Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ...........to...............
Commission File Number 000-29957
TENGTU INTERNATIONAL CORP.
--------------------------
(Exact name of registrant as specified in its charter)
Delaware 77-0407366
- --------------------------------- ----------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
236 Avenue Road, Toronto, Ontario Canada M5R 2J4
--------------------------------------------------------------
(Address of Principal Executive Offices)
(Zip Code)
(416) 963-3999
--------------------------------------------------------------
(Registrant's telephone number, including Area Code)
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 past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act.
Yes |X| No |_|
1
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: there were 109,178,743 shares
outstanding as of November 30, 2004.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements in this report which are not historical facts or
information are forward-looking statements, including, but not limited to, the
information set forth in the Management's Discussion and Analysis section. Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause our actual results, levels of activity,
performance or achievement, or industry results, to be materially different from
any future results, levels of activity, performance or achievement expressed or
implied by such forward-looking statements. Such factors include, among others,
the following: general economic and business conditions in the United States,
China and Canada; our ability to implement our business strategy; our access to
financing; our ability to successfully identify new business opportunities; our
ability to attract and retain key executives; our ability to achieve anticipated
cost savings and profitability targets; changes in the industry; competition;
the effect of regulatory and legal restrictions imposed by foreign governments;
the effect of regulatory and legal proceedings and other factors discussed in
our Forms 10, 10-K, 10-Q, 8-K, and amendments thereto, and registration
statement filings. As a result of the foregoing and other factors, no assurance
can be given as to our future results and achievements. Neither we nor any other
person assumes responsibility for the accuracy and completeness of these
statements.
2
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
Tengtu International Corp. and Subsidiaries
Consolidated Balance Sheets
(unaudited)
As of As of
ASSETS September 30 June 30
CURRENT ASSETS 2004 2004
----------- -----------
Cash and cash equivalents 1,507,503 2,358,536
Accounts receivables, net 1,009,440 1,033,658
Prepaid expenses 214,345 74,778
Inventories 343,870 511,119
Other receivables 511,239 173,150
----------- -----------
Total Current Assets 3,586,397 4,151,240
----------- -----------
PROPERTY AND EQUIPMENT, net 180,669 197,253
----------- -----------
OTHER ASSETS
Long-term Investment 1,194,111 1,229,660
1,194,111 1,229,660
----------- -----------
TOTAL ASSETS 4,961,177 5,578,153
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable 783,518 619,937
Accrued expenses 3,581,963 3,292,601
Prepaid revenue from customers 510,976 482,404
Due to related party consultants 1,207,714 1,207,714
Short-term loans 2,051,279 1,973,159
Other liabilities 299,561 398,033
----------- -----------
Total Current Liabilities 8,435,011 7,973,847
----------- -----------
Minority interest 12,627 77,742
COMMITMENTS [Note 9]
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock, par value $.01 per share; authorized
10,000,000 shares; issued -0- shares 0 0
Common stock, par value $.01 per share; authorized
150,000,000 shares; issued 109,057,213 shares
(2004-110,706,914); outstanding 108,978,793 shares
(2004-110,628,494) 1,089,788 1,106,285
Additional paid in capital 85,194,983 85,178,486
Accumulated deficit (89,790,588) (88,777,563)
Accumulated other comprehensive income (loss):
Cumulative translation adjustment 20,140 20,140
----------- -----------
(3,485,677) (2,472,652)
Less: Treasury stock, at cost, 78,420 common shares (784) (784)
----------- -----------
Total Stockholders' Equity (3,486,461) (2,473,436)
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 4,961,177 5,578,153
=========== ===========
The accompanying notes are an integral part of the unaudited
consolidated financial statements.
3
Tengtu International Corp. and Subsidiaries
Consolidated Statements of Operations
(unaudited) (unaudited)
Three Months Three Months
Ended Ended
September 30, September 30,
2004 2003
(Restated)
------------- -------------
SALES $ 200,351 $ 425,843
COST OF SALES $ 47,159 $ 193,224
------------- -------------
153,192 232,619
------------- -------------
OPERATING EXPENSES
Research and development 164,004 --
General and administrative 549,974 475,275
Related party consultants 164,030 84,321
Collection provision 3,823 17,022
Advertising -- --
Selling 248,932 322,899
Depreciation 16,584 7,296
------------- -------------
1,147,347 906,812
------------- -------------
Operating Loss (994,155) (674,193)
OTHER INCOME (EXPENSE)
Equity earnings (loss) in investee (35,549) (22,991)
Interest income 19,130 370
Interest expense (94,718) (35,731)
Other income 27,151 59,576
Other expense -- 6,619
------------- -------------
(83,986) 7,843
------------- -------------
Income (Loss) before minority interests
(1,078,141) (666,350)
Minority interest in subsidiaries'-Income
(Loss) (65,116)
------------- -------------
Net Loss $ (1,013,025) $ (666,350)
============= =============
WEIGHTED AVERAGE NUMBER OF SHARES:
Basic 102,792,110 70,230,120
Common stock equivalents
------------- -------------
Diluted 102,792,110 70,230,120
============= =============
EARNINGS (LOSS) PER COMMON SHARE:
Basic (0.01) (0.01)
Diluted (0.01) (0.01)
The accompanying notes are an integral part of the unaudited
consolidated Financial statements.
