Monday, December 11, 2006
China Education Alliance (CEDA) 2006 Q3
CEDA (sec, chart) I looked at the 2005 10-K here and the 2004 10-K here.
Here's the 10-Q for Q3 (comparing to the 2005 10-K):
Haha, cut and paste error right up front. The title says it's "For the quarterly period ended June 30, 2006", when it's really for Sept 30.
Still 58 million shares on Nov 13, 2006 (20K new shares added since 10-K).
BALANCE SHEET:
Ten times as much cash, $5.6 million, the cash flow statement should be interesting.
Ridiculously low inventory (debit cards).
PP&E is huge (as I noted before) and slowly depreciating.
On the liability side, AP is down to almost nothing.
Advances on accounts (that's the debit card prepayments) is $477K, up from around $300K at year end. If revenues have greatly increased, then this is fine.
The loan from shareholder has actually increased.
There's a $1.5 million notes payable which wasn't on the year end balance sheet. That would explain some of the new cash.
Net cash is $3.3 million. With only $9.7 million in assets, that's a strong balance sheet. 75% equity.
INCOME STATEMENT:
Revenues:
Q1 2005: $0.08 million
Q2 2005: $0.29 million
Q3 2005: $1.02 million (also stated in this report)
Q4: $1.73 million (i.e. $3.11 million - $1.38 million)
Q1: $1.35 million
Q2: $2.17 million
Q3: $2.28 million
In the notes, they say that the increase in revenue is due to the training center which was opened in Q3 2005. It started out small but increased revenue rapidly. In 2006, they've added new vocational and certification programs (see below NOTES section). Advertising income also increased on the website. It seems like the bricks and mortar learning center is where most of the revenue really comes from.
Revenues for the trailing 12 months is $7.5 million vs $3.1 million for all of 2005. You can see from the list of quarters above, that revenue is increasing strongly.
Gross margins [update: I mean gross costs are small, gross margins are huge] are meaninglessly small, but I wonder if they're correctly accounting for cost of the services for the training center. It all works out the same at the bottom line.
SG&A is $359K, or 16% of revenues (13% for 9 months).
No tax provisions this year because they got approval for being a "foreign invested company" and thus they get zero taxes for 2 years and half-taxes for [I'm not sure if it's 3 more years or just the 3rd year] (see NOTE 11). I would value the business as if they paid tax because they will before too long.
So let's assume about $800K for net income. 1.31 cents per diluted share (roughly 4 cents for 9 months).
CASH FLOW:
Cash flow from operations looks perfectly normal: it's roughly net income plus depreciation and capex is roughly equal to depreciation (which is not much, most of the PP&E is buildings and machinery and depreciates slowly).
The only other cash flows are $7K from issuing stock, the $164K increase in loan from shareholder mentioned above, and the $1.53 million notes payable mentioned above.
NOTES:
CEDA is a holding company for ZHLD and Zhonghe Education Training Center ("ZHTC"). ZHLD is a technology company for online education in China. ZHTC is wholely owned by ZHLD except for 1% owned by CEO as required by PRC law. ZHLD also owns 70% of Beijing Hua Yu Hui Zhong Technology Development Co ("BHYHZ"), formed on Sept 30, 2006 (need to check this out).
US GAAP applies here, as expected.
Depreciation schedule:
Buildings: 20 years ($2.8 million)
Communication equipment: 10 years (seems too long for telecom equipment) ($1.1 million?)
Vehicles: 5 years (I've seen Chinese companies use 10 years) ($128K)
Furniture, fixtures, equipment: 5 years ($328K?)
$69K foreign currency translaton benefit, shows up in separate equity account, not income statement.
There are some deferred revenue apart from the debit card stuff.
Advertising for the quarter was $1.5K.
The $1.53 million notes payable is a bridge loan (also here). Sept 29, 2006. 6% interest. Matures March 29, 2007. CEO is pledging 7.9 million shares but it's actually a floorless toxic pledge. Only the CEO is at risk, not the other shareholders. The warrant strike price is 50 cents. Roughly 3 million warrants. 61 million fully diluted shares?
Also, the company contributes to a post-retirement plan based on 20% of employee basic salaries. PRC is responsible for the liability.
The CEO has been paying dollar denominated fees within the US for accounting, legal fees, etc. from a personal bank account in dollars due to the Renminbi restrictions. This matures in 2006 and can be converted to stock at the market price.
Here's some info about the website. I've gone through some of the parts that don't require login, although I don't read simplified Chinese (or any kind of Chinese).
They also have the learning center with about 36K square feet of usable space, 17 classrooms, and a capacity of 1,200 students. There are courses for the compulsory subjects for middle and high school.
New services are for vocational education, with a website.
