CHINA EDUCATION ALLIANCE, INC.

INDEX

PART I FINANCIAL INFORMATION
Item 1. Financial Statements:			1
Condensed Consolidated Balance Sheet as of September 30, 2006			1
Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2006 and 2005			2
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005			3
Notes to the Condensed Consolidated Financial Statements			4
Item 2. Management’s Discussion and Analysis or Plan of Operation			11
Item 3. Controls and Procedures			19
PART II OTHER INFORMATION
Item 1. Legal Proceedings			19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			19
Item 3. Defaults upon Senior Securities			19
Item 4. Submission of Matters to a Vote of Security Holders			19
Item 5. Other Information			19
Item 6. Exhibits			20
Signatures			21

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PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

China Education Alliance and Subsidiaries

Condensed Consolidated Balance Sheet

As of September 30, 2006

(Expressed in US Dollars)

(Unaudited)

ASSETS
Current Assets
Cash and Cash Equivalents (Note 5)		$	5,610,885
Inventories (Note 6)			72
Prepaid Expense			142,088
Total Current Assets			5,753,045
Property and Equipment
Fixed Assets, Net of Accum. Depreciation (Note 7)			3,905,808
Total Property and Equipment			3,905,808
Investment
Total Assets		$	9,658,853
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts Payable and Accrued Expenses		$	2,021
Advances on Accounts (Note 8)			477,496
Loan from Shareholder (Note 14)			281,503
Wages Payable			8,766
Welfare Payable			6,649
Taxes Payable (Note 9)			38,090
Notes Payable (Note 10)			1,530,000
Total Current Liabilities			2,344,525
Total Liabilities			2,344,525
Commitments and Contingencies (Note 15)
Shareholders' Equity
Preferred Stock ($0.001 par value, 5,000,000 shares authorized, none issued and outstanding)			-
Common Stock ($0.001 par value, 150,000,000 shares authorized, 57,935,000 issued and outstanding)			57,935
Additional Paid-in Capital			2,414,949
Currency Conversion Adjustment (Note 3)			68,910
Retained Earnings			4,772,534
Total Shareholders' Equity			7,314,328
Total Liabilities and Shareholders' Equity		$	9,658,853

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China Education Alliance and Subsidiaries

Consolidated Statements of Operations

For the Three and Nine Months Ended September 30, 2006 and 2005

(Expressed in US Dollars)

(Unaudited) 

 

		For the Three Months Ended September 30						For the Nine Months Ended September 30
		2006			2005			2006			2005
REVENUES
Sales and Tuition (Note 3)		$	2,284,521		$	1,019,020		$	5,798,779		$	1,383,048
Less: Cost of Good Sold			734,034			477,445			1,891,397			533,739
Gross Profit			1,550,487			541,575			3,907,382			849,309
OPERATING EXPENSES
General, Administrative and Selling Expenses			359,456			65,931			738,361			144,192
Total Operating Expenses			359,456			65,931			738,361			144,192
Income from Operations			1,191,031			475,644			3,169,021			705,117
Other Expense (Income)
Interest Expense (Income)			(5,127	)		629			(10,049	)		5,552
Other Expense			-			51			-			1,287
Total Other Expense (Income)			(5,127	)		680			(10,049	)		6,839
Income before Tax Provision			1,196,158			474,964			3,179,070			698,278
Less: Provision for Income Taxes (Note 11)			-			159,913			-			237,627
Net Income		$	1,196,158		$	315,051		$	3,179,070		$	460,651
Earnings per share attributed to China Education Alliance common stock:
Basic income per share		$	0.021		$	0.005		$	0.055		$	0.008
Diluted income per share		$	0.021		$	0.005		$	0.055		$	0.008
Basic weighted average shares outstanding			57,921,667			57,915,000			57,917,222			57,915,000

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China Education Alliance and Subsidiaries

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2006

(Expressed in US Dollars)

(Unaudited)

 

		For the Nine Months Ended September 30
		2006			2005
Cash flows from operating activities:
Net income		$	3,179,070		$	460,651
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation			238,621			147,527
Changes in assets and liabilities -
Increase in accounts receivable						(18,421	)
Decrease in inventories			449			(5,963	)
Increase in prepaid expense			(65,647	)		(370,222	)
Decrease in accounts payable and accrued expenses			(74,834	)		9,422
Decrease in advance on account			180,371
Increase in wages payable			2,912
Increase in welfare payable			6,273
Decrease in taxes payable			13,641			235,430
Net cash provided by operating activities			3,480,856			458,424
Cash flows from investing activities:
Purchases of fixed assets			(217,816	)		(222,281	)
Net cash used by investing activities			(217,816	)		(222,281	)
Cash flows from financing activities:
issuance of common stock			7,000			23,778
Increase in loan from shareholders			163,558			23,500
Increase in notes payable			1,530,000			(19,182	)
Net cash provided by financing activities			1,700,558			28,096
Currency conversion adjustments			49,843			9,747
Net increase in cash			5,013,441			273,986
Cash at beginning of year			597,444			89,741
Cash at end of year		$	5,610,885		$	363,727

