ITEM 1A. RISK FACTORS

Any investment in our securities involves a high degree of risk. Investors should carefully consider the risks described below and all of the information contained in this report before deciding whether to purchase our securities. Our business, financial condition or results of operations could be materially adversely affected by these risks if any of them actually occur. The trading price of our common stock could decline due to any of these risks, and an investor may lose all or part of his investment. Some of these factors have affected our financial condition and operating results in the past or are currently affecting our company. This report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks we face as described below and elsewhere in this report. With respect to this discussion, the terms, “we,” “us,” or “our” refer to China Architectural Engineering, Inc., and all of our subsidiaries.

RISKS RELATED TO OUR OPERATIONS

If we are unable to accurately estimate and control our contract costs and timelines, then we may incur losses on our contracts, which may result in decreases in our operating margins and in a significant reduction or elimination of our profits.

If we do not control our contract costs, we may be unable to maintain positive operating margins or experience operating losses. Approximately 95% of our sales are from fixed-price contracts. The remaining 5% of our 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. Under each type of contract, if we are unable to estimate and control costs and/or project timelines, we may incur losses on our contracts, which may result in decreases in our operating margins and in a significant reduction or elimination of our profits.

Due to global recession, its negative effect on the construction industry, and other reasons, we do not intend to engage in any international projects in 2010, which accounted for a majority of our revenues in 2009.  We have shifted our focus to projects located in mainland China and our contract revenues and net income will be materially reduced if we are not able to secure sufficient projects in China.

For fiscal 2009, 2008 and 2007, revenue from sales of our products and services internationally (for our purposes, outside of China) represented approximately 57%, 44.6% and 4.9%, respectively, of our total revenue.  As a result of our recent restructure and reorganization to turn back to local instead of oversea market due to the recent change in international economic environments, our Shenzhen office was down sized and moved out from the leasehold multi-floor office building to a smaller leased place at minimal operations in September 2009. The set up of the Shenzhen office was originally for the support of the overseas operations which we have decided to discontinue. As a result, the current improvement works to the leasehold multi-floor office building were stopped and was written off in the third quarter of 2009, a loss of $1.9 million.  In addition, a substantial percentage of our revenue has been derived from international projects in the past few years, and with the loss of such sources of revenue going forward, our results of operations will suffer if we are unable to secure a sufficient amount of projects in mainland China to offset the void in revenue that we have received from international projects in the past, which could negatively affect our stock price.

We depend on a small number of customers for the vast majority of our sales. A reduction in business from any of these customers could cause a significant decline in our sales and profitability.

The vast majority of our sales are generated from a small number of customers. For the year ended December 31, 2009, we had three customers that each accounted for at least 7.0% of the revenues that we generated, with one customer accounting for 43.2% of our revenue. These three customers accounted for a total of approximately 59.4% of our revenue for that period. We expect that we will continue to depend upon a small number of customers for a significant majority of our sales for the foreseeable future.  A reduction in business from any of these customers could cause a significant decline in our sales and profitability.

 

 

10

---

 

A substantial portion of our assets has been comprised of construction contract receivables representing amounts owed by a small number of customers. If any of these customers fails to timely pay us amounts owed, we could suffer a significant decline in cash flow and liquidity which, in turn, could cause us to be unable to pay our liabilities and purchase an adequate amount of inventory to sustain or expand our sales volume.

Our construction contract receivables represented approximately 65.7% and 68.8% of our total current assets as of December 31, 2009 and 2008, respectively. As of December 31, 2009, our largest customer represented over 43.9% of the total amount of our construction contract receivables. As a result of the substantial amount and concentration of our construction contract receivables, if any of our major customers fails to timely pay us amounts owed, we could suffer a significant decline in cash flow and liquidity which could adversely affect our ability to borrow funds to pay our liabilities and to purchase inventory to sustain or expand our current sales volume.

The growth of aging receivables and a deterioration in the collectability of these accounts could adversely affect our results of operations.

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 recorded a general provision for doubtful accounts amounting to approximately $5.2 million in 2008 and $1.4 million in 2009, which management believes is commensurate to cover the associated credit risk in the portfolio of our construction contract related receivables.  As of December 31, 2009 our provision for doubtful accounts was $6.6 million, which was 6.9% of our construction contract related receivables of $95.8 million. We believed it was appropriate to increase the reserve for doubtful accounts primarily due to an increase in the aging of our accounts receivable, the growth of the outstanding balance of receivables as of December 31, 2009, and the general decline in the domestic and global economy.  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.

Our use of the “percentage-of-completion” method of accounting could result in reduction or reversal of previously recorded revenues and profits.  

A substantial portion of our revenues and profits are measured and recognized using the “percentage-of-completion” method of accounting, which is discussed further in Note 2, “Summary of Significant Accounting Policies” to our “Financial Statements.” Our use of this method results in recognition of revenues and profits ratably over the life of a contract, based generally on the proportion of costs incurred to date to total costs expected to be incurred for the entire project. The effect of revisions to revenues and estimated costs is recorded when the amounts are known or can be reasonably estimated.  There are uncertainties inherent in the estimating process, and estimate revisions may occur.  Such revisions could occur in any period and their effects could be material.   As is customary in the construction industry, we intend to conduct interim reviews on a rolling basis, and it may be determined during these reviews that actual costs on a project or projects vary materially from estimates, including reductions or reversals of previously recorded revenues and profits.  Our results of operations for current and past periods may be negatively affected by revisions to estimates and reductions or reversals of previously recorded revenues and profits, which could harm the value of our securities.

Our dispute with the master contractor on the Dubai Metro Rail Project may result in costly and time-consuming litigation that could require significant time and attention of management and a reversal of recognized revenue in accordance with the “percentage of completion” method of accounting, either of which may have a material adverse effect on our financial position and results of operations.

Techwell, our wholly owned subsidiary, was removed by the master contractor of the Dubai Metro Rail Project, and such master contractor 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 guarantor of the bonds that were paid by the banks, and we are liable under the guarantee agreements for such amounts paid by the banks.  Although we do not believe that the master contractor had a proper basis for calling the bonds, there can be no assurance can be given that the dispute will be resolved in our favor.  We had generated approximately $105.4 million in total revenue since construction began in 2008, and depending on the evolving status of the dispute, we may be required to reverse revenue that we have recognized in previously periods under the “percentage of completion” accounting method, which would have a material adverse effect on our results of operations.

Our failure to adequately recover on claims brought by us against project contractors, such as the contractor of the Dubai Metro Rail Project, for additional contract costs could have a negative impact on our liquidity and profitability.

 

We have brought claims against project contractors for additional costs exceeding the contract price or for amounts not included in the original contract price.  These types of claims occur due to matters such as contractor- or owner-caused delays or changes from the initial project scope, both of which may result in additional cost.  Often, these claims can be the subject of lengthy arbitration or litigation proceedings, and it is difficult to accurately predict when these claims will be fully resolved.  For example, we are currently in a dispute with the contractor of the Dubai Metro Rail Project for amounts that we believe are owed to us but with which the project owner disagrees, including additional contract costs.  At dispute is approximately $42.1 million.  When these types of events occur and unresolved claims are pending, we have used working capital in projects to cover cost overruns pending the resolution of the relevant claims.  A failure to promptly recover on these types of claims, if at all, could have a negative impact on our liquidity and profitability.

 

11

---

 

In 2009, the contractor of the Dubai Metro Rail Project called bonds that were established on our behalf, and our ability to maintain adequate bonding capacity is necessary for us to successfully bid on and win contracts.

 

In line with industry practice, we are often required to provide performance or payment bonds to clients under contracts. These bonds indemnify the customer should we fail to perform our obligations under the contract. If a bond is required for a particular project and we are unable to obtain an appropriate bond, we cannot pursue that project. In 2009, the contractor of Dubai Metro Rail Project called for and received payment of $2.1 million in performance bonds and $7.3 million in advance payment bonds that were issued on our behalf for the project. Such action had a negative effect on our bonding capacity. We have experienced a decrease in the trading price of our common stock, and as a result, the value of the stock price has lead to insufficient collateral value of bonds and credits. We believe that we still have bonding capacity but, as is typically the case, the issuance of a bond is at the surety’s sole discretion. Moreover, due to events that affect the insurance and bonding markets generally, bonding may be more difficult to obtain in the future or may only be available at significantly higher costs. There can be no assurance that our bonding capacity will continue to be available to us on reasonable terms. Our inability to obtain adequate bonding and, as a result, to bid on new contracts could have a material adverse effect on our business, financial condition, results of operations and cash flows.

If we fail to timely complete, miss a required performance standard or otherwise fail to adequately perform on a project, then we may incur a loss on that project, which may affect our overall profitability.  

We may commit to a client that we will complete a project by a scheduled date. We may also commit that a project, when completed, will achieve specified performance standards. If the project is not completed by the scheduled date or subsequently fails to meet required performance standards, we may either incur significant additional costs or be held responsible for the costs incurred by the client to rectify damages due to late completion or failure to achieve the required performance standards. The uncertainty of the timing of a project can present difficulties in planning the amount of personnel needed for the project. If the project is delayed or canceled, we may bear the cost of an underutilized workforce that was dedicated to fulfilling the project. In addition, performance of projects can be affected by a number of factors beyond our control, including unavoidable delays from weather conditions, unavailability of vendor materials, changes in the project scope of services requested by clients or labor disruptions. In some cases, should we fail to meet required performance standards, we may also be subject to agreed-upon financial damages, which are determined by the contract. To the extent that these events occur, the total costs of the project could exceed our estimates and we could experience reduced profits or, in some cases, incur a loss on that project, which may affect our overall profitability.

 

We have failed to make the required interest payment under our $28 million convertible bonds.  The bondholders may declare a default under the Bonds and require us to pay the Bonds.  We have entered into a waiver with the bondholders, but if we are unable to meet the terms and condition of the waiver agreement, which could result in bankruptcy or otherwise impair our ability to maintain sufficient liquidity to continue our operations.

 

On February 24, 2010, we and the holders of our Bonds and the 2008 Bond Warrants entered into an Amendment and Waiver Agreement (the “Waiver”).  Pursuant to Waiver, which has a three month term, the bondholders and warrantholder agreed to waive their right to a reduction in the conversion price of the Bonds and exercise price of the 2008 Bond Warrants due to our proposed issuance of up to 25,000,000 shares of common stock to First Jet Investment Limited to acquire an equity interest in ConnGame at a price per share less than the current conversion prices of the Bonds and exercise price of the 2008 Bond Warrants.  Pursuant to the Waiver, 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 further 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 and the Bonds have been redeemed in full and that any new indebtedness incurred by us 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.

If we fail to make any of the payments specified in the Waiver or fail to uphold any obligation in the Waiver, then the waiver will be null and void and the bondholders are declare a default and call the bonds for payment.  If we are required to redeem all or a portion of the Bonds, we may be required to seek 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 would have a material adverse effect on our results of operation, financial position, and cash flows and liquidity, and could result in bankruptcy.

 

12

---

 

Mandatory redemption of the Bonds could have a material adverse effect on our liquidity and cash resources.

If we are required to redeem all or any portion of the $8 million and $20 million outstanding Bonds, this may have a material adverse effect on our liquidity and cash resources, and may impair our ability to continue to operate. In addition, at any time after April 12, 2010, each holder of the 2007 Bonds can require us to redeem the 2007 Bonds at 126.51% of the principal amount of the 2007 Bonds and we are required to redeem any outstanding 2007 Bonds at 150.87% of its principal amount on April 4, 2012.  Also, on April 15 and October 15 of each year on or after April 15, 2010, the holders of the 2008 Bonds may require us to redeem the 2008 Bonds at 116.61% of their principal amount.  We are required to redeem any outstanding 2008 Bonds at 116.61% of its principal amount on April 15, 2011.  If a triggering event occurs and we are requested by the holders to repurchase all or a portion of the 2007 or 2008 Bonds, we will be required to pay cash to redeem all or a portion of the Bonds.

Pursuant to the Waiver, upon our timely payment of all of the required payments under the Waiver, the bondholders have agreed to commence negotiations in good faith with us to waive their rights under the trust deed governing the 2007 Bonds to require us to redeem the 2007 Bonds at 126.51% of the principal amount, plus all accrued but unpaid interest, at any time after April 12, 2010, and their rights under the trust deed governing the 2008 Bonds to require us to redeem the 2008 Bonds at 116.61% of the principal amount of the Bonds redeemed, plus all accrued but unpaid interest, on any Interest Payment Date on or after April 15, 2010.  However, we cannot assure you that we will be able to reach an agreement with the bondholders for their waiver of such rights.  If we are required to repurchase all or a portion of the Bonds and do not have sufficient cash to make the repurchase, we may 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.