In 2004, the Chinese online education market was at $1.8 billion and will probably increase over time. A "well-known market consulting firm" iResearch predicts the market will become twice as big as that within a year or so. Another research firm estimates there are 111 million Internet users in China.
CEDA plans to duplicate its Harbin area model in other parts of China.
They will probably raise an additional $6 million (presumably around 12 million shares) for expansion in the future. So long as they do it right and get the same return on assets, that's fine.
I would actually be more comfortable if CEDA's success rests mostly in the training center revenue than the online revenue. Revenue has clearly expanded and the company is doing well. The business model seems to be quite good, but I wonder about competition in the future.
So far in 2006, they seem to be heading toward a free cash flow of about $4 million for the year. With 61 million fully diluted shares, that works out to about 6.5 cents per share, which alone would justify a share value of around a dollar. The future growth is the real wild card here.
The financial statements seem fine, but they could be better. There are details here, but there isn't a big picture of how the business works. I don't get a clear mental image of how the customers, the schools, the instructors, etc. all interact in terms of how the whole machine functions. Is it a Sylvan Learning Center sort of tutoring thing? Is it a voc/tech school sort of thing? Is it like a Cliff Notes distribution company? An SAT preparation type thing? If it's a combination of these, what are the business segment characteristics?
Here's the 10-Q for Q3 (comparing to the 2005 10-K):
Haha, cut and paste error right up front. The title says it's "For the quarterly period ended June 30, 2006", when it's really for Sept 30.
Still 58 million shares on Nov 13, 2006 (20K new shares added since 10-K).
BALANCE SHEET:
Ten times as much cash, $5.6 million, the cash flow statement should be interesting.
Ridiculously low inventory (debit cards).
PP&E is huge (as I noted before) and slowly depreciating.
On the liability side, AP is down to almost nothing.
Advances on accounts (that's the debit card prepayments) is $477K, up from around $300K at year end. If revenues have greatly increased, then this is fine.
The loan from shareholder has actually increased.
There's a $1.5 million notes payable which wasn't on the year end balance sheet. That would explain some of the new cash.
Net cash is $3.3 million. With only $9.7 million in assets, that's a strong balance sheet. 75% equity.
INCOME STATEMENT:
Revenues:
Q1 2005: $0.08 million
Q2 2005: $0.29 million
Q3 2005: $1.02 million (also stated in this report)
Q4: $1.73 million (i.e. $3.11 million - $1.38 million)
Q1: $1.35 million
Q2: $2.17 million
Q3: $2.28 million
In the notes, they say that the increase in revenue is due to the training center which was opened in Q3 2005. It started out small but increased revenue rapidly. In 2006, they've added new vocational and certification programs (see below NOTES section). Advertising income also increased on the website. It seems like the bricks and mortar learning center is where most of the revenue really comes from.
Revenues for the trailing 12 months is $7.5 million vs $3.1 million for all of 2005. You can see from the list of quarters above, that revenue is increasing strongly.
Gross margins [update: I mean gross costs are small, gross margins are huge] are meaninglessly small, but I wonder if they're correctly accounting for cost of the services for the training center. It all works out the same at the bottom line.
SG&A is $359K, or 16% of revenues (13% for 9 months).
No tax provisions this year because they got approval for being a "foreign invested company" and thus they get zero taxes for 2 years and half-taxes for [I'm not sure if it's 3 more years or just the 3rd year] (see NOTE 11). I would value the business as if they paid tax because they will before too long.
So let's assume about $800K for net income. 1.31 cents per diluted share (roughly 4 cents for 9 months).
CASH FLOW:
Cash flow from operations looks perfectly normal: it's roughly net income plus depreciation and capex is roughly equal to depreciation (which is not much, most of the PP&E is buildings and machinery and depreciates slowly).
The only other cash flows are $7K from issuing stock, the $164K increase in loan from shareholder mentioned above, and the $1.53 million notes payable mentioned above.
NOTES:
CEDA is a holding company for ZHLD and Zhonghe Education Training Center ("ZHTC"). ZHLD is a technology company for online education in China. ZHTC is wholely owned by ZHLD except for 1% owned by CEO as required by PRC law. ZHLD also owns 70% of Beijing Hua Yu Hui Zhong Technology Development Co ("BHYHZ"), formed on Sept 30, 2006 (need to check this out).
US GAAP applies here, as expected.
Depreciation schedule:
Buildings: 20 years ($2.8 million)
Communication equipment: 10 years (seems too long for telecom equipment) ($1.1 million?)
Vehicles: 5 years (I've seen Chinese companies use 10 years) ($128K)
Furniture, fixtures, equipment: 5 years ($328K?)
$69K foreign currency translaton benefit, shows up in separate equity account, not income statement.
There are some deferred revenue apart from the debit card stuff.
Advertising for the quarter was $1.5K.
