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HQGE.OB > SEC Filings for HQGE.OB > Form 10-K on 14-Dec-2011All Recent SEC Filings

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Form 10-K for HQ GLOBAL EDUCATION INC.


14-Dec-2011

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the consolidated financial condition and results of operation of the Company for the years ended August 31, 2010 and 2011, should be read in conjunction with the selected financial data, the financial statements and the notes to those statements that are included elsewhere in this filing. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors, Cautionary Notice Regarding Forward-Looking Statements and Business sections in this annual report. We use terms such as "anticipate," "estimate," "plan," "project," "continuing," "ongoing," "expect," "believe," "intend," "may," "will," "should," "could," and similar expressions to identify forward-looking statements.

Management's discussion and analysis is intended to help the reader understand the results of operations and financial condition of the Company. The following discussion should be read in conjunction with the Consolidated Financial Statements and accompanying notes ("Notes") included in this Form 10-K.

OVERVIEW

We are a leading vocational education service provider in China. We offer a wide range of educational programs and services through vocational secondary schools under "Customized Education" mode. Our business mainly consists of various vocational skills training programs, remote network education, school logistic services, human resource services and development of educational materials. We have abundant student sources that cover 25 provinces and 26 nationalities, including graduates from junior high schools, senior high schools and junior colleges, unemployed people and rural labor force.

Since China's entrance into World Trade Organization, hosting the 2008 Olympic Games, and hosting the 41st World Expo in Shanghai and Asian Olympics in Guangzhou in 2010, China has attracted international financial sources. In line with the high economic growth rate, demand for workers and technicians with specific skills has increased dramatically. To match the requirements, the Chinese government issued several regulations such as Vocational Education Law of the People's Republic of China, Regulations of the People's Republic of China on Chinese-Foreign Cooperation in Running Schools, Law of the People's Republic of China on the Promotion of Privately-run Schools and State Guidelines for medium-to-long-term Education Reform and development Plan to enhance the development of the vocational education industry. Under such preferential policies, we have experienced significant and stable growth in our business in recent years. We have established cooperative relationship with 128 enterprises. We supply our trained students to these enterprises and make various training courses available to their employees. These cooperative enterprises are mainly located in the economic centers of China, which cover, INTER ALIA, Yangtze River Delta (radiating from Shanghai to Nanjing, Hangzhou, Wuxi, Ningbo and other coastal areas), the Pearl River Delta (radiating from Shenzhen to Dongguan, Guangzhou, Huizhou, Panyu, Qingyuan, Shaoguan and other coastal areas), and many inland provinces in China. HQ Global has become increasingly renowned throughout China for its superior training to meet employer needs and its successful production of outstanding technical specialists. As of August 31, 2011, the employment rate remained 100% for the students who graduated from our vocational programs and the supply is still inadequate to meet the demand.

OPERATIONS

Mr. Guangwen He is the founder and CEO of Oya Education Technology Co., Ltd., Changsha HQ Global Vocational School and Shaoshan HQ Global Technical School. He has been engaged in vocational education and related investments since 1994. In China, "Order-oriented Education", or customized education, was initially created by Mr. Guangwen He and currently is our main operation mode. Order-oriented Education refers to the educational program that tailors vocational education and training via cooperation agreements between us and various enterprises. Under Order-oriented Education, we combine the cultivation targets with the specific needs of enterprises, curriculums with industry production process, vocational training with position requirements. We create qualified students in compliance with the requirements of the industry. At this stage, our revenue is derived from the students' tuition and is recognized proportionately within the semester.


We divide our teaching calendar into two semesters per year. Our first and second semesters for fiscal year 2011 lasted from September 2010 to January 2011 and from February 2011to August 2011 (including two-month summer break), respectively. Our most recent teaching semester lasted from February 1, 2011 to August 31, 2011. During this semester, we offered approximately 60 programs under 17 categories to 36,926 students.

During the winter and summer breaks, off-campus internships are provided to students. Our teachers work as the team leaders for these students who are sent to different enterprises in groups. Such on-field practice help students understand the business, the production process, management model and position requirements. As a result, students are prepared for their position without further training once they are placed with the enterprise clients.

We receive commissions from the enterprise clients for placing intern students with them. The amount of commission is based on the number of students an enterprise client receives. We also receive management fees from the intern students at a monthly fixed rate based on the duration of their internship. Such revenue is recognized upon the completion of the internship arrangement. Upon graduation, eligible students are usually hired by the same enterprise client with which they interned. In such instances, we will receive placement fees from the students and service fees from enterprise clients. Such revenue is recognized upon the completion of all the services related to the job arrangement.