There are restrictive covenants in the trust deeds governing our outstanding Bonds and the Waiver relating to our ability to incur future indebtedness.

Each of the trust deeds governing the 2007 and 2008 Bonds does not limit our ability to incur indebtedness, except that as long as any of such Bonds remains outstanding, we agreed not to create any encumbrance upon our present or future assets or revenues to secure any indebtedness or to secure any guarantee of or indemnity in respect of any such indebtedness unless our obligations under the Bonds are secured by the same encumbrance or have the benefit from a guarantee or indemnity in substantially identical terms. The trust deeds do not contain any financial or operating covenants or restrictions on the payment of dividends, incurrence of indebtedness (other than as stated above), transactions with affiliates, incurrence of liens, or the issuance or repurchase of securities by us or any of our subsidiaries.

Pursuant to the Waiver, we agreed that we will not repay or prepay any debt prior to its currently scheduled due date until we make all of the payments required by the Waiver and the Bonds have been redeemed in full.  Additionally, we agreed that any new indebtedness incurred by us for the purpose of repaying the amounts owed to the Overdraft Lender under the overdraft facility letter (i) will not exceed the amounts due under the facility and (ii) will be subordinated to all amounts owed under the Bonds.  Therefore, after we make all of the required payments pursuant to the Waiver, we may incur additional debt, including secured indebtedness or indebtedness by, or other obligations of, our subsidiaries to which the Bonds would be structurally subordinate. A higher level of indebtedness increases the risk that we may default on our indebtedness. We cannot assure you that we will be able to generate sufficient cash flow to pay the interest on our indebtedness or that future working capital, borrowings or equity financing will be available to pay or refinance such indebtedness.

We issued convertible bonds that include features that will have the effect of reducing our reported operating results during the term of the bonds.

We issued $10,000,000 Variable Rate Convertible Bonds due in 2012 in April 2007 (the “2007 Bonds”) and $20,000,000 12% Convertible Bonds due in 2011 in April 2008 (the “2008 Bonds,” and collectively with the 2007 Bonds, the “Bonds”). At of December 31, 2009, $2 million of the 2007 Bonds have been converted.  The terms of 2007 Bonds and 2008 Bonds include conversion features allowing the holders to convert the Bonds into shares of our common stock. Certain of those conversion features that allow for the reduction in conversion price upon the occurrence of stated events constitute a “beneficial conversion feature” for accounting purposes.  The accounting treatment related to the beneficial conversion and mandatory redemption features of the 2007 and 2008 Bonds and the value of the warrants to purchase 300,000 shares of our common stock expiring 2013 issued in connection with the 2008 Bonds (the “2008 Bond Warrants”) will have an adverse impact on our results of operations for the term of the Bonds. The application of Generally Accepted Accounting Principles required us to allocate $2,171,429 to the beneficial conversion feature of the 2007 Bonds, and $2,183,085 and $1,413,503 to the 2007 Bonds Warrants and 2008 Bond Warrants, respectively, which have been reflected in our financial statements as an interest discount. Also, we have determined that the total redemption premium associated with the mandatory redemption feature of the 2007 and 2008 Bonds is $4,138,418 and ($702,579), respectively. All of the aforementioned amounts associated with the beneficial conversion and mandatory redemption feature of the bonds and the value of the bond warrants are being amortized as additional interest expense over the term of the bonds. This accounting will result in an increase in interest expense in all reporting periods during the term of the bonds, and, as a result, reduce our net income accordingly.

 

 

13

---

 

Because we depend on governmental agencies for a significant portion of our revenue, our inability to win or renew government contracts could harm our operations and significantly reduce or eliminate our profits.

Revenues from Chinese government contracts represented approximately 35.2% and 24.4% of our revenues for the years ended December 31, 2009 and 2008, respectively. Our inability to win or renew Chinese government contracts could harm our operations and significantly reduce or eliminate our profits. Chinese government contracts are typically awarded through a regulated procurement process. Some Chinese government contracts are awarded to multiple competitors, causing increases in overall competition and pricing pressure. The competition and pricing pressure, in turn may require us to make sustained post-award efforts to reduce costs in order to realize revenues under these contracts. If we are not successful in reducing the amount of costs we anticipate, our profitability on these contracts will be negatively impacted.

Adverse capital and credit market conditions, in addition to the negative effects of our rapid growth, may significantly affect our ability to meet liquidity needs, access to capital and cost of capital.

The capital and credit markets have been experiencing extreme volatility and disruption in recent months, including, among other things, extreme volatility in securities prices, severely diminished liquidity and credit availability, ratings downgrades of certain investments and declining valuations of others. Governments have taken unprecedented actions intended to address extreme market conditions that have included severely restricted credit and declines in real estate values. In some cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers. While currently these conditions have not impaired our ability to utilize our current credit facilities and finance our operations, there can be no assurance that there will not be a further deterioration in financial markets and confidence in major economies such that our ability to access credit markets and finance our operations might be impaired. Without sufficient liquidity, we may be forced to curtail our operations. Adverse market conditions may limit our ability to replace, in a timely manner, maturing liabilities and access the capital necessary to operate and grow our business. As such, we may be forced to delay raising capital or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Demand for our services is cyclical and vulnerable to economic downturns.   The current tightening of credit in financial markets could adversely affect the ability of our customers to obtain financing for purchases of our services and could result in a decrease in or cancellation of orders for our services. We are unable to predict the duration and severity of the current disruption in financial markets and the global adverse economic conditions and the effect such events might have on our business. Our results of operations, financial condition, cash flows and capital position could be materially adversely affected by disruptions in the financial markets.

In addition, our ability to meet liquidity needs and access capital has been detrimentally affected by our failure to timely control the speed and magnitude of the company’s expansion after the listing of our common stock on a US national exchange in 2007.  In addition, the delayed payment by customers caused insufficient cash flows, the difficulty of payments caused the delayed payment of bond interests and bank loans, and breaching the contracts.  Rapid growth has caused the internal management and control unable to maintain proper development during and after the expansion such that operation costs dramatically increased.  In response, we have increased our cost-cutting efforts in the first half of 2009.  Nevertheless, the large amount of preliminary spending and substantial costs due to the downsizing have caused the depletion of our capital to the point that it may no longer be able to continue or support regular operations.

The global economic conditions caused by the decline in the worldwide economy and constraints in the credit market has caused, and may continue to cause, clients to delay, curtail or cancel proposed and existing projects, thus decreasing the overall demand for our services and weakening our financial results.

 

Our clients and potential clients have been impacted by the global economic conditions caused by the decline in the overall economy and constraints in the credit market.  As a result, some clients have delayed, curtailed or cancelled proposed and existing projects and may continue to do so, thus decreasing the overall demand for our services and adversely impacting our results of operations.   Since 2008, we have conducted a substantial work for the development and undertaking of the international projects, and contributed a large amount of labor, materials and financial resources. As a result, we rapidly obtained numerous high value and high profit projects, and the team and management system were built up at the same time.  However, after the global financial crisis worsened, these projects failed to progress smoothly.  Some national projects were stopped and some unconstructed projects were shut down or the progress of them were slowed down, such as Hong Kong Polytechnic University Project, Nine Dragon Marine Park and Studios Projects, Abu Dhabi Project and the U.S 371 Project.  In addition, progress of other projects were delayed and the receipt of payments for those projects were slowed down, such as Guangzhou Opera House Project, Kuwait Project, Singapore Conservatory Complex, and the At Gardens By the Bay Project.  We have taken a number of measures to prevent the deterioration of the situation, but the results were minimal, and a significant portion of our preliminary spending did not result in revenues for our company.

The current economic volatility has also made it very difficult for us to predict the short-term and long-term impacts on our business and made it more difficult to forecast our business and financial trends.  In addition, our clients may find it more difficult to raise capital in the future due to substantial limitations on the availability of credit and other uncertainties in the federal, municipal and corporate credit markets.  Also, our clients may find it increasingly difficult to timely pay invoices for our services, which would impact our future cash flows and liquidity.  Any inability to timely collect our invoices may lead to an increase in our accounts receivable and potentially to increased write-offs of uncollectible invoices.  The economic downturn, tightened credit markets and the decline in commodity prices have resulted in reductions in spending capital for the development of new production facilities, adversely affecting our revenues.  Also, ongoing credit constraints in the market could limit our ability to access credit markets in the future and, therefore, impact our liquidity.

 

14

---

 

Demand for our services is cyclical and vulnerable to economic downturns and reductions in government and private industry spending.  If the global economy remains weak or client spending declines further, then our revenues, profits and our financial condition may continue to deteriorate.

 

In fiscal 2009, we experienced a substantial decline in our revenues compared to fiscal 2008 and a decrease in project awards.  If the economy remains weak or client spending declines further, then our revenues, backlog, net income and overall financial condition may continue to deteriorate.  In light of current macroeconomic conditions, we are projecting declines in revenues in our power and industrial and commercial market sectors for 2009.  Demand for our services is cyclical and vulnerable to economic downturns and reductions in government and private industry spending, which may result in delaying, curtailing or canceling proposed and existing projects by clients.

If our goodwill resulting from our 2007 acquisition of Techwell becomes impaired, then our financial condition and profits may be reduced.

 

A decline in our stock price and market capitalization, such as our stock price decline in 2009, could result in an impairment of a material amount of our goodwill, which could reduce our earnings.  Goodwill may be impaired if the estimated fair value of one or more of our reporting units’ goodwill is less than the carrying value of the unit’s goodwill.  In 2007, we acquired Techwell Engineering, and its accordingly recorded goodwill assets in the amount of approximately $8.0 million, which represents a significant portion of our assets.  We perform an analysis on our goodwill balances to test for impairment on an annual basis and whenever events occur that indicate an impairment could exist.  There are several instances that may cause us to further test our goodwill for impairment between the annual testing periods including:  (i) continued deterioration of market and economic conditions that may adversely impact our ability to meet our projected results; (ii) declines in our stock price caused by continued volatility in the financial markets that may result in increases in our weighted-average cost of capital or other inputs to our 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 our reporting units.

Our impairment review did not indicate an impairment of the goodwill, however while this review indicated that the estimated fair value exceeded the carrying value of goodwill, it is reasonably possible that changes in the numerous variables associated with the judgments, assumptions and estimates we made in assessing the fair value of our goodwill, could cause the respective value of this or other reporting units to become impaired.  If our goodwill is impaired, we would be required to record a non-cash charge that could have a material adverse effect on our condensed consolidated financial statements.

Our future revenues depend on our ability to consistently bid and win new contracts and renew existing contracts and, therefore, our failure to effectively obtain future contracts could adversely affect our profitability.

Our future revenues and overall results of operations require us to successfully bid on new contracts and renew existing contracts. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which is affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. If negative market conditions arise, or if we fail to secure adequate financial arrangements or the required governmental approval, we may not be able to pursue particular projects, which could adversely affect our profitability.

Our results could be adversely impacted by product quality and performance.

We manufacture or install products based on specific requirements of each of our customers. We believe that future orders of our products or services will depend on our ability to maintain the performance, reliability and quality standards required by our customers. If our products or services have performance, reliability or quality problems, we may experience delays in the collection of accounts receivables, higher manufacturing or installation costs, additional warranty and service expense, and reduced, cancelled or discontinued orders. Additionally, performance, reliability or quality claims from our customers, with or without merit, could result in costly and time-consuming litigation that could require significant time and attention of management and involve significant monetary damages.

  

Continued price volatility and supply constraints in the steel and aluminum markets could prevent us from meeting delivery schedules to our customers or reduce our profit margins.

We buy semi-finished products made of aluminum, steel and glass, and, to a degree, our business is dependent on the prices and supply of steel and aluminum, which, along with glass, are the principal raw materials used in our products. The steel and aluminum industries are highly cyclical in nature, and steel and aluminum prices have been volatile in recent years and may remain volatile in the future. Our purchases of aluminum ranged from approximately $5.49 to $7.86 per pound and $3.48 to $6.65 per pound during the years ended December 31, 2009 and 2008, respectively, fluctuations of approximately 30% and 91% respectively. The price we paid for steel also fluctuated. For the year ended December 31, 2009, prices for seamless steel tubes ranged from approximately $658 to $731 per ton (a difference of approximately 10%), prices for angled steel ranged from approximately $556 to $614 per ton (a difference of approximately 10%), and prices for steel plates ranged from approximately $527 to $629 per ton (a difference of approximately 17%).