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1.	Description of Business

Nature of organization

China Education Alliance, Inc. (CEDA), formerly known as ABC Realty Co., was originally organized under the laws of the State of North Carolina on December 2, 1996. The main function for the ABC Realty was to engage in residential real estate transactions as a broker or agent. On September 15, 2004, ABC Realty was reorganized pursuant to the Plan of Exchange to acquire Harbin Zhong He Li Da Education Technology, Inc. (“ZHLD”), a Corporation formed on August 9, 2004 in the city of Harbin of Heilongjiang Province, The People’s Republic of China, with an authorized capital of $60,386 (RMB500,000).

On September 15, 2004, ABC Realty Co. executed a Plan of Exchange with ZHLD, and Duane C. Bennett, Chairman of ABC Realty Co., pursuant to which ZHLD exchanged all of its registered capital of $60,386 for 55,000,000 shares, or approximately 95% of the common stock. On November 17, 2004, ABC Realty Co. changed its name to China Education Alliance, Inc. On December 13, 2004, China Education Alliance, Inc. consummated the Plan of Exchange with ZHLD. As a result of the Plan of Exchange, the transaction was treated for accounting purposes as a capital transaction and a recapitalization by the accounting acquirer, ZHLD and as reorganization by the accounting acquired, China Education Alliance, Inc.

China Education Alliance, Inc. is only a holding company, it has no revenues. The Company carries its business mainly through its wholly owned subsidiaries, ZHLD and the Zhonghe Education Training Center in the business of online education and training center in China.

ZHLD is a technology company engaged in the online education industry in China. Its mission is to impel the distance learning development in China, to improve the efficiency and effectiveness of elementary education, higher education, vocational education, skill education, continuing education, and professional training programs, and to integrate with the international education system. As a multiplicative, comprehensive, and authoritative education frontrunner, the Company has firmly occupied its hegemonic position in the online education industry through its abundant teachers, rich teaching knowledge, and plentiful teaching achievements.

Heilongjiang Zhonghe Education Training Center (“ZHTC”) was registered in The People’s Republic of China on July 8, 2005 with a registered capital of $60,386, is the wholly owned subsidiary of ZHLD. ZHLD owns 99% of interest in the ZHTC with a de minimis number of 1% shares owned by present executive officer, Xi Qun Yu of ZHLD and ZHTC, as required by The People’s Republic China’s Business Enterprise law.

ZHLD also owns 70% of Beijing Hua Yu Hui Zhong Technology Development Co., Ltd (“BHYHZ”). BHYHZ was formed on September 30, 2006。It is a development stage company.

The Company’s online education business has established leading positions in several high growth segments, including supplemental education and the test preparation for grades kindergarten through high school.

The Company’s products include on-line test preparation materials, teachers’ materials, study guides and audio recordings of popular classes. It is a full range professional education resource service provider. The business scope includes distance learning technology, education resource development, education project planning and promoting, teaching platform, and the class development and schedule, education information, and technical service. The products cover all education ranges, including pre-school education, elementary and middle school education, vocational education, continuing education, enterprise training program, intelligence authentication, agricultural labor education, education for the disabled, first time employment education, re-employment education, study abroad, education for the aged people.

2.	Basis of Preparation of Financial Statements

China Education Alliance is only a holding company; it has no revenues but only minor maintenance expenses. The functional currency for its subsidiaries is denominated in “Renminbi” (“RMB”) or “Yuan”. The subsidiaries, ZHLD, Zhonghe Education Training Center and Beijing Hua Yu Hui Zhong Technology Developments Co., Ltd. maintain the books and accounting records in Renminbi (“RMB”). It is the currency of the primary economic environment in which the entities operates, and in accordance with law and accounting requirements of The People’s Republic of China law and accounting practices.

The financial statements have been prepared in order to present the consolidated financial position and consolidated results of operations in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) and are expressed in terms of US dollars (see paragraph “Foreign Currency Translation Methodology” below).

 

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The accompanying financial statements differ from the financial statements used for statutory purposes in PRC in that they reflect certain adjustments, recorded on the entities’ books, which are appropriate to present the financial position, results of operations and cash flows in accordance with US GAAP. The principal adjustments are related to revenue recognition, foreign currency translation, deferred taxation, consolidation, accounting for derivatives, and depreciation and valuation of property and equipment and intangible assets.

Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries, ZHLD, Zhonghe Education Training Center and Beijing Hua Yu Hui Zhong Technology Developments Co., Ltd. All inter-company transactions and balances were eliminated.

3.	Summary of Significant Accounting Policies

Use of estimates - The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affected the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reported periods.

Significant estimates included values and lives assigned to acquired intangible assets, reserves for customer returns and allowances, uncollectible accounts receivable, slow moving, obsolete and/or damaged inventory and stock option valuation. Actual results may differ from these estimates.

Cash and cash equivalents - The Company considers all highly liquid debt instruments purchased with maturity period of three months or less to be cash equivalents. The carrying amounts reported in the accompanying consolidated balance sheet for cash and cash equivalents approximate their fair value.

Inventories - inventories were accounted for using the first-in, first-out method and included freight-in, materials, packing materials, labor and overhead costs and were stated at the lower of cost or market, cost being determined by a moving weighted average. Provision is made for slow moving, obsolete and/or damaged inventory based on a periodic analysis of individual inventory items, including an evaluation of historical usage and/or movement, age, expiration date and general condition.

Property and equipment - Property and equipment are stated at the historical cost, less accumulated depreciation. Depreciation on property, plant and equipment is provided using the straight-line method over the estimated useful lives of the assets after taking into account estimated residual value of 5% of cost or valuation for both financial and income tax reporting purposes as follows:

 

Buildings			20 years
Communication Equipments			10 years
Motor vehicles			5 years
Furniture, Fixtures, and Equipments			5 years

 

Expenditures for renewals and betterments were capitalized while repairs and maintenance costs are normally charged to the statement of operations in the year in which they are incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset, the expenditure is capitalized as an additional cost of the asset.

Upon sale or disposal of an asset, the historical cost and related accumulated depreciation or amortization of such asset were removed from their respective accounts and any gain or loss was recorded in the Condensed Consolidated Statements of Operations.

Property and equipment are evaluated for impairment in value annually or whenever an event or change in circumstances indicates that the carrying values may not be recoverable. If such an event or change in circumstances occurs and potential impairment is indicated because the carrying values exceed the estimated future undiscounted cash flows of the asset, the Company would measure the impairment loss as the amount by which the carrying value of the asset exceeds its fair vale.

Foreign currency translation - These financial statements have been prepared in U.S. dollars. China Education Alliance is only a holding company; it has no revenues with minor expenses, except those related to its ownership interest in ZHLD and Zhonghe Education Training Center. The functional currency for the ZHLD and Zhonghe Education Training is denominated in “Renminbi” (“RMB”) or “Yuan”. ZHLD and Zhonghe Education Training maintain its books and accounting records in Renminbi ("RMB"). It is the currency of the primary economic environment in which the entities operates.

 

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FASB Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation” requires differentials to be calculated and allocated using the current rate method if the foreign entity’s functional and local currencies are the same. Non-monetary assets and liabilities are translated at historical exchange rates. Monetary assets and liabilities are translated at the exchange rates in effect at the end of the year. The income statement accounts are translated at average exchange rates.

The conversion gains and losses are not recognized in the income statement under the functional currency approach. They are accumulated in a separate account in stockholders’ equity (i.e., the cumulative foreign exchange translation adjustments account). This treatment is based on the FASB’s view that translation gains or losses are not directly related to the foreign entities’ operating cash flows. As a result, the Company recognized in equity the effect of currency translation in the amount of $68,910.

Income recognition - Revenue is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, which states that revenue should be recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the service has been rendered; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. The Company believes that these criteria are satisfied upon customers download prepaid debit card. Revenue is reduced by provisions for estimated returns and allowances, which are based on historical averages that have not varied significantly for the periods presented, as well as specific known claims, if any.

Prepaid debit cards allow our subscribers to make a predetermined monetary amount of download materials posted on our website. The Company new system is able to track usage of the debit card once the end user uses the debit cards for its service.

At the time that the prepaid debit card is purchased, the receipt of cash is recorded as a subscriber prepayment. Revenues are recognized in the month when services are actually rendered. Unused value relating to debit cards is recognized as revenues when the prepaid debit card has expired.

Interest income is recognized when earned, taking into account the average principal amounts outstanding and the interest rates applicable

Prepayments Account-Prepaid expenses are primarily comprised of advance payments made for services to teachers for online materials and video. It also includes other receivable that acts as a prepaid account including advances to employees, cash prepaid to employees for their travel, entertainment and transportation expenditures.