The $1.53 million notes payable is a bridge loan (also here). Sept 29, 2006. 6% interest. Matures March 29, 2007. CEO is pledging 7.9 million shares but it's actually a floorless toxic pledge. Only the CEO is at risk, not the other shareholders. The warrant strike price is 50 cents. Roughly 3 million warrants. 61 million fully diluted shares?
On September 29, 2006 China Education Alliance, Inc., a North Carolina corporation, consummated a bridge financing pursuant to which the Company issued $1,530,000 aggregate principal amount of secured promissory notes and warrants to acquire an aggregate number of shares of common stock of the registrant equal to the highest dollar amount of the principal prior to the maturity date for an exercise price per share of $ 0.50.$407K (10%) of cumulative net income is reserved for the PRC non-distributable reserve to offset extraordinary losses in the future (general reserve), part of it is reserved for company expansion, some for employee welfare, some for a "bonus reserve". NOTE 12.
Also, the company contributes to a post-retirement plan based on 20% of employee basic salaries. PRC is responsible for the liability.
The CEO has been paying dollar denominated fees within the US for accounting, legal fees, etc. from a personal bank account in dollars due to the Renminbi restrictions. This matures in 2006 and can be converted to stock at the market price.
Here's some info about the website. I've gone through some of the parts that don't require login, although I don't read simplified Chinese (or any kind of Chinese).
www.edu-chn.com is a major functional education resources portal website in China. It provides plenty of client resources and strong brand promotion for business developing. Under the website, there are four modules, eight alliances, nine platforms and eight columns of interactive entertainment columns. It provides informative education products through the updated communication tools under www.edu-chn.com. It provides multi-media resources such as college school, middle school and elementary school test papers, courseware, and video data since 1980s, owning intellectual property rights for more than 300,000 sets of courseware and test papers. www.edu-chn.com is a major enterprise-class comprehensive education network platform which based on the network video technology and the large data sources of elementary education resources. It provides online education and material download for customers by integrating “the big classroom of the famed instructors”. By the end of 2005, more than 3 million visitors had viewed the website.I need to get a Chinese reader to look over it.
They also have the learning center with about 36K square feet of usable space, 17 classrooms, and a capacity of 1,200 students. There are courses for the compulsory subjects for middle and high school.
New services are for vocational education, with a website.
CEDA leverages the existing resources of China Vocational Education Society which as members including provincial education bureau and more than one thousand vocational training schools across the country in carry out its fast expansion strategic cooperation with the outstanding training agencies in local area, especially in the aspects of joint enrollment, resources exchanging and on-site training agencies establishments. The Company has carried out various level cooperation with over one thousand professors in their respective expertise fields, more than two thousand membership schools, over three thousand school principals, over fifty thousand school teachers, as well as over one hundred news media and twenty scholarly research organizations.And here's something interesting:
CEDA’s “Millions of College Students Employment Crossroad” program is developed in response to the high jobless rate for China’s current college graduates. More than 35% of the college graduates can not find a job in the year of graduation. Many of the college graduates pursue vocational training after college education. CEDA’s “Millions of College Students Employment Crossroad” program is to establish a long term training program for college students to build connections with corporations and obtain education programs prescribed by the hiring corporations.There are about 16,000 high schools in China, 847 are "key schools" which have the best teachers and resources. In key schools, the college entrace rate is actually above 90%! Student with poor performance can still get into key school by paying a sort of tuition. Overall in China, this amounted to over $3 billion in 2005. That's about $3.5 million per school which might be something like $2,000 per student? That's a lot of money.
In 2004, the Chinese online education market was at $1.8 billion and will probably increase over time. A "well-known market consulting firm" iResearch predicts the market will become twice as big as that within a year or so. Another research firm estimates there are 111 million Internet users in China.
CEDA plans to duplicate its Harbin area model in other parts of China.
They will probably raise an additional $6 million (presumably around 12 million shares) for expansion in the future. So long as they do it right and get the same return on assets, that's fine.
CONCLUSION
I would actually be more comfortable if CEDA's success rests mostly in the training center revenue than the online revenue. Revenue has clearly expanded and the company is doing well. The business model seems to be quite good, but I wonder about competition in the future.
So far in 2006, they seem to be heading toward a free cash flow of about $4 million for the year. With 61 million fully diluted shares, that works out to about 6.5 cents per share, which alone would justify a share value of around a dollar. The future growth is the real wild card here.
The financial statements seem fine, but they could be better. There are details here, but there isn't a big picture of how the business works. I don't get a clear mental image of how the customers, the schools, the instructors, etc. all interact in terms of how the whole machine functions. Is it a Sylvan Learning Center sort of tutoring thing? Is it a voc/tech school sort of thing? Is it like a Cliff Notes distribution company? An SAT preparation type thing? If it's a combination of these, what are the business segment characteristics?
// posted by Bruce @ 3:47 PM 