 

15

---

 

Steel and aluminum prices are influenced by numerous factors beyond our control, including general economic conditions, competition, labor costs, production costs, import duties and other trade restrictions. In the past, there have been unusually rapid and significant increases in steel and aluminum prices and severe shortages in the steel and aluminum industries due in part to increased demand from China’s expanding economy and high energy prices. We do not have any long-term contracts for the purchase of steel and aluminum and normally do not maintain inventories of steel and aluminum in excess of our current production requirements. We can give you no assurance that steel and aluminum will remain available or that prices will not continue to be volatile. If the available supply of steel and aluminum declines, we could experience price increases that we are not able to pass on to our customers, a deterioration of service from our suppliers or interruptions or delays that may cause us not to meet delivery schedules to our customers. Any of these problems could adversely affect our results of operations and financial condition.

Our business is characterized by long periods for collection from our customers and short periods for payment to our suppliers, the combination of which may cause us to have liquidity problems.

We experience an average accounts settlement period ranging from two months to as high as one year from the time we provide services to the time we receive payment from our customers for domestic contracts.  For our overseas projects, we typically experience an account settlement period according to the contracts.  In most international contracts, the account settlement period is approximately two months.   In contrast, we typically need to place certain deposits 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 are typically paid by the contractor the entire amount due to us for our services and products once the entire project is completed, which could be significantly after we complete the curtain wall portion of the project. China’s policy requires the contractor to pay 85% of our total contract value to us before the project is completed, and the remainder may be paid when the contractor completes the entire project. Because our payment cycle is considerably shorter than our receivable cycle, we may experience working capital shortages. Working capital management, including prompt and diligent billing and collection, is an important factor in our results of operations and liquidity. We cannot assure you that system problems, industry trends or other issues will not extend our collection period, adversely impact our working capital.

The industries in which we operate are highly competitive.

The markets we serve are very competitive, price and lead-time sensitive and are impacted by changes in the commercial construction industry, including unforeseen delays in project timing and work flow. In addition, competition in the markets of the building industry and in the metal coil coating industry is intense. It is based primarily on:

·

quality;

 

·

service;

 

·

delivery;

 

·

ability to provide added value in the design and engineering of buildings;

 

·

price;

 

·

speed of construction in buildings and components; and

 

·

personal relationships with customers.

 

We compete with several large integrated glass manufacturers, numerous specialty, architectural glass and window fabricators, and major contractors and subcontractors. We also compete with a number of other manufacturers of engineered building systems ranging from small local firms to large national firms. In addition, we and other manufacturers of engineered high-end curtain walls compete with alternative methods of building construction. If these alternative building methods compete successfully against us, such competition could adversely affect us. Demand for our services is cyclical and vulnerable to economic downturns. If the economy weakens, then our revenues, profits and our financial condition may deteriorate. Many of our competitors have greater financial or other resources than we do.

 

 

16

---

 

We are currently a defendant in a lawsuit in Hong Kong regarding our acquisition of Techwell Engineering Limited (“Techwell”) in November 2007, pursuant to which the sellers have alleged that,  inter alia , (i) we misrepresented to them the financial status of our company and operations during the course the negotiations of the acquisition; and (ii) we failed to perform our obligations under a settlement agreement alleged to have been agreed to by us in January 2009.  We believe this lawsuit to have limited merit and we shall vigorously defend such lawsuit. If however we are unsuccessful in defending the lawsuit, we may be required to pay damages and we may potentially lose our ownership of Techwell.

 

Pursuant to a Stock Purchase Agreement dated November 7, 2007, the previous shareholders of Techwell, Mr. Ng, Chi Sum and Miss Yam, Mei Ling Maria agreed to sell 100% of the shares in Techwell to us for approximately $11.7 million in cash and shares of common stock of our 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 us and our subsidiary, Full Art International Limited.  The lawsuit alleges that, inter alia, (i) we misrepresented to them the financial status of our company and operations during the course the negotiations of the acquisition of Techwell; (ii) we failed to perform our obligations under a settlement agreement alleged to have been agreed to by us in January 2009; and (iii) the dismissal of Mr. Ng was unlawful and invalid. 

 

On January 23, 2009 an ex-parte injunction order was granted to Mr. Ng, restraining us 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.

 

We intend to vigorously defend this pending lawsuit; however, no assurance can be given that the lawsuit will be resolved in our favor.  Even if we successfully defend the lawsuit, we may incur substantial costs defending or settling the lawsuit, in addition to a possible diversion of the time and attention of our management from our business.  If we are unsuccessful in defending the lawsuit, we may be required to pay a significant amount of damages and/or we may potentially lose ownership of Techwell, which will have a material adverse effect on our 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.

If we acquire or invest in other businesses or other assets, we may be unable to integrate them with our business, our financial performance may be impaired or we may not realize the anticipated financial and strategic goals for such transactions.

If appropriate opportunities present themselves, we may acquire or make investments in businesses and other assets that we believe are strategic. We may not be able to identify, negotiate or finance any future acquisition or investment successfully. Even if we do succeed in acquiring or investing in a business or other asset, such acquisitions and investments involve a number of risks, including:

·

retaining key employees and maintaining the key business and customer relationships of the businesses we acquire;

 

·

cultural challenges associated with integrating employees from an acquired company or business into our organization;

 

·

the possibility that the combined company would not achieve the expected benefits, including any anticipated operating and product synergies, of the acquisition as quickly as anticipated or that the costs of, or operational difficulties arising from, an acquisition would be greater than anticipated;

 

·

significant acquisition-related accounting adjustments or charges, particularly relating to an acquired company's deferred revenue, that may cause reported revenue and profits of the combined company to be lower than the sum of their stand-alone revenue and profits;

 

·

the need to integrate an acquired company's accounting, management information, human resource and other administrative systems to permit effective management and timely reporting, and the need to implement or remediate controls, procedures and policies appropriate for a public company in an acquired company that, prior to the acquisition, lacked these controls, procedures and policies; and

 

·

litigation or other claims in connection with, or inheritance of claims or litigation risks as a result of, an acquisition, including claims from terminated employees, customers or other third parties.

 

 

17

---

 

 

Future acquisitions and investments could also involve the issuance of our equity and equity-linked securities (potentially diluting our existing stockholders), the incurrence of debt, contingent liabilities or amortization expenses, write-offs of goodwill, intangibles, or acquired in-process technology, or other increased cash and non-cash expenses such as stock-based compensation. Any of the foregoing factors could harm our financial condition or prevent us from achieving improvements in our financial condition and operating performance that could have otherwise been achieved by us on a stand-alone basis. Our stockholders may not have the opportunity to review, vote on or evaluate future acquisitions or investments.

Our business activities have required our employees to travel to and work in high security risk countries, which could result in employee death or injury, repatriation costs or other unforeseen costs.  

As a company that engaged in international projects, our employees have often traveled to and worked in high security risk countries around the world that are undergoing political, social and economic upheavals resulting in war, civil unrest, criminal activity or acts of terrorism. Currently we have approximately 31 employees working in Doha, Qatar and 3 employees in Dubai, UAE. During the peak construction period, we had approximately 52 installation workers in Doha and about 400 installation workers in Dubai, which consist of about 49% full-time company employees (engineers, project managers and supervisors) and 75% non-company contract labor.  As a result, we may be subject to costs related to employee death or injury, repatriation or other unforeseen circumstances.

 

Force majeure events, including natural disasters and terrorists’ actions have negatively impacted and could further negatively impact the economies in which we operate, which may affect our financial condition, results of operations or cash flows.

Force majeure events, including natural disasters, such as Typhoon Pai Bi An that affected the Southeastern China Coast in August 2006 and terrorist attacks, such as those that occurred in New York and Washington, D.C. on September 11, 2001, could negatively impact the economies in which we operate.

We typically remain obligated to perform our services after a terrorist action or natural disaster unless the contract contains a force majeure clause that relieves us of our contractual obligations in such an extraordinary event. If we are not able to react quickly to force majeure, our operations may be affected significantly, which would have a negative impact on our financial condition, results of operations or cash flows.

 

We may suffer as a result of product liability or defective products.

We may produce products which injure or kill individuals despite proper testing. Existing PRC, Qatar and UAE laws and regulations do not require us to maintain third party liability insurance to cover product liability claims. In the United States and Australia, we are required to maintain third party liability insurance. However, if a product liability claim is brought against us, it may, regardless of merit or eventual outcome, result in damage to our reputation, breach of contract with our customers, decreased demand for our products, costly litigation, product recalls, loss of revenue, and the inability to commercialize some products.

We incur costs to comply with environmental laws and have liabilities for environmental cleanups.

Because we have air emissions, discharge wastewater, and handle hazardous substances and solid waste at our fabrication facilities, we incur costs and liabilities to comply with environmental laws and regulations and may incur significant additional costs as those laws and regulations change in the future or if there is an accidental release of hazardous substances into the environment. The operations of our fabrication facilities are subject to stringent and complex environmental laws and regulations that regulate the cleanup of hazardous substances that may have been released at properties currently or previously owned or operated by us or locations to which we have sent waste for disposal. Failure to comply with these laws and regulations may trigger a variety of administrative, civil and criminal enforcement measures, including the assessment of monetary penalties, the imposition of remedial requirements, and the issuance of orders enjoining future operations.

If our partners fail to perform their contractual obligations on a project, we could be exposed to legal liability, loss of reputation or reduced profits.  

We sometimes enter into subcontracts, joint ventures and other contractual arrangements with outside partners to jointly bid on and execute a particular project. The success of these joint projects depends upon, among other things, the satisfactory performance of the contractual obligations of our partners. If any of our partners fails to satisfactorily perform its contractual obligations, we may be required to make additional investments and provide additional services to complete the project. If we are unable to adequately address our partner’s performance issues, then our client could terminate the joint project, exposing us to legal liability, loss of reputation or reduced profits.

Our failure to attract and retain key employees could impair our ability to provide services to our clients and otherwise conduct our business effectively.

As we shift the focus of our business to that of a professional and technical services company, we will become increasingly labor intensive, and, therefore, our ability to attract, retain and expand our senior management and our professional and technical staff is an important factor in determining our future success.  Key personnel include, but is not limited to, Luo Ken Yi, our Chief Executive Officer, Tang Nianzhong, our Vice General Manager, and Ye Ning, our Vice General Manager, each of whom perform vital functions in the operation of our business.  From time to time, it may be difficult to attract and retain qualified individuals with the expertise and in the timeframe demanded by our clients.   In addition, we rely heavily upon the expertise and leadership of our senior management.  If we are unable to retain executives and other key personnel, the roles and responsibilities of those employees will need to be filled, which may require that we devote time and resources in identifying, hiring and integrating new employees.  In addition, the failure to attract and retain key individuals could impair our ability to provide services to our clients and conduct our business effectively.

 

18

---

 

 

We cannot guarantee the protection of our intellectual property rights and if infringement or counterfeiting of our intellectual property rights occurs, our reputation and business may be adversely affected.

Our success depends in part on our ability to preserve our patents and trade secrets and operate without infringing the proprietary rights of third parties. If we fail to maintain our patents and trade secret protections, we may not be able to prevent third parties from using our proprietary rights. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage. If a third party initiates litigation regarding our patents, and is successful, a court could revoke our patents or limit the scope of coverage for those patents. We also rely upon trade secrets, proprietary know-how and continuing technological innovation to remain competitive. We attempt to protect this information with security measures such as the use of confidentiality agreements with our employees, consultants and corporate collaborators. It is possible that these individuals will breach these agreements and that any remedies for a breach will be insufficient to allow us to recover our costs. Furthermore, our trade secrets, know-how and other technology may otherwise become known or be independently discovered by our competitors.

Furthermore, we have registered and applied for registration of our trademarks in the PRC, where we have a substantial business presence, to protect the reputation of our products. Our products are sold under these trademarks. There is no assurance that there will not be any infringement of our brand name or other registered trademarks or counterfeiting of our products in the future. Should any such infringement or counterfeiting occur, our reputation and business may be adversely affected. We may also incur significant expenses and substantial amounts of time and effort to enforce our intellectual property rights in the future. Such diversion of our resources may adversely affect our existing business and future expansion plans.

We enjoyed certain preferential tax concessions and loss of these preferential tax concessions may cause our tax liabilities to increase and our profitability to decline.

