The accompanying notes are an integral part of these Condensed Consolidated Financial Statements. -4-




---



##### Table of Contents



Kid Castle Educational Corporation 
 Condensed Consolidated Statements of Operations (Expressed in US Dollars) Three months ended March 31,2005
    
    
    2004(Unaudited)Operating RevenueSales of goods
    
    $
    2,375,155
    
    
    $
    2,029,853Franchising income
    
    
    597,925
    
    
    
    528,132Other operating revenue
    
    
    149,912
    
    
    
    52,353Total net operating revenue
    
    
    3,122,992
    
    
    
    2,610,338Operating costsCost of goods sold
    
    
    (927,731
    )
    
    
    (674,505
    )Cost of franchising
    
    
    (113,613
    )
    
    
    (132,101
    )Other operating costs
    
    
    (74,196
    )
    
    
    (57,195
    )Total operating costs
    
    
    (1,115,540
    )
    
    
    (863,801
    )Gross profit
    
    
    2,007,452
    
    
    
    1,746,537Advertising costs
    
    
    (33,363
    )
    
    
    (126,642
    )Other operating expenses
    
    
    (1,785,500
    )
    
    
    (2,016,424
    )Income (loss) from operations
    
    
    188,589
    
    
    
    (396,529
    )Interest expenses, net
    
    
    (59,253
    )
    
    
    (21,765
    )Share of loss of investments
    
    
    12,483
    
    
    
    46,967Other non-operating (loss) income, net
    
    
    (48,939
    )
    
    
    43,673Income (loss) before income taxes and minority interest income
    
    
    92,880
    
    
    
    (327,654
    )Provision for taxes
    
    
    (143,453
    )
    
    
    Loss before minority interest income
    
    
    (50,573
    )
    
    
    (327,654
    )Minority interest income
    
    
    143
    
    
    
    Net loss
    
    $
    (50,430
    )
    
    $
    (327,654
    )Loss per share  basic and diluted
    
    $
    (0.003
    )
    
    $
    (0.017
    )Weighted-average shares used to compute (loss) earnings per
share  basic and diluted
    
    
    18,999,703
    
    
    
    18,999,703
 The accompanying notes are an integral part of these Condensed Consolidated Financial Statements. -5-




---



##### Table of Contents



Kid Castle Educational Corporation 
 Condensed Consolidated Statements of Stockholders Equity (Expressed in US Dollars) Common StockAccumulatedAdditional
    
    
    
    
    
    
    
    
    
    
    otherNumber of
    
    
    
    
    
    
    paid-in
    
    
    Legal
    
    
    Accumulated
    
    
    comprehensiveshares
    
    
    Amount
    
    
    capital
    
    
    reserve
    
    
    deficit
    
    
    loss
    
    
    TotalBalance, December 31, 2003
    
    
    18,999,703
    
    
    
    7,669,308
    
    
    
    194,021
    
    
    
    65,320
    
    
    
    (6,057,482
    )
    
    
    (163,170
    )
    
    
    1,707,997Net loss for 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,254,592
    )
    
    
    
    
    
    
    (1,254,592
    )Cumulative translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (59,480
    )
    
    
    (59,480
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,314,072
    )Balance, December 31, 2004
    
    
    18,999,703
    
    
    $
    7,669,308
    
    
    $
    194,021
    
    
    $
    65,320
    
    
    $
    (7,312,074
    )
    
    $
    (222,650
    )
    
    $
    393,925Net loss for the three months ended
March 31, 2005 (Unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50,430
    )
    
    
    
    
    
    
    (50,430
    )Cumulative translation adjustment
(Unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,670
    )
    
    
    (16,670
    )Comprehensive loss (Unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (67,100
    )Balance, March 31, 2005 (Unaudited)
    
    
    18,999,703
    
    
    $
    7,669,308
    
    
    $
    194,021
    
    
    $
    65,320
    
    
    $
    (7,362,504
    )
    
    $
    (239,320
    )
    
    $
    326,825
 The accompanying notes are an integral part of these Condensed Consolidated Financial Statements. -6-




---



##### Table of Contents



Kid Castle Educational Corporation 
 Condensed Consolidated Statements of Cash Flows (Expressed in US Dollars) Three months ended March 31,2005
    
    
    2004(Unaudited)Cash flows from operating activitiesNet loss
    
    $
    (50,430
    )
    
    $
    (327,654
    )Adjustments to reconcile net loss to
net cash provided by (used in) operating activitiesDepreciation of property and equipment
    
    
    66,681
    
    
    
    52,266Amortization of intangible assets
    
    
    42,835
    
    
    
    40,509Allowance for sales returns
    
    
    95,267
    
    
    
    71,890Allowance for doubtful debts
    
    
    284,537
    
    
    
    156,221Provision for (reversal of) allowance for loss on
inventory obsolescence and slow-moving items
    
    
    6,452
    
    
    
    (69,180
    )Gain on disposal of property and equipment
    
    
    (9,010
    )
    
    
    Minority interest income
    
    
    (143
    )
    
    
    Share of gain of investments
    
    
    (12,483
    )
    
    
    (46,967
    )(Increase)/decrease in:Notes and accounts receivable
    
    
    (775,674
    )
    
    
    192,461Inventories
    
    
    4,514
    
    
    
    204,320Other receivables
    
    
    (129,129
    )
    
    
    72,016Prepayments and other current assets
    
    
    41,002
    
    
    
    (6,073
    )Deferred income tax assets
    
    
    (32,194
    )
    
    
    3,314Other assets
    
    
    46,591
    
    
    
    (31,084
    )Increase/(decrease) in:Notes and accounts payable
    
    
    60,036
    
    
    
    107,712Accrued expenses
    
    
    148,876
    
    
    
    (46,463
    )Other payables
    
    
    124,933
    
    
    
    (76,311
    )Receipts in advance
    
    
    (147,307
    )
    
    
    (261,384
    )Income taxes payable
    
    
    115,635
    
    
    
    (3,314
    )Deposits received
    
    
    67,207
    
    
    
    29,413Accrued pension liabilities
    
    
    29,115
    
    
    
    (16,266
    )Net cash provided by (used in) operating activities
    
    
    (22,689
    )
    
    
    45,426Cash flows from investing activitiesPurchase of property and equipment
    
    
    (104,562
    )
    
    
    Proceeds from disposal of property and equipment
    
    
    72,795
    
    
    
    Bank fixed deposits  pledged
    
    
    (58,629
    )
    
    
    (135,818
    )Pledged notes receivable
    
    
    29,990
    
    
    
    30,129Net cash used in investing activities
    
    
    (60,406
    )
    
    
    (105,689
    )
 -7-




---



##### Table of Contents



Kid Castle Educational Corporation Condensed Consolidated Statements of Cash Flows  Continued (Expressed in US Dollars) Three months ended March 31,2005
    
    
    2004(Unaudited)Cash flows from financing activitiesProceeds from bank borrowings
    
    $
    795,968
    
    
    $
    2,829,827Repayment of bank borrowings
    
    
    (781,513
    )
    
    
    (2,169,859
    )Proceeds from capital leases
    
    
    57,089
    
    
    
    Repayment of capital leases
    
    
    (10,910
    )
    
    
    (5,662
    )Repayment of loan from officers/stockholders
    
    
    
    
    
    
    (586,529
    )Net cash provided by financing activities
    
    
    60,634
    
    
    
    67,777Net increase (decrease) in cash and cash equivalents
    
    
    (22,461
    )
    
    
    7,514Effect of exchange rate changes on cash and
cash equivalents
    
    
    (17,934
    )
    
    
    (30,792
    )Cash and cash equivalents at beginning of period
    
    
    213,564
    
    
    
    1,273,723Cash and cash equivalents at end of period
    
    $
    173,169
    
    
    $
    1,250,445Supplemental disclosure of significant non-cash
transactionsIncrease (decrease) of notes receivable and pledged
notes receivable corresponding to the increase
(decrease) in the following accounts:Deposits received
    
    $
    1,586
    
    
    $
    (18,896
    )Other payables
    
    $
    6,473
    
    
    $
    (10,112
    )Receipts in advance
    
    $
    258,156
    
    
    $
    (123,465
    )
 The accompanying notes are an integral part of these Condensed Consolidated Financial Statements. -8-




---



##### Table of Contents



Kid Castle Educational Corporation 
 Notes to Condensed Consolidated Financial Statements (Expressed in US Dollars) NOTE 1  ORGANIZATION AND DESCRIPTION OF BUSINESS Kid Castle Internet Technologies Limited (KCIT) was incorporated on December 17, 1999 under
the provisions of the Company Law of the Republic of China (ROC) as a limited liability company.
KCIT is engaged in the business of childrens education focusing on the English language. The
business comprises publication, sales and distribution of related books, magazines, audio and
videotapes and compact disc, franchising and sales of merchandises complementary to the business.
KCIT commenced operations in April 2000 when it acquired the above business from a related company,
Kid Castle Enterprises Limited (KCE), which was owned by two directors and stockholders of KCIT. On March 9, 2001, KCIT formed a wholly-owned subsidiary, Premier Holding Investment Property
Limited incorporated in the British Virgin Islands, which held the entire common stock of Higoal
Developments Limited (Higoal) incorporated in the Cayman Islands on March 8, 2001. On September
10, 2001, Higoal established a wholly owned subsidiary, Kid Castle Educational Software Development
Company Limited (KCES) in the Peoples Republic of China (the PRC). The existing operations of
Higoal are principally located in Taiwan and are being expanded in the PRC. In June 2002, after
KCIT undertook a series of group restructurings, KCIT became the direct owner of the outstanding
shares of Higoal. Premier Holding Investment Property Limited was then liquidated in June 2003. On September 18, 2002, Higoal issued 11,880,000 shares of common stock to the stockholders of
KCIT in exchange for 100% of the outstanding common stock of KCIT. As a result of this
reorganization, KCIT became a wholly owned subsidiary of Higoal. On October 1, 2002, Kid Castle
Educational Corporation (the Company), formerly King Ball International Technology Limited
Corporation entered into an exchange agreement with Higoal whereby the Company issued to the
stockholders of Higoal 11,880,000 shares of common stock of the Company in exchange for 100% of the
issued and fully paid up capital of Higoal. As a result of the share exchange, the former stockholders of Higoal hold a majority of the
Companys outstanding capital stock. Generally accepted accounting principles require in certain
circumstances that a company whose stockholders retain the majority voting interest in the combined
business to be treated as the acquirer for financial reporting purposes. Accordingly, the
acquisition has been accounted for as a reverse acquisition whereby Higoal is deemed to have
purchased the Company. However, the Company remains the legal entity and the Registrant for
Securities and Exchange Commission reporting purposes. In July 2003, KCES entered into an agreement with 21st Century Publishing House to
incorporate Jiangxi 21st Century Kid Castle Culture Media Co., Ltd (Culture Media).
It was agreed that KCES and 21st Century Publishing House each owned 50% ownership and
that each party contributed RMB$1 million for the incorporation. On July 2, 2004, KCES acquired
additional 40% of ownership in Culture Media from 21st Century Publishing House. KCES
now owns 90% of Culture Media. -9-