"Order-oriented Education" reflects the resource sharing between schools and enterprises. It benefits our students in their job hunting endeavors after graduation. As a consequence, student recruitment witnessed a significant expansion in recent years for our eleven (11) schools that are located in Shaoshan, Changsha and Shaoyang of Hunan Province, in Lushan, Shimian, Tianquan and Yingjing of Sichuan Province, in Tianzhen of Shanxi Province, and in Zhangwu of Liaoning province, respectively. To carry out the customized training program, we established cooperative relationships with 128 enterprises as of August 31, 2011, including Fuji Xerox Technology (Shenzhen) Co., Ltd., Flextronics (Zhuhai) Co., Ltd., Dongguan Master Electronics Co., Ltd., ASUSTeK Computer (Shenzhen) Inc., Shanghai Inventec Co., Ltd., among many others.

PROSPECT

Under economic globalization, enterprises in China are expanding faster than ever and this has resulted in a serious shortage of labor force. According to the Secondary Vocational Education Innovation and Development Plan (Year 2010-2012) issued on November 27, 2010 by the Ministry of Education, in the coming three years, about 20 million skilled workers will be trained and they will become driving force for social and economic development. A study conducted by National Institute for Educational Research showed that the shortage of technical talents will range from 17.46 million to 26.65 million by the end of 2010. This provides a huge expansion space for the vocational education in the mainland of China and provides desirable opportunities for the development of our business.

CRITICAL ACCOUNTING POLICIES AND MANAGEMENT ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis and use them on historical experience and various other assumptions that are believed to be reasonable under the circumstances as 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 because of different assumptions or conditions.

We believe the following critical accounting policies affect our significant estimates and judgments used in the preparation of our consolidated financial statements. These policies should be read in conjunction with Note 2 of the Notes to consolidated financial statements.

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP"). The consolidated financial statements include the financial statements of the Company, Risetime, Global Education, Xiangtan Nicestar, Oya, as well as Oya's subsidiaries and VIEs. All significant inter-company balances and transactions are eliminated in consolidation.

USE OF ESTIMATES

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes, and disclosure of contingent liabilities at the date of the consolidated financial statements. Estimates are used for, but not limited to, the selection of the useful lives and residual values of property and equipment and intangible assets, provision for doubtful accounts, provision necessary for contingent liabilities, fair values, revenue recognition, and other similar charges. Management believes that the estimates utilized in preparing its consolidated financial statements are reasonable and prudent. Actual results could differ from these estimates.


FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company adopted the provisions of Accounting Standards Codification ("ASC") 820, Fair Value Measurements and Disclosures. ASC 820 clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.

Level 3-Inputs are unobservable inputs which reflect the reporting entity's own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

The Company's financial instruments include cash, accounts receivable, advances to vendors, other receivables, accounts payable, payroll payable, taxes payable, loans, other payable and accrued liabilities. Management has estimated that the fair value of these financial instruments approximate their carrying amounts due to their short-term nature. The Company uses the Level 3 method to measure fair value of its long-term bank loan. The carrying amount of the bank loan approximates the fair value based on the Company's estimate for debt with comparable risk in market.

REVENUE RECOGNITION

The Company recognizes revenues in accordance with ASC 605 "Revenue Recognition". The Company recognizes revenue when the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the services have been rendered, (iii) the fees are fixed or determinable and (iv) collection of the resulting receivable is reasonably assured.

(a) Tuition revenue received from educational programs and services is recognized proportionately according to the progress the student completes regarding educational programs in the school. Tuition paid in advance is recorded as unearned revenues.

(b) We provide off-campus internship arrangements for students and collect service charges at fixed amount from both recruiters and students. Revenue is recognized upon completion of the internship program.

(c) We provide other services, mainly logistic services, for our students and the revenue from such services is recognized upon completion of the service.

ACCOUNTS RECEIVABLE

Accounts receivable consists of balances receivable for the charges of education services we provided and for tuition revenues. Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible amounts. As of August 31, 2011 and 2010, total accounts receivable were $10,462,232 and $9,023,824 respectively, of which, $7,717,859 and $6,946,895 were tuition fees due from governmental organizations and associations under the impoverished student aid programs for the years ended August 31, 2011 and 2010.

The Company does periodical reviews as to whether the carrying values of accounts have become impaired. The assets are considered to be impaired if the collectability of the balances become doubtful, accordingly, the management estimates the valuation allowance for anticipated uncollectible receivable balances. When facts subsequently become available to indicate that the allowance provided requires an adjustment, then the adjustment will be recorded as a change in allowance for doubtful accounts. As of August 31, 2011 and August 31, 2010, the allowance for doubtful accounts was $75,616 and $-0-, respectively.