We have historically enjoyed preferential tax concessions in the PRC as a high-tech enterprise. The PRC Enterprise Income Tax Law (the “EIT Law”) was enacted on March 16, 2007. Under the EIT Law, which became effective on January 1, 2008, China adopted a uniform tax rate of 25.0% for all enterprises (including foreign-invested enterprises) and canceled several tax incentives enjoyed by foreign-invested enterprises. However, for foreign-invested enterprises established before the promulgation of the EIT Law, a five-year transition period is provided during which reduced rates will apply but gradually be phased out. Because we are classified as high tech foreign-invested enterprise, prior to 2008 we were subject to a 15% preferential tax rate in China. We believe that our tax rate will gradually increase to 25% during a five-year transition period commencing in 2008 until it reaches 25% in 2012. Further, any future increase in the enterprise income tax rate applicable to us or other adverse tax treatments, such as the discontinuation of preferential tax treatments for high and new technology enterprises altogether, would have a material adverse effect on our results of operations and financial condition.

 

RISKS RELATED TO US DOING BUSINESS IN CHINA

Substantially all of our assets are located in China and substantially all of our revenues are derived from our operations in China, and changes in the political and economic policies of the PRC government could have a significant impact upon the business we may be able to conduct in the PRC and the results of operations and financial condition.

Our business operations may be adversely affected by the current and future political environment in the PRC. The PRC has operated as a socialist state since the mid-1900s and is controlled by the Communist Party of China. The Chinese government exerts substantial influence and control over the manner in which we must conduct our business activities. The PRC has only permitted provincial and local economic autonomy and private economic activities since the late-1970s. The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.

 

 

19

---

 

Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.

We are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some that may compete with us, are not subject to these prohibitions, and therefore may have a competitive advantage over us. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC, particularly in our industry since it involves obtaining project contracts from the government of China and other countries.  Our executive officers and employees have not been subject to the United States Foreign Corrupt Practices Act prior to 2007. We can make no assurance that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

 

The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. Any changes in such PRC laws and regulations may have a material and adverse effect on our business.

The PRC’s legal system is a civil law system based on written statutes, in which system decided legal cases have little value as precedents unlike the common law system prevalent in the United States. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. The Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. We are considered a foreign persons or foreign funded enterprise under PRC laws, and as a result, we are required to comply with PRC laws and regulations. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses. If the relevant authorities find us in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including, without limitation:

·

levying fines;

 

·

revoking our business and other licenses;

 

·

requiring that we restructure our ownership or operations; and

 

·

requiring that we discontinue any portion or all of our business.

 

Inflation in the PRC could negatively affect our profitability and growth.

While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. According to the National Bureau of Statistics of China, the change in China’s Consumer Price Index increased to 8.5% in April 2008. If prices for our products and services rise at a rate that is insufficient to compensate for the rise in the costs of supplies such as raw materials, it may have an adverse effect on our profitability.

Furthermore, in order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. In January 2010, the Chinese government took steps to tighten the availability of credit including ordering banks to increase the amount of reserves they hold and to reduce or limit their lending. The implementation of such policies may impede economic growth. In October 2004, the People’s Bank of China, the PRC’s central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the Chinese economy. In April 2006, the People’s Bank of China raised the interest rate again. Repeated rises in interest rates by the central bank would likely slow economic activity in China which could, in turn, materially increase our costs and also reduce demand for our products and services.

 

 

20

---

 

PRC regulations relating to acquisitions of PRC companies by foreign entities has created regulatory uncertainties that could restrict or limit our ability to operate. Our failure to obtain the prior approval of the China Securities Regulatory Commission, or the CSRC, for the listing and trading of our common stock on a national securities exchange in the United States could have a material adverse effect on our business, operating results, reputation and trading price of our common stock.

Within the last five years, the PRC government has, on several occasions, amended its regulations relating to overseas listings of PRC businesses. Most recently, on August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State Administration for Industry and Commerce, CSRC and SAFE, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors. This regulation became effective on September 8, 2006 and includes provisions that purport to require offshore special purpose vehicles:

(i)

controlled directly or indirectly by PRC companies or citizens; and

(ii)

formed for the purpose of effecting an overseas listing of a PRC company

to obtain the approval of CSRC prior to the completion of the overseas listing. On September 8, 2006, CSRC published procedures regarding the approval process associated with overseas listings of special purpose vehicles. There is little precedent as to how CSRC will interpret the new regulation and apply the related procedures.

Our PRC counsel, Guangdong Seagull Law Firm, has advised us that because we completed our restructuring before September 8, 2006, the effective date of the new regulation, it is not necessary for us to submit the application to the CSRC for its approval, and the listing and trading of our Common Stock on a national securities exchange does not require CSRC approval.

If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval was required for our initial public offering that was completed on October 3, 2007, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from our initial public offering or subsequent offerings into the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our Common Stock.

These new rules may significantly affect the means by which offshore-onshore restructurings are undertaken in China in connection with offshore private equity and venture capital financings, mergers and acquisitions. It is expected that such transactional activity in China in the near future will require significant case-by-case guidance from Ministry of Commerce and other government authorities as appropriate. Given the uncertainties regarding interpretation and application of the new rules, we may need to expend significant time and resources to maintain compliance. It is uncertain how our business operations or future strategy will be affected by the interpretations and implementation of these new rules. Our business operations or future strategy could be adversely affected by these new rules. For example, we may be subject to more stringent review and approval process with respect to our foreign exchange activities.

Under the New EIT Law, we and Full Art may be classified as “resident enterprises” of China for tax purpose, which may subject us and Full Art to PRC income tax on taxable global income.

Under the new PRC Enterprise Income Tax Law (the “New EIT Law”) and its implementing rules, both of which became effective on January 1, 2008, enterprises are classified as resident enterprises and non-resident enterprises. An enterprise established outside of China with its “de facto management bodies” located within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese domestic enterprise for enterprise income tax purposes. The implementing rules of the New EIT Law define de facto management body as a managing body that in practice exercises “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise. Due to the short history of the New EIT law and lack of applicable legal precedents, it remains unclear how the PRC tax authorities will determine the PRC tax resident treatment of a foreign company such as us and Full Art. Both our and Full Art’s members of management are located in China. If the PRC tax authorities determine that we or Full Art is a “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income, including interest income on the proceeds from this offering, as well as PRC enterprise income tax reporting obligations. Second, the New EIT Law provides that dividend paid between “qualified resident enterprises” is exempted from enterprise income tax. A circular issued by the State Administration of Taxation regarding the standards used to classify certain Chinese-invested enterprises controlled by Chinese enterprises or Chinese group enterprises and established outside of China as “resident enterprises” clarified that dividends and other income paid by such “resident enterprises” will be considered to be PRC source income, subject to PRC withholding tax, currently at a rate of 10%, when recognized by non-PRC shareholders. It is unclear whether the dividends that we or Full Art receives from Zhuhai King Glass Engineering Co., Limited or any of our other PRC subsidiaries will constitute dividends between “qualified resident enterprises” and would therefore qualify for tax exemption, because the definition of qualified resident enterprises is unclear and the relevant PRC government authorities have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. We are actively monitoring the possibility of “resident enterprise” treatment for the applicable tax years and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible. As a result of the New EIT Law, our historical operating results will not be indicative of our operating results for future periods and the value of our common stock may be adversely affected.

 

21

---

 

Dividends payable by us to our foreign investors and any gain on the sale of our shares may be subject to taxes under PRC tax laws.

If dividends payable to our shareholders are treated as income derived from sources within China, then the dividends that shareholders receive from us, and any gain on the sale or transfer of our shares, may be subject to taxes under PRC tax laws.

Under the New EIT Law and its implementing rules, PRC enterprise income tax at the rate of 10% is applicable to dividends payable by us to our investors that are non-resident enterprises so long as such non-resident enterprise investors do not have an establishment or place of business in China or, despite the existence of such establishment of place of business in China, the relevant income is not effectively connected with such establishment or place of business in China, to the extent that such dividends have their sources within the PRC. Similarly, any gain realized on the transfer of our shares by such investors is also subject to a 10% PRC income tax if such gain is regarded as income derived from sources within China and we are considered as a resident enterprise which is domiciled in China for tax purpose. Additionally, there is a possibility that the relevant PRC tax authorities may take the view that the purpose of us and Full Art is holding Zhuhai King Glass Engineering Co., Limited or any of our other PRC subsidiaries, and the capital gain derived by our overseas shareholders or investors from the share transfer is deemed China-sourced income, in which case such capital gain may be subject to a PRC withholding tax at the rate of up to 10%. If we are required under the New EIT Law to withhold PRC income tax on our dividends payable to our foreign shareholders or investors who are non-resident enterprises, or if you are required to pay PRC income tax on the transfer or our shares under the circumstances mentioned above, the value of your investment in our shares may be materially and adversely affected.

In January, 2009, the State Administration of Taxation promulgated the Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Non-resident Enterprises (“Measures”), pursuant to which, the entities which have the direct obligation to make the following payment to a non-resident enterprise shall be the relevant tax withholders for such non-resident enterprise, and such payment includes: incomes from equity investment (including dividends and other return on investment), interests, rents, royalties, and incomes from assignment of property as well as other incomes subject to enterprise income tax received by non-resident enterprises in China. Further, the Measures provides that in case of equity transfer between two non-resident enterprises which occurs outside China, the non-resident enterprise which receives the equity transfer payment shall, by itself or engage an agent to, file tax declaration with the PRC tax authority located at place of the PRC company whose equity has been transferred, and the PRC company whose equity has been transferred shall assist the tax authorities to collect taxes from the relevant non-resident enterprise. However, it is unclear whether the Measures refer to the equity transfer by a non-resident enterprise which is a direct or an indirect shareholder of the said PRC company. Given these Measures, there is a possibility that we may have an obligation to withhold income tax in respect of the dividends paid to non-resident enterprise investors.

The foreign currency exchange rate between U.S. Dollars and Renminbi could adversely affect our financial condition.

To the extent that we need to convert U.S. Dollars into Renminbi for our operational needs, our financial position and the price of our common stock may be adversely affected should the Renminbi appreciate against the U.S. Dollar at that time. Conversely, if we decide to convert our Renminbi into U.S. Dollars for the operational needs or paying dividends on our common stock, the dollar equivalent of our earnings from our subsidiaries in China would be reduced should the dollar appreciate against the Renminbi. We currently do not hedge our exposure to fluctuations in currency exchange rates.

Countries, including the United States, have argued that the Renminbi is artificially undervalued due to China’s current monetary policies and have pressured China to allow the Renminbi to float freely in world markets. In July 2005, the PRC government changed its policy of pegging the value of the Renminbi to the dollar. Under the new policy the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of designated foreign currencies. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further and more significant appreciation of the Renminbi against the dollar.

Any recurrence of Severe Acute Respiratory Syndrome (SARS), Avian Flu, or another widespread public health problem, in the PRC could adversely affect our operations.

A renewed outbreak of Severe Acute Respiratory Syndrome, Avian Flu or another widespread public health problem in China, where all of our manufacturing facilities are located and where all of our sales occur, could have a negative effect on our operations. Such an outbreak could have an impact on our operations as a result of:

·

quarantines or closures of some of our manufacturing facilities, which would severely disrupt our operations,

 

·

the sickness or death of our key officers and employees, and

 

 

22

---

 

·

a general slowdown in the Chinese economy.

 

Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations.

Contract drafting, interpretation and enforcement in China involves significant uncertainty, which could leave us vulnerable to legal disputes and challenges related to our contracts.

We have entered into numerous contracts governed by PRC law, many of which are material to our business. As compared with contracts in the United States, contracts governed by PRC law tend to contain less detail and are not as comprehensive in defining contracting parties’ rights and obligations.  As a result, contracts in China are more vulnerable to disputes and legal challenges. In addition, contract interpretation and enforcement in China is not as developed as in the United States, and the result of any contract dispute is subject to significant uncertainties. Therefore, we cannot assure you that we will not be subject to disputes under our material contracts, and if such disputes arise, we cannot assure you that we will prevail.

The scope of our business license in China is limited, and we may not expand or continue our business without government approval and renewal, respectively.

Any company that conducts business in the PRC must have a business license that covers a particular type of work. Our business license covers our present business, which is to design, fabricate and install curtain wall systems (including glass, stone and metal curtain walls), roofing systems, steel construction systems, eco-energy saving building conservation systems and provision of related products, for public works and commercial real estate projects.  Any amendment to the scope of our business requires further application and government approval.  In order for us to expand our business beyond the scope of our license, we will be required to enter into a negotiation with the PRC authorities for the approval to expand the scope of our business.  We cannot assure you that we will be able to obtain the necessary government approval for any change or expansion of its business.