4
Tengtu International Corp. and Subsidiaries
Consolidated Statements of Cash Flows
(unaudited) (unaudited)
Three Months Three Months
Ended Ended
September 30, September 30,
2004 2003
------------ ------------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,013,025) $ (666,350)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 16,584 7,339
Collection provision 3,823
Loss on investment at equity 35,549 22,991
Minority interest (65,115)
Noncash interest expense - convertible debenture 60,000 23,689
Changes in operating assets and liabilities:
Accounts receivable 20,395
Due from related party -- 207,815
Prepaid expenses (139,567) 22,905
Inventories 167,248 --
Other receivables (338,089) 85,859
Accounts payable 163,582 38,157
Accrued expenses 289,362 131
Prepaid revenue from customers 28,572 --
Other liabilities (98,472) 2,569
----------- -----------
Net Cash Used by Operating Activities (869,153) (254,895)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from short-term loans 60,400 116,741
Cash paid on short-term loans (42,280)
Cash received for shares and options issued 18,750
----------- -----------
Net Cash Provided by Financing Activities 18,120 135,491
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH -- 3,255
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS (851,033) (116,149)
----------- -----------
CASH AND CASH EQUIVALENTS, beginning of the period 2,358,536 283,802
CASH AND CASH EQUIVALENTS, end of the period $ 1,507,503 $ 167,653
=========== ===========
Supplemental disclosures of cash flows information and noncash investing and
financing activities:
For the three months ended September 30, 2004, the Company paid cash for
interest expenses of $34,718 (September 30, 2003-$26,945) and $0 for income
taxes (September 30,2003-$0).
During the three months ended September 30, 2004, the following noncash
financing transactions occurred:
1. 1,838,679 common shares that had been issued as security against a liability
of the Company and held in escrow were released from escrow and cancelled.
2. 188,978 common shares were issued upon a cashless exercise of options.
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
5
NOTES
BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary in order to fairly present
the interim financial information have been included. Results for the three
months ended September 30, 2004 are not necessarily indicative of the results
that may be expected for the fiscal year ending June 30, 2005. For further
information, please refer to the consolidated financial statements and notes
thereto included in Tengtu International Corp. and Subsidiary's annual report on
Form 10-K for the fiscal year ended June 30,2004.
1. The Company
Tengtu International Corp. ("we," "us," or the "Company"), through its
wholly owned subsidiary, Beijing Tengtu United Electronics Development Co., Ltd.
("Tengtu United"), is engaged in the sale of software and educational materials
to schools in the People's Republic of China ("PRC"). Currently, these products
and materials consist principally of:
i. the Education Resource for Microsoft(R) Office software which
incorporates educational and teaching resources contained in our Total
Solution software with Microsoft's Office 2003;
ii. educational resources based on the PRC's required K-12
curriculum which are distributed by satellite and on hard disk drives by
Hua Xia Bo Xin Education Software Co., a joint venture with the PRC
Ministry of Education of which we currently own 53% and which we refer to
as CBERC; and
iii. teacher training resources.
Our current business consists principally of the following:
i. Providing our products, educational materials and systems
integration services to schools as part of the PRC "Western Rural School
Projects," and
ii. Developing educational resources and negotiating with potential
strategic partners for the creation of a commercial "National Education
Portal" ("NEP"), which is to be an internet and fee-based educational
portal where students and parents can purchase additional and supplemental
educational resources.
6
2. SHORT-TERM DEBT
In December 1999, the Company issued a $1,500,000 convertible debenture to
Top Eagle Holdings, Ltd. ("Top Eagle"), which was due on December 15, 2003. On
that date, the Company entered into an agreement with Top Eagle pursuant to
which it paid Top Eagle $300,000 and issued to Top Eagle a new convertible
debenture in the principal amount of $1.2 million, due December 15, 2004, in
exchange for the outstanding convertible debenture in the principal amount of
$1.5 million. The Company made another principal payment of $200,000 on June 1,
2004 and reduced the principal amount to $1 million. Interest on both debentures
is equal to the best lending rate of The Hong Kong and Shanghai Banking
Corporation plus two percent (approximately 7% at September 30, 2004). The total
interest expense for the quarter ended September 30, 2004 was $77,888 (September
30, 2003-$50,522), which includes amortization of the discount on the
convertible debenture of $60,000 (September 30, 2003-$23,689).
On September 10, 2004 Beijing Tengtu Electronic Publishing Co., Ltd.,
("TEP") renewed a loan with an outstanding principal balance of RMB 8.5 million
(approximately $1,027,000) with Agriculture Bank of China. TEP repaid principal
of RMB350,000(approximately $42,800) and the loan has been extended for other
three months with the maturity date of December 10, 2004. The annual interest
rate for the loan is 6.372%.
On September 14, 2004, Dr. Liu Penghui, the Company's interim CEO,
advanced RMB 500,000 (approximately $60,400) to the Company for general
operating and administrative expenses.
3. Related Party Transactions
During the quarter ended September 30, 2004, the Company incurred
consulting expenses of $164,030 from officers and directors of the Company.
Consulting expenses for September 30, 2003 were $84,321.
4. Taxes
None of the Company's subsidiaries is eligible to be consolidated into the
Company's U.S income tax return, therefore, separate income tax provisions are
calculated for the Company and each of its subsidiaries. For U.S. income tax
purposes, the Company has recorded a deferred tax asset due to net operating
loss carry forwards. The asset has been offset by a full valuation allowance, as
the Company believes it is more likely than not that the losses will not be
utilized.