---



##### Table of Contents



The Company, Higoal and its subsidiaries collectively are referred to as the Group. The
operations of the Group are principally located in Taiwan and the PRC. NOTE 2 - BASIS OF PRESENTATION The accompanying financial data as of March 31, 2005 and for the three months ended March
31, 2005 and 2004 have been prepared by the Group, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been condensed or omitted
pursuant to such rules and regulations. However, the Group believes that the disclosures are
adequate to make the information presented not misleading. These financial statements should be
read in conjunction with the financial statements and the notes thereto included in the Groups
audited annual financial statements for the year ended December 31, 2004. The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates that affect the
reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent
assets and liabilities. Actual results could differ from these estimates. The Group has incurred operating losses since inception and hence, as of March 31, 2005, the
balance of accumulated deficit was $7,362,504. The Group plans to fund its working capital needs
by obtaining new credit lines from financial institutions and raising capital through the sale of
equity securities. If the Group is unable to meet its current operating plan, it will be required
to obtain additional funding. Management believes such funding will be available, but there can be
no assurances that such funding will be available, or if it is available, on terms acceptable to
the Group. Management believes that if funding is not available, other actions can and will be
taken to reduce costs. These actions may entail the Group to reduce headcount, sales and
marketing, other expansion activities, which may affect the future growth of the Groups
operations. NOTE 3 - SUMMARY OF IMPORTANT ACCOUNTING POLICIES REVENUE RECOGNITION Sales of books, magazines, audio and video tapes, compact disc and other merchandises are
recognized as revenue on the transfer of risks and rewards of ownership, which generally coincides
with the time when the goods are delivered to customers and title has passed. Provision is made
for expected future sales returns and allowances when revenue is recognized. Franchise fees are the annual licensing fees for franchisees to use the Groups brand name and
consulting services. Franchising income is recognized on a straight-line basis over the terms of
the relevant franchise agreements. ALLOWANCE FOR DOUBTFUL ACCOUNTS An allowance for doubtful accounts is provided based on the evaluation of collectibility and
aging analysis of notes and accounts receivables. -10-




---



##### Table of Contents



INVENTORIES Inventories are stated at the lower of cost or market. Cost includes all costs of purchase,
cost of conversion and other costs incurred in bringing the inventories to their present location
and condition, and is calculated using the weighted average method. Market value is determined by
reference to the sales proceeds of items sold in the ordinary course of business after the balance
sheet date or to management estimates based on prevailing market conditions. PROPERTY AND EQUIPMENT AND DEPRECIATION Property and equipment are stated at cost. Depreciation is computed using the straight-line
method to allocate the cost of depreciable assets over the estimated useful lives of the assets as
follows: Estimated useful life(in years)Land
    
    IndefiniteBuildings
    
    50Furniture and fixtures
    
    3-10Transportation equipment
    
    2.5-5Miscellaneous equipment
    
    5-10
 Maintenance, repairs and minor renewals are charged directly to the statement of
operations as incurred. When assets are disposed of, the related cost and accumulated depreciation
thereon are removed from the financial statements and any resulting gain or loss is included in the
statement of operations. LONG-LIVED ASSETS Long-lived assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of the assets might not be recoverable. The Group does not
perform a periodic assessment of assets for impairment in the absence of such information or
indicators. Conditions that would necessitate an impairment assessment include a significant
decline in the observable market value of an asset, a significant change in the extent or manner in
which an asset is used, or a significant adverse change that would indicate that the carrying
amount of an asset or group of assets is not recoverable. For long-lived assets to be held and
used, the Group measures fair value based on quoted market prices or based on discounted estimates
of future cash flows. INCOME TAXES The Company and its subsidiaries accounts for income taxes in accordance with Statement of
Financial Accounting Standards (SFAS) No. 109 Accounting for Income Taxes. Under SFAS No. 109,
deferred tax liabilities or assets at the end of each period are determined using the tax rate
expected to be in effect when taxes are actually paid or recovered. Valuation allowances are
established when it is considered more likely than not that the deferred tax assets will not be
realized. INTANGIBLE ASSETS Franchises and copyrights are stated at cost and amortized on the straight-line method over
their estimated useful lives of 10 years. COMPREHENSIVE INCOME (LOSS) -11-




---



##### Table of Contents



Comprehensive income (loss) is defined as the change in equity of a company during a period
from transactions and other events and circumstances excluding transactions resulting from
investments from owners and distributions to owners. Comprehensive income (loss) is disclosed in
the condensed consolidated statement of stockholders equity. NET EARNINGS (LOSS) PER COMMON SHARE The Group computes net earnings (loss) per share in accordance with SFAS No. 128, Earnings
per Share. Under the provisions of SFAS No. 128, basic net earnings (loss) per share is computed
by dividing the net earnings (loss) available to common shareholders for the period by the weighted
average number of shares of common stock outstanding during the period. The calculation of diluted
net earnings (loss) per share gives effect to common stock equivalents. For the three months ended
March 31, 2005 and 2004, the Group did not have any potential common shares. RECLASSIFICATION The presentation of certain prior information has been reclassified to conform to current
presentation. NOTE 4  RECENT ACCOUNTING PRONOUNCEMENTS In September 2004, the EITF delayed the effective date for the recognition and measurement
guidance previously discussed under EITF Issue No. 03-01, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments (EITF 03-01) as included in paragraphs
10-20 of the proposed statement. The proposed statement will clarify the meaning of
other-than-temporary impairment and its application to investments in debt and equity securities,
in particular investments within the scope of FASB Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities, and investment accounted for under the cost method.
The Group is currently evaluating the effect of this proposed statement on its financial position
and results of operations. In November 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 151,
Inventory Costs, which clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material. SFAS No. 151 will be effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. We do not believe the adoption of SFAS
No. 151 will have a material impact on our financial statements. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, which
eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have commercial substance.
SFAS No. 153 will be effective for nonmonetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. We do not believe the adoption of SFAS No. 153 will have a material
impact on our financial statements. NOTE 5  NOTES AND ACCOUNTS RECEIVABLE -12-




---



##### Table of Contents



March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)Notes and accounts receivable Third parties
    
    $
    3,198,682
    
    
    $
    2,420,647 Related parties (NOTE 10)
    
    
    281,286
    
    
    
    177,445Total
    
    
    3,479,968
    
    
    
    2,598,092Allowance for doubtful accounts and sales returns
    
    
    (576,747
    )
    
    
    (196,188
    )Notes and accounts receivable, net
    
    $
    2,903,221
    
    
    $
    2,401,904
 NOTE 6  INVENTORIES March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)Work in process
    
    $
    106,262
    
    
    $
    99,610Finished goods and other merchandises
    
    
    3,663,746
    
    
    
    3,655,8643,770,008
    
    
    
    3,755,474Less: Allowance for obsolete inventories and
decline of market value
    
    
    (786,118
    )
    
    
    (775,736
    )$
    2,983,890
    
    
    $
    2,979,738
 NOTE 7  OTHER RECEIVABLES March 31,
    
    
    December 31,2005
    
    
    2003(Unaudited)Other receivables  third parties:Tax paid on behalf of landlord
    
    $
    973
    
    
    $
    1,575Advances to staff
    
    
    84,856
    
    
    
    74,396Grants from Market Information Center
    
    
    
    
    
    
    29,959Receivables from Shanghai Wonderland Educational
Resources Co., Ltd. (Shanghai Wonderland) (Note (i))
    
    
    169,538
    
    
    
    87,082Other receivables
    
    
    150,161
    
    
    
    114,900Sub-total
    
    
    405,528
    
    
    
    307,912Other receivables  related parties (NOTE 10)
    
    
    14,822
    
    
    
    29,936$
    420,350
    
    
    $
    337,848
   Note:  (i)
    
    Shanghai Wonderland is a distributor of the Group. The Group loaned Shanghai Wonderland
RMB$500,000 (approximately $60,000), RMB$250,000 (approximately $30,477), and RMB$500,000 each
for operations in July 2004, January 2005, and March 2005, respectively, which are all
unsecured and bear no interest. These loans are due in one year. -13-




---



##### Table of Contents



NOTE 8  INTEREST IN ASSOCIATES March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)21st Century Kid Castle Language and Education Center
(Education Center) (Note (i))Investment cost
    
    $
    91,430
    
    
    $
    90,620Share of loss
    
    
    18
    
    
    
    (32,752
    )$
    91,448
    
    
    $
    57,868Tianjin Kid Castle Educational Investment Consulting Co., Ltd. (Tianjin
Consulting) (Note (ii))Investment cost
    
    $
    85,335
    
    
    $
    60,413Share of loss
    
    
    (56,890
    )
    
    
    (40,886
    )$
    28,445
    
    
    $
    19,527Lanbeisi Education &Culture Industrial Co., Ltd (Lanbeisi) (Note (iii))Investment cost
    
    $
    43,886
    
    
    $
    43,498Share of loss
    
    
    (26,566
    )
    