If we fail to maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected.

PRC companies have not historically been required to adopt a Western style of management and financial reporting concepts and practices, which includes strong corporate governance, internal controls and, computer, financial and other control systems. We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any actual or perceived weaknesses and conditions that need to be addressed in our internal control over financial reporting, disclosure of management’s assessment of our internal controls over financial reporting or disclosure of our public accounting firm’s attestation to or report on management’s assessment of our internal controls over financial reporting may have an adverse impact on the price of our common stock.

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based upon U.S. laws, including the federal securities laws or other foreign laws against us or our management.

Most of our current operations are conducted in China. Moreover, most of our directors and officers are nationals and residents of China. All or substantially all of the assets of these persons are located outside the United States and in the PRC. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon these persons. In addition, uncertainty exists as to whether the courts of China would recognize or enforce judgments of U.S. courts obtained against us or our officers and/or directors predicated upon the civil liability provisions of the securities law of the United States or any state thereof, or be competent to hear original actions brought in China against us or such persons predicated upon the securities laws of the United States or any state thereof.

The ability of our Chinese operating subsidiaries to pay dividends may be restricted due to foreign exchange control regulations of China.

The ability of our Chinese operating subsidiaries to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balance of the Chinese operating subsidiaries. Because substantially all of our operations are conducted in China and a majority of our revenues are generated in China, all of our revenue being earned and currency received are denominated in Renminbi (RMB). RMB is subject to the exchange control regulation in China, and, as a result, we may unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict our ability to convert RMB into US Dollars.

 

23

---

 

We will not be able to complete an acquisition of prospective acquisition targets in the PRC unless their financial statements can be reconciled to U.S. generally accepted accounting principles in a timely manner.

Companies based in the PRC may not have properly kept financial books and records that may be reconciled with U.S. generally accepted accounting principles. If we attempt to acquire a significant PRC target company and/or its assets, we would be required to obtain or prepare financial statements of the target that are prepared in accordance with and reconciled to U.S. generally accepted accounting principles. Federal securities laws require that a business combination meeting certain financial significance tests require the public acquirer to prepare and file historical and/or pro forma financial statement disclosure with the SEC. These financial statements must be prepared in accordance with, or be reconciled to U.S. generally accepted accounting principles and the historical financial statements must be audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), or PCAOB. If a proposed acquisition target does not have financial statements that have been prepared in accordance with, or that can be reconciled to, U.S. generally accepted accounting principles and audited in accordance with the standards of the PCAOB, we will not be able to acquire that proposed acquisition target. These financial statement requirements may limit the pool of potential acquisition targets with which we may acquire and hinder our ability to expand our retail operations. Furthermore, if we consummate an acquisition and are unable to timely file audited financial statements and/or pro forma financial information required by the Exchange Act, such as Item 9.01 of Form 8-K, we will be ineligible to use the SEC’s short-form registration statement on Form S-3 to raise capital, if we are otherwise eligible to use a Form S-3. If we are ineligible to use a Form S-3, the process of raising capital may be more expensive and time consuming and the terms of any offering transaction may not be as favorable as they would have been if we were eligible to use Form S-3.

RISKS RELATED TO THE PROPOSED ACQUISITION OF 60% EQUITY INTEREST IN CONNGAME

Because our current management has no experience in the development and operation of MMORPG, our business has a higher risk of failure.

Our current management has no professional training or technical credentials in the field of in the development and operation of MMORPG. As a result, they may not be able to recognize and take advantage of potential opportunities in the sector without the aid from the management of ConnGame.  Consequently our operations, earnings and ultimate financial success may suffer harm as a result.

Although we expect that the proposed acquisition will result in benefits to us, we may not realize those benefits because of integration difficulties and other challenges.

The success of the proposed acquisition of ConnGame will be dependent in large part on the success of our management in integrating the operations, technologies and personnel of the two companies. Our failure to meet the challenges involved in successfully completing the integration of the operations of ConnGame or to otherwise realize any of the anticipated benefits of the acquisition, including additional revenue opportunities, could impair our results of operations.

Challenges involved in this integration include, without limitation:

·

integrating successfully each company's operations, technologies, products and services;

 

·

reducing the costs associated with operations;

 

·

coordinating the publishing, distribution and marketing efforts to effectively promote the services and products of our combined company; and

 

·

combining the corporate cultures, maintaining employee morale and retaining key employees.

 

We may not successfully complete the integration of our operations and ConnGame in a timely manner and we may not realize the anticipated benefits of the proposed acquisition of ConnGame to the extent, or in the timeframe, anticipated. Anticipated benefits assume a successful integration and are based on projections, which are inherently uncertain, and other assumptions. Even if integration is successful, anticipated benefits may not be achieved.

 

24

---

 

Our proposed acquisition of ConnGame is subject to adverse tax consequences, including but not limited to the uncertainty under Circular on Strengthening the Administration of Enterprise Income Tax on Non-resident Enterprises' Share Transfer (“Circular 698”) released in December 2009 by China's State Administration of Taxation (SAT), effective as of January 1, 2008.

The recent introduction of Circular 698 increases the risk of a general anti avoidance tax challenge by the Chinese tax authority on indirect disposals of the shares in the underlying Chinese companies with a potential consequence of paying Chinese tax on the gain derived from such disposals.  Pursuant to Circular 698, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country (jurisdiction) where the effective tax burden is less than 12.5% or where the offshore income of her residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers.  Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through the abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the tax authority may re-assess the nature of the equity transfer in accordance with the “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes.

While the term "indirectly transfer" is not defined, we understand that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. The relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country (jurisdiction) and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. Meanwhile, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our proposed acquisition will comply with the Circular 698.  As a result, there is uncertainty as to whether the payment of our common stock for may be subject to tax liability or foreign exchange control in the PRC and there is a risk of unforeseen tax liability, each of which may have a material adverse effect to our financial condition and results of operations.

Through FirstJet, Mr. Jun Tang will become our largest shareholder and the Chairman of our Board of Directors, and the interests of First Jet and Mr. Jun Tang may conflict with the interests of our other shareholders.

As a result of the issuance of 25,000,000 shares to First Jet, it will become our largest shareholder and Mr. Jun Tang will have the ability to strongly influence the nominations of our board of directors and determine the outcome of certain matters submitted to our stockholders, such as the approval of significant transactions. As a result, actions that may be supported by a majority of other stockholders may be blocked by First Jet and Mr. Jun Tang.

If the proposed acquisition of ConnGame closes, we will issue 25,000,000 shares of common stock and our shareholders will suffer immediate and substantial dilution of their investment.

We intend to issue 25,000,000 shares of common stock upon the closing of the ConnGame acquisition in exchange for 60% of the equity ownership of ConnGame, which does not have substantial tangible assets.  As a result of the share issuance, our shareholders will suffer immediate and substantial dilution of their investment based on the adjusted net tangible book value of our company after the transaction.

The development of MMORPG products requires substantial up-front expenditures. We may not be able to recover development costs for our future MMORPG products.

Consumer preferences for games are usually cyclical and difficult to predict, and even the most successful titles remain popular for only limited periods of time, unless refreshed with new content. We will be required to continuously develop new products and enhancements to existing products. Because of the significant complexity of MMORPG games, these products require a longer development time and are more expensive to create than traditional console game products. In addition, the long lead time involved in developing a MMORPG product and the significant allocation of financial resources that each product requires means it is critical that we accurately predict consumer demand for new MMORPG products. If future MMORPG products do not achieve expected market acceptance or generate sufficient sales upon introduction, we may not be able to recover the development and marketing costs associated with new products, and our financial results could suffer.

The interactive entertainment industry is highly competitive and it will be difficult to obtain market share.

We expect to compete with other interactive entertainment gaming publishers. Those competitors vary in size from small companies with limited resources to very large corporations with significantly greater financial, marketing, and product development resources than we have. Certain of these competitors may spend more money and time on developing and testing products, undertake more extensive marketing campaigns, and adopt more aggressive pricing policies than we do.   Competition in the interactive entertainment industry is intense and we expect new competitors to continue to emerge.

We may be subject to intellectual property claims.

As the number of interactive entertainment products increases and the features and content of these products continue to overlap, software developers increasingly may become subject to infringement claims.  Our products often utilize complex technology that may become subject to emerging intellectual property rights of others. It is possible that third parties still may claim infringement.  From time to time, we receive communications from third parties regarding such claims. Existing or future infringement claims against us, whether valid or not, may be time consuming, distracting to management and expensive to defend.

 

25

---

 

Intellectual property litigation or claims could force us to do one or more of the following:

·

cease selling, incorporating, supporting or using products or services that incorporate the challenged intellectual property;

 

·

obtain a license from the holder of the infringed intellectual property, which if available at all, may not be available on commercially favorable terms; or

 

·

redesign the affected interactive entertainment software products or hardware peripherals, which could result in additional costs, delay introduction and possibly reduce commercial appeal of the affected products.

 

Any of these actions may harm our business and financial results.

Integrating and maintaining internal controls for the combined business may strain our resources and divert management's attention. If we fail to establish and maintain proper internal controls, our ability to produce accurate financial statements or comply with applicable regulations could be impaired.

ConnGame is currently not subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Sarbanes-Oxley Act of 2002 and the rules and regulations of any stock exchange. Upon the completion of the proposed acquisition and as a subsidiary of our company, ConnGame will be subject to such rules and regulations. As described in Item 9A of this Form 10-K, it was determined that we had material weaknesses in our internal control over financial reporting. Integrating and maintaining appropriate internal controls and procedures for the combined business will require specific compliance training of certain officers and employees, will entail substantial costs in order to modify existing accounting systems, and will take a significant period of time to complete.  We may not be able to demonstrate compliance with Section 404 of the Sarbanes-Oxley Act in a timely manner, or that our internal controls are perceived as inadequate, or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and our stock price could decline.

RISKS RELATED TO OUR SECURITIES AND RELATED REGULATIONS

Our stock price is volatile and you might not be able to sell your securities at or above the price you have paid.

Since our initial public offering and listing of our common stock in October 2007, the price at which our common stock had traded has been highly volatile, with a high and low sales price of $0.60 and $27.25, respectively, as through March 2, 2010.  On March 2, 2010, the closing trading price of our common stock was $1.04 per share.  You might not be able to sell the shares of our common stock at or above the price you have paid. The stock market has experienced extreme volatility that often has been unrelated to the performance of its listed companies. Moreover, only a limited number of our shares are traded each day, which could increase the volatility of the price of our stock. These market fluctuations might cause our stock price to fall regardless of our performance.

The market price of our Common Stock might fluctuate significantly in response to many factors, some of which are beyond our control, including, but not limited to, the following:

·

actual or anticipated fluctuations in our annual and quarterly results of operations;

 

·

variations in our operating results, which could cause us to fail to meet analysts’ or investors’ expectations;

 

·

conditions and trends in our industry and the economy;

 

·

future sales of equity or debt securities, including sales which dilute existing investors.

 

If our stock price decreases further, the Nasdaq Stock Market may delist our securities, which could limit investors’ ability to trade in our securities.

Nasdaq Listing Rule 5550(a)(2) (the “Rule”) requires that our common stock maintain a minimum bid price of $1.00 per share for 30 consecutive business days.  As of March 2, 2010, our stock price closed at $1.04.  If we do not meet the requirement, our securities may become subject to delisting.  If our common stock is delisted by Nasdaq, the trading market for our common stock would likely be adversely affected, as price quotations may not be as readily obtainable, which would likely have a material adverse effect on the market price of our common stock.

 

26

---

 

Shares eligible for future sale may adversely affect the market price of our common stock, as the future sale of a substantial amount of outstanding stock in the public marketplace could reduce the price of our common stock.

The market price of our Common Stock could decline as a result of sales of a large number of shares of our common stock in the market or the perception that these sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.  As of March 2, 2010, we had approximately 55.2 million shares of Common Stock outstanding, and approximately 25.3 million have been registered and/or are otherwise freely tradable without further restriction under the Securities Act of 1933, as amended, by persons other than our affiliates (within the meaning of Rule 144 under the Securities Act). In addition, we registered a total of 6.7 million shares of common stock that are issuable upon the conversion and exercise of outstanding bonds and warrants, based on the current conversion and exercise prices.   All of the shares included in an effective registration statement may be freely sold and transferred.