TUC has an income tax "holiday" for its first profitable and four
subsequent years as computed on a Chinese Tax basis, which is a hybridized cash
basis of accounting. This holiday reduces income taxes by 100% for years one and
two, and by 50% for years three through five.
5. Commitments and Contingencies
The Company is obligated to fund CBERC as follows: 30 million
(approximately $3,624,000) within twelve months after the establishment of CBERC
and RMB 20 million (approximately $2,416,000) within eighteen months after the
establishment of CBERC. CBERC was established in January 2003. In January 2004,
a new agreement was reached between Tengtu Untied and CBERC, pursuant to which
the payment due in January, 2004 was extended by six months. The Company is
currently seeking to renegotiate its relationship with the minority of CBERC and
the payment that is due.
7
Because the Tengtu China Group still conducts some of the business of Tengtu
United, Tengtu United has determined that it was necessary for it to guarantee
repayment of certain outstanding loans to the Tengtu China Group. The guarantees
currently outstanding, and their amounts, in Chinese renminbi, are set forth
below:
Bank Loan Amount
---- -----------
Hua Xia Bank RMB 16 million
($1,931,970)
Agricultural Bank of China RMB 14.1 million
($1,702,548)
As the result of the loan guarantees TUC provided, the Company accrued
$3.15 million as a liability for the loans as of June 30, 2004, which is still
outstanding at September 30, 2004.
Also, the Estate of Fan Qi Zhang, which controlled the Tengtu China Group
companies, has given authorization to Tengtu United to use the 15 million shares
bequeathed by Mr. Zhang to pledge to the banks holding guarantees from Tengtu
United in substitution for the Tengtu United guarantees. Discussions with these
banks are currently ongoing.
The Company has contracted with Agriculture Bank of China ("ABC") to have
ABC provide financing to eligible customers of the Company. ABC will provide up
to 80% of the contracted selling price of the Company to the customer. The
Company provides a guaranty to the bank for any financing provided. As of
September 30, 2004, ABC has not extended any financing to the Company's
customers.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
Tengtu International Corp. ("we," "us," or the "Company"), through its
wholly owned subsidiary, Beijing Tengtu United Electronics Development Co., Ltd.
("Tengtu United"), is engaged in the sale of software and educational materials
to schools in the People's Republic of China ("PRC"). Currently, these products
and materials consist principally of:
i. the Education Resource for Microsoft(R) Office software which
incorporates educational and teaching resources contained in our Total
Solution software with Microsoft's Office 2003;
ii. educational resources based on the PRC's required K-12
curriculum which are distributed by satellite and on hard disk drives by
Hua Xia Bo Xiu Education Software Co., a joint venture with the PRC
Ministry of Education of which we currently own 53% and which we refer to
as CBERC and which we consolidate in our financial statements as of April
5, 2004; and
iii. teacher training resources.
Our current business consists principally of the following:
i. Providing our products, educational materials and systems
integration services to schools as part of the PRC "Western Rural School
Projects," and
8
ii. Developing educational resources and negotiating with potential
strategic partners for the creation of a commercial "National Education
Portal" ("NEP"), which is to be an internet and fee-based educational
portal where students and parents can purchase additional and supplemental
educational resources.
RECENT BUSINESS DEVELOPMENTS
RESTRUCTURING
On September 15, 2003, we entered into an agreement with Tengtu China,
Beijing Jiade Tengtu Technology Group Co., Ltd., Fan Qi Zhang and Beijing
Oriental Tai He Technology Development Co., Ltd. (collectively the "Tengtu China
Group"), pursuant to a July 1, 2003 Terms Memorandum for a restructuring
pursuant to which we acquired 100% of Tengtu United and all of the profits
generated by its business in China while the Tengtu Group continues to operate
that business (the "Restructuring Agreement"). The Restructuring Agreement was
approved by our stockholders at our annual meeting of stockholders on January
20, 2004 and the agreement was consummated on April 5, 2004.
Since April 5, 2004, we, through our Audit Committee, have conducted a
thorough examination of the financial condition of Tengtu United, its operations
and the present and former operations of our former joint venture partner,
Beijing Tengtu China Culture and Education Electronics Development Co., Ltd.
("Tengtu China"), and the Tengtu China Group. Prior to the acquisition, Tengtu
China conducted all of Tengtu United's business with all Chinese government
entities as its agent and still conducts some of Tengtu United's business.
As a result of the examination, we have discovered that there were
inadequate internal and financial controls and systems at Tengtu China and the
Tengtu China Group which, to date, we have discovered resulted in inaccurate
recordkeeping, accounting errors, double counting of sales, and recognition of
revenue that is considered premature under United States generally accepted
accounting principles. We have, to date, implemented a number of measures to
correct weaknesses in internal controls and financial reporting systems as
follows:
i. We have reorganized the finance and accounting departments;
ii. We have replaced financial management responsible for financial
reporting, and appointed Simon Xia as Chief Financial Officer of Tengtu
United to oversee the Company's financial review and reorganization;
iii. We require our Chief Financial Officer to pre-approve all large
contracts for products or services, perform credit worthiness reviews of
all customers, perform thorough analysis of the profitability and capital
requirements of individual contracts and hold sales employees accountable
for the profitability and collectibility of sales made.
Our systems of internal control, however, are still in the process of
evaluation and improvement as personnel are replaced and new procedures are
implemented.
