Attached files
file | filename |
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EX-31.1 - China Architectural Engineering, Inc. | v185860_ex31-1.htm |
EX-32.1 - China Architectural Engineering, Inc. | v185860_ex32-1.htm |
EX-31.2 - China Architectural Engineering, Inc. | v185860_ex31-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
x QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
For
the quarterly period ended March 31, 2010
OR
o TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
Commission
File Number
001-33709
CHINA
ARCHITECTURAL ENGINEERING, INC.
(Exact
name of small business issuer as specified in its charter)
Delaware
(State
or other jurisdiction of incorporation
or
organization)
|
51-05021250
(I.R.S.
Employer Identification
No.)
|
|
105
Baishi Road, Jiuzhou West Avenue,
Zhuhai,
People’s Republic of China
(Address
of principal executive offices)
|
519070
(Zip
Code)
|
0086-756-8538908
(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 o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files). Yes o
No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
Large
accelerated filer ¨
|
Accelerated
filer ¨
|
Non-accelerated
filer x
|
Smaller
reporting company ¨
|
(Do
not check if a smaller
|
|||
reporting
company)
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o
No
x
There
were 55,156,874 shares outstanding of registrant’s common stock, par value
$0.001 per share, as of May 14, 2010.
CHINA
ARCHITECTURAL ENGINEERING, INC.
FORM
10-Q QUARTERLY REPORT
TABLE
OF CONTENTS
Page
|
||
PART
I - FINANCIAL INFORMATION
|
3
|
|
ITEM
1.
|
FINANCIAL
STATEMENTS
|
3
|
Consolidated
Balance Sheet as of March 31, 2010 (unaudited) and December 31,
2009
|
5
|
|
Unaudited
Interim Consolidated Statements of Income for the three months ended March
31, 2010 and 2009
|
6
|
|
Unaudited
Interim Consolidated Statements of Cash Flows for the three months ended
March 31, 2010 and 2009
|
7
|
|
Unaudited
Consolidated Statements of Stockholders’ Equity from January 1, 2010 to
March 31, 2010
|
8
|
|
Notes
to the Unaudited Interim Consolidated Financial
Statements
|
9
|
|
ITEM
2.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
|
29
|
ITEM
3.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
|
38
|
ITEM
4.
|
CONTROLS
AND PROCEDURES
|
38
|
PART
II - OTHER INFORMATION
|
41
|
|
ITEM
1.
|
LEGAL
PROCEEDINGS
|
41
|
ITEM
1A.
|
RISK
FACTORS
|
41
|
ITEM
2.
|
UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|
42
|
ITEM
3.
|
DEFAULTS
UPON SENIOR SECURITIES
|
42
|
|
||
ITEM
4.
|
REMOVED
AND RESERVED
|
42
|
ITEM
5.
|
OTHER
INFORMATION
|
42
|
ITEM
6.
|
EXHIBITS
|
42
|
SIGNATURES
|
43
|
2
PART
I - FINANCIAL INFORMATION
ITEM
1. FINANCIAL
STATEMENTS
The
accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and with the instructions to Form 10-Q.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
The accompanying unaudited financial statements reflect all adjustments that, in
the opinion of management, are considered necessary for a fair presentation of
the financial position, results of operations, and cash flows for the periods
presented. The results of operations for such periods are not necessarily
indicative of the results expected for the full fiscal year or for any future
period. The accompanying unaudited financial statements should be read in
conjunction with the audited financial statements of China Architectural
Engineering, Inc. as contained in its Annual Report for the fiscal year ended
December 31, 2009 on Form 10-K, as filed with the Securities and Exchange
Commission on March 4, 2010, and as amended by Amendment No.1 on April 30, 2010
and Amendment No.2 on May 14, 2010.
3
CHINA
ARCHITECTURAL ENGINEERING, INC.
CONSOLIDATED
BALANCE SHEETS
AS
OF MARCH 31, 2010 (UNAUDITED) AND DECEMBER 31, 2009
(STATED
IN US DOLLARS)
Note
|
March 31, 2010
|
December 31,
2009
|
||||||||||
(unaudited)
|
||||||||||||
ASSETS
|
||||||||||||
Current
assets
|
||||||||||||
Cash
and cash equivalents
|
$ | 497,348 | $ | 740,125 | ||||||||
Restricted
cash
|
2,024,080 | 3,033,819 | ||||||||||
Contract
receivables, net
|
(3)
|
88,281,494 | 89,189,103 | |||||||||
Costs
and earnings in excess of billings
|
10,193,454 | 8,100,580 | ||||||||||
Job
disbursements advances
|
1,957,233 | 2,696,794 | ||||||||||
Other
receivables
|
(4)
|
25,821,226 | 30,768,067 | |||||||||
Inventories
|
(5)
|
162,346 | 727,499 | |||||||||
Deferred
income taxes, current
|
112,893 | 113,033 | ||||||||||
Other
current assets
|
497,884 | 297,838 | ||||||||||
Total
current assets
|
129,547,958 | 135,666,858 | ||||||||||
Non-current
assets
|
||||||||||||
Plant
and equipment, net
|
(6)
|
2,361,334 | 2,539,457 | |||||||||
Intangible
assets
|
(7)
|
59,987 | 70,610 | |||||||||
Goodwill
|
7,995,896 | 7,995,896 | ||||||||||
Other
non-current asset
|
36,424 | 287,586 | ||||||||||
TOTAL
ASSETS
|
$ | 140,001,599 | $ | 146,560,407 | ||||||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||||||
Current
liabilities
|
||||||||||||
Short-term
bank loans
|
(8)
|
$ | 7,856,554 | $ | 9,529,880 | |||||||
Accounts
payable
|
25,873,394 | 26,614,484 | ||||||||||
Billings
over costs and estimated earnings
|
5,346,341 | 6,098,666 | ||||||||||
Amount
due to shareholder
|
3,504,156 | 10,080,345 | ||||||||||
Other
payables
|
9,864,960 | 9,360,314 | ||||||||||
Business
and other taxes payable
|
4,734,098 | 4,923,771 | ||||||||||
Customers’
deposits
|
8,097,324 | 6,392,676 | ||||||||||
Other
Accrual
|
6,034,195 | 4,324,011 | ||||||||||
Total
current liabilities
|
71,311,022 | 77,324,147 |
The
accompanying notes are an integral part of these financial
statements.
4
CHINA
ARCHITECTURAL ENGINEERING, INC.
CONSOLIDATED
BALANCE SHEETS (Continued)
AS
OF MARCH 31, 2010 (UNAUDITED) AND DECEMBER 31, 2009
(STATED
IN US DOLLARS)
Note
|
March 31,
2010
|
December 31,
2009 |
||||||||||
(unaudited)
|
||||||||||||
Non-current
liabilities
|
||||||||||||
Long
term bank loans
|
(8)
|
$ | 89,850 | $ | 109,239 | |||||||
Convertible
bond payable, net
|
(9)
|
25,475,167 | 24,564,161 | |||||||||
TOTAL
LIABILITIES
|
$ | 96,876,039 | $ | 101,997,547 | ||||||||
STOCKHOLDERS’
EQUITY
|
||||||||||||
Preferred
stock, $0.001 par value, 10,000,000 shares authorized, 0 shares issued and
outstanding at March 31, 2009 and December 31, 2009; Common stock, $0.001
par value, 100,000,000 shares authorized, 55,156,874 and 53,256,874 shares
issued and outstanding at March 31, 2009 and December 31, 2009,
respectively
|
$ | 55,157 | $ | 53,257 | ||||||||
Additional
paid in capital
|
28,458,440 | 26,495,876 | ||||||||||
Statutory
reserves
|
3,040,595 | 3,040,595 | ||||||||||
Accumulated
other comprehensive income
|
3,986,558 | 3,868,437 | ||||||||||
Retained
earnings
|
7,609,728 | 11,131,084 | ||||||||||
Total
Company shareholders’ equity
|
43,150,478 | 44,589,249 | ||||||||||
Noncontrolling
interests
|
(24,918 | ) | (26,389 | ) | ||||||||
Total
shareholders’ equity
|
43,125,560 | 44,562,860 | ||||||||||
TOTAL
LIABILITIES AND
|
||||||||||||
STOCKHOLDERS’
EQUITY
|
$ | 140,001,599 | $ | 146,560,407 |
The
accompanying notes are an integral part of these financial
statements.
5
CHINA
ARCHITECTURAL ENGINEERING, INC.
UNAUDITED
CONSOLIDATED STATEMENTS OF INCOME
FOR
THE THREE-MONTH PERIODS ENDED MARCH 31, 2010 AND 2009
(STATED
IN US DOLLARS)
Three Months Ended March 31,
|
||||||||||||
Note
|
2010
|
2009
|
||||||||||
Contract
revenues earned
|
(10)
|
$ | 11,472,123 | $ | 36,343,064 | |||||||
Cost
of contract revenues earned
|
(9,144,193 | ) | (28,162,233 | ) | ||||||||
Gross
profit
|
$ | 2,327,930 | $ | 8,180,831 | ||||||||
Selling,
general and administrative expenses
|
(4,175,480 | ) | (5,951,030 | ) | ||||||||
Finance
expenses
|
(47,201 | ) | - | |||||||||
Income
/ (Loss) from operations
|
$ | (1,894,751 | ) | $ | 2,229,801 | |||||||
Interest
income
|
2,416 | 3,706 | ||||||||||
Interest
expense
|
(1,626,111 | ) | (1,311,733 | ) | ||||||||
Other
income
|
7,514 | 21,837 | ||||||||||
Other
expenses
|
(849 | ) | - | |||||||||
Income/(Loss)
before taxation on Continuing Operations
|
$ | (3,511,781 | ) | $ | 943,611 | |||||||
Income
tax / tax benefit
|
(11)
|
9,575 | - | |||||||||
Net
earnings/(Loss) including non-controlling interest
|
(3,521,356 | ) | 943.611 | |||||||||
Loss
attributable to non-controlling interests
|
1,471 | - | ||||||||||
Net
earnings/(Loss) attributable to the Company
|
$ | (3,519,885 | ) | $ | 943,611 | |||||||
Earnings
per share:
|
||||||||||||
Basic
|
$ | (0.06 | ) | $ | 0.02 | |||||||
Diluted
|
$ | (0.06 | ) | $ | 0.02 | |||||||
Weighted
average shares outstanding:
|
||||||||||||
Basic
|
54,729,908 | 53,256,874 | ||||||||||
Diluted
|
54,729,908 | 53,256,874 |
The
accompanying notes are an integral part of these financial
statements.
6
CHINA
ARCHITECTURAL ENGINEERING, INC.
UNAUDITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR
THE THREE-MONTH PERIODS ENDED MARCH 31, 2010 AND 2009
(STATED
IN US DOLLARS)
Three Months Ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Cash
flows from operating activities
|
||||||||
Net
income/(loss)
|
$ | (3,521,356 | ) | $ | 943,611 | |||
Noncontrolling
interest
|
1,471 | - | ||||||
Depreciation
expense
|
178,043 | 252,852 | ||||||
Bad
debt expense
|
193,753 | - | ||||||
Amortization
expense on intangible assets
|
10,623 | 22,000 | ||||||
Stock
compensation expenses
|
1,964,464 | - | ||||||
Amortization
expense on convertible bond
|
911,006 | 674,087 | ||||||
Loss/(Gain)
on disposal of fixed assets
|
519 | (11,450 | ) | |||||
Deferred
income taxes
|
- | 3,264 | ||||||
Decrease
in inventories
|
565,153 | 17,441 | ||||||
Decrease
in receivables
|
3,567,823 | 16,848,651 | ||||||
Decrease
in other assets
|
790,817 | 980 | ||||||
Increase/(decrease)
in payables
|
2,236,390 | (14,489,451 | ) | |||||
Net
cash provided by operating activities
|
$ | 6,898,706 | $ | 4,261,985 | ||||
Cash
flows from investing activities
|
||||||||
Purchases
of assets
|
$ | (439 | ) | $ | (64,262 | ) | ||
Proceeds
from disposal of fixed assets
|
- | 76,190 | ||||||
Decrease
in restricted cash
|
1,009,739 | 1,320,226 | ||||||
Net
cash provided by investing activities
|
$ | 1,009,300 | $ | 1,332,154 | ||||
Cash
flows from financing activities
|
||||||||
Repayment
of short-term loans
|
$ | (1,673,326 | ) | $ | (4,542,187 | ) | ||
Repayment
of long-term loans
|
(19,389 | ) | (73,434 | ) | ||||
Repayment
of shareholder loans
|
(6,576,189 | ) | (1,952,809 | ) | ||||
Net
cash used in financing activities
|
$ | (8,268,904 | ) | $ | (6,568,430 | ) | ||
Net
decrease in cash and cash equivalents
|
$ | (360,898 | ) | $ | (974,291 | ) | ||
Effect
of foreign currency translation on cash and cash
equivalents
|
118,121 | 257,501 | ||||||
Cash
and cash equivalents - beginning of period
|
740,125 | 9,516,202 | ||||||
Cash
and cash equivalents - end of period
|
$ | 497,348 | $ | 8,799,412 | ||||
Other
supplementary information:
|
||||||||
Cash
paid during the period for:
|
||||||||
Interest
paid
|
$ | 1,260,000 | $ | 120,000 | ||||
Income
tax paid
|
$ | - | $ | 21,151 |
The
accompanying notes are an integral part of these financial
statements.
7
CHINA
ARCHITECTURAL ENGINEERING, INC.
UNAUDITED
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
FOR
THE PERIOD FROM JANUARY 1, 2010 TO MARCH 31, 2010
(STATED IN US
DOLLARS)
Total
Number of
shares
|
Common
stock
|
Additional paid
in capital
|
Statutory
reserves
|
Accumulated
other
comprehensive
income
|
Retained
earnings
|
Noncontrolling
interests
|
Total
|
|||||||||||||||||||||||||
Balance,
January 1, 2010
|
53,256,874 | $ | 53,257 | $ | 26,495,876 | $ | 3,040,595 | $ | 3,868,437 | $ | 11,131,084 | $ | (26,389 | ) | $ | 44,562,860 | ||||||||||||||||
Net
Loss including non-controlling interests
|
(3,521,356 | ) | 1,471 | (3,519,885 | ) | |||||||||||||||||||||||||||
Additional
paid-in capital from grant of stock option to employee
|
7,464 | 7,464 | ||||||||||||||||||||||||||||||
Value
of stock grants to employees
|
1,900,000 | 1,900 | 1,955,100 | 1,957,000 | ||||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
118,121 | 118,121 | ||||||||||||||||||||||||||||||
Total
comprehensive income
|
(1,437,300 | ) | ||||||||||||||||||||||||||||||
Balance,
March 31, 2010
|
55,156,874 | $ | 55,157 | $ | 28,458,440 | $ | 3,040,595 | $ | 3,986,558 | $ | 7,609,728 | $ | (24,918 | ) | $ | 43,125,560 |
The
accompanying notes are an integral part of these financial
statements.