Our principal stockholder holds 24.2 million shares which may be sold subject to Rule 144. Under Rule 144, an affiliate stockholder who has satisfied a the required holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. As of December 31, 2009, 1% of our issued and outstanding shares of common stock was approximately 552,000 shares. Non-affiliate stockholders are not subject to volume limitations. Any substantial sale of common stock pursuant to any resale prospectus or Rule 144 may have an adverse effect on the market price of our Common Stock by creating an excessive supply.

Our principal stockholder has significant influence over us.

As of March 2, 2010, our largest shareholder, KGE Group Limited, or KGE Group, beneficially owns or controls approximately 43.7% of our outstanding shares.  Luo Ken Yi, who is our Chief Executive Officer and Chairman of the Board, and Ye Ning, who is our Vice General Manager, are directors of KGE Group. In addition, Luo Ken Yi and Ye Ning own approximately 70% and 10%, respectively, of KGE Group’s issued and outstanding shares.  As a result of its holding, KGE Group has controlling influence in determining the outcome of any corporate transaction or other matters submitted to our shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors, and other significant corporate actions. KGE Group also has the power to prevent or cause a change in control. In addition, without the consent of KGE Group, we could be prevented from entering into transactions that could be beneficial to us. The interests of KGE Group, and its control persons, may differ from the interests of our stockholders.

Upon completion of the proposed acquisition of ConnGame and the issuance of 25,000,000 shares to First Jet, it will become our largest stockholder and Mr. Jun Tang, who is First Jet’s sole shareholder and will be our Chairman of the Board upon the completion of the acquisition, will have the ability to strongly influence the nominations of our board of directors and determine the outcome of certain matters submitted to our stockholders, such as the approval of significant transactions. The interests of First Jet, and its control persons, may differ from the interests of our stockholders.

Our officers and directors have limited experience in public company reporting and financial accounting, which could impair our ability to satisfy public company filing requirements and increase our securities compliance costs.

Our officers and directors have limited experience as officers and directors of a publicly traded company, or in complying with the regulatory requirements applicable to a public company. As a result, we could have difficulty satisfying the regulatory requirements applicable to public companies, which could adversely affect the market for our common stock. At present, we rely upon outside experts to advise us on matters relating to financial accounting and public company reporting. While we believe that it will be possible to satisfy our public company reporting requirements through the use of third party experts, our general and administrative costs will remain higher to the extent our officers alone are not able to satisfy our public company reporting requirements.

If we fail to comply with Section 404 of the Sarbanes-Oxley Act Of 2002, our business could be harmed and our stock price could decline.

Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of our internal control over financial reporting, and attestation of this assessment by our company’s independent registered public accountants.  Last year’s annual report on Form 10-K for 2008 contained our first attestation requirement of management’s assessment by our independent registered public accountants.  The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. We may encounter problems or delays in completing activities necessary to make an assessment of our internal control over financial reporting.  Although we were not required to comply with the auditor attestation requirement  this year because we became a non-accelerated filer, we will have to comply with this requirement against next year for our 2010 annual report.  The attestation process by our independent registered public accountants is a relatively new process and we may encounter problems or delays in completing the implementation of any requested improvements and receiving an attestation of our assessment by our independent registered public accountants. If we cannot assess our internal control over financial reporting as effective, or our independent registered public accountants, when required, are unable to provide an unqualified attestation report on such assessment, investor confidence and share value may be negatively impacted.

 

27

---

 

As more fully discussed in Item 9A of this Form 10-K, management’s assessment of our internal control over financial reporting identified numerous material weaknesses that rendered our internal control over financial reporting to be ineffective as of December 31, 2009.  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 company’s annual or interim financial statements will not be prevented or detected on a timely basis.  Our material weaknesses include, but are not limited to, a lack of technical expertise and processes to ensure compliance with our policies in a major operating subsidiary, insufficient complement of personnel with an appropriate knowledge and skill to comply with our specific engineering financial accounting and reporting requirements and low materiality thresholds, and noncompliance with our authorization policy.  While we have implemented steps to remediate the identified deficiencies, as disclosed in Item 9A of this Form 10-K, there can be no guarantee that we will be successful in our attempts to correct our significant deficiencies. Our identified material weaknesses may raise concerns for investors and may have an adverse impact on the price of our common stock.

We do not foresee paying cash dividends in the foreseeable future.

We do not plan to declare or pay any cash dividends on our shares of common stock in the foreseeable future and we currently intend to retain any future earnings for funding growth. As a result, you should not rely on an investment in our securities if you require dividend income. Capital appreciation, if any, of our shares may be your sole source of gain for the foreseeable future. Moreover, you may not be able to sell your shares in our company at or above the price you paid for them.

ITEM 1B.  UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

We have offices and processing sites in Zhuhai, Shenzhen, Guangzhou, Shanghai, Beijing, Wuhan in China, a corporate office in Hong Kong, one in New York, U.S.A.. All buildings and land are leased. The leases end within 2010 and are under negotiation for renewal. The central office is in Zhuhai, where the majority of design and engineering staff are located. The Beijing and Shanghai offices have smaller design teams as well. All offices are also sales centers for the area.

 

Hong Kong
63rd Floor, Bank of China Tower, 1 Garden Road		577.7 square meters (office)
Central, Hong Kong
Zhuhai
105 Baishi Road, Jiuzhou West Avenue, Zhuhai, Guangdong		1,080 square meters (office)
		1,700 square meters (factory)
Beijing
1302, No.1 Baiyun Road, XiCheng District, Beijing		146 square meters (office)
Shanghai
Room 102, Building A Lane 521 (Hengchang Garden), Wanping South Road Xuhui District, Shanghai		120 square meters (office)
Shunde
No.5 Technology area, Xingtan town, Shunde district, Fo Shan City		5,600 square meters (office & factory)
Shenzhen
West Building 1302, Innovation and Technology Square II, Tain’an Cyber Park, Futian District, Shenzhen		390 square meters (office)]
28G, Yayunxuan, Shi Xia Bei San Jie, Futian District, Shenzhen		260 square meters (office)
Wuhan
Floor 38, No. 568 Jianshe road, Wu Han International Trade Center, Jianghan district, WuHan city		200 square meters (office)
Guangzhou
Room 702, Hui Xiang Ge, Xianglong Garden, No.175 Tianhe North Road, Tianhe District, Guangzhou City		137 square meters (office)

 

28

---

 

New York City, U.S.A 110 Wall St, 14th Floor, New York, NY 10005, USA

312 square meters (office)

ITEM 3. LEGAL PROCEEDINGS

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.

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.

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 Techwell, 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 guarantors 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 intends to vigorously pursue and 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, 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.

ITEM 4.  (REMOVED AND RESERVED)

 

29

---

 

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

From September 28, 2007 to June 9, 2008, our shares of common stock were listed for trading on the NYSE Amex under the ticket symbol “RCH.”  On June 10, 2008, our common stock commenced trading on the NASDAQ Global Select Market under the symbol "CAEI." As of March 2, 2010 we had approximately 80 stockholders of record. This number does not include an indeterminate number of stockholders whose shares are held by brokers in street name.

On March 2, 2010 the closing sales price for our common stock on the NASDAQ Global Select Market was $1.04 per share.

The following table summarizes the high and low sales prices of our common stock as reported by the NYSE Amex (on and prior to June 9, 2008) and NASDAQ (on and after June 10, 2008).

		High				Low
Year ended December 31, 2009
Fourth Quarter		$	1.79			$	0.92
Third Quarter		$	2.84			$	1.46
Second Quarter		$	2.47			$	0.89
First Quarter		$	2.60			$	0.60
Year ended December 31, 2008
Fourth Quarter		$	7.48			$	1.63
Third Quarter		$	9.97			$	5.08
Second Quarter		$	11.82			$	5.25
First Quarter		$	9.10			$	4.75

The price of our common stock will likely fluctuate in the future. The stock market in general has experienced extreme stock price fluctuations in the past few years.   Please see “Risk Factors—Our stock price is volatile and you might not be able to sell your securities at or above the price you have paid.”

 

30

---

 

Performance Stock Graph

 

September 28, 2007, the date of our initial listing on a national securities exchange, to the cumulative return over such period of The Nasdaq Stock Market Composite Index, and the Russell 2000 Index.  We do not use a published industry or line-of-business basis, and does not believe we could reasonably identify a different peer group. The graph assumes that $100 was invested on the date on which we completed the public offering of our common stock conducted with its initial listing on September 28, 2007 and in each of the comparative indices on the same date. The graph further assumes that such amount was initially invested in the common stock of our company at the price to which such stock was first offered to the public by our company on the date of our public offering price of $3.50 per share that was conducted in connection with our initial listing. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

COMPARISON OF CUMULATIVE TOTAL RETURN

AMONG CHINA ARCHITECTURAL ENGINEERING, INC.,

THE NASDAQ STOCK MARKET (U.S.) INDEX

AND THE RUSSELL 2000 INDEX

 

 

		9/28/07				12/31/07				3/31/08				6/30/08				9/30/08				12/31/08				3/31/09				6/30/09				9/30/09				12/31/09
China Architectural Engineering, Inc.		$	100			$	247.14			$	155.71			$	279.14			$	202.57			$	70.29			$	28.00			$	55.71			$	47.71			$	30.00
Nasdaq Stock Market (U.S.)		$	100			$	98.18			$	84.36			$	84.88			$	77.43			$	58.38			$	56.58			$	67.93			$	78.56			$	84.00
Russell 2000 Index		$	100			$	95.11			$	85.41			$	85.62			$	84.37			$	62.01			$	52.49			$	63.11			$	75.02			$	77.64

 

31

---

 

Dividend Policy

We do not expect to declare or pay any cash dividends on our common stock in the foreseeable future, and we currently intend to retain future earnings, if any, to finance the expansion of our business. The decision whether to pay cash dividends on our common stock will be made by our board of directors, in its discretion, and will depend on our financial condition, operating results, capital requirements and other factors that the board of directors considers significant.  We did not pay any cash dividends during 2009, 2008 and 2007.

The ability of our Chinese operating subsidiaries to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balance of the Chinese operating subsidiaries. Because substantially all of our operations are conducted in China and a majority of our revenues are generated in China, substantially all of our revenue being earned and currency received are denominated in Renminbi (RMB). RMB is subject to the exchange control regulation in China, and, as a result, we may unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict our ability to convert RMB into US Dollars.

Transfer Agent

The transfer agent and registrar for our common stock is Computershare Trust Company.

Equity Compensation Plan Information

Our equity compensation plan information is provided as set forth in Part III, Item 11.

Recent Sales of Unregistered Securities

None.