Liquidity and Capital Resources for the Three Months Ended September 30, 2004
and 2003
Three Months Ended September 30, 2004
For the three months ended September, 2004, net cash used by operating
activities totalled $869,153. The net loss for the three months was $1,013,025.
Other cash changes in operating activities include non-cash charges for
depreciation and amortization of $16,584, equity loss on investment of $35,549,
a collection provision of $3,823, non-cash interest expense of $60,000 related
to the convertible debenture, and the loss of a subsidiary allocated to the
minority interest of $65,115.
9
Cash was increased as a result of the decrease of $20,395 in accounts
receivable, and $167,248 of inventories. The increase in prepaid expenses of
$139,567, $338,089 of other receivables, and a decrease of $98,472 in other
liabilities resulted in a negative change to operating cash flow. Cash was
increased as a result of the increase of accounts payable of $163,582, accrued
expenses of $289,362, and prepaid revenue from customers of $28,572.
We did not make any investments during the quarter ended September 30,
2004.
Net cash flow from financing activities was $18,120, which includes
proceeds from a short term loan of $60,400 and $42,800 of cash payment for an
outstanding loan.
CONTRACTUAL OBLIGATIONS
The following summarizes the Company's contractual obligations at
September 30, 2004.
Payment Due by Period
Contractual Obligation Total Less than 1 Year 1-3 Years 4-5 Years After 5 Years
- ---------------------- ----- ---------------- --------- --------- -------------
Short-term loans $2,051,279 $2,051,279(1)
Total Contractual Obligation $2,051,279 $2,051,279(1)
Notes:
(1) The short-term loan includes (a) a $1,000,000 convertible debenture less
discount owed to Top Eagle Holdings, Ltd. ("Top Eagle"); (b) a short-term loan
of $984,520 owed by Beijing Tengtu Electronic Publishing Co., Ltd., ("TEP") to
Agricultural Bank of China; (c) a short term loan of $65,942 owed to Orion
Capital Incorporated; and (d) a $60,400 loan owed to Dr. Liu, the interim CEO.
The loan from Top Eagle is due December 15, 2004. We are in discussions with Top
Eagle concerning the refinancing of all or a portion of such loan.
In addition to the foregoing, we are committed to fund CBERC as follows:
RMB 30 million (approximately $3,624,000) within twelve months after the
establishment of CBERC and RMB 20 million (approximately $2,416,000) within
eighteen months after the establishment of CBERC. CBERC was established in
January 2003. In January 2004, an agreement was reached between Tengtu United
and CBERC, pursuant to which the payment due in January, 2004 was extended by
six months. Originally, our relationship with CBERC contemplated the creation of
a fully user supported internet-based portal which could also be used for
commercial purposes. The PRC Government, has, however, decided not to pursue
such a portal, and instead focuses on providing satellite based resources and
content and hard disk drives pre-loaded with resources and content. Therefore,
while we are currently committed to fund CBERC with approximately RMB 30
million, we believe that we will be able to renegotiate our CBERC relationship
to continue our cooperation with respect to content and resources, with a lower
capital contribution. However, there can be no assurance that the PRC government
will cooperate in such renegotiations, and, even if they do, that sufficient
capital will be available to contribute to CBERC to fulfill our obligations. The
loss of our interest in CBERC would materially and adversely affect our business
and operations.
Because the Tengtu China Group still conducts some of the business of
Tengtu United, Tengtu United has determined that it was necessary for it to
guarantee repayment of certain outstanding loans to the Tengtu China Group. The
guarantees currently outstanding, and their amounts, in RMB, are set forth
below:
Bank Loan Amount
Hua Xia Bank RMB 16 million
Agricultural Bank of China RMB 14.1 million
As previously reported by the Company, when Fan Qi Zhang died on October
24, 2003, he bequeathed 15 million of the 30 million shares of our common stock
that he was to receive upon the closing of the Restructuring to "solve the
funding difficulties" of the companies in the Tengtu China Group. The "funding
difficulties" of the Tengtu China Group are principally the above loans
guaranteed by Tengtu United, as well as an additional RMB 37.8 million in Tengtu
China Group debts which have not been guaranteed by Tengtu United as set forth
below:
Bank/Lender Loan Amount Obligor(s)
----------- ----------- ----------
Agricultural Bank of China RMB3.8 million Beijing Jiade Science and
(458,842 USD) Technology Group, Ltd.
("Jiade")
Bank of China RMB 15 million Jiade and Tengtu Electronic
(1,811,222 USD) Publishing House
The Estate of Fan Qi Zhang, which controlled the Tengtu China Group
companies, has given authorization to Tengtu United to use the 15 million shares
bequeathed by Mr. Zhang to pledge to the banks holding guarantees from Tengtu
United in substitution for the Tengtu United guarantees. Discussions with these
banks are currently ongoing.
We are planning to raise additional funds to meet the cash requirements
for CBERC project and the needs of our operations for the next 12 months. There
can be no assurance that such financing will be available, or if available, that
it will be on acceptable terms.
OPERATING RESULTS FOR THE THREE MONTHS ENDED September 30, 2004 AND 2003
Revenues and Gross Margin
Tengtu United sales for the three months ended September 30, 2004 and 2004
were $200,351, and $425,843 respectively. Please refer to the chart below for
more information about revenues and gross margin for the quarter.