8
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
1.
|
ORGANIZATION
AND PRINCIPAL ACTIVITIES
|
China
Architectural Engineering, Inc. (the “Company”) formerly SRKP 1, Inc., was
incorporated in the State of Delaware, United States on March 16, 2004. The
Company’s common stock was initially listed for trading on the American Stock
Exchange on September 28, 2007. The Company transferred its listing
to The NASDAQ Stock Market LLC on June 10, 2008.
The
Company through its subsidiaries conducts its principal activity as building
envelope systems contractors, specializing in the design, engineering,
fabrication and installation of curtain wall systems, roofing systems, steel
construction systems and eco-energy saving building conservation systems,
throughout China, Australia, Southeast Asia, the Middle East, and the United
States.
The
Company's work is performed under cost-plus-fee contracts, fixed-price
contracts, and fixed-price contracts modified by incentive and penalty
provisions. These contracts are undertaken by the Company or its wholly owned
subsidiaries. The length of the Company's contracts varies but is typically
about one to two years.
2.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING
POLICIES
|
(a)
|
Method
of accounting
|
The
Company maintains its general ledger and journals with the accrual method
accounting for financial reporting purposes. The consolidated financial
statements and notes are representations of management. Accounting
policies adopted by the Company conform to generally accepted accounting
principles in the United States of America and have been consistently applied in
the presentation of consolidated financial statements, which are compiled on the
accrual basis of accounting.
(b)
|
Consolidation
|
The
consolidated financial statements include the accounts of the Company and its 14
subsidiaries. Significant inter-company transactions have been eliminated in
consolidation. The consolidated financial statements include 100% of the assets
and liabilities of these majority-owned subsidiaries, and the ownership
interests of minority investors are recorded as noncontrolling
interests.
The
Company owned the subsidiaries through its reverse-merger on October 17, 2006
and through direct investments or acquisitions after October 17,
2006. As of March 31, 2010, detailed identities of the consolidating
subsidiaries are as follows:
Name of Company
|
Place of
Incorporation
|
Attributable Equity
interest %
|
||||
Full
Art International Limited
|
Hong
Kong
|
100 | ||||
Zhuhai
King Glass Engineering Co., Ltd.
|
PRC
|
100 | ||||
Zhuhai
King General Glass Engineering Technology Co., Ltd.
|
PRC
|
100 | ||||
King
General Engineering (HK) Limited
|
Hong
Kong
|
100 | ||||
KGE
Building System Limited
|
Hong
Kong
|
100 | ||||
KGE
Australia Pty Limited
|
Australia
|
55 | ||||
Zhuhai
Xiangzhou District Career Training School
|
PRC
|
72 | ||||
Techwell
Engineering Limited
|
Hong
Kong
|
100 | ||||
Techwell
International Limited
|
Macau
|
100 | ||||
Techwell
Building System (Shenzhen) Co., Ltd.
|
PRC
|
100 | ||||
CAE
Building Systems, Inc.
|
USA
|
100 | ||||
China
Architectural Engineering (Shenzhen) Co., Ltd.
|
PRC
|
100 | ||||
Techwell
International (SEA) Pte Ltd.
|
Singapore
|
100 | ||||
CAE
Building Systems (Singapore) Pte Ltd
|
Singapore
|
100 |
9
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
(c)
|
Use
of estimates
|
The
preparation of the consolidated financial statements in conformity with
generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting periods.
Management makes these estimates using the best information available at the
time the estimates are made; however, actual results could differ materially
from those estimates.
(d)
|
Plant
and equipment
|
Plant and
equipment are carried at cost less accumulated
depreciation. Depreciation is provided over their estimated useful
lives, using the straight-line method. Estimated useful lives of the plant and
equipment are as follows:
Building
|
20 years
|
Machinery
and equipment
|
5 -
10 years
|
Furniture
and office equipment
|
5 years
|
Motor
vehicle
|
5 years
|
The cost
and related accumulated depreciation of assets sold or otherwise retired are
eliminated from the accounts and any gain or loss is included in the statement
of income. The cost of maintenance and repairs is charged to income as incurred,
whereas significant renewals and betterments are capitalized.
(e)
|
Accounting
for the impairment of long-lived
assets
|
The
long-lived assets held and used by the Company are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
assets may not be recoverable. It is reasonably possible that these assets could
become impaired as a result of technology or other industry
changes. Determination of recoverability of assets to be held and
used is by comparing the carrying amount of an asset to future net undiscounted
cash flows to be generated by the assets.
If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
During
the reporting periods, there was no impairment loss.
(f)
|
Goodwill
and Intangible Assets
|
In
accordance with ASC 350, “Goodwill and Other Intangible Assets.” the Company
does not amortize goodwill or intangible assets with indefinite
lives.
Upon
indication that the carrying values of such assets may not be recoverable, the
Company recognizes an impairment loss as a charge against current
operations.
The
Company performs an analysis on its goodwill balances to test for impairment on
an annual basis and whenever events occur that indicate an impairment could
exist. The amount of its goodwill is fully attributable to a subsidiary,
Techwell Engineering Limited. There are several instances that may cause the
Company to further test its goodwill for impairment between the annual testing
periods including: (i) continued deterioration of market and economic
conditions that may adversely impact its ability to meet its projected results;
(ii) declines in the Company’s stock price caused by continued volatility in the
financial markets that may result in increases in its weighted-average cost of
capital or other inputs to its goodwill assessment; (iii) the occurrence of
events that may reduce the fair value of a reporting unit below its carrying
amount, such as the sale of a significant portion of one or more of the
Company’s reporting units. In the three month periods ended March 31, 2010, no
instance indicates that an impairment could exist.
10
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
Material
assumptions include: (1) The reporting unit continues to have the
profitable operations for a period of next 10 years; (2) the revenue has the
steady annual growth rate ranging from 5% to 8% as in line with the estimated
growth rate of PRC economy; (3) costs of funds kept stable for the period of
next 10 years resulting in a stable discount rate for the projection of
estimated fair value; and (4) no material change in the prevailing payment terms
of the construction industry that allowing the working capital requirement kept
at a low level at 15%. Uncertainties include: (1) The
ability of the reporting unit to continue as a profitable operation
may be affected by changes in technologies and the market of the construction
industry; (2) the growth of the PRC economy may not be as steady as projected
that in turn affect the steady growth of the revenue of the reporting unit, (3)
it is also uncertain about the capital market that affect the costs of fund of
the company; and (4) the prevailing payment terms used in the construction
industry may be changed as a result of changes in the business environment for
the construction industry. Potential events include (1) the appreciation of the
value of RMB that would slow down the export and in turn the economic
development of China that in turn have negative effect of property development
industry in China; and (2) the controlling policies towards the property market
by the PRC government.
For other
intangible assets, impairment tests are performed annually and more frequently
whenever events or changes in circumstances indicate carrying values exceed
estimated reporting unit fair values.
(g)
|
Inventories
|
Inventories
are raw materials, which are stated at the lower of weighted average cost or
market value.
(h)
|
Contracts
receivable
|
Contracts
receivable from performing construction of industrial and commercial buildings
are based on contracted prices. The Company provides an allowance for
doubtful accounts, which is based upon a review of outstanding receivables,
historical collection information, and existing economic
conditions.
(i)
|
Cash
and cash equivalents
|
The
Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
(j)
|
Restricted
cash
|
Restricted
cash represents time deposit accounts to secure notes payable and bank
loans.
(k)
|
Earnings
per share
|
The
Company computes earnings per share (“EPS’) in accordance with ASC 260,
“Earnings per Share”. ASC 260 requires companies with complex capital structures
to present basic and diluted EPS. Basic EPS is measured as the income or loss
available to common shareholders divided by the weighted average common shares
outstanding for the period. Diluted EPS is similar to basic EPS but presents the
dilutive effect on a per share basis of potential common shares (e.g.,
convertible securities, options, and warrants) as if they had been converted at
the beginning of the periods presented, or issuance date, if later. Potential
common shares that have an anti-dilutive effect (i.e., those that increase
income per share or decrease loss per share) are excluded from the calculation
of diluted EPS.
The
calculation of diluted weighted average common shares outstanding for the three
months periods ended March 31, 2010 and 2009 is based on the estimate fair value
of the Company’s common stock during such periods applied to warrants and
options using the treasury stock method to determine if they are dilutive. The
Convertible Bond is included on an “as converted” basis when these shares are
dilutive.
11
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
Components
of basic and diluted earnings per share were as follows:
Three Months Ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Net
Income / (Loss)
|
$ | (3,519,885 | ) | $ | 943,611 | |||
Basic
Weighted Average Shares Outstanding
|
54,729,908 | 53,256,874 | ||||||
Dilutive
Shares:
|
||||||||
- Addition
to Common Stock from Conversion of Bonds
|
- | - | ||||||
-
Addition to Common Stock from Exercise of Options and
Warrants
|
- | - | ||||||
Diluted
Weighted Average Outstanding Shares:
|
54,729,908 | 53,256,874 | ||||||
Earnings
Per Share
|
||||||||
-
Basic
|
$ | (0.06 | ) | $ | 0.02 | |||
-
Diluted
|
$ | (0.06 | ) | $ | 0.02 |
(l)
|
Revenue
and cost recognition
|
Revenues
from fixed-price and modified fixed-price construction contracts are recognized
on the percentage-of-completion method, measured by the percentage of costs
incurred to date to estimated total cost for each contract.
Contract
costs include all direct material and labor costs and those indirect costs
related to contract performance, such as indirect labor, supplies, tools,
repairs, and depreciation costs.
Provisions
for estimated losses on uncompleted contracts are made in the period in which
such losses are determined. Changes in job performance, job conditions, and
estimated profitability, including those arising from contract penalty
provisions, and final contract settlements may result in revisions to costs and
income and are recognized in the period in which the revisions are determined.
Profit incentives are included in revenues when their realization is reasonably
assured. An amount equal to contract costs attributable to claims is included in
revenues when realization is probable and the amount can be reliably
estimated.
Selling,
general, and administrative costs are charged to expense as
incurred.
Total
estimated gross profit on a contract, being the difference between total
estimated contract revenue and total estimated contract cost, is determined
before the amount earned on the contract for a period can be
determined.
The
measurement of the extent of progress toward completion is used to determine the
amount of gross profit earned to date and that the earned revenue to date is the
sum of the total cost incurred on the contract and the amount of gross profit
earned.
12
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
Earned
revenue, cost of earned revenue, and gross profit are determined as follows:
-
a.
|
Earned
Revenue is the amount of gross profit earned on a contract for a period
plus the costs incurred on the contract during the
period.
|
b.
|
Cost
of Earned Revenue is the cost incurred during the period, excluding the
cost of materials not unique to a contract that have not been used for the
contract.
|
c.
|
Gross
Profit earned on a contract is computed by multiplying the total estimated
gross profit on the contract by the percentage of completion. The excess
of that amount over the amount of gross profit reported in prior periods
is the earned gross profit that should be recognized in the income
statement for the current
period.
|
Change
orders are common for the changes in specifications or
design. Contract revenue and costs are adjusted to reflect change
orders approved by the customer and the contractor regarding both scope and
price. Recognition of amounts of additional contract revenue relating
to claims is appropriate only if it is probable that the claim will result in
additional contract revenue and if the amount can be reliably
estimated.
(m)
|
Income
taxes
|
The
Company uses the accrual method of accounting to determine and report its
taxable reduction of income taxes for the year in which they are
available. The Company has implemented ASC 740-270, Accounting
for Income Taxes.
Income
tax liabilities computed according to the United States, People’s Republic of
China (PRC), Hong Kong SAR, Macau SAR and Australia tax laws are provided for
the tax effects of transactions reported in the financial statements and
consists of taxes currently due plus deferred taxes related primarily to
differences between the basis of fixed assets and intangible assets for
financial and tax reporting. The deferred tax assets and liabilities
represent the future tax return consequences of those differences, which will be
either taxable or deductible when the assets and liabilities are recovered or
settled. Deferred taxes also are recognized for operating losses that
are available to offset future income taxes. A valuation allowance is
created to evaluate deferred tax assets if it is more likely than not that these
items will either expire before the Company is able to realize that tax benefit,
or that future realization is uncertain.
In
respect of the Company’s subsidiaries domiciled and operated in China and Hong
Kong, the taxation of these entities can be summarized as
follows:
·
|
Zhuhai
King Glass Engineering Co., Limited (“Zhuhai KGE”) and Zhuhai King General
Glass Engineering Technology Co., Limited (“Zhuhai KGGET”) are located in
Zhuhai and were subject to the PRC corporation income tax rate of 18% in
2008 and 20% in 2009. In accordance to China’s Enterprise Income Tax Law
(“EIT Law”) effective from January 1, 2008, the tax rate for these two
subsidiaries will be gradually increased to 25% by 2012.The Company
anticipates that as a result of the EIT law, its income tax provision will
increase, which could adversely affect Zhuhai KGE’s financial condition
and results of operations.
|
·
|
China
Architectural Engineering (Shenzhen) Co., Ltd. is located in Shenzhen and
is subject to the 20% income tax rate that will be gradually increased to
the uniform rate of 25% by 2012 as according to the new EIT
law.
|
·
|
Full
Art International Limited, King General Engineering (HK) Limited, and KGE
Building System Limited are subject to the Hong Kong profits tax rate of
16.5%.
|
13
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
·
|
Techwell
Engineering Limited is subject to a Hong Kong profits tax rate of 16.5%.
Techwell International Limited is a Macau registered company and therefore
is subject to Macau profits tax rate of 12%. Techwell Building
System (Shenzhen) Co. Limited is located in Shenzhen and is subject to PRC
corporate income tax rate of 20% that will be gradually increased to the
uniform rate of 25% by 2012 as according to the new EIT
law.
|
·
|
KGE
Australia Pty Limited is subject to a corporate income tax rate of
30%.
|
The
Company is subject to United States Tax according to Internal Revenue Code
Sections 951 and 957.
The
Company, after a reverse-merger on October 17, 2006, revived to be an active
business enterprise because of the operations with subsidiaries in the PRC and
Hong Kong. Based on the consolidated net earnings for the year ended
December 31, 2009, the Company shall be taxed at the 35% tax
rate.
Techwell
Engineering Limited has established a branch in Dubai, which has zero corporate
income tax rate except on oil companies and bank.
Subsidiaries
in Singapore are subject a effective corporate income tax rate of 8.5% on
taxable income amount in excess of Singapore dollar $100,000.
(n)
|
Advertising
|
The
Company expensed all advertising costs as incurred. Advertising expenses
included in selling expenses were $nil and $10,973 for the three-month periods
ended March 31, 2010 and 2009, respectively.