 

32

---

 

ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated statement of operations data for each of the years in the five-year period ended December 31, 2009 and the consolidated balance sheet data as of year-end for each of the years in the five-year period ended December 31, 2009 were derived from the audited consolidated financial statements. Such selected financial data should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements starting on page F-1 and with “Item 7 -  Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

		Year Ended December 31,
Consolidated Statements of Income		2009				2008				2007				2006				2005
		(in thousands, except share amounts and earnings per share)
Contract revenues earned		$	117,191			$	151,666			$	86,617			$	63,359			$	49,515
Cost of contract revenues earned			(94,722	)			(128,885	)			(64,354	)			(46,796	)			(36,368	)
Gross profit		$	22,469			$	22,781			$	22,263			$	16,563			$	13,146
Selling, general and administrative expenses			(21,087	)			(26,063	)			(5,525	)			(5,989	)			(6,463	)
Non-recurring general and administrative expenses			—				—				—				(3,806	)			—
Finance Expense			—				—				(208	)			—				—
Income/(Loss) from operations		$	1,382			$	(3,282	)		$	16,530			$	6,768			$	6,683
Interest income			58				1				108				—				—
Interest expense			(6,333	)			(4,377	)			(2,145	)			—				(117	)
Other income			177				1,922				88				700				501
Other expenses			(329	)			(161	)			(127	)			—				—
Income/(Loss) before taxation		$	(5,045	)		$	(5,897	)		$	14,455			$	7,468			$	7,068
Income tax			107				4				(2,422	)			(1,318	)			(1,157	)
Discontinued Operation Loss, net of tax			(1,901	)			—				—				—				—
Net Earnings/(Loss)			(6,839	)			(5,893	)			12,032				6,150				5,910
Net Loss attributable to non-controlling interest			33				20				—				—				—
Net income/(loss)		$	(6,806	)		$	(5,873	)		$	12,032			$	6,150			$	5,910
Basic and diluted net income/(loss) per common share			(0.13	)			(0.11	)			0.24				0.14				0.14
Basic and diluted dividend paid per common share			—				—				—				0.04				0.06
Basic weighted average common shares outstanding			53,256,874				52,034,921				50,357,454				44,679,990				43,304,125
Diluted weighted average common shares outstanding			53,256,874				52,034,921				51,088,144				44,679,990				43,304,125

 

		December 31,
Consolidated Balance Sheets		2009				2008				2007				2006				2005
		(in thousands)
Current Assets		$	135,667			$	127,607			$	84,988			$	43,821			$	21,712
Total Assets			146,560				141,538				95,737				44,861				22,320
Current Liabilities			77,324				66,770				39,313				21,784				14,016
Long-term Debt			24,673				25,237				3,910				2,565				-
Total Liabilities			101,997				92,017				43,272				24,349				14,016
Total Stockholders' Equity			44,563				49,521				52,465				20,513				8,304

 

33

---

 

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

Forward-Looking Statements

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. This report contains forward-looking statements. 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, general economic and business conditions, changes in foreign, political, social, and economic conditions, regulatory initiatives and compliance with governmental regulations, the ability to achieve further market penetration and additional customers, and various other matters, many of which are beyond our control. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated. 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

We were incorporated in the state of Delaware on March 16, 2004. We were originally organized as a “blank check” shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. On October 17, 2006, we closed a share exchange transaction described below, pursuant to which we (i) became the 100% parent of Full Art International, Ltd., a Hong Kong company (“Full Art”), which has four subsidiaries, including the wholly-owned subsidiary, Zhuhai King Glass Engineering Co., Ltd., a company formed under the laws of the People’s Republic of China (“PRC” or “China”), (ii) assumed the operations of Full Art and its subsidiaries and (iii) changed our name from SRKP 1, Inc. to China Architectural Engineering, Inc. Full Art was incorporated in Hong Kong on July 30, 1992 under the Companies Ordinance of Hong Kong.

Domestic (China) and International Construction

We have traditionally specialized in high-end curtain wall systems (including glass, stone and metal curtain walls), roofing systems, steel construction systems, eco-energy saving building conservation systems and related products, for public works and commercial real estate projects.   We compete on the strength of our reputation, relationships with government and commercial clients, and our ability to give expression to the vision of leading architects.

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.

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.

 

34

---

 

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.

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.

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.

 

35

---

 

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.

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.

Nine Dragon Project

In May 2009, we entered into a Framework Agreement to undertake several large scale constructions of projects at the Zhejiang Nine Dragon Holiday Resort in China. Pursuant to the terms of the Framework Agreement, the projects are to include the construction of a marine park, playland, movie city and hotel.  In July 2009, we entered into a Letter of Intent of Land Transfer with the affiliates of Shanghai Nine Dragon, and we agreed to sell 17 million shares of our common stock to affiliates of Nine Dragon, with the related proceeds being used as the working capital for the construction of Nine Dragon Project. However, the affiliates attempted to renegotiate the use of proceeds to instead be used for the purchase the apartments of Nine Dragon. Such request was rejected by our board of directors and majority of the stockholders, and as a result, the transaction was not completed. We actively maintain communication with Shanghai Nine Dragon, endeavoring to obtain the design and construction work contracts of the project.

Shenzhen Office Relocation

In September 2009, our Shenzhen office was downsized and moved out from the leasehold multi-floor office building to a smaller leased place at minimal operations. The move was a result from our recent restructure and reorganization to turn back to the domestic market in China instead of overseas market due to the recent change in international economic environments. The set up of the Shenzhen office was originally for the support of the overseas operations which now we decided to be discontinued.  As a result, the current improvement works to the leasehold multi-floor office building were stopped and being written off in the period under this report as discontinued operation loss of $1.9 million.

Critical Accounting Policies, Estimates and Assumptions

Management’s discussion and analysis of results of operations and financial condition are based upon our consolidated financial statements. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require management to make certain estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. The most significant estimates and assumptions include provisions for income taxes, allowance for doubtful accounts, and the recoverability of the long-lived assets. Actual results could differ from these estimates. Periodically, we review all significant estimates and assumptions affecting the financial statements and record the effect of any necessary adjustments.

 

36

---

 

The following critical accounting policies rely upon assumptions and estimates and were used in the preparation of our consolidated financial statements:

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 cost incurred to date to the estimated total cost for each contract. The revenue earned in a period is based on the ratio of costs incurred to the total estimated costs required by the 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. 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 recognized. The measurement of the extent of progress toward completion are used to determine the amount of gross profit earned to date; the earned revenue to date is the sum of the total cost incurred on the contract and the amount of gross profit earned.

Earned revenue, cost of earned revenue, and gross profit are determined as follows:

i. 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.

ii. 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.

iii. 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.

Selling, General, And Administrative Costs – Selling, general, and administrative costs are charged to expense as incurred. Allowances 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.

Contract Receivable – Contract receivable represents billings to customers on the percentage of work completed and recognized to date based on contract price. An allowance is provided for doubtful collections which is based upon a review of outstanding receivables, historical collection information, and existing economic conditions. We record an allowance for doubtful collections for our outstanding contract receivable at the end of the period in accordance with generally accepted accounting principles in the United States, and we consider that allowance to be reasonable at December 31, 2009, 2008, and 2007.  As of December 31, 2009, our provision for doubtful accounts was $6.6 million, which was 6.9% of our construction contract related receivables of $95.8 million.

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. Our current components of other comprehensive income are the foreign currency translation adjustment.

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.

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.

 

37

---

 

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. For goodwill and other intangible assets, impairment tests are performed annually and more frequently whenever events or changes in circumstances indicate goodwill carrying values exceed estimated reporting unit fair values. 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.  Based on the impairment tests performed, there was no impairment of goodwill or other intangible assets in fiscal 2009, 2008 and 2007.

Foreign Currency Translation – The consolidated financial statements are presented in United States Dollars (US$). Our functional currency is the US$, while domestic subsidiaries’ use the Renminbi (RMB) and Hong Kong and overseas subsidiaries use local currencies as their functional currencies.  The consolidated financial statements are translated into United States dollars from RMB, HKD, MOP and AED at year-end 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. 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 USD at the rates used in translation.

Statutory Reserves – Surplus reserves for foreign investment enterprises are referring to the amount appropriated from the net income in accordance with PRC 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.

Results of Operations

The following table sets forth our consolidated statements of income for the years ended December 31, 2009, 2008 and 2007 in U.S. dollars:

		Year Ended December 31,
		2009				2008				2007
		(in thousands, except share amounts and earnings per share)
Contract revenues earned		$	117,191				151,666				86,617
Cost of contract revenues earned			(94,721	)			(128,885)				(64,354)
Gross profit		$	22,469				22,781				22,263
Selling, general and administrative expenses			(21,087)				(26,063)				(5,525)
Non-recurring general and administrative expenses			—				—				—
Finance Expense			—				—				(208)
Income/(Loss) from operations		$	1,382				(3,282)				16,530
Interest income			58				1				108
Interest expense			(6,333)				(4,377)				(2,145)
Other income			177				1,922				88
Other expenses			(329)				(161)				(127)
Income/(Loss) before taxation		$	(5,046)				(5,897)				14,455
Income tax			107				4				(2,422)
Discontinued Operation Loss, net of tax			(1,901)				—				—
Net Earnings/(Loss)			(6,839)				(5,893)				12,032
Net Loss attributable to non-controlling interest			33				20				—
Net Earnings/(Loss) attributable to the Company		$	(6,806)				(5,873)				12,032
Basic and diluted net income/(loss) per common share			(0.13)				(0.11)				0.24
Basic weighted average common shares outstanding			53,256,874				52,034,921				50,357,454
Diluted weighted average common shares outstanding			53,256,874				52,034,921				51,088,144

 

 

38

---

 

Years ended December 31, 2009 and 2008

Contract revenues earned for the year ended December 31, 2009 were $117.2 million, a decrease of $34.5 million, or 23%, from the contract revenues earned of $151.7 million for the comparable period in 2008. The primary reasons for the decrease in contract revenues earned were due to major international projects entering the completion phase from which project revenue was declining, such as the Metro Red Line Project in Dubai as well as projects in Doha and New York.  During 2009, we completed approximately 37 projects, with our three largest projects being the Dubai Metro Red Line, Guangdong Science City Headquarter Phase I, and Doha High Rise Office Tower, which accounted for approximately 43.2 %, 9.2 % and 7.0% of our contract revenues, respectively, for the year ended December 31, 2009.  We do not expect to engage in international projects in 2010.

Cost of contract revenues earned for the year ended December 31, 2009 was $94.7 million, a decrease of $34.2 million, or 27%, from $128.9 million for the comparable period in 2008. Cost of contract revenues earned consists of raw materials, labor and other operating costs related to contract performance. The decrease in costs of contract revenues earned was primarily due to a decrease in revenue in 2009.  As a percentage of contract revenues, cost of contract revenues was approximately 80.8% for the year ended December 31, 2009, as compared to 85.0% for the same period in 2008.  The decrease in cost of contract revenues as a percentage of revenues was primarily due to various costs control and cutting measures taken in 2009, such as the downsizing of our Shenzhen office.

Gross profit for the year ended December 31, 2009 was $22.5 million, a decrease of $0.3 million, or 1%, from $22.8 million for the comparable period of 2008. Our gross margin for the year ended December 31, 2009 was 19.2% as compared with 15.0% for the year ended December 31, 2008. The increase was primarily a result the costs controlling and cutting measures taken place in the fourth quarter of 2009, including the downsizing of the design and engineering team and reduction of project site-staffing.

Selling, general and administrative expenses mainly consists of staffing related costs, rental charges for offices and equipments, office administrative expenditures, business travel expenses, and depreciation charges. Selling, general and administrative expenses were $21.1 million for the year ended December 31, 2009, a decrease of approximately $5.0 million, or 19%, from $26.1 million for the comparable period in 2008. The decrease was primarily a result of our operational contraction in the fourth quarter of 2009, including a reduction in staffing, office rental and other costs savings associated with curtailing of overseas operations during 2009.

Interest expenses and finance expenses were approximately $6.3 million for the year ended December 31, 2009, an increase of approximately $1.9 million, from $4.4 million for the comparable period in 2008. The increase was primarily due to the additional interest expense for the full year 2009 related to the $20 million convertible bonds that we issued April 2008. The interest expenses related to convertible bonds were $5.9 million, $2.9 million and $1.1 million for the year ended December 31, 2009, 2008 and 2007 respectively.

Income tax benefit was $107,000 in 2009, compared with $4,000 for the year ended December 31, 2008. The primary reason for the decrease in tax was due to the zero corporate income tax rate associated with revenues from the Dubai project, our largest ongoing project during the year 2009 and the deferred tax benefit of a subsidiary, Techwell Engineering Ltd.

Net loss for the year ended December 31, 2009 was $6.8 million, as compared to net income of $5.9 million in 2008.

Years Ended December 31, 2008 and 2007

Contract revenues earned for the year ended December 31, 2008 were $151.7 million, an increase of $65.1 million, or 75%, from the contract revenues earned of $86.6 million for the comparable period in 2007. The primary reason for the increase in contract revenues earned was an increase in the number and size of projects for the year ended December 31, 2008 due to our rapid expansion into the overseas market, such as Dubai and New York.

Cost of contract revenues earned for the year ended December 31, 2008 was $128.9 million, an increase of $64.5 million, or 100%, from $64.4 million for the comparable period in 2007. Cost of contract revenues earned consists of raw materials, labor and other operating costs related to contract performance. The increase in costs of contract revenues earned was primarily due to the increased number and size of projects for the year ended December 31, 2008.   Our cost of contract revenues grew at a faster rate than our contract revenues primarily due to the increase in costs of raw materials, project set-up costs, and labor costs.

Gross profit for the year ended December 31, 2008 was $22.8 million, an increase of $0.5 million, or 2%, from $22.3 million for the comparable period of 2007. Our gross margin for the year ended December 31, 2008 was 15.0% as compared with 25.7% for the year ended December 31, 2007. The decrease was primarily a result of higher raw material, project set-up costs, and labor costs, especially in our domestic market of China.

Selling, general and administrative expenses were $26.1 million for the year ended December 31, 2008, an increase of approximately $20.6 million, or 375%, from $5.5 million for the comparable period in 2007. The increase was primarily due to our operational expansion, including the growth in staff, office rental and other start-up costs associated with the expansion of our overseas operations during 2008. Techwell, which we acquired in November 2007, contributed approximately half to the increase in the expenses.   In addition, there was $5 million bad debt provision recorded in 2008 as a result of global slowdown.