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost less accumulated depreciation and any impairment losses. The cost of an asset is comprised of its purchase price and any directly attributable costs of bringing the asset to its working condition and location for its intended use. Expenditures incurred after the property and equipment have been put into operation, such as repairs and maintenance and overhaul costs is normally charged to the profit and loss account in the year in which it is incurred.


We estimates the useful lives of property and equipment using the straight-line method over the estimated useful lives of the assets, less any estimated residual value. Estimated useful lives of the assets are as follows:

Teaching and dormitory facilities 10 - 30 years Educational equipments and books 5 years Office equipments and other equipments 5 years Automobiles 5 years

IMPAIRMENT OF LONG-LIVED ASSETS

In accordance with ASC 360, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company is required to review its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value.

The Company tests long-lived assets, including property, plant and equipment and other assets, for recoverability when events or circumstances indicate that the net carrying amount is greater than its fair value. Assets are grouped and evaluated at the lowest level for their identifiable cash flows that are largely independent of the cash flows of other groups of assets. The Company considers historical performance and future estimated results in its evaluation of potential impairment and then compares the carrying amount of the asset to the future estimated cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated expected undiscounted future cash flows, the Company measures the amount of impairment by comparing the carrying amount of the asset to its fair value. The estimation of fair value is generally determined by using the asset's expected future discounted cash flows or market value. The Company estimates fair value of the assets based on certain assumptions such as budgets, internal projections, and other available information as considered necessary. There was no impairment of long-lived assets during the years ended August 31, 2011 and 2010.

INTANGIBLE ASSETS

Intangible assets are accounted for in accordance with the provisions of ASC 350, "Goodwill and Other Intangible Assets". Intangible assets with a defined useful life are amortized over their useful lives.

INCOME TAX

The Company did not generate any taxable income outside of the PRC for the year ended August 31, 2011 and 2010 and the Company is governed by the Income Tax Law of the PRC. The Company accounts for income taxes using an asset and liability approach which allows for the recognition and measurement of deferred tax assets based upon the likelihood of realization of tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefits, or that future deductibility is uncertain. In the event the PRC government determines that the Company is no longer exempt from income taxes, the Company would be subject to a statutory tax rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments.

The Company was incorporated in the United States and, accordingly, is governed by the income tax laws of the United States. The Company incurred a net operating loss for U.S. income tax purposes. This loss carry forward, which August be available to reduce future periods' taxable income, will expire, if not utilized, in twenty years from the date the loss was incurred. The net operating loss gives rise to a deferred tax asset. However, the management believes that the realization of the benefits arising from this loss appear to be uncertain due to Company's limited operating history and continuing losses for United States income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at the balance sheet dates against its deferred tax asset. The management reviews this valuation allowance periodically and makes adjustments as warranted. The valuation allowance on August 31, 2011 was the same as August 31, 2010.
In accordance with ASC topic 740, interest costs related to unrecognized tax benefits are required to be calculated (if applicable) and would be classified as Interest expense, net". Penalties if incurred would be recognized as a component of "General and administrative" expenses.

RESULTS OF OPERATIONS FOR THE YEARS ENDED AUGUST 31, 2011 AND 2010

Our chief operating decision maker ("CODM") is our Chief Executive Officer who reviews the financial information of separate operating segments when making decisions about allocating resources and assessing performance of the group. Based on management's assessment, we have determined that we have three operating segments: Vocational Education, Order-oriented Service, and Campus services. These three operating segments are also identified as reportable segments.


Vocational education services are our main business currently and we provide a wide range of programs through our vocational secondary schools. Fee based revenues from vocational education services primarily consist of student tuition and fees derived from the programs we offer and collected from students based on the fee standards that are filed and approved by the related local authorities;

Revenues generated from Order-oriented services mainly consist of fees we collected from students and enterprises sponsors related to campus internship arrangement and job placement services;

Revenues generated from campus services primarily consist of canteen services and grocery sales provided to our students.

Results of operations are a general reflection of our experience in providing customized educational programs, the operation time of our schools, the reputation of our schools, the scalability of our schools and the total number of students, all of which demonstrated a growth trend in the past years and are expected to expand in the future. Our expansion can be reflected specifically in the increase of our student enrollment, the development of new customized educational programs, the cooperation with more target employers, the education appropriations from local government for running new schools. It also will be reflected in our return from the investment on new business in the future. The number of students increased from 34,477 as of August 31, 2010 to 36,926 for the year ended August 31, 2011.