(o)
|
Research and
development
|
All
research and development costs are expensed as incurred. Research and
development costs included in general and administrative expenses were $nil and
$2,926 for the three-month periods ended March 31, 2010 and 2009,
respectively.
(p)
|
Retirement
benefits
|
Retirement
benefits in the form of contributions under defined contribution retirement
plans to the relevant authorities are charged to the statements of income as
incurred.
14
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
(q)
|
Foreign
currency translation
|
The
accompanying consolidated financial statements are presented in United States
Dollars (US$). The Company’s functional currency is the US$, while certain
domestic subsidiaries’ use the Renminbi (RMB) and Hong Kong and overseas
subsidiaries use local currencies as their functional
currency. The consolidated financial statements are translated
into US$ from RMB, Hong Kong Dollars (HKD), United Arab Emirate Dirham (AED) and
other local currencies at March 31, 2010 exchange rates as to assets and
liabilities and average exchange rates as to revenues and expenses. Capital
accounts are translated at their historical exchange rates when the capital
transactions occurred.
March 31,
2010
|
December 31,
2009
|
March 31,
2009
|
||||||||||
Period
end RMB : US$ exchange rate
|
6.8361 | 6.8372 | 6.8349 | |||||||||
Average
quarterly RMB : US$ exchange rate
|
6.8360 | 6.8331 | 6.8360 |
March 31,
2010
|
December 31,
2009
|
March 31,
2009
|
||||||||||
Period
end HKD : US$ exchange rate
|
7.7647 | 7.7551 | 7.7506 | |||||||||
Average
quarterly HKD : US$ exchange rate
|
7.7639 | 7.7518 | 7.7542 |
March 31,
2010
|
December 31,
2009
|
March 31,
2009
|
||||||||||
Period
end AED : US$ exchange rate
|
3.6739 | 3.6738 | 3.6700 | |||||||||
Average
quarterly AED : US$ exchange rate
|
3.6736 | 3.6710 | 3.6700 |
The RMB
is not freely convertible into foreign currency and all foreign exchange
transactions must take place through authorized institutions. No
representation is made that the RMB amounts could have been, or could be,
converted into US$ at the rates used in translation.
(r)
|
Statutory
reserves
|
Statutory
reserves for foreign investment enterprises are referring to the amount
appropriated from the net income in accordance with laws or regulations, which
can be used to recover losses and increase capital, as approved, and are to be
used to expand production or operations.
(s)
|
Comprehensive
income
|
Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. Among other
disclosures, all items that are required to be recognized under current
accounting standards as components of comprehensive income are required to be
reported in a financial statement that is presented with the same prominence as
other consolidated financial statements. The Company’s current
components of other comprehensive income are the foreign currency translation
adjustment.
15
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
(t)
|
Recent
accounting pronouncements
|
In June
2009, FASB issued FASB Statement No. 166, Accounting for Transfers for
Financial Assets (FASB ASC 860 Transfers and Servicing )
and FASB Statement No. 167 (FASB ASC 810 Consolidation ),
a revision to FASB Interpretation No. 46 (Revised December 2003), Consolidation of
Variable Interest Entities (FASB ASC 810 Consolidation ) .
Statement
166 is a revision to FASB Statement No. 140, Accounting for Transfers and
Servicing of Financial
Assets and Extinguishments of Liabilities (FASB ASC 860 Transfers and
Servicing )
, and will require more information about transfers of
financial assets, including securitization transactions, and where entities have
continuing exposure to the risks related to transferred financial assets. It
eliminates the concept of a “qualifying special-purpose entity,” changes the
requirements for derecognizing financial assets, and requires additional
disclosures. Statement No. 166 (FASB ASC 860 Transfers and
Servicing ) must be applied as of the beginning of each reporting
entity’s first annual reporting period that begins after November 15, 2009, for
interim periods within that first annual reporting period and for interim and
annual reporting periods thereafter. Earlier application is prohibited. This
Statement must be applied to transfers occurring on or after the effective date.
The Company is still evaluating the impact of the above
pronouncement.
Statement
167 is a revision to FASB Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest
Entities (FASB ASC 810 Consolidation
) , and
changes how a reporting entity determines when an entity that is insufficiently
capitalized or is not controlled through voting (or similar rights) should be
consolidated. The determination of whether a reporting entity is required to
consolidate another entity is based on, among other things, the other entity’s
purpose and design and the reporting entity’s ability to direct the activities
of the other entity that most significantly impact the other entity’s economic
performance. Statement No. 167 (FASB ASC 810 Consolidation ) shall be
effective as of the beginning of each reporting entity’s first annual reporting
period that begins after November 15, 2009, for interim periods within that
first annual reporting period, and for interim and annual reporting periods
thereafter. Earlier application is prohibited. The Company is still
evaluating the impact of the above pronouncement.
(u)
|
Stock-based
compensation
|
Stock
compensation accounting guidance (FASB ASC 718, “Compensation-Stock
Compensation”) requires that the compensation cost related to share-based
payment transactions be recognized in financial statements. That cost will be
measured based on the grant date fair value of the equity or liability
instruments issued. The stock compensation accounting guidance covers a wide
range of share-based compensation arrangements including stock options,
restricted share plans, performance-based awards, share appreciation rights and
employee share purchase plans.
Stock
compensation accounting guidance requires that compensation cost for all stock
awards be calculated and recognized over the employees’ service period,
generally defined as the vesting period. For awards with graded-vesting,
compensation cost is recognized on a straight-line basis over the requisite
service period for the entire award. A Black-Scholes model is used to estimate
the fair value of stock options while the market price of the Corporation’s
common stock at the date of grant is used for restricted stock
awards.
On
October 5, 2009, the Company granted options to purchase a total of 100,000
shares of its common stock to an executive officer. The stock options
vest at the rate of 10,000 shares per month, with the first vesting of 10,000
options occurring on November 27, 2009 and with the last vesting of 10,000
options ending upon the total vested being 100,000. The Company uses
the Black-Scholes option-pricing model to value stock option awards and expensed
the stock-based compensation based on the vesting periods. The fair
value of these options was calculated using the following assumptions: (1)
risk-free interest rates of 4%, (2) an expected life of 1 to 5 years, (3)
expected volatility of 41%, (4) expected forfeitures of 0%, and (5) a dividend
yield of 0%. Based on the foregoing, the value of the options is a total of
$24,878 and for the three-month periods ended March 31, 2010, $7,464 was
expensed related to the grant of these options.
16
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
On
January 18, 2010, the Board of Directors of the Company approved the issuance of
a total of 1.9 million shares of restricted stock (the “Restricted Stock
Grants”) to certain of its officers, directors, and key employees under
the China Architectural Engineering, Inc. 2009 Omnibus Incentive Plan (the
“Plan”), which
was previously approved by our stockholders at the 2009 Annual Meeting of
Stockholders. As approved, the Restricted Stock Grants were subject
to and contingent upon the Company’s filing of a registration statement on Form
S-8 with the Securities and Exchange Commission, which occurred on January 21,
2010. As granted, the Restricted Stock Grants were set to vest such that ¼ would
vest on March 31, 2010, ¼ would vest on June 30, 2010, ¼ would vest on September
30, 2010, and the remaining ¼ would vest on December 31, 2010, except for the
Restricted Stock Grant for 200,000 shares of common stock that was made to a
senior officer, which vested 100% upon the date of grant. The vesting
of the grants were subject to the terms and conditions of the Plan and the
Restricted Stock Agreement entered into by and between the recipients and the
Company. In the first quarter of 2010, the Board of Directors of the
Company accelerated vesting of the restricted stock awards such that all of the
Restricted Stock Grants became fully vested immediately on March 9, 2010. The
market price of the Company’s share closed on that date at $1.03. The
transaction was recognized in accordance with the FASB ASC 718,
Compensation-Stock Compensation and the value of the grants is a total of
$1,957,000 as the stock compensation expense.
3.
|
CONTRACT
RECEIVABLES
|
March 31, 2010
|
December 31,
2009
|
|||||||
Contract
receivables
|
$ | 91,340,006 | $ | 95,831,489 | ||||
Less: Allowance for
doubtful accounts
|
(3,058,512 | ) | (6,642,386 | ) | ||||
Net
|
$ | 88,281,494 | $ | 89,189,103 |
Allowance for Doubtful Accounts
|
March 31, 2009
|
December 31,
2009
|
||||||
Beginning
balance
|
$ | 6,642,386 | $ | 5,215,701 | ||||
Add:
Allowance created
|
193,752 | 1,426,685 | ||||||
Less:
Written off of receivables
|
(3,777,626 | ) | - | |||||
Ending
balance
|
$ | 3,058,512 | $ | 6,642,386 |
17
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
4.
|
OTHER
RECEIVABLES
|
Other
receivables consisted of the following:
March 31,
2010
|
December 31,
2009
|
|||||||
Due
from sellers of Techwell, the subsidiary (1)
|
$ | 11,112,555 | $ | 11,333,253 | ||||
Due
from Kangbao Electrical Company Limited (Kangbao) , a related
party (2)
|
847,135 | 6,054,905 | ||||||
Drawdown
of advance payment and performance bonds by client of the projects in
Dubai (3)
|
9,402,757 | 9,414,397 | ||||||
Other
related parties receivables
|
- | 253,638 | ||||||
Deposits
for site operations of projects in PRC
|
3,986,828 | 2,903,171 | ||||||
Other
|
471,951 | 808,703 | ||||||
Total
|
$ | 25,821,226 | $ | 30,768,067 |
(1)
|
On
November 6, 2007, the Company, through Full Art International, Ltd. (“Full
Art”), acquired all of the issued and outstanding shares in the capital of
Techwell Engineering Limited, a limited liability company incorporated in
Hong Kong (“Techwell”) pursuant to a Stock Purchase Agreement (the
“Agreement”) dated November 6, 2007, entered into by and among Ng Chi Sum
and Yam Mei Ling (each a “Shareholder” and collectively, the
“Shareholders”), the Company and Full Art. Pursuant to the
terms and conditions of the Agreement, the Shareholders agreed that
each of them would pay any and all accounts receivables of Techwell if not
paid by the customers within 24 months of the acquisition
date. The 24 month period has expired and a total of $9,909,130
is due and payable from the Shareholders. The amount is included in the
other receivable due from sellers of
Techwell.
|
|
|
(2)
|
The
amount mainly represents the purchases advances to Kangbao Electrical
Company Limited (Kangbao) for the supplies of materials for the projects
of the Company.
|
|
|
(3)
|
The
Company believes that the client of the Dubai projects did not have proper
grounds for the drawdown of the advance payment and performance bonds
which the company issued for the projects. The Company also
believes that the client should not be entitled to the drawdown and is now
proceeding the claim back of the
amount.
|
5.
|
INVENTORIES
|
March 31, 2010
|
December 31,
2009
|
|||||||
Raw
materials at sites
|
$ | 162,346 | $ | 727,499 |
18
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
6.
|
PLANT
AND EQUIPMENT
|
Plant and
equipment consist of the following as of:
March 31, 2010
|
December 31, 2009
|
|||||||
At
cost
|
||||||||
Motor
vehicle
|
$ | 1,242,453 | $ | 1,242,928 | ||||
Machinery
and equipment
|
2,383,096 | 2,381,755 | ||||||
Furniture,
software and office equipment
|
1,794,223 | 1,795,595 | ||||||
Building
|
- | - | ||||||
Leasehold
improvement
|
266,773 | 267,038 | ||||||
$ | 5,686,545 | $ | 5,687,316 | |||||
Less:
Accumulated depreciation
|
||||||||
Motor
vehicle
|
$ | 868,277 | $ | 825,536 | ||||
Machinery
and equipment
|
1,465,385 | 1,420,536 | ||||||
Furniture,
software and office equipment
|
882,047 | 804,516 | ||||||
Building
|
- | - | ||||||
Leasehold
improvement
|
109,502 | 97,271 | ||||||
$ | 3,325,211 | $ | 3,147,859 | |||||
$ | 2,361,334 | $ | 2,539,457 |
Depreciation
expenses included in the selling and administrative expenses for periods ended
March 31, 2010 and 2009 were $178,043 and $252,852,
respectively.
7.
|
INTANGIBLE
ASSETS
|
March
31, 2010
|
December
31, 2009
|
|||||||
At
cost
|
||||||||
Intangible
Assets
|
$ | 98,673 | $ | 98,673 | ||||
Less:
Accumulated amortization
|
38,686 | 28,063 | ||||||
$ | 59,987 | $ | 70,610 |
19
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
8.
|
LOANS
|
A.
|
SHORT-TERM
BANK LOANS
|
March 31, 2010
|
December 31, 2009
|
|||||||
ABN
Amro N.V. Overdraft in Current Account at interest rate at 6.5% per
annum
|
$ | 3,238,656 | $ | 4,906,266 | ||||
ABN
Amro N.V. Temporary Loan for the drawing of performance and advance
payment bonds at interest rate at Bank's Cost of Fund +
6%
|
4,540,883 | 4,546,504 | ||||||
Automobile
capital lease obligation (hire purchase),amount due within one year, last
installment due November 9, 2012
|
77,015 | 77,110 | ||||||
$ | 7,856,554 | $ | 9,529,880 |
B.
|
LONG-TERM
BANK LOANS
|
March 31, 2010
|
December 31,
2009
|
|||||||
Automobile
capital lease obligation (hire purchase),amount due after one year, last
installment due November 9, 2012
|
89,850 | 109,239 | ||||||
$ | 89,850 | $ | 109,239 |
Full Art
International Limited borrowed a hire purchase (car) loan from DBS
Bank.
20
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
9.
|
CONVERTIBLE
BONDS AND BOND WARRANTS
|
(a)
|
$10,000,000
Variable Rate Convertible Bonds due in
2012
|
On April 12, 2007, the Company
completed a financing transaction with The Royal Bank of Scotland, London Branch
(formerly “ABN AMRO N.V., London Branch) (the “Subscriber”) issuing (i)
$10,000,000 Variable Rate Convertible Bonds due in 2012 (the “Bonds”) and (ii)
800,000 warrants to purchase an aggregate of 800,000 shares of the Company’s
common stock, subject to adjustments for stock splits or reorganizations as set
forth in the warrant, that expire in 2010 (the “Warrants”).
On September 29, 2008, the Subscriber
converted $2,000,000 into 571,428 shares at the conversion price of $3.50 per
share. As of March 31, 2009, the face value of the bonds outstanding was
$8,000,000.
Effective from April 12, 2009, the
conversion price has been reset to $2.45, which is 70% of $3.50 as the average
closing price of the Company’s shares for the period of 20 consecutive trading
days immediately prior to April 12, 2009 was $0.94. The reset of the
conversion price resulted in additional $3.4 million of bonds discount and will
be amortized over the remaining outstanding periods of the
bonds.
On November 8, 2008, the Subscriber
exercised all the 800,000 warrants into 800,000 shares at the exercise price of
$0.01 per share.