 

39

---

 

Interest expenses and finance expenses were approximately $4.4 million for the year ended December 31, 2008, an increase of approximately $2.0 million, from $2.4 million for the comparable period in 2007. The increase was primarily due to our issuance of $20 million convertible bonds in April 2008.

Income tax benefit was $4,000 in 2008, compared with expenses of $2.4 million for the year ended December 31, 2007. The primary reason for the decrease was due to the zero corporate income tax rate associated with revenues from the Dubai project, our largest ongoing project during the year 2008.

Net loss for the year ended December 31, 2008 was $5.9 million, as compared to net income of $12.03 million in 2007.

Liquidity and Capital Resources

At December 31, 2009, we had cash and cash equivalents of $0.7 million.

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 a share exchange transaction, 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.

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.

 

40

---

 

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 December 31, 2009.

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 5.832% and interest rate adjusts every 6 months. We did not have any amount outstanding as of December 31, 2009.

Full Art International Limited incurred an automobile capital lease obligation due November 09, 2012 that had an outstanding amount of $186,349 as of December 31, 2009.

We also lease certain administrative and production facilities from third parties. Accordingly, for the years ended December 31, 2009 and 2008, we incurred rental expenses of $3,254,251 and $1,602,501, respectively.

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 December 31, 2009, the facility is fully utilized.

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 December 31, 2009, 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$10,218,978).  On September 30, 2009, the facility was amended to allow Open Account Financing – Accounts Receivable against invoices from acceptable buyers up to RMB21,000,000 and Open Account Financing and Overdraft in Current Account up to RMB16,800,000.  ABN AMRO requires irrevocable and unconditional guarantee from us and cash collateral of 20% of bank’s acceptance bill issued. and Open Account Financing.  As of December 31, 2009, Zhuhai KGE utilized RMB nil (US$ nil) of Bank Accepted Draft and RMB 33.6 million (US$4.9 million) of Overdraft 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 December 31, 2009, 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. In contrast, 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.

 

41

---

 

We experienced a decrease of revenue of $34.5 million for the year ended December 31, 2009 compared to an increase of $65.1 million for the same period in 2008. Construction contract related receivables, including contract receivables and costs and earnings in excess of billings as of December 31, 2009 were $97.3 million, an increase of $9.5 million, over construction contract related receivables of $87.8 million as of December 31, 2008. 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.

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 are currently involved in six lawsuits in which we are suing other parties for overdue payments. The total amount involved is approximately $3.2 million.  We have decided to record a general provision for doubtful accounts amounting to $1.4 million in 2009, which management believes is commensurate to cover the associated credit risk in the portfolio of our construction contract related receivables.  As of December 31, 2009, our provision for doubtful accounts was $6.6 million, which was 6.9% of our construction contract related receivables of $95.8 million.  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 December 31, 2009, 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 used in operating activities for the year ended December 31, 2009 was approximately $21.2 million, as compared to $3.0 million used in the same period in 2008. The change is primarily due to the significant increase in payables in year of 2008, which did not occur in fiscal 2009. The increase in payables in fiscal 2008 consisted of a $10.1 million increase in notes payables and a $16.8 million increase in trade payable as result of the business expansion.  Net cash used in operating activities for the year ended December 31, 2008 was $3.0 million, as compared to $15.5 million used in the same period in 2007. The change is primarily due to the significant increase in payables, including the $10.1 million increase in notes payables, financing the business expansion in year of 2008.

Net cash provided by investing activities was approximately $4.2 million for the year ended December 31, 2009 compared to approximately $10.7 million used by investing activities for the year ended December 31, 2008. The change was mainly a result of the decrease in restricted cash in 2009, which resulted primarily from the release of $5.0 million fixed deposits that were pledged in 2008 for the issuance of advance and performance bonds for Dubai projects to repay the drawdown of the bonds by the client in 2009, in addition to purchases of plant and equipment in 2008 that included $2.2 million for the leasehold improvement and equipments of Shenzhen.  Net cash used by investing activities was approximately $10.7 million for the year ended December 31, 2008 compared to approximately $1.1 million provided for the year ended December 31, 2007. The change was mainly a result of the increases of restricted cash and purchases of plant and equipment in 2008 as indicated above.

Net cash provided by financing activities was $8.3 million for the year ended December 31, 2009 compared to $16.4 million provided for year ended December 31, 2008. The change was primarily a result of the $19.5 million received from the issuance of convertible bonds and warrants in 2008, $9.5 million proceeds from short-term loans in 2009 which mainly represents $4.9 million bank overdraft financing the material purchases, and $4.5 million outstanding balance of the advance and performance bonds drawdown by the client of projects in Dubai, $10.2 million repayments of notes payables and $9.2 million proceeds from shareholders both in 2009.  Net cash provided by financing activities was $16.4 million for the year ended December 31, 2008 compared to $14.9 million provided for the year ended December 31, 2007. The increase was primarily a result of the differences in the proceeds received from the issuance of convertible bonds and warrants, receipt from public offering, proceeds from shareholder and repayment long-term loans among the two years.

 

42

---

 

Contractual obligations

The following table describes our contractual commitments and obligations as of December 31, 2009:

 

		Payments due by period
		Total				Less than 1 year				1-3 years				3-5 years				More than 5 years
Operating Lease Obligations		$	1,063,043				1,063,043				-				-				-
Contingent Liabilities (1)		$	5,331,411			$	5,331,411			$	-			$	-			$	—
Long-term debt (2)		$	24,673,400				-				24,673,400				-				-

(1)           Includes the $3,500,000 standby guarantee expiring May 2, 2010 issued by ABN AMRO Bank N.V. and $1,831,411 performance bond expiring June 30, 2010 issued by HSBC.

(2)           Includes the $8 million convertible bond which is required to be redeemed at 150.87% at maturity at April 4, 2012, which may also be converted into our common stock at a current conversion price of $2.45 per share, accordingly we may re-classify upon conversion, if any. Also includes the $20 million convertible bond which is required to be redeemed at 116.61% at maturity at April 15, 2011, which may be converted into our common stocks at a current conversion price of $6.35 per share, accordingly we may re-classify upon conversion, if any.

Quarterly Information

The table below presents selected results of operations for the quarters indicated.  All amounts are in thousands, except share and per share amounts.

		Quarter Ended
		December 31, 2009				September 30, 2009				June 30, 2009				March 31, 2009				Total
Contract revenues earned		$	24,691			$	25,558			$	30,599			$	36,343			$	117,191
Income / (loss) from operations			394				(5,074)				3,832				2,230				1,382
Net earnings (loss)			(1,913)				(8,381)				2,544				944				(6,806)
Net earnings / (loss) per share:
Basic and Diluted			(0.04)				(0.16)				0.05				0.02				(0.13)

 

		Quarter Ended
		December 31, 2008				September 30, 2008				June 30, 2008				March 31, 2008				Total
Contract revenues earned		$	28,959			$	55,978			$	41,380			$	25,349			$	151,666
Income / (loss) from operations			(28,589)				11,110				8,752				5,445				(3,282)
Net earnings (loss)			(28,586)				9,910				7,629				5,174				(5,873)
Net earnings / (loss) per share:
Basic			(0.51)				0.19				0.15				0.10				(0.11)
Diluted			(0.51)				0.18				0.14				0.09				(0.11)

Segment Information

We have one reportable segment that conducts business in the following geographic regions. All amounts are in thousands.

Revenues

		For the year ended December 31,
		2009				2008				2007
For the year ended December 31
Middle East		$	58,685			$	64,929			$	-
Asia			51,979				83,505				86,617
United States			6,527				3,232				-
Total		$	117,191			$	151,666			$	86,617

 

43

---

 

Long-lived assets

		Middle East				Asia				United States				Total
As of December 31, 2009
Plant and equipment, net		$	384			$	2,026			$	130			$	2,540
Intangible assets			-				71				-				71
Goodwill			-				7, 996				-				7, 996
Other non-current assets			161				95				31				287
Total		$	545			$	10,188			$	161			$	10,894
As of December 31, 2008
Plant and equipment, net		$	488			$	5,187			$	177			$	5,852
Intangible assets			-				51				-				51
Goodwill			-				7,996				-				7,996
Other non-current assets			-				1				31				32
Total		$	488			$	13,235			$	208			$	13,931

Off-Balance Sheet Arrangements

None.

New Accounting Pronouncements

See Note 2(u) of the accompanying audited consolidated financial statements included in this Form 10-K for a discussion of recent accounting pronouncements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Credit Risk

We are exposed to credit risk from our cash at bank, fixed deposits and contract receivables. The credit risk on cash at bank and fixed deposits is limited because the counterparts are recognized financial institutions. Contract receivables are subject to credit evaluations. We periodically record a provision for doubtful collections based on an evaluation of the collectability of contract receivables by assessing, among other factors, the customer’s willingness or ability to pay, repayment history, general economic conditions and our ongoing relationship with the customers. We are currently involved in six lawsuits in which we are suing other parties for overdue payments. The total amount involved is US$3,201,424.  We decided to record a general provision for doubtful accounts amounting to $1.4 million in 2009, which management believes is commensurate to cover the associated credit risk in the portfolio of our construction contract related receivables.  As of December 31, 2009, our provision for doubtful accounts was $6.6 million, which was 6.9% of our construction contract related receivables of $95.8 million. 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.

Foreign Currency Risk

The Company’s functional currency is United States Dollar (USD), while certain domestic subsidiaries use Renminbi (RMB) and Hong Kong and oversea subsidiaries’ use local currencies as their functional currency.    The majority of our operations are conducted in the PRC. Substantially all of our sales and purchases are conducted within the PRC in RMB. Conversion of RMB into foreign currencies is regulated by the People’s Bank of China through a unified floating exchange rate system. Although the PRC government has stated its intention to support the value of the RMB, there can be no assurance that such exchange rate will not again become volatile or that the RMB will not devalue significantly against the U.S. dollar. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from our operations in the PRC. In addition, the RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.

Country Risk

A substantial portion of our business, assets and operations are located and conducted in China. While China’s economy has experienced significant growth in the past twenty years, growth has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall economy of China, but may also have a negative effect on us. For example, our operating results and financial condition may be adversely affected by government control over capital investments or changes in tax regulations applicable to us. If there are any changes in any policies by the Chinese government and our business is negatively affected as a result, then our financial results, including our ability to generate revenues and profits, will also be negatively affected.

 

44

---

 

 

 

49

---

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Zhuhai, People’s Republic of China, on March 3, 2010

China Architectural Engineering, Inc.

/s/  Luo Ken Yi

Luo Ken Yi

Chief Executive Officer and Chairman of the Board

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

SIGNATURE		TITLE		DATE
/s/  Luo Ken Yi		Chief Executive Officer and Chairman of the Board (Principal Executive Officer)		March 3, 2010
Luo Ken Yi
/s/  Gene Michael Bennett		Acting Chief Financial Officer (Principal Financial and Accounting Officer)		March 3, 2010
Gene Michael Bennett
/s/  Tang Nianzhong		Vice General Manager and Director		March 3, 2010
Tang Nianzhong
/s/  Zheng Jinfeng		Director		March 3, 2010
Zheng Jinfeng
/s/  Zhao Bao Jiang		Director		March 3, 2010
Zhao Bao Jiang
/s/  Kelly Wang		Director		March 3, 2010
Kelly Wang
		Director
Miu Cheung
/s/  Chia Yong Whatt		Director		March 3, 2010
Chia Yong Whatt

 

50

---

 

 

F-19

---

 

CHINA ARCHITECTURAL ENGINEERING, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

(Stated in US Dollars)

 

3.	CONTRACT RECEIVABLES

 

		December 31, 2009				December 31, 2008
Contract receivables		$	95,831,489			$	77,027,328
Less: Allowance for doubtful accounts			(6,642,386	)			(5,215,701	)
Net		$	89,189,103			$	71,811,627

 

Allowance for Doubtful Accounts		December 31, 2009				December 31, 2008
Beginning balance		$	5,215,701			$	215,701
Add: Allowance created			1,426,685				5,000,000
Ending balance		$	6,642,386			$	5,215,701

 

 

F-20

---

 

CHINA ARCHITECTURAL ENGINEERING, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

(Stated in US Dollars)

 

4.	OTHER RECEIVABLES