-------------------------------------------------
September 30, 2004 September 30, 2003
-------------------------------------------------
Product Revenues GM % Revenues GM%
- -------------------------------------------------------------------------------
Software products $196,238 75% $346,934 58%
- -------------------------------------------------------------------------------
Satellite Equipment $ 78,607 -8%
- -------------------------------------------------------------------------------
Other Products and Services $ 4,113 100%
- -------------------------------------------------------------------------------
Total: $200,351 76% $425,541 55%
- -------------------------------------------------------------------------------
Revenues for the three months ended September 30, 2004 include sales of both TUC
and CBERC
GM % means the gross margin percentage in the table above.
10
Research and development
September 30, 2004 September 30, 2003
------------------ ------------------
$164,004 --
For the three months ended September 30, 2004, $164,004 research and
development expenses were incurred for CBERC. We recorded no research and
development expenses for the same period of 2003.
General and Administrative Expenses
September 30, 2004 September 30, 2003
------------------ ------------------
$549,974 $475,275
For the three months ended September 30, 2004, general and administrative
expenses were $549,974. The general and administrative expenses incurred by
Tengtu United amounted to $206,392. The major components of the remaining
balance were legal and professional fees of $206,779, accounting fees of
$27,118, and $57,210 of business travel expenses. The increase was primarily due
to legal fees and business travel expenses.
Related Party Consultants
September 30, 2004 September 30, 2003
------------------ ------------------
$164,030 $84,321
Related party consultants' expense relates to staff that manages technical
developments and financing activities in North America and China. The higher
expense in the quarter was due to hiring 3 consultants for the financing and
restructuring related activities in North America and China.
Collection Provision
September 30, 2004 September 30, 2003
------------------ ------------------
$3,823 $17,022
The expense represents an estimate of potential uncollectible accounts
associated with sales by Tengtu United. The lower amount in 2004 was primarily
due to the lower sales in 2004.
11
Selling Expense
September 30, 2004 September 30, 2003
------------------ ------------------
$248,932 $322,899
The majority of selling expenses relates to staff salary and travel
expenses in the marketing department in Tengtu China. The lower amount in 2004
was primarily due to the lower sales.
Depreciation and Amortization
September 30, 2004 September 30, 2003
------------------ ------------------
$16,584 $7,296
As Tengtu China manages the joint venture in China, we have not made any
significant purchases of equipment in the past few years.
Equity Losses in Investee
September 30, 2004 September 30, 2003
------------------ ------------------
$35,549 $22,991
The equity losses in investee relate to our investment in the Shaanxi
LBERC joint venture.
Interest Expense
September 30, 2004 September 30, 2003
------------------ ------------------
$94,718 $35,731
For the three months ended September 30, 2004, interest expense was the
interest on the Top Eagle loan of $78,082 and $16,636 for the TEP short term
loan in China. Interest in 2003 was incurred on the Top Eagle loan, and this was
offset by a reversal of an overaccrual of interest in the year ended June 30,
2003 of approximately $15,500.
Other Income
September 30, 2004 September 30, 2003
------------------ ------------------
$27,151 $59,576
Other income is principally the credits for value added tax paid in China
for Tengtu United's sales.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles or GAAP in
the United States. The preparation of those financial statements requires us to
make estimates and judgments that affect the reported amount of assets and
liabilities at the date of our financial statements. Actual results may differ
from these estimates under different assumptions or conditions.
12
Critical accounting policies are those that reflect significant judgments or
uncertainties, and potentially result in materially different results under
different assumptions and conditions. Our critical accounting policies are
described in our Form 10K/A filed for the fiscal year ended June 30, 2004.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We operate through subsidiaries located in Beijing, China and the
administrative offices are located in Toronto, Canada. We grant credit to its
customers principally in China.
We perform certain credit evaluation procedures and do not require
collateral. We believe that credit risk is limited because we routinely assess
the financial strength of our customers, and based upon factors surrounding the
credit risk of our customers, establish an allowance for uncollectible accounts
and, as a consequence, believe that our accounts receivable credit risk exposure
beyond such allowances is limited.
We established an allowance for doubtful accounts of $3,823 at September
30, 2004.
At September 30, 2004, we had $1,507,503 of cash in banks uninsured.
We do not require collateral or other securities to support financial
instruments that are subject to credit risk.
For the three months ended September 30, 2004, approximately 99% of sales
were generated through Tengtu United. For the three months ended September 30,
2004 and 2003, no customer accounted for more than 10% of total sales.
MARKET RISK SENSITIVE INSTRUMENTS
FINANCIAL INSTRUMENT CARRYING VALUE FAIR VALUE
-------------- ----------
Instruments entered into for trading purposes
NONE
Instruments entered into for other than
trading purposes
Cash and Cash equivalents
United States $ -- $ --
Foreign 1,507,503 1,507,503
---------- ----------
Total $1,507,503 $1,507,503
========== ==========
Accounts payable
United States $ 116,467 $ 116,467
Foreign 667,052 667,052
---------- ----------
Total $ 783,519 $ 783,519
========== ==========
13
Cash and cash equivalents and accounts payable are short-term financial
instruments, and as such are not subject to significant market risk.
Substantially all financial instruments are settled in the local currency
of each subsidiary, and therefore, the Company has no substantial exposure to
foreign currency exchange risk. Cash is maintained by each subsidiary in its
local currency.