The following table summarizes our audited consolidated operating results for the years ended August 31, 2011 and 2010:

                           For the years ended August 31,               Comparison
                               2011                2010             Amount        Percent
                               US$                  US$              US$             %

Revenue
-Fee based                     40,881,647         34,755,064        6,126,583         17.6
-Service based                 14,690,984         12,300,242        2,390,742         19.4
                               55,572,631         47,055,306        8,517,325         18.1

Cost of revenue
-Fee based                    (21,911,066 )      (19,488,030 )     (2,423,036 )       12.4
-Service based                (12,378,498 )       (9,635,489 )     (2,743,009 )       28.5
                              (34,289,564 )      (29,123,519 )     (5,166,045 )       17.7

Gross profit                   21,283,067         17,931,787        3,351,280         18.7

Selling expenses               (1,038,506 )         (915,265 )       (123,241 )       13.5
G&A expenses                   (3,253,140 )       (2,327,716 )       (925,424 )       39.8

Income from operations         16,991,421         14,688,806        2,302,615         15.7

Other expenses                   (228,027 )       (1,119,803 )        891,776        (79.6 )

Income taxes                            -                  -                -            -

Net income                     16,763,394         13,569,003        3,194,391         23.5

In line with the business expansion, both revenue and profit have demonstrated significant growth in these periods. For the year ended August 31, 2011, we achieved total revenue of $55,572,631, representing an increase of $8,517,325 or 18.1% as compared to $47,055,306 for the year ended August 31, 2010. Our net income for the year ended August 31, 2011 was $16,763,394, representing an increase of $3,194,391 or 23.5% as compared to $13,569,003 for the year ended August 31, 2010.


Year Ended August 31, 2011 Compared With Year Ended August 31, 2010

Revenues, Cost of Revenues and gross profit by segment

                                                          For the yearss ended August 31,
                                               2011             2010           Amount         Percentage
Revenues
Vocational Education - fee based           $ 32,288,730     $ 28,642,779     $ 3,645,951               13 %
Order-oriented service - fee based            8,592,917        6,112,285       2,480,632               41 %
Campus Services - service based              14,690,984       12,300,242       2,390,742               19 %
                                             55,572,631       47,055,306       8,517,325               18 %
Cost of Revenues
Vocational Education - fee based             20,747,993       18,571,780       2,176,213               12 %
Order-oriented service - fee based            1,163,073          916,250         246,823               27 %
Campus Services - service based              12,378,498        9,635,489       2,743,009               28 %
                                             34,289,564       29,123,519       5,166,045               18 %
Gross Profit
Vocational Education - fee based             11,540,737       10,070,999     $ 1,469,738               15 %
Order-oriented service - fee based            7,429,844        5,196,035       2,233,809               43 %
Campus Services - service based               2,312,486        2,664,753        -352,267              -13 %
                                           $ 21,283,067     $ 17,931,787     $ 3,351,280               19 %

(1) Revenues from vocational education primarily consisted of tuition and fees derived from the programs we offered and collected from students based on the fee standards that are filed and approved by the related local authorities. For the year ended August 31, 2011, total tuition and miscellaneous fees increased 13% as compared to tuition and miscellaneous fees for the year ended August 31, 2010. The increase was the result of increases in our student enrollment and tuition rates as well as the expansion of our business.

Our student enrollment increased to 37,408 and 36,926 for the first and second semester of fiscal 2011 as compared to 32,238 and 34,477 for the first and second semester of fiscal 2010, representing an increase of 16% and 7%. Our order-oriented education mode, excellent job placement rate and great reputation have attracted a greater number of students to study in our schools.

Our tuition rates for fiscal year 2011 increased 11% compared with fiscal year 2010. The increase in tuition rates also led to the increase in revenue.

Cost of vocational education services mainly includes salary and welfare of teachers, depreciation of teaching facilities and educational equipment, maintenance, and other expenses. For the year ended August 31, 2011 we incurred total cost of $20,747,993, representing an increase of 12% as compared to $18,571,780 for the year ended August 31, 2010. The increase was mainly attributable to the following:

Increase in faculty and staff members in schools. The commencement of operation of the new school and the increase in student enrollment led to an increase in faculty and staff members. Besides, the Company increased the pay rates for teachers to improve their income levels. Therefore, salary and welfare for the year ended August 31, 2011 increased $708,778 as compared with the amount for the same period of the prior year.

Increase in cost of school-running cooperation. The Company has put more efforts in expanding the scale of continuing education in fiscal year 2011. For the first and second semester of fiscal 2011 the total number of students enrolled in continuing education program was 3,756 and 3,839, representing an increase of 113% and 90% when compared with the number of students for the . . .

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