(b)
|
$20,000,000
12% Convertible Bonds due in
2011
|
On April 15, 2008, the Company
completed a financing transaction with the Subscriber, CITIC Allco Investments
Limited (the “Subscribers,” and each a “Subscriber”), and CITIC Capital Finance
Limited issuing (i) $20,000,000 12% Convertible Bonds due in 2011 (the “Bonds”)
and (ii) 300,000 warrants to purchase an aggregate of 300,000 shares of the
Company’s common stock, subject to certain adjustments as set forth in the
warrant instrument, that expire in 2013 (the “Bond Warrants”). The transaction
was completed in accordance with a subscription agreement entered into by the
Company, Subscribers, and CITIC Capital Finance Limited, dated April 2, 2008
(the “Subscription Agreement”).
The above
items (a) and (b) are to be amortized to interest expense over the term of the
bonds by the effective interest method as disclosed in the table
below.
The
Convertible Bonds Payable, net consists of the following:
March 31,
2010
|
December
31, 2009
|
|||||||
Convertible
Bonds Payable
|
$ | 28,000,000 | $ | 28,000,000 | ||||
Less:
Interest discount – Warrants
|
(3,305,938 | ) | (3,305,938 | ) | ||||
Less:
Interest discount – Beneficial conversion feature
|
(1,882,404 | ) | (1,882,404 | ) | ||||
Less:
Bond discount
|
(760,069 | ) | (760,069 | ) | ||||
Accretion
of interest discount
|
3,423,578 | 2,512,572 | ||||||
Net
|
$ | 25,475,167 | $ | 24,564,161 |
21
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
The
Company has failed to make interest payments as originally agreed upon under the
Bonds, as follows:
$10,000,000
Variable Rate Convertible Bonds due in 2012
|
||||
Interest
for 6 months from April to October 2009, due October 4,
2009
|
$ | 120,000 | ||
$20,000,000
12% Convertible Bonds due in 2011
|
||||
Interest
for 6 months from October 2008 to April 2009, due April 15,
2009
|
$ | 1,200,000 | ||
Interest
for 6 months from April 2009 to October 2009, due October 15,
2009
|
1,200,000 | |||
Total
missed interest payments:
|
$ | 2,520,000 |
(c)
|
Waiver
of Conversion Price Adjustment on Convertible
Bonds
|
On
February 24, 2010, the Company entered into an Amendment and Waiver Agreement
(the “Waiver”) with the holders of its Bonds and warrants to purchase 300,000
shares of common stock of the Company expiring 2013 (the “2008 Warrants”).
Pursuant to the Waiver, the holders of the Bonds and the 2008 Warrants agreed to
waive their right to a reduction in the conversion price of the Bonds and the
exercise price of the 2008 Warrants upon the Company’s anticipated issuance of
up to 25,000,000 shares of its common stock (the “Shares”) for a proposed
acquisition of a 60% ownership interest in Shanghai ConnGame Network Co. Ltd.
(“ConnGame”). Additionally, the holders of the 2008 Bonds agreed to waive any
default under the terms and conditions of the trust deed governing the 2008
Bonds relating to the requirement that KGE Group Limited own at least 45% of the
Company’s issued and outstanding common stock.
The
Waiver is subject to numerous conditions. The Company agreed to pay the
Bondholders the interest in arrears owed on the Bonds as of March 31, 2010 in
two equal payments on March 31, 2010 and May 31, 2010 of approximately $1.26
million USD each and to pay 100% of the interest payments on the Bonds that
becomes due in April to be paid on April 15, 2010 of approximately $1.32 million
USD. The foregoing interest payments, in aggregate, are equal to approximately
$3.84 million USD. The Company also agreed to repay the principal and all
accrued interest owed by the Company to ABN AMRO Bank (China) Co., Ltd.,
Shenzhen Branch (the “Overdraft Lender”) under an Overdraft Facility letter (the
“Total Amount Owed”) in three separate installments. The first installment is
due on the earlier of (a) within 30 days of the Company’s receipt of a payment,
if any, in respect to a .claim in Dubai or (b) March 31, 2010. The second
installment is due on April 30, 2010 and the third installment is due on May 31,
2010. The first installment equals 34% of the Total Amount Owed and the
second and third installments each equal 33% of the Total Amount Owed. The Total
Amount Owed is equal to approximately $4.91 million USD. The Company further
agreed that it will not repay or prepay any debt prior to its currently
scheduled due date until the Company makes all of the payments specified in the
Waiver and the Bonds have been redeemed in full and that any new indebtedness
incurred by the Company for the purpose of repaying the Overdraft Facility shall
(i) not exceed the outstanding amount due and payable under the Overdraft
Facility and (ii) be subordinated to all amount owed under the Bonds (the
“Covenants”). The Company paid USD1,260,000 of the outstanding amount
as of March 31, 2010 in accordance with the Waiver.
In
addition, the Company entered into an Amendment and Waiver Agreement with the
Bondholders on August 6, 2009 pursuant to which the Bondholders agreed to extend
interest payments under the Bonds. The Company then entered into
another Amendment and Waiver Agreement with the Bondholders, other creditors and
other interested parties as specified in the agreement dated February 24, 2010
pursuant to which that the Bondholders extended the payment of overdue interest
of $2,520,000 to March 31, 2010 and April 15, 2010. The convertible
bonds are classified as long term debt due to the waivers, but the Company may
be required to reclassify the bonds as a current liability if the Company is not
required to the covenants that must be met under the
Bonds. The Company may be required to reclassify the Bonds as a
current liability if (i) a covenant violation that gives the bondholders the
right to call the debt has occurred at the balance sheet date or would have
occurred absent a loan modification, and (ii) it is probable that the Company
will not be able to cure the default (comply with the covenant) at measurement
dates that are within the next 12 months. The Company believed that it is not
probable that the Company will not be able to cure the default at measurement
dates that are within the next 12 months.
22
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
10.
|
CONTRACT
REVENUES EARNED
|
The
contract revenues earned for the three-month periods ended March 31, 2010 and
2009 consist of the following:
March 31, 2010
|
March 31, 2009
|
|||||||
Billed
|
$ | 10,173,136 | $ | 28,279,372 | ||||
Unbilled
|
1,298,987 | 8,063,692 | ||||||
$ | 11,472,123 | $ | 36,343,064 |
The
unbilled
contract revenue earned represents those revenue that should be recognized
according to the percentage of completion method for accounting for construction
contract because the Company is entitled to receive payment from the customers
for the amount of work that has been rendered to
and completed for that customer
according to the terms and progress being
made as stipulated under that contract between the Company and that customer. As
an industrial practice, there are certain procedures that need to be performed,
such as project account finalization, by both the customer and the Company
before the final billing is issued; however this does not affect the
Company’s recognition of revenue and respective cost according to the
terms of the contract with the consistent application of the
percentage-of-completion method.
A single
customer accounted for 40.4% of the Company’s contract revenues for the
three months ended March 31, 2010. No other customer accounts for 10% or more of
the Company’s contract revenues in the period.
11.
|
INCOME
TAXES
|
On
October 17, 2006, income from the Company’s foreign subsidiaries became subject
to U.S. income tax liability; however, this tax is deferred until foreign source
income is repatriated to the Company, which has not yet
occurred.
The
Company has also retained an U.S. tax-preparer firm to aide in preparation of
its U.S. income tax returns in order to maintain a high level of compliance with
U.S. tax laws.
Effective
January 1, 2008, the PRC income tax rules were changed. The PRC
government implemented a new 25% tax rate for all enterprises whether domestic
or foreign enterprise, and abolished the tax holiday.
23
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
Income
before taxes and the provision for taxes for the periods ended March 31, 2010
and 2009 consists of the following:
March 31,
|
||||||||
2010
|
2009
|
|||||||
Continuing
income before taxes:
|
||||||||
U.S.
|
$ | (4,093,545 | ) | $ | (2,025,063 | ) | ||
Singapore
|
(388 | ) | (651 | ) | ||||
China
|
356,519 | (1,881,006 | ) | |||||
Australia
|
(3,100 | ) | (3,673 | ) | ||||
Hong
Kong
|
(140,794 | ) | (672,728 | ) | ||||
Dubai
|
371,631 | 5,568,937 | ||||||
Macau
|
(2,104 | ) | (42,205 | ) | ||||
Total
continuing income before taxes
|
(3,511,781 | ) | 943,611 | |||||
Provision
for taxes expense/(benefit):
|
||||||||
Current:
|
||||||||
U.S.
Federal
|
- | - | ||||||
U.S.
State
|
9,575 | - | ||||||
9,575 | - | |||||||
Deferred:
|
||||||||
U.S.
Federal
|
9,575 | - | ||||||
Hong
Kong
|
- | - | ||||||
Currency
Effect
|
- | - | ||||||
Total
provision for taxes
|
9,575 | - | ||||||
Effective
tax rate
|
-0.29 | % | 0.00 | % |
24
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amount of assets and liabilities for financial reporting purposes and
the amounts for income tax purposes. Significant components of our deferred tax
assets and liabilities at March 31, 2010 and December 31, 2009 are as
follows:
March 31, 2010
|
December 31, 2009
|
|||||||
Deferred
tax assets
|
||||||||
Net
operating loss
|
$ | 112,893 | $ | 113,033 | ||||
112,893 | 113,033 | |||||||
Valuation
allowance
|
- | - | ||||||
Total
deferred tax assets
|
112,893 | 113,033 | ||||||
Deferred
tax liabilities
|
||||||||
Total
deferred tax liabilities
|
- | - | ||||||
Net
deferred tax assets
|
112,893 | 113,033 | ||||||
Reported
as:
|
||||||||
Current
deferred tax assets
|
112,893 | 113,033 | ||||||
Non-current
deferred tax assets
|
- | - | ||||||
Non-current
deferred tax liabilities
|
- | - | ||||||
Net
deferred taxes
|
$ | 112,893 | $ | 113,033 |
Current
deferred tax assets represents net operating loss of a subsidiary Techwell
Engineering Limited in Hong Kong. The losses can be carried forward to set-off
future assessable profits in Hong Kong without expiry date. The differences
between the U.S. federal statutory income tax rates and the Company’s effective
tax rate for the periods ended March 31, 2010 and 2009 is shown in the following
table:
2010
|
2009
|
|||||||
U.S.
federal statutory income tax rate
|
34.00 | % | 34.00 | % | ||||
Lower
rates in PRC, net
|
-9.00 | % | -9.00 | % | ||||
Accruals
in foreign jurisdictions
|
-0.29 | % | -0.00 | % | ||||
Tax
Holiday
|
-25.00 | % | -25.00 | % | ||||
-0.29 | % | 0.00 | % |
25
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
The
following table accounts for the differences between the actual tax provision
and the amounts obtained by applying the relevant applicable corporation income
tax (see tax rates discussed above) before tax for the periods ended March 31,
2010 and 2009:-
2010
|
2009
|
|||||||
Income/(loss)
before tax
|
(3,511,781 | ) | 943,611 | |||||
Taxes
at the applicable income tax rates
|
9,558 | - | ||||||
Miscellaneous
non taxable income
|
17 | - | ||||||
and
non-deductible expenses
|
||||||||
$ | 9,575 | $ | - |
Effective
January 1, 2008, the PRC government implemented a new 25% tax rate across the
board for all enterprises regardless of whether domestic or foreign enterprise
without any tax preferences which is defined as “two-year exemption followed by
three-year half exemption” enjoyed by tax payers. As a result of the tax law, a
standard 15% tax preference terminated as of December 31, 2007. The PRC
government has established a set of transition rules to allow enterprises using
tax preferences before January 1, 2008 to continue using the tax preferences on
a transitional basis until being the new tax rates are fully implemented over a
five year period.
12.
|
COMMITMENTS
AND CONTINGENCIES
|
(a)
Operating lease commitments
The
Company leases certain administrative and production facilities from third
parties. Accordingly, for the three-month periods ended March 31,
2010 and 2009, the Company incurred rental expenses of $267,036 and $829,465
respectively.
The
Company has commitments with respect to non-cancelable operating leases for
these offices, as follows:
For
the 12 months ending March 31,
|
||||
2011
|
716,481 | |||
2012
|
- | |||
2013
|
- | |||
2014
or after
|
- | |||
$ | 716,481 |
(b)
Pending Litigation
Techwell litigation
Pursuant
to a Stock Purchase Agreement dated November 7, 2007, the previous shareholders
of Techwell Engineering Limited (“Techwell”), Mr. Ng, Chi Sum and Miss Yam, Mei
Ling Maria agreed to sell 100% of the shares in Techwell to the Company for
approximately $11.7 million in cash and shares of common stock of the Company.
Subsequent to the said acquisition, Mr. Ng and Miss Yam were employed by
Techwell.
26
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
On
January 14, 2009, the board of directors of Techwell passed a board resolution,
to dismiss both Mr. Ng and Miss Yam with immediate effect and remove Mr. Ng from
the board of Techwell (the “Resolution”). On January 16, 2009, Mr. Ng and Miss
Yam filed a lawsuit in the High Court of Hong Kong against the Company and its
subsidiary, Full Art International Limited. The lawsuit alleges that, inter
alia, (i) the Company misrepresented to them the financial status of the Company
and operations during the course the acquisition of Techwell was being
negotiated; (ii) the Company failed to perform its obligations under a
settlement agreement alleged to be agreed by the Company in January 2009; and
(iii) the dismissal of Mr. Ng was unlawful and invalid. The lawsuit filed by Mr.
Ng and Miss Yam requests the court for specific performance of the settlement
agreement that was allegedly entered into, which would require the return of the
Techwell company to Mr. Ng and Miss Yam, and in the absence of such grant of
relief, Mr. Ng and Miss Yam request unspecified damages lieu of return of the
Techwell company.
On
January 23, 2009 an ex-parte injunction order was granted to Mr. Ng, restraining
the Company from implementing the Resolution, which was eventually dismissed
with immediate effect on February 25, 2009 after a court session in the High
Court of Hong Kong. Mr. Ng was also ordered to bear the costs of the various
court proceedings in connection with the said injunction order. On March 27,
2009, Mr. Ng and Miss Yam filed a summons in the High Court of Hong Kong seeking
a court order for leave to join the Company’s principal shareholder, KGE Group
Limited, as a defendant of the said lawsuit, which was granted on April 9, 2009.
As a result, KGE Group Limited became one of the defendants of the lawsuit. On
May 12, 2009, the Company filed a Defense and Counterclaim at the High Court of
Hong Kong in response to a Statement of Claim served by Mr. Ng and Miss Yam on
the Company on April 7, 2009.