 

Advances on Accounts - Advances on accounts include deferred revenue and subscriber prepayments that related to subscription services represents the portion of unearned subscription revenue, which is amortized on a monthly, straight-line basis, as earned. Deferred revenue related to education service website advertising service, or technology services represents that portion of amounts billed by the Company, or cash collected by the Company, for which services have not yet been provided or earned in accordance with the Company's revenue recognition policy.

Impairment of Long-Lived Assets - The Company periodically evaluates the recoverability of the carrying amount of its long-lived assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. Whenever events or changes in circumstances indicate that the carrying amounts of those assets may not be recoverable, the Company compares the undiscounted net cash flows estimated to be generated by those assets to the carrying amount of those assets.

When these undiscounted cash flows are less than the carrying amounts of the assets, the Company will record impairment losses to write the asset down to fair value, measured by the discounted estimated net future cash flows expected to be generated from the assets. During the periods ended September 30, 2006, no such impairments have occurred.

Advertising - The Company expensed advertising costs the first time the respective advertising took place. These costs were included in selling, general and administrative expenses. The total advertising expenses incurred for period ended September 30, 2006 was $1,478.

Income Taxes - Provision is made in the financial statements for taxation of profits in accordance with PRC legislation currently in force. The Company accounts for income taxes under the liability method in accordance with SFAS No. 109, “Accounting for Income Taxes”. Under the liability method, deferred income taxes reflect the future tax consequences of temporary differences between the tax and financial statement basis of assets and liabilities and are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided when it is more likely than not that some or all of the deferred tax assets will not be realized in the future. These evaluations are based on the expectations of future taxable income and reversals of the various taxable temporary differences.

 

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Provision for The People’s Republic of China enterprise income tax is calculated at the prevailing rate based on the estimated assessable profits less available tax relief for losses brought forward. As of September 30, 2006, the Company is still enjoyed the income tax exemption for 2 years and half for 3 years suitable as foreign invested company.

Enterprise income tax

Under the Provisional Regulations of The People’s Republic of China Concerning Income Tax on Enterprises promulgated by the State, income tax is payable by enterprises at a rate of 33% of their taxable income. Preferential tax treatment may, however, be granted pursuant to any law or regulations from time to time promulgated by the State Council.

Enterprise income tax (“EIT”) is provided on the basis of the statutory profit for financial reporting purposes, adjusted for income and expense items, which are not assessable or deductible for income tax purposes.

Value added tax

The Provisional Regulations of The People’s Republic of China Concerning Value Added Tax promulgated by the State Council came into effect on January 1, 1994. Under these regulations and the Implementing Rules of the Provisional Regulations of the PRC Concerning Value Added Tax, value added tax is imposed on goods sold in or imported into the PRC and on processing, repair and replacement services provided within the PRC.

Value added tax payable in The People’s Republic of China is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold or, in the case of taxable services provided, at a rate of 17% on the charges for the taxable services provided, but excluding, in respect of both goods and services, any amount paid in respect of value added tax included in the price or charges, and less any deductible value added tax already paid by the taxpayer on purchases of goods and services in the same financial year.

Contingent liabilities and contingent assets - A contingent liability is a possible obligation that arises from past events and whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Company. It can also be a present obligation arising from past events that is not recognized because it is not probable that outflow of economic resources will be required or the amount of obligation cannot be measured reliably.

A contingent liability is not recognized but is disclosed in the notes to the financial statements. When a change in the probability of an outflow occurs so that outflow is probable, they will then be recognized as a provision.

A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain events not wholly within the control of the Company.

Contingent assets are not recognized but are disclosed in the notes to the financial statements when an inflow of economic benefits is probable. When inflow is virtually certain, an asset is recognized.

Related companies - A related company is a company in which the director has beneficial interests in and in which the Company has significant influence.

Retirement benefit costs - According to The People’s Republic of China regulations on pensions, the Company contributes to a defined contribution retirement scheme organized by the municipal government in the province in which the Company was registered and all qualified employees are eligible to participate in the scheme. Contributions to the scheme are calculated at 23.5% of the employees’ salaries above a fixed threshold amount and the employees contribute 2% to 8% while the Company contributes the balance contribution of 21.5% to 15.5%. The Company has no other material obligation for the payment of retirement benefits beyond the annual contributions under this scheme.

Fair value of financial instruments - The carrying amounts of certain financial instruments, including cash, accounts receivable, commercial notes receivable, other receivables, accounts payable, commercial notes payable, accrued expenses, and other payables approximate their fair values as of September 30, 2006 because of the relatively short-term maturity of these instruments.

 

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