    
    (21,426
    )$
    17,320
    
    
    $
    22,072Total
    
    $
    137,213
    
    
    $
    99,467
   Note:  (i)
    
    In October 2003, the Group obtained the governments approval to co-found Education Center
with 21st Century Publishing House in the PRC. In 2004, Education Center
registered the total capital as RMB$1,500,000, and KCES and 21st Century Publishing
House each owns 50% of the investee. It has been determined that the Group has significant
influence and should therefore account for its investee on the equity method.For the three months ended March 31, 2005 and 2004, the Group recognized investment income
(loss) accounted for under the equity method in Education Center of $33,084 and ($41),
respectively.(ii)
    
    On April 1, 2004, the Group signed a joint venture agreement with Tianjin Foreign Enterprises
& Experts Service Corp., in Tianjin City, PRC. Pursuant to this joint venture agreement, the
Group and Tianjin Foreign Enterprises & Experts Service Corp. each owns a 50% interest in
Tianjin Kid Castle Educational Investment Consulting Co., Ltd. It has been determined that
the Group has significant influence and should therefore account for its investee on the
equity method.For the three months ended March 31, 2005, the Group recognized an investment loss of
$15,649, accounted for under the equity method, in Tianjin Consulting.(iii)
    
    On April 28, 2004, the Group signed a joint venture agreement with Lanbeisi Education &
Culture Industrial Co., Ltd in Sichuan Province, PRC and Sichuan Province Education
Institutional Service Center in Sichuan Province, PRC. Pursuant to this joint venture
agreement, -14-




---



##### Table of Contents



the Group, Lanbeisi Education & Culture Industrial Co., Ltd and Sichuan Province Education
Institutional Service Center own, respectively, 45%, 45% and 10% interests in Sichuan
Lanbeisi Kid Castle Education Development Co., Ltd. It has been determined that the Group
has significant influence and should therefore account for its investee using the equity
method.For the three months ended March 31, 2005, the Group recognized an investment loss of
$4,952, accounted for under the equity method, in Lanbeisi. NOTE 9  INCOME TAXES The income taxes of the Group are substantially attributable to the operations in Taiwan and
the PRC whose statutory tax rates are 25% and 15%, respectively. The principal differences between
taxes on income computed at the applicable statutory income tax rates and recorded income tax
expense are as follows: Three months ended March 31,2005
    
    
    2004(Unaudited)Income taxes credit calculated on applicable statutory tax rates
    
    $
    (99,849
    )
    
    $
    (432,789
    )Higher/(lower) effective income tax rates of other countries
    
    
    16,296
    
    
    
    33,955Valuation allowance
    
    
    384,329
    
    
    
    146,148Non-taxable income
    
    
    (57,694
    )
    
    
    (18,720
    )Non-deductible expenses
    
    
    (129,302
    )
    
    
    226,322Tax on undistributed earnings
    
    
    29,673
    
    
    
    45,085Income taxes expenses as recorded in statement of operations
    
    $
    143,453
    
    
    $
    
 At March 31, 2005, KCESD had net operating loss of approximately US$1,587,730, available
to be carried forward to offset future taxable income which will expire in the period from 2006 to
2010. KCESDs net operating loss carry-forwards to offset future taxable income is insignificant. NOTE 10  RELATED PARTY TRANSACTIONS  A.
    Names of related parties and relationship with the Group are as follows: Names of related parties
    
    Relationship with the CompanyMr. Kuo-An Wang
    
    He is a director, stockholder
and chairman of the CompanyMr. Yu-En Chiu
    
    He is a director, stockholder
and vice chairman of the CompanyChevady Culture Enterprise Limited
(CCE)
    
    Its chairman is Mr. Kuo-An WangPrivate Kid Castle Short Term Language
Cram School (PKC Language)
    
    Its chairman is Mr. Yu-En ChiuTaipei Country Private Kid Castle
Short Term Language Cram School (TCP
PKC)
    
    Its chairman is Mr. Yu-En ChiuTaipei Country Private Chevady
    
    Its chairman is Mr. Yu-En Chiu
 -15-




---



##### Table of Contents



Names of related parties
    
    Relationship with the CompanyPreschool (TCP Chevady)Taipei Country Private Chung-hua
Preschool (TCP Chung-hua)
    
    Its chairman is Mr. Yu-En ChiuTaipei Country Private Wonderland
Preschool (TCP Wonderland)
    
    Its chairman is Mr. Yu-En ChiuTaipei City Private Kid Castle
Preschool (TCP Kid Castle)
    
    Its chairman is Mr. Yu-En Chiu21st Century Publishing House
(Publishing House)
    
    A joint venturerJiangxi 21st Century Kid Castle
Culture Media Co., Ltd (Culture
Media)
    
    An investment accounted for under
the equity method before July 2,
2004. It has become a
consolidated entity after July 2,
2004.21st Century Kid Castle Language and
Education Center (Education Center)
    
    An investment accounted for under
the equity method.Tianjin Kid Castle Educational
Investment Consulting Co.,
Ltd.(Tianjin Consulting)
    
    An investment accounted for under the equity methodSichuan Lanbeisi Kid Castle Education
Development Co., Ltd. (Lanbeisi)
    
    An investment accounted for under the equity method
  B.
    Significant transactions and balances with related parties are as follows: Three months ended March 31,2005
    
    
    2004(Unaudited)(i)
    
    Sales to:- PKC Language
    
    $
    3,030
    
    
    $
    3,979- TCP PKC
    
    
    3,030
    
    
    
    3,979- TCP Chevady
    
    
    7,614
    
    
    
    5,191- TCP Chung-hua
    
    
    7,614
    
    
    
    4,086- TCP Wonderland
    
    
    5,349
    
    
    
    5,191- TCP Kid Castle
    
    
    4,996
    
    
    
    4,949- English School
    
    
    6,034
    
    
    
    - Tianjin Consulting
    
    
    4,589
    
    
    
    - Lanbeisi
    
    
    26,793
    
    
    
    $
    69,049
    
    
    $
    27,375(ii)
    
    Rental income from:- CCE
    
    $
    476
    
    
    $
    450$
    476
    
    
    $
    450(iii)
    
    Franchising income from:- PKC Language
    
    $
    136
    
    
    $
    129- TCP PKC
    
    
    136
    
    
    
    129- TCP Kid Castle
    
    
    1,854
    
    
    
    2,014- TCP Chung-Hua
    
    
    
    
    
    
    214- TCP Chevady
    
    
    927
    
    
    
    1,007- TCP Wonderland
    
    
    927
    
    
    
    1,007$
    3,980
    
    
    $
    4,500(iv)
    
    Purchase from:- Publishing House
    
    $
    319,640
    
    
    $
    $
    319,640
    
    
    $
    
 -16-




---



##### Table of Contents



(v)
    The two directors and stockholders, Mr. Kuo-An Wang and Mr. Yu-Eng Chiu, have given
personal guarantees to certain bank loans and borrowings. Please see the details as described
in Note 12  Borrowings.The management of the Group is of the opinion that the above transactions were carried out
in the normal course of business at agreed upon terms.(vi)
    Accounts and notes receivable  related parties: March 31,
    
    
    December 31,Name of related parties
    
    2005
    
    
    2004(Unaudited)- KCE
    
    $
    3,803
    
    
    $
    - PKC Language
    
    
    20,345
    
    
    
    16,772- TCP PKC
    
    
    20,345
    
    
    
    16,772- TCP Chung-hua
    
    
    39,353
    
    
    
    27,506- TCP Chevady
    
    
    40,505
    
    
    
    24,431- TCP Wonderland
    
    
    40,505
    
    
    
    24,431- TCP Kid Castle
    
    
    47,564
    
    
    
    31,586- Education Center
    
    
    57
    
    
    
    726- Tianjin Consulting
    
    
    15,439
    
    
    
    15,746- Lanbeisi
    
    
    53,370
    
    
    
    19,475$
    281,286
    
    
    $
    177,445
  (vii)
    Other receivables  related parties: March 31,
    
    
    December 31,Name of related parties
    
    2005
    
    
    2004(Unaudited)Amount due from Publishing House (Note 1)
    
    $
    5,408
    
    
    $
    13,781Amount due from Education Center (Note 2)
    
    
    271
    
    
    
    268Amount due from Tianjin Consulting (Note 3)
    
    
    
    
    
    
    6,825Amount due from Lanbeisi (Note 4)
    
    
    9,143
    
    
    
    9,062$
    14,822
    
    
    $
    29,936
   Note: 1.
    As of March 31, 2005 and December 31, 2004, the amounts due from Publishing House consist
primarily of certain operating expenses paid on behalf of Publishing House.2.
    Education Center was founded in October 2003. The amount due from the associate is mainly
inventory purchases paid by the Group on behalf of Education Center. The amount due from this
related party has no fixed repayment term and bears no interest. -17-




---



##### Table of Contents



3.
    Tianjin Consulting was incorporated in April 2004. The Group paid certain pre-operating costs
on behalf of Tianjin Consulting. The amount due from this related party has no fixed repayment
term and bears no interest.4.
    Lanbeisi was incorporated in April 2004. The Group paid pre-operating costs of RMB$75,000
(approximately $9,000) on behalf of Lanbeisi. The amount due from this related party has no
fixed repayment term and bears no interest.  (viii)
    Prepayments and other current assets March 31,
    
    
    December 31,Name of related parties
    
    2005
    
    
    2004(Unaudited)Prepayments to Publishing House
    
    
    168,026
    
    
    
    265,223$
    168,026
    
    
    $
    265,223
 Prepayments to Publishing House are mainly for inventory ordered by Culture Media.
According to the purchase agreements signed with Publishing House, Culture Media has to prepay a
certain percentage of inventories purchased upon the effectiveness of the contracts. The remaining
payments are to be made three months after the initial payment.  (ix)
    Accounts payable  related parties: March 31,
    
    
    December 31,Name of related parties
    
    2005
    
    
    2004(Unaudited)- Publishing House
    
    $
    391,397
    
    
    $
    265,077$
    391,397
    
    
    $
    265,077
 NOTE 11  INTANGIBLE ASSETS March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)Gross carrying amountFranchise
    