The
Company intends to vigorously defend this pending lawsuit; however, no assurance
can be given that the lawsuit will be resolved in the Company’s favor. Even if
the Company successfully defends the lawsuit, the Company may incur substantial
costs defending or settling the lawsuit, in addition to a possible diversion of
the time and attention of the Company’s management from its business. If the
Company is unsuccessful in defending the lawsuit, its may be required to pay a
significant amount of damages and/or it may potentially lose ownership of
Techwell, which will have a material adverse effect on the Company’s business,
financial condition or results of operations. In the last quarter of 2009, Mr.
Ng made a settlement proposal to the Company for consideration and the Company
is negotiating the settlement agreement with Mr. Ng as of March 31,
2010.
Dubai
Metro Rail Project Dispute
On
September 9, 2009, the Red Line, or first phase, of the Dubai Metro was
officially opened. The Company, through its subsidiary, had been working towards
completion of its external envelopes for stations along the Red Line of the
Dubai Metro System. According to the Company’s original construction
blueprint, the majority of its construction work was completed at the end of
June 2009, and final construction milestones were scheduled for completion in
the third quarter of 2009. With less than 5% of its contract
remaining to be completed, Techwell was removed by the master contractor of the
project, which also called for and received payment of $2.1 million in
performance bonds and $7.3 million in advance payment bonds that were issued on
Techwell's behalf for the project. The calling of the advance payment bonds was
based on the master contractor's belief that it had paid in excess of the
construction work performed. The Company and certain of its
subsidiaries are guarantor of the bonds that were paid by the banks, and the
Company is liable under the guarantee agreements for such amounts paid by the
banks. The Company does not believe that the master contractor had a
proper basis for calling the bonds and intend to vigorously defend all of its
legal rights and remedies related to the dispute. The Company has
engaged a construction claims consultant to facilitate resolution of the
dispute. The Company and its construction claims consultant, based on
a review of the facts, documents, and materials available, believes that it has
a reasonable opportunity to collect the amounts due to Techwell from the master
contractor, less appropriate credits as its final amount due for work performed
through September 2009. The Company, with the assistance of its
claims consultant, will continue to evaluate the dispute and probability of
success on this dispute going forward and make the appropriate adjustments;
however, no assurance can be given that the dispute will be resolved in the
Company’s and Techwell’s favor. The Company’s counsel in Dubai is preparing the
legal documents for the claims as of March 31, 2010.
27
CHINA
ARCHITECTURAL ENGINEERING, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated
in US Dollars)
13.
|
RELATED
PARTIES TRANSACTIONS
|
The
account balance with shareholders at March 31, 2010 was payables of $3,504,156,
while at December 31, 2009 it was $10,080,345. The payables balance was mainly
loans from the largest shareholder, with such loans being interest-free,
fee-free and has no fixed repayment schedule.
During
the three months period ended March 31, 2010, the Company purchased construction
materials amounting to $0.3 million from Guangdong Canbo Electrical Co., Ltd.
(Canbo), a subsidiary of the Company’s major shareholder, KGE Group Limited.
Canbo is a preferred supplier of the Company as it is able to procure materials
at favorable price levels due to its purchased quantities. More important,
application of certain of the Company’s patented technology is preferably routed
through Canbo to prevent undesired distribution of this technology. The Company
at times provides advance payment to Canbo in order to obtain a more favorable
pricing. As of March 31, 2010, the Company’s advance to Canbo was $0.8
million.
The
transactions with related parties during the periods were carried out in the
ordinary course of business and on normal commercial
terms.
28
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
Forward-Looking
Statements
The
following discussion should be read in conjunction with our consolidated
financial statements and related notes included elsewhere in this quarterly
report and the audited consolidated financial statements and related notes and
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” contained in our annual report on Form 10-K for the year ended
December 31, 2009.
This
quarterly report contains forward-looking statements that involve substantial
risks and uncertainties. The words “anticipated,” “believe,” “expect,
“plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar
expressions are intended to identify forward-looking statements. These
statements include, among others, information regarding future operations,
future capital expenditures, and future net cash flow. Such statements reflect
our management’s current views with respect to future events and financial
performance and involve risks and uncertainties, including, without limitation,
identification and remediation of the Company's deficiencies and weaknesses in
its internal controls over financial reporting, potential claims or litigation
that may result from the occurrence of restatements, the negotiation and
execution of a definitive acquisition agreement for the proposed acquisition of
ConnGame and satisfactory completion of related due diligence and closing
conditions, including but not limited to regulatory approvals; ability to
identify and secure debt, equity, and/or other financing required to continue
the operations of the Company, particularly in the event that the Company is not
able to conduct the proposed acquisition of ConnGame; required Company payments
under the waiver agreement and ability to obtain an extension; difficulties
related to integration and management of the combined operations; reduction or
reversal of the Company's recorded revenue or profits due to "percentage of
completion" method of accounting and expenses; the Company's ability to obtain a
modification for the Waiver agreement with the bondholders applicable to the
proposed acquisition of ConnGame; increasing provisions for bad debt related to
the Company's accounts receivable; fluctuation and unpredictability of costs
related to our products and services; the Company's plans to enter into real
estate development projects such as the Nine Dragons Project; adverse capital
and credit market conditions; fluctuation and unpredictability of costs related
to the Company's products and services; expenses and costs associated with its
convertible bonds, regulatory approval requirements and competitive conditions;
and various other matters, many of which are beyond our control. Actual
results may vary materially and adversely from those anticipated, believed,
estimated or otherwise indicated should one or more of these risks or
uncertainties occur or if any of the risks or uncertainties described elsewhere
in this report or in the “Risk Factors” section of our 2009 annual report
occur. Consequently, all of the forward-looking statements
made in this report are qualified by these cautionary statements and there
can be no assurance of the actual results or developments.
Overview
The
recent trends in the global economy have had a significant adverse impact on the
commercial construction industry as a whole. As a result, the competitive
environment in which we operate has become more competitive, increasing the
number of re-bid construction projects and amount of time between bidding and
award of a project, reducing selling prices, and causing competitors to modify
the scope and type of projects on which they bid. In 2008 we
increased the number of international construction projects, but in 2009 the
spread of the global recession and reduction in the nature and scope of
international construction projects has led us to primarily focus our attention
on domestic projects in China. Dubai, Doha, Kuwait and other middle
east region have been suffered a great impact markedly under the global
financial crisis. Our projects suffered a certain degree of impact as
well. During 2009, we have experienced a decrease in the project
turnover and an increase in costs and delays in customer payments. As a result,
our results of operations have suffered. However, we conducted our
Dubai and Doha Projects construction under the original schedule, and executed
the design for Kuwait project. After the completion of “soft-open” of
Dubai Metro Rail Project in September 2009, the contractor called bonds and
refused to sign and pay for the project payments, which have resulted in a cash
flow difficulties for our company. As described below, we dispute the
contractor’s rights to call the bonds and seeking remedies for its
actions. In addition, after a thorough review and analysis of the
feasibility and profitability of the Singapore Project, we determined that it
was in the best interests of our company to withdraw from the
project.
We do not
believe that the international economy will experience a swift recovery in the
near future and therefore its negative impact on construction industry still
exists and will exist in the near future. As a result, we suspended
the orders of the construction of international projects, and shifted the focus
of our business to design and professional consulting services. We have taken
steps to continue our development and research of new technologies and to
maintain our company’s position in the industry. To develop
projects and generate revenue, we have sought to join new projects in the
position of design and project consultant and the role of material
supplier.
29
In the
past, the number and size of our international projects had been increasing, but
during 2009 our management has moved to refocus our resources to projects in the
mainland China. During the second quarter of 2009, we decided to
terminate our work on the project in Singapore and stop the guarantee related to
the project. Our management reviewed and created updated forecasts for the
project and concluded that there will be major differences between the design
concept as originally contemplated and the final site structures. As a result,
we decided to terminate our work on the project since we did not receive
approval for our improvement proposal, and resources related to the project were
moved to projects in China.
We
believe that the Chinese market has faired much better than most of the
international markets. With the strength of our reputation and
history of notable projects in China, we are focusing our resources and efforts
in our domestic market. We believe that we have long-standing
relationships with leading Chinese and international architects, having
completed high profile projects in China. During the year 2009, we
commenced certain landmark projects in China, which consisted of the Changsha
Train Station, Changsha Museum, Guangzhou Science Town, and projects in Jinan
and Inner Mongolia. These projects are expected to be completed in
2010.
Revenues
and earnings recognition on many construction contracts are measured based on
progress achieved as a percentage of the total project effort or upon the
completion of milestones or performance criteria rather than evenly or linearly
over the period of performance. Our work is performed under
cost-plus-fee contracts and fixed-price contracts. The length of our contracts
varies but typically has a duration of approximately one to two years.
Approximately 95% of our sales are from-fixed price contracts. The remaining
sales are from cost-plus-fee contracts. Under fixed-price contracts, we receive
a fixed price. Consequently, we realize a profit on fixed-price contracts only
if we control our costs and prevent cost over-runs on the contracts.
Approximately 70% of contracts are modified after they begin, usually to
accommodate requests from clients to increase project size and scope. In cases
where fixed-price contracts are modified, the fixed price is renegotiated and
adjusted upwards accordingly. Under cost-plus-fee contracts, which may be
subject to contract ceiling amounts, we are reimbursed for allowable costs and
fees, which may be fixed or performance-based. If our costs exceed the contract
ceiling or are not allowable under the provisions of the contract or any
applicable regulations, we may not be reimbursed for all our
costs.
Recent
Events
Proposed
Acquisition of 60% Equity Interest in ConnGame
In
December 2009, we and First Jet entered into a letter of intent for the
Acquisition (“Letter of Intent”) that set forth the principal terms under which
we would issue up to 25,000,000 shares of our common stock to First Jet to
acquire 60% of the equity interest of Shanghai ConnGame Network Co. Ltd., a
company formed under the laws of the People’s Republic of China (“ConnGame”),
which is a developer and publisher of MMORPG (Massively Multiplayer Online Role
Playing Game). In January 2010, our board of directors and
stockholders approved our acquisition of a 60% equity interest in
ConnGame. We believe our acquisition of ConnGame will enable us to
strengthen our core architectural engineering and design abilities, in addition
to enabling us to enter China's large online game market, with ConnGame’s two
to-be-released MMORPG games. We believe that the online game industry
and its related business model will be a growing market in
China.
Pursuant
to the terms of the Letter of Intent, we would issue the total 25,000,000 shares
of common stock to First Jet if an independent valuation firm determined that
the value of ConnGame was equal or greater to $50 million. We
received an appraisal report dated January 17, 2010 from Shanghai Xinda Asset
Appraisal Co., Ltd. According to the appraisal, subject to its
assumptions and limitations, the fair market value of ConnGame on January 15,
2010 was approximately $52 million (RMB 357 million), based on a discounted cash
flow model. In addition, the proposed acquisition and the issuance of
the shares will be subject to numerous closing conditions, including the
execution of a waiver of reduction to conversion price of our outstanding Bonds
or exercise price of the 2008 Warrants. As described below, we and
the bondholders, in addition to other parties, entered into a waiver agreement
on February 24, 2010.
Upon the
consummation of the acquisition, if and when it shall occur, it is anticipated
that Luo Ken Yi will resign as Chairman of the Board of
Directors. Mr. Luo will remain as a member of the
Board. Upon Mr. Luo’s resignation as the Chairman of the Board, the
Board will appoint Mr. Jun Tang, the sole shareholder of First Jet, as Chairman
of the Board. Mr. Jun Tang, 47, currently serves as the President and
Chief Executive Officer of New Huadu Group, Fujian. From 2004 to
2008, Mr. Tang served as President of Shanghai SNDA (Nasdaq: SNDA), a
interactive entertainment media company in China. Prior to that, he
served as President of Microsoft China Co., Ltd from 2002 to
2004. From 1997 to 2002, he served as General Manager of Microsoft
Global Technical Engineering Center, and from 1994 to 1997 he served as Senior
Project Manager for Microsoft US. Mr. Tang received his
doctorate degree, master’s degree and bachelor’s degree in the U.S., Japan and
China, respectively.
30
Completion
of the proposed acquisition is subject to negotiation and execution of a
definitive equity transfer agreement, regulatory approvals, and other customary
closing conditions. Therefore, there can be no guarantee that the
acquisition will be consummated.
Wavier
Agreement
On
February 24, 2010, we entered into an Amendment and Waiver Agreement (the “Waiver Agreement”)
with the holders of our outstanding Variable Rate Convertible Bonds due 2012
(the “2007
Bonds”) and 12% Convertible Bonds due 2011 (the “2008 Bonds,” and
collectively with the 2007 Bonds, the “Bonds”) and warrants
to purchase 300,000 shares of our common stock expiring 2013 (the “2008
Warrants”). Pursuant to the Waiver Agreement, the holders of
the Bonds and the 2008 Warrants agreed to waive their right to a reduction in
the conversion price of the Bonds and the exercise price of the 2008 Warrants
upon our anticipated issuance of up to 25,000,000 shares for the proposed
acquisition of a 60% ownership interest in ConnGame. Additionally,
the holders of the 2008 Bonds agreed to waive any default under the terms and
conditions of the trust deed governing the 2008 Bonds relating to the
requirement that KGE Group Limited, our largest shareholder, own at least 45% of
our issued and outstanding common stock.
The waivers contained in
the Waiver Agreement are subject to numerous conditions. We agreed to
pay the Bondholders the interest in arrears owed on the Bonds as of March 31,
2010 in two equal payments on March 31, 2010 and May 31, 2010
of approximately $1.26 million each and to pay 100% of the interest
payments on the Bonds that becomes due in April 2010 to be paid on April
15, 2010 of approximately $1.32 million, for aggregate payments of approximately
$3.84 million. We also agreed to repay the principal and all accrued
interest that we owe to ABN AMRO Bank (China) Co., Ltd., Shenzhen Branch (the
“Overdraft
Lender”) under an Overdraft Facility letter in three equal separate
installments. The total amount owed to the Overdraft Lender is equal to
approximately $4.91 million. The first installment is due no later than March
31, 2010, the second installment is due on April 30, 2010 and the third
installment is due on May 31, 2010. We also agreed that we will not
repay or prepay any debt prior to its currently scheduled due date until we make
all of the payments specified in the Waiver Agreement and the Bonds have been
redeemed in full and that any new indebtedness incurred by us for the purpose of
repaying the Overdraft Facility will (i) not exceed the outstanding amount due
and payable under the Overdraft Facility and (ii) be subordinated to all amount
owed under the Bonds. The Company paid USD1,260,000 of the
outstanding amount as of March 31, 2010 in accordance with the
Waiver.
If we
fail to make any of the payments specified in the Waiver Agreement, then all
rights of the holders of the Bonds and 2008 Warrants waived under the Waiver
Agreement to or to be waived under the Waiver Agreement, will not be waived and
will be reinstated, and any previous waivers will be null and
void. In such case, appropriate adjustments may be made to reduce the
conversion and exercise price of the Bonds and 2008 Warrants. In addition, the
bondholders may declare a default under the Bonds and require us to pay the
Bonds, which could result in bankruptcy or otherwise impair our ability to
maintain sufficient liquidity to continue our operations.