Item 4. Controls and Procedures
In connection with the Company's April 2004 acquisition of the remaining
43% interest in Tengtu United from its former joint venture partner, Tengtu
China, the Company, through its Audit Committee, has been conducting a thorough
examination of the financial condition of Tengtu United and its operations.
Since April 5, 2004, we, through our Audit Committee, have conducted a
thorough examination of the financial condition of Tengtu United, its operations
and the present and former operations of our former joint venture partner,
Beijing Tengtu China Culture and Education Electronics Development Co., Ltd.
("Tengtu China"), and the Tengtu China Group. Prior to the acquisition, Tengtu
China conducted all of Tengtu United's business with all Chinese government
entities as its agent and still conducts some of Tengtu United's business.
As a result of the examination, we have discovered that there were
inadequate internal and financial controls and systems at Tengtu China and the
Tengtu China Group which, to date, we have discovered resulted in inaccurate
recordkeeping, accounting errors, double counting of sales, and recognition of
revenue that is considered premature under United States generally accepted
accounting principles. We have, to date, implemented a number of measures to
correct weaknesses in internal controls and financial reporting systems as
follows:
i. We have reorganized the finance and accounting departments;
ii. We have replaced financial management responsible for financial
reporting, and appointed Simon Xia as Chief Financial Officer of Tengtu
United to oversee the Company's financial review and reorganization;
iii. We require our Chief Financial Officer to pre-approve all large
contracts for products or services, perform credit worthiness reviews of
all customers, perform thorough analysis of the profitability and capital
requirements of individual contracts and hold sales employees accountable
for the profitability and collectibility of sales made.
Our systems of internal control, however, are still in the process of
evaluation and improvement as personnel are replaced and new procedures are
implemented.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As previously reported in our public filings, the Company was engaged in
litigation with VIP Tone, Inc. ("VIP") in the Superior Court of California for
the County of Alameda. On August 27, 2004 a verdict adverse to the Company was
rendered. A judgment based on the verdict was issued on October 1, 2004, but
execution of the judgment was stayed for 60 days to accommodate the Company's
post-trial motions to reduce the judgment.
It was found that the Company had breached a contract it had entered into
with VIP in November 2001 under which VIP was to provide services to the Company
in connection with the Company's development of the Central Broadband Education
Resources Center the Company has been developing with a division of the Ministry
of Education of the People's Republic of China. The jury also found that the
Company misrepresented certain facts and induced VIP to enter into the contract.
The Company had counterclaimed against VIP, alleging that VIP had breached the
contract and had misrepresented certain facts to the Company.
The amount of the judgment entered against the Company was $1,272,878. It
was also determined that the Company recover nothing on any of the Company's
counterclaims.
On November 29, 2004, the California court granted the Company's motion
for a new trial, subject to the condition that if VIP will consent to a
reduction of the judgment from $1,272,878 to $419,190, a new judgment in that
amount will be entered and VIP will not be compelled to re-try the entire case.
VIP has until the fifteenth day after the formal filing of the November 29
ruling to opt for the entry of the $419,190 judgment.
In the event that VIP will opt for the $419,190 judgment, the Company may
appeal from that judgment. The Company believes that there are strong grounds
for such an appeal.
Item 3. Defaults Upon Senior Securities
We defaulted on our quarterly interest payment to Top Eagle Holdings
Limited on a $1,500,000 Floating Convertible Debenture which was due on December
15, 2001. Pursuant to the terms of the Debenture interest accrued on the unpaid
interest at the same rate as other sums under the Debenture plus an additional
5%. The necessary payment was made in May, 2002. The loan was subsequently
refinanced with Top Eagle.
14
On September 30, 2002, Pak Kwan Cheung was removed as one of our
Directors. If Pak Kwan Cheung is no longer one of our Directors or our Chief
Executive Officer, it is an Event of Default which gives Top Eagle the right, at
its option, and in its sole discretion, to consider the Debenture immediately
due and payable, without presentment, demand, protest or notice of any kind.
Upon an Event of Default, the amounts due under the Debenture may be paid in
cash, or stock, at the prevailing conversion price set forth in the Debenture,
which is currently $4.00.
As previously disclosed by the Company, at the time of the closing of the
Restructuring, the Tengtu Group Companies had approximately $8.37 million in
bank debts and loans. The Company is currently in the process of resolving and
rescheduling these bank debts and loans as set forth below:
Settlement of Lawsuit by China Machinery Electronics Export Investment
Corporation ("CME") against Tengtu United and the interest in the Central
Broadband Education Resources Center ("CBERC")
In January, 2003, Beijing Jiade Science and Technology Group, Ltd.
("Jiade") borrowed approximately RMB 19 million from CME, a Chinese state-owned
company. When the loan was not repaid, CME commenced a lawsuit in July, 2004
against Jiade in the Beijing No. 1 Intermediate People's Court, requesting Jiade
to pay back the loan. At the same time, CME applied to the court to freeze the
assets of Jiade.
The principal asset of Jiade is the Company's interest in Hua Xia Bo Xin
Education Software Co., or CBERC. The interest in CBERC was held by Jiade on
behalf of the Company and Tengtu United pursuant to April 17 and April 25, 2001
agreements with the Tengtu Group companies. In addition, the September 15, 2003
Restructuring Agreement with the Tengtu Group companies, which closed on April
5, 2004, required that the interest in CBERC be transferred to Tengtu United or
the Company. Pending completion of the transfer, the interest in CBERC was
pledged to Tengtu United by Jiade, which pledge was registered with the Beijing
Commercial Bureau.
