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Monday, December 11, 2006

China Education Alliance (CEDA) 2005 10-K

I had looked at CEDA (sec, chart) here. I looked at the 2004 10-K here.

It's a classic Chinese reverse merger from Sept 2004. They're located in Harbin (very large city in very northern China). They are/were the only website in China having copyrights of exam material for Chinese primary and middle schools. The exam materials (such as textbooks) are downloaded over the Internet and through SMS. Their business model is to sell debit cards which are then used to purchase online materials.

The 2004 10-K said they had 270K users who visit the website. At that time, they were ramping up and had a net loss for the year.

One big issue I had with the company was that they were recording revenue when the cards were sold rather than when the actual purchase of materials was made and the materials shipped to the customer. There were other red flags as well.

2005 10-K
Period ending Dec 31, 2005.
58 million shares on April 14, 2006.
Wholely-owned foreign enterprise. Funding through official China banking channel. Dividends can be repatriated to the US.
The Company has historical relationships with the Chinese vocational educational society, the government education information center, the authentication training center, and other government departments and education entities. The Company further promotes its materials and services through cooperation with more than one thousand professors, over two thousand membership schools, over three thousand school principals, more than fifty thousand school teachers, one hundred news media outlets, and twenty scholarly research organizations.
Here are their plans for 2006:
99 employees, 33 in actual education, 22 in marketing. HQ is 4.2K square feet of sole-use office space in Harbin. Also 7.2K square feet in two other buildings.

Depreciation schedule seems ok (See other SEC filings post for more details).

No legal proceedings.

No government approvals needed and they don't see anything likely on the horizon. Self-insured.

Revenue recognition has been fixed:
The revenues from the general and specific study cards are recorded when they were either actually used or expired since these study cards are not refundable after the expiration date. Tuition revenue is recorded on a straight-line basis over the length of the applicable course. The revenues from e-business, advertisement, and domain name service are recorded when the services were provided and completed.
54% net margins. I doubt if this is sustainable. Someone is likely to come along and offer the same sort of business for a 25% net margin or less. But it does show that this is very far from being a slugfest.

No new accounting pronouncements that are unexpected. Effects are nothing unusual.

Changed accountants from Jimmy Cheung to e-Fang Accountacy Corp. in City of Industry, California (LA area). A board of directors member at American Dairy (ADY) is on the board of directors at e-Fang. e-Fang audited Red Horse Entertainment.

Assets are 85% PP&E with most of the rest being cash. 89% equity. 596K sitting in bank deposits, no FDIC equivalent.
Liabilities are mostly prepaid debit cards, a loan from shareholder (CEO/controlling shareholder at 9% interest based on ABC Realty reverse merger, matures in 2006, can be converted to stock at the current price), and some AP.
Current ratio is a bit better than 1. All liabilities are current.

$3.1 million in revenues for 2005, up from only $52K in 2004. The increase is due to market increases, the new education center, and also advertisement and IT type services (the last stuff is hopefully a small fraction of the increase).
67% gross margins, down slightly from 2004. Any decrease in margin is due to increased depreciation and "prelection [study aid generation] cost due to the material obtained for our database."
54% operating margins, down from massive operating loss in 2004 (it played out correctly) despite the big increase in staff and depreciation. Net margin 54.7%. Very low tax.
$1.7 million net income, up from small loss in 2004.

Operating cash flow is much higher due to advances (purchases of debit cards).
Capex is actually larger than net income. Pretty much nothing in financing.

Depreciation schedule is good for China, especially given that they're in China (i.e. cars depreciated over 5 years rather than the often-times 10).

Revenue is recognized when materials are downloaded (or the debit card expires, unlike the goofy stuff in the US where I hear that states often confiscate it), with provisions based on estimates and historical averages. It was previously recognized when customers purchased the debit card, which is wrong.

Xinqun Yu, 38, Chairman, CEO, lots of experience, owns 66% of the company. Also CEO of RETONG.COM (currently???) and Chairman of Harbin Zhonghelida Technology Corp, Heilongjiang Retong Advertising Co, and Heilongjiang Wantong Telecommunication Project Co. Member of Council of China Harbin Advertising Assoc, director of China Internet Network Association. BA from Harbin U of Sci and Technology.

Chunqing Wang, 46, Vice Chairman, CFO. 2001-present CFO for mysterious "Zelda" (I didn't see any explanation of it in any SEC filings, but it appears to be the reverse merger shell company, ZHLD). 1992-2001 CFO for Tianrun Group. 1989-92 Harbin Tianrun Chemical Joint-Stock Co. 1986-89 Harbin Battery Manufacturing Co.

Yuhong Yang, 40, managed a newspaper ("Qitaihe Evening Paper", no online links), was VP of Orient Realty Development Co., president of Harbin Runtong Group, then joined CEDA.

Yanzhi Liu, 37, computer science degree, apparently a senior certified engineer?, technical mgr for Thermodynamic Company of the Harbin Power Station Group, technical mgr for Heilongjiang Wantong Telecom Project Co. (same company where CEO was). Telecom expert.

Yuzhong Wu, 35, "Certificate holder of Economist", marketing mgr for Harbin Kaida Wood Products Co, strategic planning mgr for Heilongjiang Retong Advertising Co.

No audit committee. No audit committee financial expert. They plan to bring in such a person as a director.

Audit fees make sense. $30K for e-Fang. e-Fang only audited 2005 results.

ZHTC and ZHLD are both subsidiaries of China Educational Alliance (CEDA).
Heilongjiang Zhonghe Education Training Center (“ZHTC”) was registered in the People’s Republic of China on July 8, 2005 with a registered capital of $60,386, is the wholly owned subsidiary of ZHLD.
CEDA's market is K-12 test preparation materials (K?) available online for purchase via debit cards. Also voc-tech stuff, agricultural labor education, education for disabled, etc. They have alliances with government entities, voc education society, etc. 1,000 professors. 2,000 membership schools. 3,000 school principals. 50,000+ school teachers.

Like I wrote above, revenue recognition is now done correctly. They can now track when purchases are made and materials are downloaded, with allowances based on historical averages. They record initial debit card purchases as a subscriber prepayment. Expired amounts are recorded as revenue. How long is expiration date?

Prepaid expenses are mainly advances to teachers for online materials and video.
Other receivables are advances to employees (travel, entertainment, transportation). Entertainment?

Advertising costs for 2005 were $140K, expensed the first time the advertising took place.

Credit risk of trade receivables is limited due to large number of diverse customers. 90% of AR is less than 60 days old.

Inventory is ridiculously small (debit cards).

Buildings: $2.7 million (elsewhere they say they have 4K sq ft in the main office building and two other buildings with 7K sq ft total). $245/sq ft. Seems high, but China real estate prices have gone up (in Harbin?).
Vehicles: $110K
Office Equip: $323K
Machinery: $1 million
very low amount of depreciation (i.e. new equipment, about a year old)

Dec 31, 2005: $297K subscriber prepayments. Revenues for they year were $3.1 million. So figure prepayments age for about 1 month.

Changed accounting in Jan 2006.


The big issue here is the CEO having controlling interest in the company. The revenue recognition issue was a big showstopper for me previously, but they fixed it. And the results for 2005 and for the first three quarters of 2006 that I'll cover later are very good. For now, I'm going to continue picking this one apart. The company has huge potential if it's for real. The CEO's controlling interest isn't a showstopper for me yet (although I've tossed out Chinese reverse mergers for that reason before).

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