Dubai
Metro Rail Project
On
September 9, 2009, the Red Line, or first phase, of the Dubai Metro was
officially opened. We, through our subsidiary Techwell Engineering Limited, had
been working towards completion of our external envelopes for stations along the
Red Line of the Dubai Metro System. According to our original
construction blueprint, the majority of our construction work was completed at
the end of June 2009, and final construction milestones were scheduled for
completion in the third quarter of 2009. With less than 5% of our
contract remaining to be completed, Techwell was removed by the master
contractor of the project, who also called for and received payment of $2.1
million in performance bonds and $7.3 million in advance payment bonds that were
issued on Techwell's behalf for the project. The calling of the advance payment
bonds was based on the master contractor's belief that it had paid in excess of
the construction work performed. We and certain of our subsidiaries
are guarantors of the bonds that were paid by the banks, and we are liable under
the guarantee agreements for such amounts paid by the banks. We do
not believe that the master contractor had a proper basis for calling the bonds
and intend to vigorously pursue and defend all of our legal rights and remedies
related to this dispute. We have engaged a construction claims
consultant to facilitate resolution of this dispute. We and our
construction claims consultant, based on a review of the facts, documents, and
materials available, believe that we have a reasonable opportunity to collect
the amounts due to Techwell from the master contractor, less appropriate credits
as our final amount due for work performed through September
2009. We, with the assistance of our claims consultant, have
been continuously evaluating the dispute and probability of success on this
dispute going forward and make the appropriate adjustments; however, no
assurance can be given that the dispute will be resolved in our and Techwell’s
favor. The Company’s counsel in Dubai is preparing the legal documents for the
claims by the time of this report.
With the
use of “percentage-of-completion” method, the revenue to be recognized for each
period will included both (1) the revenue earned for the current period and (2)
the adjustment to previously recognized revenue that is required because of the
changes in estimated total revenue, costs and profitability of projects from
which the previous revenue had been recognized. The changes in the estimates may
be the result of, for example, increased costs or overhead expenses of the
projects, changes of the scope of the works of the contract as well as the
changes of technologies used which in turn affect the costs of the
project. Under these circumstances, the estimated revenue and costs
can change and as a result the estimated profitability of the project can
change, which affects the profit elements in the revenue previously recognized
and may be required to be revised accordingly. The “adjustments” or
“revisions” are made via adjustment to the current period revenue because it is
the changes in estimates that are requiring the revisions and not a restatement
of the previous period figures.
31
With
respect to the Dubai Metro Rail Project, which was the primary focus of
Techwell, an adjustment under the percentage-of-completion method described
above may be required if, for example, the Company and the Company’s claim
consultant modifies its evaluation of the Company’s claims such that the Company
is not likely to recover its claims as currently anticipated, if the Company
encounters any unexpected difficulties in the claiming process which making the
increase of claiming costs, and if a commercial settlement between the parties
is reached on a amounts different from current value estimates. In
such scenarios, the final project revenue or estimated costs may be changed to
affect the revenue recognition of the project. However, neither of
the situations is considered to exist at the moment of the reporting that
affects the accounting estimates of revenue and costs used for the
period. As such, the Company believes that the revenue recognized to
date is appropriate as there were periodic reviews of the estimates of the
project revenue and costs by the Company to reflect the latest profitability of
the project for revenue recognition.
One of
the primarily reasons that the Company’s contract receivables have increased is
the delay in payment by client of the Dubai projects since April
2009. The underlying receivable as of September 30, 2009 from the
Dubai projects was equal to approximately $19.2 million, which represented 23%
of the total contract receivables as of such date. The Company has employed a
claim consultant, Hill International, to facilitate the Company’s claim for the
back payment. The Company currently expects that there will be
progress and payments will be received as early as the third quarter of
2010. However, due to the ongoing dispute, there is no guarantee that
the Company will collect all or a portion of the contract
receivable. For receivables related to the Dubai Project, the client
delayed payment to us since April 2009 by refusing to issue the Certificates for
Value of Work Done. No Certificates have been issued since April
2009. The Certificates are pre-requisites to proceed with payment to
the Company. The client paid for all work for Certificates for Value of Work
Done issued in or before April 2009. Such payments were made prior to
December 31, 2009. As a result, no account receivables at March 31,
2010 represent work for the above-referenced Certificates issued in or before
April 2009. The receivables as of March 31, 2010 were recognized in
accordance with the Percentage of Completion Method and based on the claim
consultant’s report on the estimated final value of work done that the Company
completed as of March 31, 2010.
The
Company has not recorded an allowance for doubtful accounts related to the Dubai
project. The Company has engaged a construction claims consultant to
facilitate resolution of the dispute. The Company and its
construction claims consultant, based on a review of the facts, documents, and
materials available, believe that the Company has a reasonable opportunity to
collect the amounts due to Techwell from the master contractor, less appropriate
credits as its final amount due for work performed through September
2009. The Company, with the assistance of its claims consultant, have
been continuously evaluating the dispute and probability of success on this
dispute going forward and make the appropriate adjustments; however, no
assurance can be given that the dispute will be resolved in the Company’s
and Techwell’s favor. In the report of the claim consultant, there
are the high and low estimates for the final total value of work done for the
Dubai project. The Company started with the low estimates with prudence and
adjusted such amounts with the amounts that the claim consultant’s expressed
that there was an excellent opportunity for the Company to be
recovered. Furthermore, as the client of the projects being the joint
venture of two reputable Japanese corporations and one Turkish corporation with
long operating histories, the Company believes that the possibility of default
in payment is considered not likely to occur. Based on these
supporting documents and analysis, the Company believes that the receivables
will be collected and no allowance is required. However, the Company
will be required to account for doubtful collection of the receivables related
to the Dubai Project in the event it concludes that it is not likely that the
Company will be able to collect the receivables.
Techwell
Litigation
Pursuant
to a Stock Purchase Agreement dated November 7, 2007, the previous shareholders
of Techwell Engineering Limited (“Techwell”), Mr. Ng, Chi Sum and Miss Yam, Mei
Ling Maria, agreed to sell 100% of the shares in Techwell to the Company for
approximately $11.7 million in cash and shares of common stock of the Company.
Subsequent to the acquisition, Mr. Ng and Miss Yam were employed by
Techwell.
On
January 14, 2009, the board of directors of Techwell passed a board resolution,
to dismiss both Mr. Ng and Miss Yam with immediate effect and remove Mr. Ng from
the board of Techwell (the “Resolution”). On January 16, 2009,
Mr. Ng and Miss Yam filed a lawsuit in the High Court of Hong Kong against the
Company and its subsidiary, Full Art International Limited. The
lawsuit alleges that, inter
alia, (i) the Company misrepresented to them the financial status of the
Company and its operations during the course the negotiations of the Techwell
acquisition; (ii) the Company failed to perform its obligations under a
settlement agreement alleged to have been agreed to by the Company in
January 2009; and (iii) the dismissal of Mr. Ng was unlawful and
invalid. The lawsuit filed by Mr. Ng and Miss Yam requests the court
for specific performance of the settlement agreement that was allegedly entered
into, which would require the return of the Techwell company to Mr. Ng and Miss
Yam, and in the absence of such grant of relief, Mr. Ng and Miss Yam request
unspecified damages in lieu of return of the Techwell
company.
32
On
January 23, 2009 an ex-parte injunction order was granted to Mr. Ng, restraining
the Company from implementing the Resolution, which was eventually dismissed
with immediate effect on February 25, 2009 after a court session in the High
Court of Hong Kong. Mr. Ng was also ordered to bear the costs of the various
court proceedings in connection with the injunction order. On March 27, 2009,
Mr. Ng and Miss Yam filed a summons in the High Court of Hong Kong seeking a
court order for leave to join the Company’s principal shareholder, KGE Group
Limited, as a defendant in the lawsuit, which was granted on April 9,
2009. As a result, KGE Group Limited became one of the defendants of
the lawsuit. On May 12, 2009, the Company filed a Defense and Counterclaim at
the High Court of Hong Kong in response to a Statement of Claim served by Mr. Ng
and Miss Yam on the Company on April 7, 2009.
As of the
date of this report, the Company, Mr. Ng, and Miss Yam are in discussions and
negotiations to settle all disputes between the parties. However,
there is no guarantee that the parties will reach an agreement to settle the
dispute, in which case the Company intends to vigorously defend itself against
the lawsuit. There can be no assurance that the lawsuit will be
resolved in the Company’s favor. Even if the Company successfully
defends the lawsuit, the Company may incur substantial costs defending or
settling the lawsuit, in addition to a possible diversion of the time and
attention of the Company’s management away from its business. If the
Company is unsuccessful in defending the lawsuit, its may be required to pay a
significant amount of damages and/or it may potentially lose ownership of
Techwell, which will have a material adverse effect on the Company’s business,
financial condition or results of operations. In the event we lose
ownership of Techwell, we will lose the approximately $17.3 million of profit
contribution since the acquisition of Techwell.
Results
of Operations
The
following table sets forth statements of operations for the three months ended
March 31, 2010 and 2009 in U.S. dollars (unaudited):
For Three Months Ended March 31,
|
||||||||
2010
|
2009
|
|||||||
(in thousands, except for share
and per share amounts) |
||||||||
Contract
revenues earned
|
$ | 11,472 | $ | 36,343 | ||||
Cost
of contract revenues earned
|
(9,144 | ) | (28,162 | ) | ||||
Gross
profit
|
$ | 2,328 | $ | 8,181 | ||||
Selling,
general and administrative expenses
|
(4,223 | ) | (5,951 | ) | ||||
Income
from operations
|
$ | (1,895 | ) | $ | 2,230 | |||
Interest
income
|
2 | 4 | ||||||
Interest
expenses
|
(1,626 | ) | (1,312 | ) | ||||
Other
income
|
7 | 22 | ||||||
Income
before taxes
|
$ | (3,512 | ) | $ | 944 | |||
Income
tax
|
9 | - | ||||||
Equity
loss and minority interests
|
(1 | ) | - | |||||
Net
income (loss)
|
$ | (3,520 | ) | $ | 944 | |||
Earnings
per share:
|
||||||||
Basic
|
$ | (0.06 | ) | $ | 0.02 | |||
Diluted
|
$ | (0.06 | ) | $ | 0.02 | |||
Weighted
average shares outstanding:
|
||||||||
Basic
|
54,729,908 | 53,256,874 | ||||||
Diluted
|
54,729,908 | 53,256,874, |
33
Three
Months Ended March 31, 2010 and 2009
Contract
revenues earned for the three months ended March 31, 2010 were $11.5 million, a
decrease of $24.8 million, or 68%, from the contract revenues earned of $36.3
million for the comparable period in 2009. The primary reason for the decrease
in contract revenues earned was due to a decline in the global economy and
construction industry, completion of international projects in 2009 such as the
Dubai Metro Red Line, Guangdong Science City Headquarter Phase I, and Doha High
Rise Office Tower, in addition to our cessation of our international
projects.
Cost of
contract revenues earned for the three months ended March 31, 2010 was $9.1
million, a decrease of $19.1 million, or 68%, from $28.2 million for the
comparable period in 2009. Cost of contract revenues earned consists of the raw
materials, labor and other operating costs related to manufacturing. The
decrease in costs of contract revenues earned was primarily due to decrease in
revenue in earned. As a percentage of contract revenues, cost of
contract revenues was approximately 79.7% for the quarter ended March 31, 2010,
as compared to 77.5% for the same period in 2009. The slight increase
in cost of contract revenues as a percentage of revenues was primarily due to
increases in raw material, labor and administrative costs in our domestic market
of China.
Provisions
for estimated losses on uncompleted contracts are charged to cost of contract
revenues earned in the period in which such losses are determined. Changes in
job performance, job conditions, and estimated profitability, including those
arising from contract penalty provisions, and final contract settlements may
result in revisions to costs and income and are recognized in the period in
which the revisions are determined. Profit incentives are included in revenues
when their realization is reasonably assured. An amount equal to contract costs
attributable to claims is included in revenues when realization is probable
and the amount can be reliably estimated.
Gross
profit for the three months ended March 31, 2010 was $2.3 million, a decrease of
$5.9 million, or 72%, from $8.2 million for the comparable period of 2009. Our
gross margin for the three months ended March 31, 2010 was 20.3% as compared
with 22.5% for the three months ended March 31, 2009. The decrease in gross
margin was primarily a result of increases in raw material, labor and
administrative costs in our domestic market of China.
Selling,
general and administrative expenses were $4.2 million for the three months ended
March 31, 2010, a decrease of approximately $1.8 million, or 30%, from
approximately $6.0 million for the comparable period in 2009. The decrease was
due to decrease in revenue in earned. Among the selling, general and
administrative expenses, payroll and social securities was the single largest
expenditure of the group, which accounted for approximately 71.8% of the
expenses including 47.6% or $2.0 million being stock compensation expenses
granted during the first quarter of 2010. Other major expenses included rental
expenses 6.3% and depreciation expenses 4.3%.
Interest
expenses and finance expenses were $1.6 million for the three months ended March
31, 2010, an increase of $0.3 million, from approximately $1.3 million for the
comparable period in 2009. The increase was primarily due to the
additional interest expense in the first quarter of 2010 related to borrowing by
short-term bank loans.
Income
tax expenses were $9,575 for the three months ended March 31, 2010 at
an effective tax rate of -0.3%, compared with $nil in taxes for the same period
of 2009 at an effective tax rate nil%. The primary reason for the
decrease was due to losses incurred by the operations of the Company as still
suffering from the effects of the recent international financial
crises.
Net loss
for the three months ended March 31, 2010 was $3.5 million, a decrease in income
of $4.4 million, or 489%, from net profit of $0.9 million for the comparable
period in 2009.
Liquidity
and Capital Resources
At March
31, 2010, we had cash and cash equivalents of $0.5
million.
34
Prior to
October 17, 2006, we financed our business operations through short-term bank
loans, cash provided by operations, and credit provided by suppliers. On October
17, 2006, concurrently with the close of our Share Exchange, we received gross
proceeds of $3.7 million in a private placement
transaction. After commissions and expenses, we received net
proceeds of approximately $3.1 million. In October 2007, we completed
an initial public offering consisting of 847,550 shares of our common stock. Our
sale of common stock, which was sold indirectly by us to the public at a price
of $3.50 per share, resulted in net proceeds of approximately $2.0
million.