The court had granted a freeze of Jiade's assets, including the interest
in CBERC, from August 3, 2004 until February 2, 2005. Subsequently, CME filed a
second lawsuit seeking to invalidate the pledge agreement between Jiade and
Tengtu United.
The Company has entered into an agreement to settle both lawsuits and
believes it will conclude a pledge agreement pursuant to which CME will grant
Jiade a one year extension of the loan to it in exchange for a commitment from
the Estate of Fan Qi Zhang to pledge five million shares of Company common
stock. The five million shares will come from 15 million shares bequeathed by
Mr. Zhang to solve the "funding difficulties" Tengtu China Group as described
below. The number of shares to be pledged has not yet been determined because
the lawsuit seeking to invalidate the pledge agreement between Jiade and Tengtu
United was dismissed on October 20, 2004, thereby strengthening our bargaining
position. CME has, however, appealed the decision.
Settlement discussions are similarly proceeding on other Bank debts and
loans.
These bank debts and loans are set out as follows as well as are
guarantees entered into on behalf of Tengtu United:
15
Because the Tengtu China Group still conducts some of the business of
Tengtu United, Tengtu United has determined that it was necessary for it to
guarantee repayment of certain outstanding loans to the Tengtu China Group. The
guarantees currently outstanding, and their amounts, in Chinese renminbi, are
set forth below (as of October 12, 2004, $1.00 was equal to 8.28170 renminbi):
Bank Loan Amount
---- -----------
Hua Xia Bank RMB 16 million
($1,931,970)
Agricultural Bank of China RMB 14.3 million
($1,727,440)
As previously reported by the Company, when Fan Qi Zhang died on October
24, 2003, he bequeathed 15 million of the 30 million shares of our common stock
that he was to receive upon the closing of the Restructuring to "solve the
funding difficulties" of the companies in the Tengtu China Group. The "funding
difficulties" of the Tengtu China Group are principally the above loans
guaranteed by Tengtu United, as well as an additional RMB 37.8 million in Tengtu
China Group debts which have not been guaranteed by Tengtu United as set forth
below:
Bank/Lender Loan Amount Obligor(s)
- ----------- ----------- ----------
Agricultural Bank of China RMB3.8 million Beijing Jiade Science and
(458,842 USD) Technology Group, Ltd. ("Jiade")
Bank of China RMB 15 million Jiade and Tengtu Electronic
(1,811,222 USD) Publishing House
The Estate of Fan Qi Zhang, which controlled the Tengtu China Group
companies, has given authorization to Tengtu United to use the 15 million shares
bequeathed by Mr. Zhang to pledge to the banks holding guarantees from Tengtu
United in substitution for the Tengtu United guarantees. Discussions with these
banks are currently ongoing. The Estate of Fan Qi Zhang has also authorized the
use of a portion of the 15 million shares to pledge to CME for settlement of the
lawsuits described previously.
The Bank of China loan is already in default and has been assigned to an
asset management company. No collection attempts have yet been made.
While we believe that we will reach a satisfactory resolution of the above
loans and guarantees, such outcome cannot be assured. In addition, the failure
to resolve these loans and guarantees, or to pay them when they are due if they
are extended, could materially and adversely affect the Company, its business
and operations.
Item 6. Exhibits
- ------- ---------
Index of Exhibits required by Item 601 of regulation S-K:
3.1 Articles of Incorporation (filed as part of our Form 10 filed on May
25, 2000 and incorporated herein by reference);
3.2 By-Laws (filed as part of our Form 10 filed on May 25, 2000 and
incorporated herein by reference);
4.3 Form of Special Warrant issued to investors in a private placements
which closed in June, 2002 through May, 2003 (filed as part of our Form
10-K filed on October 15, 2002 and incorporated herein by reference);
10.1 English Translation of Agreement between National Center for Audio
Visual Education and Tengtu Culture and Education Electronics
Development Co., Ltd. Dated September 20, 2000 - referred to as
"Operation Morning Sun" (filed as part of our Form 10-Q filed on
November 14, 2000 and incorporated herein by reference);
16
10.2 English Translation of Cooperation Agreement among the Chinese National
Center for Audio/Visual Education of the Ministry of Education, Tengtu
China and Legend Group (filed as part of our Form 10-Q filed on
November 14, 2000 and incorporated herein by reference);
10.10 Tengtu United Joint Venture Agreement and the amendment thereto (filed
as part of our Form 10 filed on May 25, 2000 and incorporated herein by
reference);
10.12 Consulting agreement between Comadex Industries, Ltd. and Tengtu (filed
as part of our Form 10 filed on May 25, 2000 and incorporated herein by
reference);
10.13 Top Eagle Holdings, Ltd. Convertible Debenture and Warrant Purchase
Agreement (filed as part of our Form 8-K dated December 23, 1999 and
incorporated herein by reference);
10.14 Top Eagle Holdings, Ltd. Investor Rights Agreement (filed as part of
our Form 8-K dated December 23, 1999 and incorporated herein by
reference);
10.15 Top Eagle Holdings, Ltd. Convertible Debenture (filed as part of our
Form 8-K dated December 23, 1999 and incorporated herein by reference);
10.16 Top Eagle Holdings, Ltd. Common Stock Warrant (filed as part of our
Form 8-K dated December 23, 1999 and Incorporated herein by reference);