    $
    1,078,380
    
    
    $
    1,072,939Copyrights
    
    
    633,914
    
    
    
    630,7161,712,294
    
    
    
    1,703,655Less: Accumulated amortizationFranchise
    
    
    (539,190
    )
    
    
    (509,646
    )Copyrights
    
    
    (316,957
    )
    
    
    (299,590
    )(856,147
    )
    
    
    (809,236
    )Net
    
    $
    856,147
    
    
    $
    894,419
 -18-




---



##### Table of Contents



Amortization charged to operations was $42,835 and $40,509 for the three months ended March 31, 2005 and 2004,
respectively. The estimated aggregate amortization expenses for each of the five succeeding fiscal years are
as follows: 2006
    
    $
    171,3402007
    
    
    171,3402008
    
    
    171,3402009
    
    
    171,3402010
    
    
    171,340$
    856,700
 NOTE 12  BORROWINGS March 31,
    
    
    December 31,Notes
    
    
    2005
    
    
    2004(Unaudited)Bank term loans
    
    (i)
    
    
    $
    950,660
    
    
    $
    945,932Short-term unsecured bank loans
    
    (ii)
    
    
    253,566
    
    
    
    725,323Mid-term loan
    
    (iii)
    
    
    958,809
    
    
    
    1,130,827Mid-term secured bank loan
    
    (iv)
    
    
    2,157,947
    
    
    
    1,482,7254,320,982
    
    
    
    4,284,807Less: Balances maturing within one year included
in current liabilitiesBank term loans
    
    
    
    
    
    
    728,627
    
    
    
    721,896Short-term unsecured bank loans
    
    
    
    
    
    
    253,566
    
    
    
    725,323Mid-term loan
    
    
    
    
    
    
    743,547
    
    
    
    726,720Mid-term secured bank loan
    
    
    
    
    
    
    717,286
    
    
    
    459,0432,443,026
    
    
    
    2,632,982Bank borrowings maturing after one year
    
    
    
    
    
    $
    1,877,956
    
    
    $
    1,651,825
   Note: (i)
    
    This line item represents bank loans that have been secured by a pledge of post-dated checks
amounting to $1,794,314 and $1,625,505 that we have received from franchisees and the Groups
bank deposits of $113,275 and $57,813 as of March 31, 2005 and December 31, 2004,
respectively, for the purpose of financing operations. The repayment dates of the loans
coincided with the maturity dates of the corresponding pledged post-dated checks. The
weighted average interest rates were 5,88% and 5.66% per annum as of March 31, 2005 and 2004,
respectively. For the three months ended March 31, 2005 and 2004, the interest
expenses charged to operations amounted to $14,758 and $12,177, respectively.(ii)
    
    In August 2003, KCIT obtained an unsecured short-term loan in the amount of $253,565, which
is guaranteed by two directors and stockholders of the Group, to finance the Groups
operations. The loan bears interest at the Taiwan basic borrowing rate plus 1.20% per annum -19-




---



##### Table of Contents



and is due and payable in June 2005. The applicable interest rate is approximately 4.50% per
annum as of March 31, 2005.In March 2004, KCIT obtained an unsecured short-term loan in the amount of
$316,957, which was guaranteed by two directors and stockholders of the Group, to
finance the Groups operations. The loan bears interest at the Taiwan basic borrowing
rate plus 1.65% per annum and was repaid in full in February 2005.In April 2004, KCIT obtained another unsecured short-term loan in the amount of
$147,102, which is also guaranteed by two directors and stockholders of the Group, to
finance the Groups operations. The loan bears interest at the Taiwan basic borrowing
rate plus 1.24% per annum and was repaid in full in January 2005.For the three months ended March 31, 2005 and 2004, the interest expense charged to
operations from the above three unsecured short-term loans amounted to $11,840 and
$3,558, respectively.(iii)
    
    In March 2003, KCIT obtained a loan of $633,914 from a financial institution, which bore
interest at 13.5% per annum and was repayable in 18 equal monthly installments, to finance the
Groups operations. The last installment was due on September 30, 2004 and the Group has
extended the term with the financial institution to September 2006. Pursuant to the amended
terms of the loan, the loan bears interest at 9.69% per annum and is repayable in 24 equal
monthly installments. As of March 31, 2005 and December 31, 2004, the loan was collateralized
by KCITs refundable deposits of $126,782 and $126,143, respectively, and guaranteed by two
directors and stockholders of the Group. As of March 31, 2005, the Group had repaid $172,435
of the loan, and $461,479 remains outstanding.In November 2004, KCIT signed a loan contract with a new financial institution to obtain a
loan of $633,914 for the purpose of financing operations, which is guaranteed by two
directors of the Group. The loan bears interest at 5.26% per annum and is repayable in 18
monthly installments. The last installment will be due on May 10, 2006. As of March 31,
2005, the loan was collateralized by KCITs refundable deposits of $158,479, and the Group
had repaid $136,584 of the loan, and $467,330 remains outstanding.For the three months ended March 31, 2005 and 2004, the interest expenses charged to
operations from the aforementioned loans amounted to $19,550 and $9,721, respectively.(iv)
    
    In August 2003, KCIT obtained a bank loan in the principal amount of $1,014,263 to repay its
mortgage loan that was originally granted by a bank on October 5, 2001 and to finance its
operations. The loan is secured by the Groups land and buildings and personal guarantees
provide by two directors and stockholders of the Group. The loan bears interest at the
lending banks basic borrowing rate plus 1.45% per annum. On July 19, 2004, the bank extended
the term of the loan and the Group repays the loan, which is now repayable in 168 equal
monthly installments starting July 30, 2004. As of March 31, 2005 and 2004, the applicable
interest rate is approximately 3.14% and 4.79% per annum, respectively. As of March 31, 2005,
the Group had repaid $43,981, and $970,282 remains outstanding under the loan.In March 2004, KCIT obtained a new bank loan of $792,393, which bears interest at 5.60% per
annum and is repayable in 24 equal monthly installments. The last installment will be due on
March 31, 2006. As of March 31, 2005, the loan was pledged by the KCITs bank deposit of
$241,141, and guaranteed by two directors of the Group. As of March 31, 2005, the Group had
repaid $385,035, and $407,358 remains outstanding under the loan. -20-




---



##### Table of Contents



In January 2005, KCIT obtained a bank loan of $475,436, which bears interest at 6.00% per
annum and is repayable in 36 equal monthly installments. The last installment will be due
on February 3, 2008. As of March 31, 2005, the Group had repaid $12,086, and $463,350
remains outstanding under the loan.In March 2005, another bank loan of $316,957 was obtained. The loan bears interest at
the Taiwan basic borrowing rate plus 1.65% per annum and is repayable in 36 equal monthly
installments. The applicable interest rate as of March 31, 2005 is approximately 5.33%.
The last installment will be due in March, 2008.For the three months ended March 31, 2005 and 2004, the interest expenses charged to
operations from the above loans amounted to $14,335 and $11,620, respectively. NOTE 13  RECEIPTS IN ADVANCE The balance comprises: March 31,
    
    
    December 31,Notes
    
    
    2005
    
    
    2004(Unaudited)Current liabilities:Sales deposits received
    
    (i)
    
    
    $
    555,759
    
    
    $
    565,053Franchising feesreceived
    
    (ii)
    
    
    1,756,352
    
    
    
    1,906,286Subscription fees received
    
    (iii)
    
    
    493,198
    
    
    
    435,635Others
    
    
    
    
    
    
    25,935
    
    
    
    89,5842,831,244
    
    
    
    2,996,558Long-term liabilities:Franchising feesreceived
    
    (ii)
    
    
    1,421,803
    
    
    
    1,124,809$
    4,253,047
    
    
    $
    4,121,367
   Note: (i)
    
    The balance represents receipts in advance from customers for goods to be sold to them.(ii)
    
    The balance mainly represents franchising fees received in advance which is attributable to
the periods after the respective period end dates.(iii)
    
    The balance represents subscription fees received in advance for subscription of
magazines published by the Group. NOTE 14  RETIREMENT PLANS The Group has a defined benefit retirement plan (the Plan) covering all regular employees of
KCIT, its ROC subsidiary in Taiwan. Under the funding policy of the Plan, commencing from
September 2003, KCIT contributes monthly an amount equal to 2% of the employees total salaries and
wages, to an independent retirement trust fund deposited with the Central Trust of China in
accordance with the ROC Labor Standards Law in Taiwan. The retirement fund is not included in the
Groups -21-




---



##### Table of Contents



financial statements. Net periodic pension cost is based on annual actuarial valuations
which use the projected unit credit cost method of calculation and is charged to the consolidated
statement of operations on a systematic basis over the average remaining service lives of current
employees. Under the plan, the employees are entitled to receive retirement benefits upon
retirement in the manner stipulated by the ROC Labor Standard Law in Taiwan. The benefits under the
plan are based on various factors such as years of service and the final base salary preceding
retirement. The net periodic pension cost is as follows: Three months ended March 31,2005
    
    
    2004(Unaudited)Service cost
    
    $
    25,500
    
    
    $
    15,424Interest cost
    
    
    4,884
    
    
    
    1,732Expected return on assets
    
    
    (1,697
    )
    
    
    (367
    )Amortization of unrecognized loss
    
    
    428
    
    
    
    322Net periodic pension cost
    
    $
    29,115
    
    
    $
    17,111
 The Group previously disclosed in its financial statements for the year ended December
31, 2004, that it expected to contribute $46,679 to the Plan in 2005. As of March 31, 2005 and
2004 contributions made by the Group amounted to $11,497 and $23,319, respectively. NOTE 15  GEOGRAPHICAL SEGMENTS The Group is principally engaged in the business of child educational teaching materials and
related services focusing on English language in Taiwan and the PRC. Accordingly, the Group has
two reportable geographic segments: Taiwan and the PRC. The Group evaluates the performance of each
geographic segment based on its net income or loss. The Group also accounts for inter-segment
sales as if the sales were made to third parties. Information concerning the operations in these
geographical segments is as follows: Taiwan
    