We have
also financed our operations through the issuance of convertible
bonds. On April 12, 2007, we completed a financing transaction
pursuant to which we issued the 2007 Bonds in the principal amount of $10
million. The 2007 Bonds bear cash interest at the rate of 6% per annum for the
first year after April 12, 2007 and 3% per annum thereafter, of the principal
amount of the 2007 Bonds. Each 2007 Bond is convertible at an initial conversion
price of $3.50 per share. At any time after April 12, 2010, holders
of the 2007 Bonds can require us to redeem the 2007 Bonds at 126.51% of the
principal amount. We are required to redeem any outstanding 2007 Bonds at
150.87% of its principal amount on April 4, 2012. We also issued
800,000 warrants on April 12, 2007 to purchase an aggregate of 800,000 shares of
our common stock, subject to adjustments for stock splits or reorganizations as
set forth in the warrant instrument. The bondholder exercised these
warrants in November 2008, and after receipt of $8,000 in exercise proceeds, we
issued 800,000 shares of common stock to the bondholder. Also, in
September 2008, $2 million worth of bonds were converted into shares of common
stock pursuant to which we issued 571,428 shares of common
stock.
On April
15, 2008, we completed a financing transaction pursuant to which we issued the
2008 Bonds in the principal amount of $20.0 million. The 2008 Bonds bear cash
interest at the rate of 12% per annum. Interest is payable semi-annually in
arrears on April 15 and October 15 of each year (each an “Interest Payment
Date”) commencing October 15, 2008. On any Interest Payment Date on or after
April 15, 2010, the holders of the Bonds can require us to redeem the Bonds at
116.61% of the principal amount. We are required to redeem any outstanding Bonds
at 116.61% of its principal amount on April 15, 2011. We also issued 300,000
warrants in connection with the 2008 Bonds on April 15, 2008 to purchase an
aggregate of 300,000 shares of our common stock, subject to adjustments for
stock splits or reorganizations as set forth in the warrant instrument. On
February 24, 2010, we entered into the Waiver Agreement with the holders of our
2007 Bonds and 2008 Bonds and 2008 Warrants. Pursuant to the Waiver
Agreement, we agreed to pay the bondholders the interest in arrears owed on the
Bonds as of March 31, 2010 in two equal payments on March 31, 2010 and May 31,
2010 of approximately $1.26 million each and to pay 100% of the interest
payments on the Bonds that becomes due in April 2010 to be paid on April 15,
2010 of approximately $1.32 million, for aggregate payments of approximately
$3.84 million. We also agreed to repay the principal and all accrued interest
that we owe to ABN AMRO Bank (China) Co., Ltd., Shenzhen Branch (the “Overdraft
Lender”) under an Overdraft Facility letter in three equal separate
installments. The total amount owed to the Overdraft Lender is equal to
approximately $4.91 million. The first installment is due no later than March
31, 2010, the second installment is due on April 30, 2010 and the third
installment is due on May 31, 2010. We also agreed that we will not repay or
prepay any debt prior to its currently scheduled due date until we make all of
the payments specified in the Waiver Agreement and the Bonds have been redeemed
in full and that any new indebtedness incurred by us for the purpose of repaying
the Overdraft Facility will (i) not exceed the outstanding amount due and
payable under the Overdraft Facility and (ii) be subordinated to all amount owed
under the Bonds. By the time of this report, the Company has honored the
payments as scheduled under the Waiver Agreement.
If we are
required to repurchase all or a portion of the outstanding amount of $28.0
million in bonds and we do not have sufficient cash to make the repurchase, we
will be required to obtain third party financing to do so, and there can be no
assurances that we will be able to secure financing in a timely manner and on
favorable terms, which could have a material adverse effect on our financial
performance, results of operations and stock price.
In
October 2006, we opened a line of credit facility with the Zhuhai branch of Bank
of East Asia for up to a maximum of RMB20,000,000. The credit facility does not
require renewal until October 2011. In order to facilitate the extension of the
credit facility, we agreed to deposit the equivalent amount in HKD on fixed
deposit terms into the Hong Kong branch of Bank of East Asia. This facility is
subject to a current interest rate of 5.508% and interest rate adjusts every 6
months. We did not have any amount outstanding as of March 31,
2010.
Our
subsidiary, Zhuhai King Glass Engineering Co., Limited, borrowed from Bank of
East Asia with a condominium as collateral. This facility, which is due October
25, 2011, is subject to a current interest rate of 5.508% and interest rate
adjusts every 6 months. The Company did not have any outstanding as of March 31,
2010.
Full Art
International Limited incurred an automobile capital lease obligation due
November 09, 2012 that had an outstanding amount of $166,865 as of March 31,
2010.
On
February 19, 2008, we and Techwell Engineering Limited were granted a bond
facility by the Hong Kong Branch of ABN AMRO Bank N.V. The facility amount was
$10,000,000, at a tenor of up to one year with 2% flat interest rate on the
issued amount of bonds such as bank guarantees, performance bonds, advanced
payment bonds and standby letters of credit. ABN AMRO required guarantees as
follows: (i) an irrevocable and unconditional guarantee executed by Zhuhai King
Glass Engineering Co. Limited and (ii) share charge over the shares of us for a
minimum value of $5,000,000 or equivalent, executed by KGE Group Limited. On May
2, 2008, the facility was increased to $12,000,000 with additional cash
collateral of $2,000,000, which is also the total amount of cash collateral for
the facility. All cash collateral was then fully used to off-set a portion of
the calling of the bonds for projects in Dubai by the beneficiary. As of March
31, 2010, the facility is fully utilized.
35
On March
28, 2008, we, Full Art and Techwell Engineering Limited were granted a bonding
facility by the Hong Kong Branch of HSBC. The facility amount was $10,000,000,
at a tenor of up to one year with 1% flat interest rate on the issued amount of
bonds such as bank guarantees, performance bonds, advanced payment bonds and
standby letters of credit. HSBC required guarantees as follows: (i) an unlimited
guarantee among China Architectural Engineering, Inc., Full Art International
Limited and Techwell Engineering Limited; and (ii) an “all monies” securities
deposits with 15% margin. On August 18, 2008, the facility was increased to
$20,000,000 with additional cash collateral of $1,500,000 that increased the
total amount of cash collateral to $3,000,000. In September 2009, $2,818,440 of
the cash collateral was used to off-set of the calling of the bonds for projects
in Dubai by the beneficiary. As of March 31, 2010, we have utilized $1.8 million
of the facility.
On July
19, 2008, Zhuhai King Glass Engineering Co., Ltd. (“Zhuhai KGE”), our
wholly-owned subsidiary was granted a Bank Accepted Draft facility by the
Shenzhen Branch of ABN AMRO Bank N.V. The facility amount is RMB70,000,000
(US$10,218,978). On September 30, 2009, the facility was amended to
allow Open Account Financing – Accounts Receivable against invoices from
acceptable buyers up to RMB21,000,000 and Open Account Financing and Overdraft
in Current Account up to RMB16,800,000. ABN AMRO requires irrevocable
and unconditional guarantee from us and cash collateral of 20% of bank’s
acceptance bill issued and Open Account Financing. As of March 31,
2010, Zhuhai KGE utilized RMB nil (US$nil million) of Bank Accepted Draft and
RMB 22.1 million (US$3.2 million) of Overdr aft in Current
Account.
In
September 2009, the beneficiary of a performance bond and advance payment bonds
for the projects in Dubai demanded the drawing of approximately $9.4 million in
total from the two issuing banks, ABN AMRO Bank NV and HSBC. The calling of the
bonds was based on the beneficiary’s belief that it had paid in excess of the
construction work performed. We do not believe that the beneficiary had the
proper basis for calling the bonds and intend to vigorously defend all of their
rights and remedies related to the dispute. As of March 31, 2010, after an
offset against collateral accounts that we held with the banks, there was
approximately $4.5 million in a shortfall amount due to ABN AMRO Bank NV by us
that was not paid off. Such amount is currently outstanding as the
temporary loan from the bank at the interest rate at the bank’s cost of funds
plus 6%.
Working
capital management, including prompt and diligent billing and collection, is an
important factor in our results of operations and liquidity. When we are awarded
construction project, we work according to the percentage-of-completion method
which matches the revenue streams with the relevant cost of construction based
on the percentage-of-completion of project as determined based on certain
criteria, such as, among other things, actual cost of raw material used compared
to the total budgeted cost of raw material and work certified by customers.
There is no guarantee that the cash inflow from these contracts is being
accounted for in parallel with the cash outflow being incurred in the
performance of such contract. In addition, a construction project is usually
deemed to be completed once we prepare a final project account, the account is
agreed upon by our customers, and all amounts related to the contract must be
settled according to the account within three months to a year from the
customer’s agreement on the final project account. As there may be different
time intervals to reach a consensus on the amount as being accounted for in the
projects before the project finalization account is being mutually agreed by
each other. We experience an average accounts settlement period ranging from
three months to as high as one year from the time we provide services to the
time we receive payment from our customers. Below is a summary of typical steps
in our processing of accounts:
|
·
|
It
takes approximately one month for our client to collect the payment
application from contractors for the contract work
completed.
|
|
·
|
Thereafter,
it takes approximately one to two months for the verification, agreement
and certification of work completed, with timing to largely depend on
whether there is disagreement in the calculation of certified value
between the parties.
|
|
·
|
Moreover,
if it is the case that the application is to finalize the project account,
it may take up to three months.
|
|
·
|
Additionally,
in the event that the client is not the owner of the project, it normally
requires an additional one to two months for processing and obtaining the
funds from the owner.
|
|
·
|
One
to two months the client to pay the
contractors.
|
In
contrast to collection times, we typically need to place certain deposit with
our suppliers on a portion of the purchase price in advance and for some
suppliers we must maintain a deposit for future orders. We attempt to maintain a
credit policy of receiving certain amounts of deposit from customers before we
begin a new project.
36
We
experienced revenue of $11.4 million for the three months ended March 31, 2010
compared to revenue of $36.3 million for the same period in 2009. Construction
contract related receivables, including contract receivables and costs and
earnings in excess of billings as of March 31, 2010 were $98.5 million, an
increase of $1.2 million over construction related receivables of $97.3 million
as of March 31, 2009. The increase reflected the holding of payment by the
customer for our project in Dubai. In addition, because the
collection period typically runs from two months to one year, the increase in
such receivables reflects the long collection period. In addition,
our payment cycle is considerably shorter than our receivable cycle, since we
typically pay our suppliers all or a portion of the purchase price in advance
and for some suppliers we must maintain a deposit for future
orders.
Among the
$88.4 million contract receivables as of March 31, 2010, $11.6 million (13.1%)
was outstanding over 365 days and $12.7 million (14.4%) over 730 days, in total
of $24.3 million which including $10.6 (12.0%) million of retention money which
would only be settled after the retention periods of two or three years. The
Company periodically prepares the aging of the receivables information and
reviews the balances with consideration of the background of each client for
assessing the realizable value of the balances and would make provision when
appropriate. The Company notes that its account receivables that are
365 and 720 days old are primarily related to the Company’s PRC operations, and
the payment cycle in the PRC commonly entails a receivable being outstanding for
over one to two years before collection. Such situations are
particularly common in the construction market and with the clients from
government. Since the Company’s older outstanding receivables are mainly of
government projects, the final accounts and payments are required to be
processed through a lengthy bureaucratic process in the PRC government. Based on
the foregoing, and despite the receivables being outstanding from 365 to 720
days, the Company considers them to be realizable because the Company believes
that there is a remote chance that the PRC Government will go into bankruptcy or
otherwise refuse to make payment on the receivables. In addition, the Company
has the policy of conducting a comprehensive review the aging of account
receivables on a regular basis every three months. Furthermore, the
Company has a designated staff member from one of its PRC subsidiaries to remain
in constant communication with the Company’s various departments regarding PRC
receivables collection status, and allowances for doubtful accounts is made, as
necessary, based on the collection status updates. As of March 31, 2010, the
contract receivables under aging of 91 to 120 days amounted to $49.4 (55.9%)
million including the receivables of the projects in Dubai which were recognized
at the end of the year at $42.1 (47.7%) million.
We
provide for bad debts principally based upon the aging of accounts receivable,
in addition to collectability of specific customer accounts, our history of bad
debts, and the general condition of the industry. We effected a direct
write off through a $3.7 million provision to the account
receivables. We recorded additional provision for doubtful accounts
of $193,752 in the three months ended March 31, 2010. As of March 31,
2010, our provision for doubtful accounts was $3.1 million, which was 3.4% of
our construction contract related receivables of $91.3 million. We believed our
current reserve for doubtful accounts is commensurate to cover the associated
credit risk in the portfolio of our construction contract related
receivables. Due to the difficulty in assessing future trends, we
could be required to further increase our provisions for doubtful
accounts. As our accounts receivable age and become uncollectible our
cash flow and results of operations are negatively impacted.
In
addition to the foregoing, we had a provision for contracts receivables that was
reclassified as “Other receivable” in the amount of approximately $9.9 million
that represented account receivables of a subsidiary, Techwell Engineering Ltd.
(Techwell). The receivables were acquired through our acquisition of
the Techwell in 2007 and have been outstanding since
acquisition. The receivables are guaranteed by previous
shareholders of Techwell if not paid within 24 months of the
acquisition. Accordingly, the provision was made and the receivable
amount was transferred to amount due from the shareholders under other
receivable balances.
At March
31, 2010, we had no material commitments for capital expenditures other than for
those expenditures incurred in the ordinary course of business. We
intend to expend a significant amount of capital to purchase materials and serve
as deposits for performance bonds for new projects that we have obtained.
Additional capital for this objective may be required that is in excess of our
liquidity, requiring us to raise additional capital through an equity offering
or secured or unsecured debt financing. The availability of additional capital
resources will depend on prevailing market conditions, interest rates, and our
existing financial position and results of operations.
Net cash
provided by operating activities for the three months ended March 31, 2010 was
approximately $6.9 million, as compared to $4.3 million in the same period in
2009. In addition to the decrease in net income (-$4.2 million), the change is
primarily due to differences in changes in receivables (-$6.1million), payables
($11.1 million) and the non-cash item of stock compensation ($2.0
million).
Net cash
provided by investing activities was approximately $1.0 million for the three
months ended March 31, 2010 compared to approximately $1.3 million for the three
months ended March 31, 2009. The change was mainly a result of the difference in
change of restricted cash.
37
Net cash
used in financing activities was $8.3 million for the three months ended March
31, 2010 compared to $6.6 million for the three months ended March 31, 2009. The
increase was primarily due to differences in changes of repayment of short-term
loans (-$2.9 million) and repayment of shareholders loan ($4.6
million).
Off-Balance
Sheet Arrangements
None.
Critical
Accounting Policies and Estimates
The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the consolidated financial statements and the reported amounts of
revenues, expenses and allocated charges during the reporting period. Actual
results could differ from those estimates.