10.17 English translation of February 13, 2001 Cooperation Agreement between
National Center for Audio/Visual Education and Tengtu Culture and
Education Electronics Development Co., Ltd. on Carrying out "Operation
Morning Sun - Phase II" (filed as part of our Form 10-Q filed on May
15, 2001 and incorporated herein by reference);
10.19 English translations of April 9, 2001 Cooperation Agreement on
Establishment of "Morning Sun Resources Center under National Center
for Audio/Visual Education of Ministry of Education" and supplemental
memorandum between Tengtu China and us (filed as part of our Form 10-Q
filed on May 15, 2001 and incorporated herein by reference);
10.20 English translation of Extension to Operation Morning Sun (filed as
part of our Form 10-Q filed on May 15, 2001 and incorporated herein by
reference);
10.21 Additional Supplemental Agreement between Tengtu China and us dated
April 25, 2001 (filed as part of our Form S-1/A filed on August 7, 2001
and incorporated herein by reference);
10.22 ShanDong Province Cooperation Agreement dated August 17, 2001 (English
translation) (filed as part of our Form 10-K on September 28, 2001 and
incorporated herein by reference);
10.24 December 21, 2001 Agreement between Tengtu International Corp. and
Lifelong.com, Inc. (filed as part of our Form 10-Q filed on May 20,
2002 and incorporated herein by reference);
10.25 English Translation of Cooperation Agreement effective September 1,
2001 between the Ministry of Education of the ShanDong Province and
Beijing Tengtu Tian Di Network Co., Ltd. (filed as part of our Form
10-Q filed on May 20, 2002 and incorporated herein by reference);
17
10.26 English Translation of September 18, 2001 Memorandum of Cooperation,
Establishment of Shaanxi Provincial Education Resources Center by and
among Li Gen Juan, Director of Shaanxi Provincial Center for
Audio/Visual Education, Suan Pai Yau, Tin Pang and Wu Oi Juan, Deputy
Directors of Shaanxi Provincial Center for Audio/Visual Education, and
Lin Xiao Feng, President of Tengtu Culture & Education Electronics
Development Co., Ltd. (filed as part of our Form 10-Q filed on February
19, 2002 and incorporated herein by reference);
10.27 English Translation of Cooperation Agreement between the Center for
Audio/Visual Education, Department of Education, Fujian Province and
Tengtu TianDi Network Co., Ltd. (filed as part of our Form 10-Q filed
on May 20, 2002 and incorporated herein by reference);
10.29 July 22, 2002 Supplemental Agreement between Tengtu International Corp.
and Lifelong.com, Inc. (filed as part of our registration statement on
Form S-1 filed on August 14, 2002 and incorporated herein by
reference);
10.30 English Translation of July 22, 2002 Cooperation Agreement between the
National Center for Audio and Visual Education and Beijing Jiade Tengtu
Science and Technology Group Companies (filed as part of our
registration statement on Form S-1 filed on August 14, 2002 and
incorporated herein by reference);
10.31 English translation of December 18, 2002 Framework Agreement between
Shaanxi Provincial Center for Audio Visual Education and Beijing Tengtu
TianDi Network Co., Ltd. (filed as part of our registration statement
on Form S-1 filed on August 14, 2002 and incorporated herein by
reference);
10.32 Amended understanding between Tengtu China and Tengtu International
Corp. Governing Activities in China Relating to Operation Morning Sun
National Center For Audio/Visual Education and the Ministry of
Education, dated as of April 25, 2001 (filed as part of our
registration statement on Form S-1 filed on August 14, 2002 and
incorporated herein by reference);
10.33 English translation of Cooperation Agreement between the Agriculture
Bank of China and Beijing Jiade Tengtu Scientific and Technology Group
entered into in September, 2002 (filed as part of our Form 10-K/A filed
on February 20, 2003 and incorporated herein by reference);
10.34 English translation of Strategic Cooperation Agreement dated July 16,
2002 between Lan Chao (Beijing Electronics Information Industry Co.,
Ltd.) and Beijing Tengtu Science & Technology Group Co., Ltd. (filed as
part of our Form 10-K/A filed on February 20, 2003 and incorporated
herein by reference);
10.35 English version of January 1, 2003 Amendment to Joint Venture Agreement
between Tengtu International Corp. and Tengtu China. (filed as part of
our Form 10-Q filed on March 19, 2003 and incorporated herein by
reference).
10.36 September 15, 2003 Restructuring Agreement (filed as exhibit 10.1 to
our Form 8-K/A filed on September 18, 2003 and incorporated herein by
reference);
11.1 Statement re: Computation of Per Share Earnings for the Three Months
Ended September 30, 2004 and 2003;
21.1 List of Subsidiaries;
18
31.1 Certification of John D. Watt pursuant to Exchange Act Rules 13a-14(a)
and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002;
31.2 Certification of Judy Ye pursuant to Exchange Act Rules 13a-14(a) and
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002;
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TENGTU INTERNATIONAL CORP.
----------------------------------------
(Registrant)
Date: December 6, 2004 John Watt
---------------- ----------------------------------------
(Name)
/s/ John Watt
----------------------------------------
(Signature)
President
----------------------------------------
(Title)
Date: December 6, 2004 Judy Ye
---------------- ----------------------------------------
(Name)
/s/ Judy Ye
----------------------------------------
(Signature)
Chief Financial Officer
----------------------------------------
(Title)
19