    
    The PRC
    
    
    Total
    
    
    Corporate
    
    
    Eliminations
    
    
    ConsolidatedThree months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months ended
    
    
    Three months endedMarch 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004RevenueExternal revenue
    
    $
    2,313,293
    
    
    $
    2,241,656
    
    
    $
    805,513
    
    
    $
    394,238
    
    
    $
    3,118,806
    
    
    $
    2,635,894
    
    
    $
    4,186
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    3,122,992
    
    
    $
    2,635,894Inter-segment revenue
    
    
    522
    
    
    
    1,362
    
    
    
    
    
    
    
    
    
    
    
    522
    
    
    
    1,362
    
    
    
    
    
    
    
    
    
    
    
    (522
    )
    
    
    (1,362
    )
    
    
    
    
    
    
    $
    2,313,815
    
    
    $
    2,243,018
    
    
    $
    805,513
    
    
    $
    394,238
    
    
    $
    3,119,328
    
    
    $
    2,637,256
    
    
    $
    4,186
    
    
    $
    
    
    
    $
    (522
    )
    
    $
    (1,362
    )
    
    $
    3,122,992
    
    
    $
    2,635,894Profit (loss) from
Operations
    
    $
    452,556
    
    
    $
    (10,560
    )
    
    $
    (206,377
    )
    
    $
    (293,247
    )
    
    $
    246,178
    
    
    $
    (303,807
    )
    
    $
    (57,590
    )
    
    $
    (69,395
    )
    
    $
    
    
    
    $
    31,187
    
    
    $
    188,589
    
    
    $
    (342,015
    )Capital expenditures
    
    $
    11,475
    
    
    $
    
    
    
    $
    3,208
    
    
    $
    
    
    
    $
    14,683
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    14,683
    
    
    $
    
 March 31,
    
    
    December 31,
    
    
    March 31,
    
    
    December 31,
    
    
    March 31,
    
    
    December 31,
    
    
    March 31,
    
    
    December 31,
    
    
    March 31,
    
    
    December 31,
    
    
    March 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Total assets
    
    $
    10,869,782
    
    
    $
    10,313,287
    
    
    $
    2,909,664
    
    
    $
    2,827,431
    
    
    $
    13,779,446
    
    
    $
    13,140,718
    
    
    $
    30,341
    
    
    $
    30,225
    
    
    $
    (356,015
    )
    
    $
    (389,519
    )
    
    $
    13,453,772
    
    
    $
    12,781,424
 NOTE 16  COMMITMENT AND CONTINGENCIES A. Lease Commitment -22-




---



##### Table of Contents



As of March 31, 2005, the Companys future minimum lease payments under non-cancellable
operating lease expiring in excess of one year are as follows: Years ending December 31,2005
    
    $
    169,4152006
    
    
    247,9352007
    
    
    221,7532008
    
    
    207,5402009
    
    
    135,129$
    981,772
 B. Going concern The accompanying financial statements have been prepared assuming the Group will continue as a
going concern. As the Group is aggressively expanding its business in the PRC and the Groups PRC
operation is still in an emerging stage and has not turned profitable, the Group has suffered
recurring losses from operations and has a net capital deficiency. The above conditions raise
substantial doubt about the Groups ability to continue as a going concern, if the investment in
the PRC will not gradually see returns. As discussed in Note 12, the majority of the Groups
existing loans were guaranteed by two directors of the Group who have expressed their continuous
support to the Group until other sources of funds have been obtained. Moreover, the Group
successfully obtained new bank facilities in the first quarter of 2005. Management believes that,
with continuous growth in the sales in the PRC, the existing directors support and the new bank
facilities, the Group will have sufficient funds for operations. The financial statements do no
include any adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that may result from the
outcome of this uncertainty. -23-




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION This report contains certain forward-looking statements and information relating to us that
are based on the beliefs and assumptions made by our management as well as information currently
available to the management. When used in this document, the words anticipate, believe,
estimate, and expect and similar expressions, are intended to identify forward-looking
statements. Such statements reflect our current views with respect to future events and are subject
to certain risks, uncertainties and assumptions. If one or more of these risks or uncertainties
materialize, or if underlying assumptions prove incorrect, actual results may vary materially from
those described herein as anticipated, believed, estimated or expected. Certain of these risks and
uncertainties are discussed under the caption Factors That May Affect Our Future Results And
Financial Condition contained herein and other factors disclosed in our filings with the
Securities and Exchange Commission including, but not limited to our Annual Report on Form 10-K for
the year ended December 31, 2004. We do not intend to update these forward-looking statements. GENERAL We are engaged in the business of childrens education, focusing on the publication and sale
of kindergarten language school and primary school teaching materials and magazines. We also
provide management and consulting services to our franchised kindergarten and language schools. Our
teaching materials include books, audio tapes, video tapes and compact discs. A major portion of
our educational materials focuses on English language education. We also sell educational tools and
equipment that are complementary to our business. Our major business originally started in Taiwan.
In 2001, we started to expand our business in the Peoples Republic of China (PRC). We officially
launched our operations in Shanghai in April 2002. As in Taiwan, we offer advanced teaching
materials and tools, and monthly and bi-weekly magazines to provide children ranging from 2 to 12
years of age a chance to learn exceptional English language and computer skills, and to provide a
pre-school education program. CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES Our discussion and analysis of our financial condition and results of operations are based
upon our financial statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates, including those related to product returns, bad debts, inventories, equity
investments, income taxes, financing operations, pensions, commitments and contingencies. We base
our estimates on historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or conditions. We
believe the following critical accounting policies affect our more significant judgments and
estimates used in the preparation of our financial statements. Revenue Recognition.We recognize sales of teaching materials and educational tools and
equipment as revenue when title of the product and risk of ownership are transferred to the
customer, which occurs at the time of delivery, or when the goods arrive at the customer designated
location, depending on the associated shipping terms. Additionally, we deliver products sold by our
distributors directly to the distributors customers and as such the delivered goods are recognized
as revenue in a similar way as sales to our direct customers. We estimate sales returns and
discounts based on historical experience and record them as reductions to revenues. -24-




---



##### Table of Contents



If market conditions were to decline, we may take actions to increase sales discounts,
possibly resulting in an incremental reduction of revenue at the time when revenues are recognized. Allowance for Doubtful Accounts.We maintain allowances for doubtful accounts for estimated
losses resulting from the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required. Allowance for Obsolete Inventories and Lower of Cost or Market.We write down our inventory
for estimated obsolescence or unmarketable inventory equal to the difference between the cost of
inventory and the estimated market value based upon assumptions about inventory aging, future
demand and market conditions. If actual market conditions are less favorable than those projected
by management, additional inventory write-downs may be required. Investment Impairments.We hold equity interests in companies having operations in areas
within our strategic focus. We record an investment impairment charge when we believe an investment
has experienced a decline in value that is not temporary. Future adverse changes in market
conditions or poor operating results of underlying investments could result in losses or an
inability to recover the carrying value of the investments that may not be reflected in an
investments current carrying value, thereby possibly requiring an impairment charge in the future. Fixed Assets and Depreciation.Our fixed assets are stated at cost. Major improvements and
betterments to existing facilities and equipment are capitalized. Expenditures for maintenance and
repairs that do not extend the life of the applicable asset are charged to expense as incurred.
Buildings are depreciated over a 50-year term. Fixtures and equipment are depreciated using the
straight-line method over their estimated useful lives, which range from two-and-a-half years to
ten years. Impairment of Long-Lived Assets.We review our fixed assets and other long-lived assets for
impairment whenever events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be
generated by the asset over its remaining useful life. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. The estimate of fair value is generally based on
quoted market prices or on the best available information, including prices for similar assets and
the results of using other valuation techniques. As of March 31, 2005, the balance of our amortizable intangible assets was $856,147, including
franchise-related intangible assets of $539,190 and copyrights of $316,957. The amortizable
intangible assets are amortized on a straight-line basis over estimated useful lives of 10 years.
In determining the useful lives and recoverability of the intangibles, assumptions must be made
regarding estimated future cash flows and other factors to determine the fair value of the assets,
which may not represent the true fair value. If these estimates or their related assumptions change
in the future, there may be significant impact on our results of operations in the period of the
change incurred. Income Taxes.We account for income taxes under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases, and tax loss carry-forwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income -25-




---



##### Table of Contents



in the period that includes the enactment date. Deferred tax assets are subject to valuation
allowances based upon managements estimates of realizability. Actual results may differ
significantly from managements estimate. RESULTS OF OPERATIONS Comparison of The Three Months Ended March 31, 2005 and 2004 Total Net Operating Revenue.Total net operating revenue consists of sales of goods,
franchising income and other operating revenue. Total net operating revenues increased by $512,654,
or 20%, to $3,122,992 for the three months ended March 31, 2005 from $2,610,338 for the three
months ended March 31, 2004, including the increase in sales of goods of $345,302 and the
franchising income of $69,793 and other operating revenues of $97,559 Sales of goods.The increase in sales of goods, from $2,029,853 for the three months ended
March 31, 2004 to $2,375,155 for the three months ended March 31, 2005, or 17%, was mainly due to
the increase in net sales of goods generated from our Shanghai operations of $301,144, or 101%, to
$598,895 for the three months ended March 31, 2005 from $297,751 for the three months ended March
31, 2004. Franchising income.The increase in franchising income, from $528,132 for the three months
ended March 31, 2004 to $597,925 for the three months ended March 31, 2005, or 13%, was mainly due
to the increase in the number of our franchised schools in Shanghai. Franchising income for
Shanghai increased by $110,039 from $96,488 for the three months ended March 31, 2004 to $206,527
for the three months ended March 31, 2005. Other operating revenue.Our other operating revenues represent revenues from other activities
and services such as training of teachers, arranging for personal English language tutors,
organizing field trips and educational fairs, and fees for designing the school layout of our
franchised schools. Other operating revenue increased by $97,559, or 186%, to $149,912 for the
three months ended March 31, 2005 from $52,353 for the three months ended March 31, 2004. The
increase was mainly due to revenue generated from our services rendered in connection with the
construction and design layout of our franchised schools and sales of education-related equipment
to our franchised schools. Gross Profit.Gross profit increased by $260,915, or 15%, to $2,007,452 for the three months
ended March 31, 2005 from $1,746,537 for the three months ended March 31, 2004. The increase in
gross profit was attributable to the fact that the rate of increase in our franchising costs and
other operating costs from March 31, 2004 to March 31, 2005 was lower than the rate of increase in
our franchising income and other operating income for the same period. In addition, the gross
margin decreased from 67% for the three months ended March 31, 2004 to 61% for the three months
ended March 31, 2005, primarily because of the consolidation of Culture Media that has a lower
gross margin than KCIT and KCESD. Culture Medias gross margin for the three months ended March 31,
2005 was approximately 50%. Total Operating Expenses.Total operating expenses decreased by $324,203, or 15%, to
$1,818,863 for the three months ended March 31, 2005 from $2,143,066 for the three months ended
March 31, 2004. Advertising costs decreased by $93,279, or 74%, to $33,363 for the three months
ended March 31, 2005 from $126,642 for the three months ended March 31, 2004. This decrease was
mainly due to the allocation of our adverting budget for 2005. We do most of our advertising
during the summer vacation period rather than winter vacation period, and therefore incur most of
our advertising expenses in the second and third quarters. -26-