We
describe our significant accounting policies in Note 2, Summary of Significant
Accounting Policies, of the Notes to Consolidated Financial Statements included
in our Annual Report on Form 10-K as of and for the year ended December 31,
2009. We discuss our critical accounting policies and estimates in
Management’s Discussion and Analysis of Financial Condition and Results of
Operations in our Annual Report on Form 10-K as of and for the year ended
December 31, 2009. Other than as indicated in this quarterly report,
there have been no material revisions to the critical accounting policies
as filed in our Annual Report for the fiscal year ended December 31, 2009 on
Form 10-K as filed with the SEC on March 4, 2010, and as amended by Amendment
No.1 on April 30, 2010 and Amendment No.2 on May 14, 2010.
Recent
Accounting Pronouncements
See
Note 2(t) of the accompanying
unaudited interim consolidated financial statements included in this Form 10-Q
for a discussion of recent accounting pronouncements.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There
have been no material changes in market risk from the information provided in
Part II, Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in
our Annual Report for the fiscal year ended December 31, 2009 on Form 10-K as
filed with the SEC on March 4, 2010, and as amended by Amendment No.1 on April
30, 2010 and Amendment No.2 on May 14, 2010.
ITEM
4. CONTROLS AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed by us in the reports that we
file or submit under the Securities Exchange Act of 1934 (the “Exchange Act”) is
recorded, processed, summarized and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms. Disclosure controls
and procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by us in the reports that we
file under the Exchange Act is accumulated and communicated to our management,
including our principal executive and financial officers, as appropriate to
allow timely decisions regarding required disclosure.
As of the
end of the period covered by this Quarterly Report, we conducted an evaluation,
under the supervision and with the participation of our Chief Executive Officer
and Chief Financial Officer, of our disclosure controls and procedures (as
defined in Rule 13a-15(e) of the Exchange Act). Based upon this evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that the Company’s
disclosure controls and procedures identified certain material weaknesses, as
described below, that caused our controls and procedures to be
ineffective. Notwithstanding the existence of the material weaknesses
described below, management has concluded that the interim consolidated
financial statements in this Form 10-Q fairly present, in all material respects,
our financial position, results of operations and cash flows for the periods and
dates presented.
These
material weaknesses primarily related (i) our restatements that we conducted in
May 2010 and (ii) one of our material operating subsidiaries, Techwell
Engineering Limited. (“Techwell”) that we acquired in November
2007.
Restatements
In May
2010, we discovered that certain of our previously filed quarterly and annual
reports contained errors that required correction and restatement. The errors
related to the timing of the interest expense related to the Company’s
outstanding $8,000,000 Variable Rate Convertible Bonds due 2012 and $20,000,000
12% Convertible Bonds due 2011 that resulted in overstatements and
understatements of the interest expenses related to the bonds during various
quarters before the second quarter of 2008. Due to the accounting errors, the
interest expense was overstated by approximately $0.3 million, $0.5 million, and
$0.7 million for the second, third, and fourth quarters of fiscal year
2007, respectively, for a total overstatement of approximately $1.5 million
for fiscal 2007. The interest expense was overstated by approximately $0.1
million in the first quarter of 2008 and all the overstatements, approximately
$1.6 million, were reversed in the second quarter of 2008. For the year ended
December 31, 2009, there was an overstatement of the interest expense of $8,000
in the second quarter and an understatement of $6,000 during the third quarter,
for a total of overstatement of $2,000 for fiscal year 2009. The net bonds
payable amounts were presented correctly in the Company’s financial statements
as of December 31, 2008 and 2009, and it was only the components of the
Convertible Bonds that were restated, while the net payable amounts as of
December 31, 2007 was stated with correction of errors.
38
Additionally,
a correction was needed for the addition of an equity compensation charge in the
amount of $4,976 related to a portion of options granted in October 2009 that
the Company inadvertently omitted in the original Form 10-K filing. Together
with the overstatement of interest expenses of $2,000, the loss for the year
ended December 31, 2009 was understated by 2,983 and the retained earnings as of
December 31, 2009 was overstated by 2,983. Additionally, $1.5 million of
consolidation exchange loss resulted from the intercompany investments
elimination was incorrectly included in the additional paid in capital instead
of the accumulated comprehensive income presented in the Stockholders’ Statement
of Equity and Comprehensive Income for the year ended December 31,
2009.
We
believe that the accounting errors were caused by lack of personnel with
expertise in US generally accepted accounting principles and SEC rules and
regulations, in addition to inadequate staffing and supervision that lead to the
untimely identification and resolution of accounting and disclosure matters and
failure to perform timely and effective reviews. We intend to take action to
remediate these deficiencies going forward.
Techwell
On
November 6, 2007, we acquired Techwell and its wholly owned subsidiaries,
Techwell Building Systems (Shenzhen) Ltd. in China and Techwell International
Ltd. in Macau. At the time, Techwell was a privately-held company and
its financial systems were not designed to facilitate the external financial
reporting required of a publicly held company under the Sarbanes-Oxley Act of
2002. In addition, Techwell’s accounting records were historically
maintained using accounting principles generally accepted in the People's
Republic of China, its personnel was not fully familiar with accounting
principles generally accepted in the United States of
America.
A
material weakness is a deficiency, or a combination of deficiencies, in internal
control over financial reporting such that there is a reasonable possibility
that a material misstatement of the annual or interim financial statements will
not be prevented or detected in a timely basis. We identified the
following material weaknesses:
1.
|
Techwell
lacked the technical expertise and processes to ensure compliance with our
policies and did not maintain adequate controls with respect to (a) timely
updating engineering budget and analysis, (b) coordination and
communication between Corporate Accounting and Engineering Staffs, and (c)
timely review and analysis of corporate journals recorded in the
consolidation process.
|
2.
|
Techwell
did not maintain a sufficient complement of personnel with an appropriate
knowledge and skill to comply with our specific engineering financial
accounting and reporting requirements and low materiality
thresholds. This was evidenced by a number of documents missing
or not matching with the records and contributed to the adjustment of
financial results. As evidenced by the significant number and
magnitude of out-of-period adjustments identified from Techwell during the
period-end closing process, management has concluded that the controls
over the period-end financial reporting process were not operating
effectively. Specifically, controls were not effective to ensure that
significant accounting estimates and other adjustments were appropriately
reviewed, analyzed, and monitored on a timely
basis.
|
3.
|
Techwell
did not comply with our authorization policy. This was evidenced by a
number of expenses incurred without appropriate authorization. This
material weakness resulted in an unauthorized and significant increase of
expenses, which significantly impacted our operating
results.
|
Remediation
Efforts
We are in
the process of developing and implementing remediation plans to address our
material weaknesses.
Restatements
We have
taken and intend to take the following actions to address the material
weaknesses and improve our internal controls over financial
reporting:
39
|
1.
|
We are seeking to improve
supervision, education, and training of our accounting staff. We are also
considering to engage third-party financial consultants to review and
analyze our financial statements and assist us in improving our reporting
of financial information.
|
|
2
|
Management intends to hire
additional personnel with technical knowledge, experience and training in
the application of generally accepted accounting principles commensurate
with our financial reporting and U.S. GAAP
requirements.
|
|
|
|
3.
|
We will continue to monitor the
effectiveness of these improvements. We are also considering to work with
outside consultants in assessing and improving our internal controls and
procedures when necessary.
|
|
4.
|
An internal SOX 404 task force is
being setting up in order to help the company strengthening its controls
and procedures on the financial
reporting.
|
Techwell
One key
change for us going forward will be the design and implementation of internal
controls over the accounting and oversight of all subsidiaries, including
enhanced accounting systems, processes, policies and procedures. We have
taken the following actions to address the material weaknesses and improve our
internal controls over financial reporting:
|
1.
|
On January 14, 2009, the board of
directors of Techwell passed a board resolution to replace management of
Techwell. We have appointed a new general manager to Techwell, as
well as three experienced project managers to the Dubai Metro
project.
|
|
2.
|
Management has initiated a
Sarbanes-Oxley Act of 2002 Section 404 Compliance Assistance Project,
which is intended to meet all requirements required by SEC in our company
and all of our subsidiaries. We engaged a consulting firm to assist in the
set-up of project and our staff thereafter continued with its
implementation.
|
|
3.
|
We have established a dedicated
and qualified internal control and audit team to implement the policies
and procedures to the standard of a US public
company.
|
|
4.
|
In June 2009, we reorganized and
restructured Techwell’s Corporate Accounting by (a) modifying the
reporting structure and establishing clear roles, responsibilities, and
accountability, (b) hiring skilled technical accounting personnel to
address our accounting and financial reporting requirements, and (c)
assessing the technical accounting capabilities in the operating units to
ensure the right complement of knowledge, skills, and
training.
|
|
|
|
5.
|
In 2009, we also reorganized and
restructured the budgeting process by (a) centralizing the procurement
function to our company to ensure budgets and analyses of Techwell are
timely prepared and properly reviewed; (b) implementing new policies and
procedures to ensure that appropriate communication and collaboration
protocols among our Engineering, Procurement and Corporate Accounting
departments; and (c) hiring the necessary technical procurement personnel
to support complex procurement activities. We have hired two
experienced technical procurement managers and expect to increase the
headcount in the purchase department in the future if
necessary.
|
|
6.
|
We strengthened the period-end
closing procedures of our operating subsidiaries by (a) requiring all
significant estimate transactions to be reviewed by Corporate Accounting,
(b) ensuring that account reconciliations and analyses for significant
financial statement accounts are reviewed for completeness and accuracy by
qualified accounting personnel, (c) implementing a process that ensures
the timely review and approval of complex accounting estimates by
qualified accounting personnel and subject matter experts, where
appropriate, and (d) developing better monitoring controls at Corporate
Accounting and the operating
units.
|
|
7.
|
In September 2009, we hired a new
Vice President of Finance who was later appointed as our Acting Chief
Financial Officer in November 2009. We believe that the addition of
this person will assist the strengthening of the controls and procedures
of our company.
|
|
8.
|
In December 2009, our Acting
Chief Financial Officer lead an extensive review of the controls and
procedures of our company and developed a detailed remediation and
implementation plan for Sarbanes-Oxley Act of 2002 Section 404 compliance
to be carried out starting in 2010, which is currently
underway.
|
We
believe that we are taking the steps necessary for remediation of the material
weaknesses identified above, and we will continue to monitor the effectiveness
of these steps and to make any changes that our management deems
appropriate.
40
Changes
in internal control over financial reporting
Based on
the evaluation of our management as required by paragraph (d) of Rule 13a-15 of
the Exchange Act, we believe that there were no changes in our internal control
over financial reporting that occurred during the first quarter of 2010 that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting, other than as described above under
“Remediation Efforts.”
PART
II-OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS
See
Note 12(b) of the
accompanying unaudited interim consolidated financial statements included in
this Form 10-Q for a discussion of our current legal
proceedings.
ITEM
1A. RISK FACTORS
Any
investment in our common stock involves a high degree of risk. Investors should
carefully consider the risks described below and all of the information
contained in our public filings before deciding whether to purchase our common
stock. Except as set forth below, there have been no material revisions to the
“Risk Factors” as filed in our Annual Report for the fiscal year ended December
31, 2009 on Form 10-K, as filed with the Securities and Exchange Commission on
March 4, 2010, and as amended by Amendment No.1 on April 30, 2010 and Amendment
No.2 on May 14, 2010.
In May
2010, our management concluded that our consolidated audited financial
statements for the years ended December 31, 2009, 2008 and 2007 and our
consolidated unaudited interim financial statements for the periods ended June
30, 2007, September 30, 2007, March 31, 2008 and June 30, 2008 needed to be
restated and should not be relied upon. For a more detailed
discussion of the restatements, amendments and their underlying circumstances,
please refer to the Explanatory Note at the beginning of our Annual Report on
Form 10-K/A for the year ended December 31, 2009 (the “Amended 2008 Form 10-K”)
and Note 1 of the Notes to the consolidated financial statements included in the
Amended 2009 Form 10-K. As a result of the restatements, the Company
may become subject to a number of significant risks, which could have an adverse
effect on its business, financial condition and results of operations, including
potential civil litigation (including stockholder class action lawsuits and
derivative claims made on behalf of the Company), and regulatory proceedings or
actions, the defense of which may require significant management attention and
significant legal expense and which litigation, proceedings or actions, if
decided against us, could require us to pay substantial judgments, settlements
or other penalties.
We
identified material weaknesses in our internal control over financial reporting
and concluded that such controls were not effective. If we fail to
maintain effective internal control over financial reporting, we may not be able
to accurately report our financial results. We can provide no
assurance that we will at all times in the future be able to report that our
internal control is effective.
Because
we have reporting obligations under the Exchange Act, we are required to report,
among other things, control deficiencies that constitute material weaknesses or
changes in internal control that, or that are reasonably likely to, materially
affect internal control over financial reporting. A “material
weakness” is a significant deficiency or combination of significant deficiencies
that results in more than a remote likelihood that a material misstatement of
the annual or interim financial statements will not be prevented or
detected. Based on the restatements to our financial statements
referenced above, our management concluded that our system of internal control
over financial reporting was not effective as of the three month period ended
March 31, 2010, in addition to prior period end dates, which were the cause of
our restatements as described above. Although management does not
anticipate making any further restatements to the financial statements for
subsequent periods, management believes that our weakness in internal controls
continued during such periods. Management has identified internal
control deficiencies which, in management’s judgment, represent material
weaknesses in internal control over financial reporting. The control
deficiencies related to controls over the accounting and disclosure for
transactions to ensure such transactions were recorded as necessary to permit
preparation of financial statements and disclosure in accordance with GAAP. If
we fail to comply with the requirements of Section 404 of the Sarbanes-Oxley Act
of 2002 or report a material weakness, we might be subject to regulatory
sanction and investors may lose confidence in our financial statements, which
may be inaccurate if we fail to remedy such material weakness.
41
ITEM
2. UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS
None.
ITEM
3. DEFAULTS UPON SENIOR
SECURITIES
ITEM
4. REMOVED AND
RESERVED
ITEM
5. OTHER
INFORMATION
None.
ITEM
6. EXHIBITS
31.1
|
Certification
of Chief Executive Officer pursuant to Section 302(a) of the
Sarbanes-Oxley Act of 2002
|
31.2
|
Certification
of Chief Financial Officer pursuant to Section 302(a) of the
Sarbanes-Oxley Act of 2002.
|
32.1
|
Certification
of Chief Executive Officer and Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of
2002.*
|
*
This exhibit shall not be deemed “filed” for purposes of Section 18 of the
Securities Exchange Act of 1934 or otherwise subject to the liabilities of that
section, nor shall it be deemed incorporated by reference in any filing under
the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made
before or after the date hereof and irrespective of any general incorporation
language in any filings.
42
SIGNATURES
In
accordance with the requirements of the Exchange Act, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CHINA
ARCHITECTURAL ENGINEERING, INC.
(Registrant)
|
||
May
19, 2010
|
By:
|
/s/ Luo
Ken Yi
|
Luo
Ken Yi
|
||
Chief
Executive Officer and Chairman of the
Board
|
43