---



##### Table of Contents



Other Operating Expenses.Other operating expenses decreased by $230,924, or 11%, to
$1,785,500 for the three months ended March 31, 2005 from $2,016,424 for the three months ended
March 31, 2004, principally due to decreases in salary expenses resulting from a reduction in
employee headcount in our Taiwan operations. Interest Expenses, Net.Net interest expenses increased by $37,488, or 172%, to $59,253 for
the three months ended March 31, 2005 from $21,765 for the three months ended March 31, 2004,
primarily due to the increase of the borrowings during the three months ended March 31, 2005
comparing to the three months ended March 31, 2004 (please refer to Note 12 to our Condensed
Consolidated Financial Statements for more information). Provision for Taxes.Provision for taxes for the three months ended March 31, 2005 and 2004
were $143,453 and $0, respectively. These provisions for income taxes relate to income taxes
resulting from our operations in Taiwan. LIQUIDITY AND CAPITAL RESOURCES Comparison of Fiscal Years 2004 and 2003 As of March 31, 2005, our principal sources of liquidity included cash and bank balances of
$173,169 which decreased from $213,564 at December 31, 2004. The decrease was mainly due to the
expenditures to fund the daily operations. Net cash (used in) provided by operating activities was ($22,689) and $45,426 during the three
months ended March 31, 2005 and 2004, respectively. Net cash used in operating activities during
the three months ended March 31, 2005 was primarily attributed to net loss. Net cash used in investing activities were $60,406 and $105,689 during the three months ended
March 31, 2005 and 2004, respectively. The $45,283 difference was primarily attributable to cash
used in purchase of property and equipment of $104,562 during the three months ended March 31, 2005
and the increase of pledged bank fixed deposits by 58,629 during the three months ended March 31,
2005, compared to increase of $135,818 during the three months ended March 31, 2004. Net cash provided by financing activities during the three months ended March 31, 2005 was
$60,634 as compared to $67,777 during the three months ended March 31, 2004. The $7,143 difference
was primarily attributable to the decrease of net proceeds from bank borrowings of 645,512, and the
repayment of loans from officers/shareholders of $586,529 during the three months ended March 31,
2004. Off-Balance Sheet Arrangements As of March 31, 2005, we did not engage in any off-balance sheet arrangements as defined in
Item 303(a)(4) of Regulation S-K promulgated by the SEC under the Securities Exchange Act of 1934. -27-




---



##### Table of Contents



Contractual Obligations The Company, Higoal and its subsidiaries are collectively referred to as the Group. The
following table represents the Groups contractual obligations: Payments Due by PeriodTotal
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter(Thousand dollars)Contractual obligationsBank borrowing
    
    
    4,321
    
    
    
    2,474
    
    
    
    780
    
    
    
    366
    
    
    
    89
    
    
    
    89
    
    
    
    523Pension benefit
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29Operating leases
    
    
    1,508
    
    
    
    169
    
    
    
    248
    
    
    
    222
    
    
    
    208
    
    
    
    135
    
    
    
    526Total
    
    
    5,858
    
    
    
    2,643
    
    
    
    1,028
    
    
    
    588
    
    
    
    297
    
    
    
    224
    
    
    
    1,078
 Bank Borrowing One of our financing sources is from bank borrowings. As of March 31, 2005 and 2004, the
balances of bank borrowings, including current and non-current portions, were $4,320,982 and
$3,217,258, respectively. Equity Investments in Joint Ventures On May 28, 2004, the Group signed a joint venture agreement with Zhangjhou Yu Hua Educational
Investment Co., Ltd. in Henan Province, PRC to establish a company, Henan Kid Castle Education
Development Co., Ltd. with registered capital of RMB$300,000. Pursuant to this joint venture
agreement, the Group and Zhangjhou Yu Hua Educational Investment Co., Ltd. own 65% and 35%
interests in Henan Kid Castle Education Development Co., Ltd., respectively. No capital
contribution has yet been made for the joint venture as of March 31, 2005. On June 29, 2004, the Group signed a joint venture agreement with Li Kai and Zhang Wuen Shou
in the PRC to establish a company, Shanxi Kid Castle Education Development Co., Ltd. with
registered capital of RMB$500,000. Pursuant to this joint venture agreement, the Group, Li Kai and
Zhang Wuen Shou own, respectively, 51%, 30% and 19% interests in Shanxi Kid Castle Education
Development Co., Ltd. No capital contribution has yet been made for the joint venture as of March
31, 2005. Pension Benefit We have a non-contributory and funded defined benefit retirement plan (the Plan) covering
all regular employees of KCIT, our subsidiary in Taiwan, as described in Note 14 to our Condensed
Consolidated Financial Statements. The benefits expected to be paid in each of the next five fiscal
years, and in the aggregate for the five fiscal years thereafter are $0 and $28,845, respectively.
We also make defined contributions to a retirement benefits plan for our employees in the PRC in
accordance with local regulations. The contributions made by us for the three months ended March
31, 2005 and 2004 amounted to $11,497, and $23,319, respectively. -28-




---



##### Table of Contents



Operating Leases We have entered into several non-cancelable lease arrangements for administrative office
space, warehouse space and sales offices for various lengths of time. Going Concern The accompanying financial statements have been prepared assuming the Group will continue as a
going concern. As the Group is aggressively expanding its business in the PRC and the Groups PRC
operation is still in an emerging stage and has not turned profitable, the Group has suffered
recurring losses from operations and has a net capital deficiency. The above conditions raise
substantial doubt about the Groups ability to continue as a going concern, if the investment in
the PRC does not gradually see returns. As discussed in Note 12 to our Condensed Consolidated
Financial Statements, the majority of the Groups existing loans were guaranteed by two directors
of the Group who have expressed their continuous support to the Group until other sources of funds
have been obtained. Moreover, the Group successfully obtained new bank facilities in the first
quarter of 2005 (please refer to Note 12 to our Condensed Consolidated Financial Statements for
more information). Management believes that, with continuous growth in the sales in the PRC, the
existing directors support and the new bank facilities, the Group will have sufficient funds for
operations. The financial statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty. NEW ACCOUNTING PRONOUNCEMENTS In September 2004, the EITF delayed the effective date for the recognition and measurement
guidance previously discussed under EITF Issue No. 03-01, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments (EITF 03-01) as included in paragraphs
10-20 of the proposed statement until further guidance is issued for its application. The proposed
statement will clarify the meaning of other-than-temporary impairment and its application to
investments in debt and equity securities, in particular investments within the scope of FASB
Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, and
investment accounted for under the cost method. The Group is currently evaluating the effect of
this proposed statement on its financial position and results of operations. In November 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 151,
Inventory Costs, which clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material. SFAS No. 151 will be effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. We do not believe the adoption of SFAS
No. 151 will have a material impact on our financial statements. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, which
eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have commercial substance.
SFAS No. 153 will be effective for nonmonetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. We do not believe the adoption of SFAS No. 153 will have a material
impact on our financial statements. Non-GAAP Financial Measures None. -29-




---



##### Table of Contents



Risks Relating to Our Business We have a history of operating losses and we anticipate losses and negative cash flow to
continue for the foreseeable future, and unless we are able to generate profits and positive cash
flow on a consistent basis we may not be able to continue operations. Our ability to attain a positive cash flow and become profitable depends on our ability to
generate and maintain greater revenue while incurring reasonable expenses. This, in turn, depends,
among other things, on the development of our business of child educational teaching materials and
related services focusing on English language in Taiwan and the PRC. We may be unable to achieve
and maintain profitability if we fail to do any of the following:  
    maintain and improve our current products and services and develop or license new
products on a timely basis;
    compete effectively with existing and potential competitors;
    further develop our business activities;
    manage expanding operations; andattract and retain qualified personnel. We have incurred operating losses since inception. As a result, as of March 31, 2005, we had
an accumulated deficit of $7,342,858. We incurred net losses of $1,906,996, $1,940,591, and
$1,254,592 for the years ended December 31, 2002, 2003 and 2004, respectively, and had cash flow
from operations of $33,886, ($2,689,688) and $(1,544,902) for the years ended December 31, 2002,
2003 and 2004, respectively. If we are unable to achieve and maintain a positive cash flow and
profitability, we may be unable to continue our operations. Even if we do achieve a positive cash
flow and profitability, we cannot be certain that we will be able to sustain or increase them on a
quarterly or annual basis in the future. Our inability to achieve or maintain profitability or positive cash flow could result in
disappointing financial results, impede implementation of our growth strategy or cause the market
price of our common stock to decrease. Specifically, if we cannot effectively maintain, improve and
develop our products and services, we may not be able to recover our fixed costs or otherwise turn
profitable. We may not be able to develop and introduce new products, services and enhancements
that respond to technological changes, evolving education industry standards or customer needs and
trends on a timely basis. We may experience difficulties that could delay or prevent the successful
development, introduction or marketing of new products, services or service enhancements. These new
products, services and service enhancements may not achieve market acceptance or our competitors
may develop alternative technologies and methods that gain broader market acceptance than our
products and services. Accordingly, we cannot assure you that we will be able to generate the cash
flow and profits necessary to sustain our business expectations, which makes our ability to
successfully implement our business plan uncertain. We cannot predict whether demand for our products and services will continue to develop,
particularly at the volume or prices that we need to become profitable. Although the market for English language instruction and education is growing rapidly, we
cannot
be certain that this growth will continue at its present rate, or at all. We believe our
success ultimately will -30-




---



##### Table of Contents



depend upon, among other things, our ability to:  
    increase awareness of our brand and the availability of our products and services;
    continue to attract and develop relationships with educational institutions and
regulatory authorities in our targeted geographic markets; and
    continue to attract and retain customers. Because our operating results are tied, in part, to the success of our franchisees, the failure of
our franchisees could adversely affect our operating results. Our revenues include licensing fees received from franchisees of Kid Castle. Accordingly, our
future revenues will be impacted by the gross revenues of Kid Castle franchisees and the number of
schools operating by these franchisees. Although our revenues from Kid Castle franchise operations
will vary directly with the gross revenues of our franchisees, we are not directly dependent on the
franchisees profitability. We believe, however, that the profitability of existing franchisees is
key to our ability to attract new franchisees and open new franchised schools. Therefore, factors
that adversely affect the revenues and profitability of our franchisees may have an adverse effect
on our operating results. There can be no assurance that our franchisees will operate schools successfully. While no
individual franchisee represents more than 1% of our franchise revenues, a significant failure of
our franchisees to operate successfully could adversely affect our operating results. The
resolution of certain franchisee financial difficulties may cause us to incur additional costs, due
to uncollectible accounts receivable related to franchise and license fees, the purchase of
teaching and learning materials and/or potential claims by franchisees and could have a material
adverse effect on our results of operations. An increase in market competition could have a negative impact on our business. Our markets are new, rapidly evolving and highly competitive, and we expect this competition
to persist and intensify in the future. This increase in competition could lead to price
reductions, decreased sales-volume, under-utilization of employees, reduced operating margins and
loss of market share. There can be no assurance that we will be able to successfully compete for
customers in our targeted markets. Our failure to maintain and enhance our competitive position could seriously harm our business
and operating results. We encounter current or potential competition from a number of sources,
including:  
    branches and franchises of international language instruction companies;
    public institutions and private schools; and
    private tutors. Because we face competition from established competitors, we may be unable to maintain the market
share. Our primary competitors, including Giraffe Language School in Taiwan, Ladder Digital Education
Corp. in Taiwan and the PRC, and Joy Enterprises Organization in Taiwan and the PRC, have
significant financial, technical and marketing resources, and/or name recognition. Some of these
competitors have a longer operating history and greater overall resources than we do. These
companies also have established customer support and professional services organizations. As a
result, our competitors may be able to adapt more quickly to changes in customer needs, offer
products and services at lower prices than we do, and devote greater resources than we do to the
development and sale of teaching/learning products and services, which could result in reducing our
market share. -31-




---



##### Table of Contents



Because we intend to expand internationally, we will be subject to risks of conducting
business in foreign countries. As we expand our operations outside of Taiwan, we will be subject to the risks of conducting
business in foreign countries, including:  
    our inability to adapt our products and services to local cultural traits and customs;
    our inability to locate qualified local employees, partners and suppliers;
    difficulties managing foreign operations;
    the potential burdens of complying with a variety of foreign laws;
    trade standards and regulatory requirements;
    geopolitical risks, such as political and economic instability and changes in
diplomatic and trade relationships;
    legal uncertainties or unanticipated changes regarding regulatory requirements,
liability, export and import restrictions, tariffs and other trade barriers;
    uncertainties of laws and enforcement relating to the protection of intellectual
property;
    political, economic and social conditions in the foreign countries where we conduct
operations;
    currency risks and exchange controls;
    potential inflation in the applicable foreign economies; and
    foreign taxation of earnings and payments received by us from our franchisees and affiliates. We cannot be certain that the risks associated with our anticipated foreign operations will
not negatively affect our operating results or prospects, particularly as these operations expand
in scope, scale and significance. Because we may not be able to protect our proprietary rights on a global basis, we may incur
substantial costs to defend or protect our business and intellectual property. We strategically pursue the registration of our intellectual property rights. However,
effective patent, trademark, service mark, copyright and trade secret protection may not always be
available and the steps we have taken may be inadequate to protect our intellectual property. In
addition, there can be no assurance that competitors will not independently develop similar
intellectual property. If others are able to copy and use our products and delivery systems, we may
not be able to maintain our competitive position. If we fail to protect our intellectual property,
we may be exposed to expensive litigation or risk jeopardizing our competitive position. We may
have to litigate to enforce our intellectual property rights, to protect our trade secrets or to
determine the validity and scope of the proprietary rights of others. This litigation could result
in substantial costs and the diversion of our management and technical resources, which could harm
our business. In addition, laws in the PRC have traditionally been less protective of intellectual property
rights -32-




---



##### Table of Contents



and enforcement relating to the protection of intellectual property in the PRC has been
sporadic at best. Deterioration in compliance with existing legal protections or reductions in the
legal protection for intellectual property rights in the PRC could adversely affect our revenue as
we continue to expand into the PRC market. Because we may not be able to avoid claims that we infringed the proprietary rights of others,
we may incur substantial costs to defend or protect our business and intellectual property. Although we have taken steps to avoid infringement claims from others, these measures may not
be adequate to prevent others from claiming that we violated their copyrights, other trademarks or
other proprietary rights. Any claim of infringement could cause us to incur substantial costs
defending against the claim, even if the claim is invalid, and could distract our management from
our business. A party making a claim could secure a judgment that requires us to pay substantial
damages or we may lose the rights to use our products or to modify them. We rely substantially on bank loans and our inability to obtain sufficient funding may
adversely affect our liquidity and financial condition. We rely substantially on bank loans to satisfy our funding requirements. As of December 31,
2002, 2003 and 2004, our bank loans and loans from financial institutions were $4,284,807,
$2,484,471 and $1,982,019 respectively. Although, in our experience, our bank loans and loans from
financial institutions have been, in the past, a stable source of funding, no assurances can be
given that this will continue to be the case. If we are unable to secure sufficient borrowings, our
liquidity position would be adversely affected, and we may be required to seek more expensive
sources of funding to finance our operations. Implementing our strategies may require substantial capital expenditures. To the extent these
expenditures exceed our cash resources, we will be required to seek additional debt or equity
financing. Our ability to obtain sufficient financing and the cost of such financing will depend on
numerous factors, some of which are beyond our control, including:  
    our financial condition;
    general economic and capital market conditions;
    availability of credit from banks or lenders and conditions in the financial markets;
    investor confidence in us; and
    economic, political and other conditions in Taiwan and the PRC. If we are unable to obtain sufficient funding for our operations or development plans on
commercially acceptable terms, or at all, our liquidity and financial condition may be adversely
affected. Because we conduct operations in New Taiwan Dollars and Renminbi (RMB), we are subject to risk
from exchange rate fluctuations. Our transactions with suppliers and customers are effected in New Taiwan dollars, the
functional currency of our Taiwanese subsidiary, Kid Castle Internet Technologies Limited (KCIT),
and, as a result of our expansion in the PRC, increasingly in RMB, the functional currency of our
PRC subsidiary, Kid
Castle Educational Software Development Company Limited (KCES). Our financial statements are
reported in U.S. dollars. As a result, fluctuations in the relative exchange rate among the U.S.
dollar, the -33-




---



##### Table of Contents



New Taiwan dollar and the RMB will affect our reported shareholders equity from one
period to the next. Such impacts could be meaningful and are independent of the underlying
performance of our business. The market price of our securities could be significantly affected by
unfavorable changes in exchange rates. We do not actively manage our exposure to such unfavorable
changes in exchange rates. Because our officers and directors are not U.S. persons, and our operating subsidiaries are
Taiwan and Peoples Republic of China companies, you may be unable to enforce judgments under the
Securities Act. Our operating subsidiaries are a Taiwanese company and a PRC company and our officers and
directors are residents of various jurisdictions outside the United States. All or a substantial
portion of the assets of our business and of such persons are located outside the United States. As
a result, it may be difficult for investors to effect service of process within the United States
upon such persons or to enforce court judgments in the United States obtained against such persons
in the United States courts and predicated upon the civil liability provisions of the Securities
Act. Our internal controls and management systems are not currently consistent with international
practices in certain respects and we are in the process of improving these controls to enable us to
certify the effectiveness of our internal controls under the Sarbanes-Oxley Act of 2002. Our
failure to timely and successfully upgrade these controls and systems could subject us to
regulatory actions and harm the price of our stock. Our internal control and management systems were designed to meet the standards generally
adopted by private Taiwan companies and the internal control and management systems of our PRC
subsidiaries were designed to the standards generally adopted by companies in China. These
standards are different from the standards and best practices adopted by companies in the United
States. We have identified areas in which our current control and management systems do not meet
international standards and practices. In addition, during their audit, our external auditors
brought to our attention a number of areas in which our current internal controls and management
systems do not reduce undetected material errors or fraud to a relatively low level of risk, which
could adversely affect our ability to accurately and timely record, process, summarize and report
financial data. Pursuant to the Sarbanes-Oxley Act of 2002 and the various rules and regulations
adopted pursuant thereto or in conjunction therewith, we are required, for fiscal year 2005, to
perform an evaluation of our internal controls over financial reporting and file an assessment of
its effectiveness with the U.S. Securities and Exchange Commission. Unless we successfully upgrade
our controls and systems, we will not be able to satisfactorily comply with our obligation under
the Sarbanes-Oxley Act of 2002 and our external auditors will be unable to provide a satisfactory
certification. We have prepared an internal plan of action for compliance, which includes a
schedule of activities to address our need to meet these standards and best practices. If we fail
to successfully complete the improvements we have scheduled on a timely basis, or if the activities
fail to raise our internal controls and management systems to the levels required by international
standards or legal requirements, or if we fail to implement new or improved controls, then we may
fail to meet our reporting obligations and our auditors may be unable to certify the managements
assertion of the effectiveness of our internal controls as required under the Sarbanes-Oxley Act of
2002. This could subject us to regulatory scrutiny and result in a loss of public confidence in our
management, which could, among other things, adversely affect our stock price. If we lose key management or other personnel, we may experience delays in our product
development and other negative effects on our business. Our success is dependent upon the personal efforts and abilities of our executive officers,
Kuo-An Wang, our Chief Executive Officer, and Yu-En Chui, our Chief Financial Officer. If these key
officers -34-




---



##### Table of Contents



cease employment with us before we find qualified replacements, it would have a
significant negative impact on our operations. We do not have employment agreements with any of our
executive officers. Moreover, our growth and success depend on our ability to attract, hire and retain additional
highly qualified management, educators, technical, marketing and sales personnel. These individuals
are in high demand and we may not be able to attract the staff we need. The hiring process is
intensely competitive, time consuming and may divert the attention of our management from our
operations. Competitors and others have in the past, and may in the future, attempt to recruit our
employees. If we lose the services of any of our senior management or key education personnel, or
if we fail to continue to attract qualified personnel, our business could suffer. Penny Stock regulations may impose certain restrictions on marketability of our common
stock. The SEC has adopted regulations which generally define penny stock to be an equity security
that has a market price of less than $5.00 per share. Our common stock may fall within the
definition of penny stock and be subject to rules that impose additional sales practice
requirements on broker-dealers who sell such securities to persons other than established customers
and accredited investors (generally those with assets in excess of $1,000,000, or annual incomes
exceeding $200,000 or $300,000, together with their spouses). For transactions covered by these rules, the broker-dealer must make a special suitability
determination for the purchase of such securities and have received the purchasers prior written
consent to the transaction. Additionally, for any transaction, other than exempt transactions,
involving a penny stock, the rules require the delivery, prior to the transaction, of a risk
disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer also
must disclose the commissions payable to both the broker-dealer and the registered representative,
current quotations for the securities and, if the broker-dealer is the sole market-maker, the
broker-dealer must disclose this fact and the broker-dealers presumed control over the market.
Finally, monthly statements must be sent disclosing recent price information for the penny stock
held in the account and information on the limited market in penny stocks. Consequently, the penny
stock rules may restrict the ability of broker-dealers to sell our common stock and may affect the
ability of investors to sell our common stock in the secondary market. An outbreak of Severe Acute Respiratory Syndrome (SARS) may adversely affect our results of
operations. In March 2003, Guangdong Province of the PRC, Hong Kong, Singapore, Taiwan and several other
Asian countries encountered an outbreak of SARS, a highly contagious form of atypical pneumonia. In
the future, if any of our employees or students is suspected to have contracted SARS, under certain
circumstances such employees, students and affected areas of our premises may have to be
quarantined. As a result, we may have to temporarily suspend all or part of our operations.
Furthermore, a future outbreak of SARS may negatively impact our ability to attract foreign
teachers, who may be less inclined to come to Taiwan, and to attract and retain students, whose
parents may choose to have them taught at home by individual tutors or forego supplemental English
learning altogether. Although the World Health Organization removed all of the above regions from
its list of areas affected by SARS by the summer of 2003, and there have been only a relatively
small number of confirmed cases of SARS since that time, we cannot rule out the possibility of a
future outbreak or predict the effect any such future outbreak could have on our company. Risks Relating to The Peoples Republic of China -35-




---



##### Table of Contents



Our operations in the PRC are subject to political, regulatory and economic uncertainties. Our operations and assets in the PRC are subject to significant political, regulatory and
economic uncertainties. Changes in laws and regulations, or their interpretation, or the imposition
of confiscatory taxation, restrictions on currency conversion, imports and sources of supply,
restrictions on the manner of operating educational institutions or disseminating educational
materials, devaluations of currency or the nationalization or other expropriation of private
enterprises could have a material adverse effect on our business, results of operations and
financial condition. Under its current leadership, the PRC government has been pursuing economic
reform policies that encourage private economic activity and greater economic decentralization.
There is no assurance, however, that the PRC government will continue to pursue these policies, or
that it will not significantly alter these policies from time to time without notice. In addition, in July 2003, our subsidiary, KCES, entered into agreements with a local Chinese
party, 21st Century Publishing House, in Jiangxi Province to establish two joint
ventures, Jiangxi 21st Century Kid Castle Culture Media Co., Ltd. (Culture Media) and
21st Century Kid Castle Language and Education Center (Education Center). Culture Media
and Education Center are established to engage primarily in the publication and distribution of
English language education materials, enter into franchise and consulting relationships with
kindergarten and language schools, and provide services to cooperative schools in China. We intend
to use them as one of our primary vehicles for our expansion into the PRC market. Although we
received, on January 19, 2004 and October 31, 2003, licenses from the applicable government
authorities to conduct the business of Culture Media and Education Center in the PRC, the
regulations with respect to operation of businesses by foreign-owned entities are still in flux.
There is no assurance that the licenses will not be challenged by the PRC authorities. The lack of remedies and impartiality under the PRCs legal system could negatively impact us. Unlike the United States, the PRC has a civil law system based on written statutes in which
judicial decisions have little precedential value. The PRC government has enacted some laws and
regulations dealing with matters such as corporate organization and governance, foreign investment,
commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing
these laws and regulations is limited, and our ability to enforce commercial claims or to resolve
commercial disputes is unpredictable. These matters may be subject to the exercise of considerable
discretion by agencies of the PRC government, and forces unrelated to the legal merits of a
particular matter or dispute may influence their determination. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risk, including from changes in certain foreign currency exchange
rates and interest rates. All of these market risks arise in the normal course of business, as we
do not engage in speculative trading activities. We have not entered into derivative or hedging
transactions to manage risk in connection with such fluctuations. The following analysis provides quantitative information regarding our exposure to foreign
currency exchange risk and interest rate risk. Interest rate exposure We are exposed to fluctuating interest rates related to variable rate bank borrowings. In
analyzing the effect of interest rate fluctuations based on the average balances of our outstanding
bank borrowings for -36-




---



##### Table of Contents



the three months ended March 31, 2005, we have projected that, if interest
rates were to increase by 1%, the result would be an annual increase in our interest expense of
$43,030. This analysis does not take into consideration the effect of changes in the level of
overall economic activity on interest rate fluctuations. Foreign currency exposure We have operations in both Taiwan and the PRC. The functional currency of Higoal Development
Ltd. and its subsidiary, Kid Castle Internet Technologies Ltd. is NT Dollars and the financial
records are maintained and the financial statements are prepared for these entities in NT Dollars.
The functional currency of Kid Castle Educational Software Development Company Ltd. and its
consolidated investee, Jiangsi 21th Century Kid Castle Culture Media Co. Ltd. is RMB and the
financial records are maintained and the financial statements are prepared for these entities in
RMB. In the normal course of business, these operations are not exposed to fluctuations in currency
values. We do not generally enter into derivative financial instruments in the normal course of
business, nor do we use such instruments for speculative purposes. The translation from the
applicable local currency assets and liabilities to the U.S. Dollar is performed using exchange
rates in effect at the balance sheet date except for shareholders equity, which is translated at
historical exchange rates. Revenue and expense accounts are translated using average exchange rates
during the period. Gains and losses resulting from such translations are recorded as a cumulative
translation adjustment, a separate component of shareholders equity. 
 ITEM 4. CONTROLS AND PROCEDURES We are in the process of identifying, developing and implementing measures to improve the
effectiveness of our disclosure controls and procedures, and, in particular, internal controls,
including plans to enhance our resources, systems and training with respect to our financial
reporting and disclosure responsibilities, and to review our actions with the audit committee and
independent auditors. Since April 2004, we have been in the process of implementing a system with
respect to internal control over financial reporting. In May 2004, we began installing a new ERP
system through an application service provider, and we expect the installation to be completed in
the fourth quarter of 2005. Our CEO and our CFO believe that such measures will help improve our
disclosure controls and procedures. Based on this information, as of March 31, 2005, our CEO and
our CFO believe that, subject to the limitations noted above, our disclosure controls and
procedures are effective in ensuring that material information required to be included in Kid
Castles SEC reports is made known to them on a timely basis. In May 2005, our accounting manager, who assisted our CFO with our internal control over
financial reporting, resigned. We are in the process of searching for a candidate to hire as an
accounting manager to handle our internal control over financial reporting. Although this personnel
change caused a temporary interruption of our internal control over financial reporting, we believe
that the ongoing implementation of our new system with respect to internal control over financial
reporting and the installation of our ERP system have minimized any adverse effect that may have
been caused by such resignation. 
 PART II
OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS We have no material pending legal proceedings. -37-




---



##### Table of Contents



ITEM 2. CHANGES IN SECURITIES Pursuant to a stock purchase agreement dated August 18, 2003, Globe Wisdom Investments Limited
(GWIL), a Samoan international business company, subscribed for 175,500 shares of our common
stock at an aggregate purchase price of $122,850 in a private offering. As of March 31, 2005, we
had not yet issued any shares to GWIL pursuant to the August 18, 2003 stock purchase agreement. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 
 ITEM 5. OTHER INFORMATION None. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K A.
    
    Exhibits31.1
    
    Certification of Kuo-An Wang, Chief Executive Officer of the
registrant, pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Yu-En Chiu, Chief Financial Officer of the
registrant, pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Kuo-An Wang, Chief Executive Officer of the
registrant, pursuant to 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Yu-En Chiu, Chief Financial Officer of the
registrant, pursuant to 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.B.
    
    Reports on Form 8-KNot applicable.
 -38-




---



##### Table of Contents



SIGNATURES In accordance with the requirements of the Exchange Act, the Registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized. Dated: May 20, 2005 By:
    /s/ Kuo-An WangName:
    Kuo-An WangTitle:
    Chief Executive Officer -39-