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EX-31.1 - China Architectural Engineering, Inc.v185860_ex31-1.htm
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EX-31.2 - China Architectural Engineering, Inc.v185860_ex31-2.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File Number
001-33709

CHINA ARCHITECTURAL ENGINEERING, INC.
(Exact name of small business issuer as specified in its charter)

Delaware
(State or other jurisdiction of incorporation
or organization)
 
51-05021250
(I.R.S. Employer Identification
No.)
     
105 Baishi Road, Jiuzhou West Avenue,
Zhuhai, People’s Republic of China
(Address of principal executive offices)
 
519070
(Zip Code)

0086-756-8538908
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x     No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  o     No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer  ¨
Accelerated filer  ¨
Non-accelerated filer  x
Smaller reporting company  ¨
   
(Do not check if a smaller
 
   
reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No  x

There were 55,156,874 shares outstanding of registrant’s common stock, par value $0.001 per share, as of May 14, 2010.

 
 

 

CHINA ARCHITECTURAL ENGINEERING, INC.
FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS

 
Page
PART I - FINANCIAL INFORMATION
3
     
ITEM 1.
FINANCIAL STATEMENTS
3
     
 
Consolidated Balance Sheet as of March 31, 2010 (unaudited) and December 31, 2009
5
     
 
Unaudited Interim Consolidated Statements of Income for the three months ended March 31, 2010 and 2009
6
     
 
Unaudited Interim Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and 2009
7
     
 
Unaudited Consolidated Statements of Stockholders’ Equity from January 1, 2010 to March 31, 2010
8
     
 
Notes to the Unaudited Interim Consolidated Financial Statements
9
     
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
29
     
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
38
     
ITEM 4.
CONTROLS AND PROCEDURES
38
     
PART II - OTHER INFORMATION
41
     
ITEM 1.
LEGAL PROCEEDINGS
41
     
   ITEM 1A.
RISK FACTORS
41
     
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
42
     
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
42
   
 
ITEM 4.
REMOVED AND RESERVED
42
     
ITEM 5.
OTHER INFORMATION
42
     
ITEM 6.
EXHIBITS
42
     
SIGNATURES
43

 
2

 
 
PART I - FINANCIAL INFORMATION

ITEM 1.         FINANCIAL STATEMENTS

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying unaudited financial statements reflect all adjustments that, in the opinion of management, are considered necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The accompanying unaudited financial statements should be read in conjunction with the audited financial statements of China Architectural Engineering, Inc. as contained in its Annual Report for the fiscal year ended December 31, 2009 on Form 10-K, as filed with the Securities and Exchange Commission on March 4, 2010, and as amended by Amendment No.1 on April 30, 2010 and Amendment No.2 on May 14, 2010.

 
3

 

CHINA ARCHITECTURAL ENGINEERING, INC.

CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2010 (UNAUDITED) AND DECEMBER 31, 2009
(STATED IN US DOLLARS)

   
Note
   
March 31, 2010
   
December 31,
2009
 
         
(unaudited)
       
ASSETS
                 
Current assets
                 
Cash and cash equivalents
        $ 497,348     $ 740,125  
Restricted cash
          2,024,080       3,033,819  
Contract receivables, net
 
(3)
      88,281,494       89,189,103  
Costs and earnings in excess of billings
            10,193,454       8,100,580  
Job disbursements advances
            1,957,233       2,696,794  
Other receivables
 
(4)
      25,821,226       30,768,067  
Inventories
 
(5)
      162,346       727,499  
Deferred income taxes, current
            112,893       113,033  
Other current assets
            497,884       297,838  
Total current assets
            129,547,958       135,666,858  
                         
Non-current assets
                       
Plant and equipment, net
 
(6)
      2,361,334       2,539,457  
Intangible assets
 
(7)
      59,987       70,610  
Goodwill
            7,995,896       7,995,896  
Other non-current asset
            36,424       287,586  
                         
TOTAL ASSETS
          $ 140,001,599     $ 146,560,407  
                         
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
Current liabilities
                       
Short-term bank loans
 
(8)
    $ 7,856,554     $ 9,529,880  
Accounts payable
            25,873,394       26,614,484  
Billings over costs and estimated earnings
            5,346,341       6,098,666  
Amount due to shareholder
            3,504,156       10,080,345  
Other payables
            9,864,960       9,360,314  
Business and other taxes payable
            4,734,098       4,923,771  
Customers’ deposits
            8,097,324       6,392,676  
Other Accrual
            6,034,195       4,324,011  
Total current liabilities
            71,311,022       77,324,147  

The accompanying notes are an integral part of these financial statements.

 
4

 

CHINA ARCHITECTURAL ENGINEERING, INC.

CONSOLIDATED BALANCE SHEETS (Continued)
AS OF MARCH 31, 2010 (UNAUDITED) AND DECEMBER 31, 2009
(STATED IN US DOLLARS)

   
Note
   
March 31,
2010
   
December 31,
200
9
 
         
(unaudited)
       
Non-current liabilities
                 
Long term bank loans
 
(8)
    $ 89,850     $ 109,239  
Convertible bond payable, net
 
(9)
      25,475,167       24,564,161  
                         
TOTAL LIABILITIES
          $ 96,876,039     $ 101,997,547  
                         
STOCKHOLDERS’ EQUITY
                       
Preferred stock, $0.001 par value, 10,000,000 shares authorized, 0 shares issued and outstanding at March 31, 2009 and December 31, 2009; Common stock, $0.001 par value, 100,000,000 shares authorized, 55,156,874 and 53,256,874 shares issued and outstanding at March 31, 2009 and December 31, 2009, respectively
          $ 55,157     $ 53,257  
Additional paid in capital
            28,458,440       26,495,876  
Statutory reserves
            3,040,595       3,040,595  
Accumulated other comprehensive income
            3,986,558       3,868,437  
Retained earnings
            7,609,728       11,131,084  
Total Company shareholders’ equity
            43,150,478       44,589,249  
Noncontrolling interests
            (24,918 )     (26,389 )
Total shareholders’ equity
            43,125,560       44,562,860  
TOTAL LIABILITIES AND
                       
STOCKHOLDERS’ EQUITY
          $ 140,001,599     $ 146,560,407  

The accompanying notes are an integral part of these financial statements.

 
5

 

CHINA ARCHITECTURAL ENGINEERING, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE-MONTH PERIODS ENDED MARCH 31, 2010 AND 2009
(STATED IN US DOLLARS)

         
Three Months Ended March 31,
 
   
Note
   
2010
   
2009
 
                   
                   
Contract revenues earned
 
(10)
    $ 11,472,123     $ 36,343,064  
                         
Cost of contract revenues earned
            (9,144,193 )     (28,162,233 )
                         
Gross profit
          $ 2,327,930     $ 8,180,831  
                         
Selling, general and administrative expenses
            (4,175,480 )     (5,951,030 )
Finance expenses
            (47,201 )     -  
                         
Income / (Loss) from operations
          $ (1,894,751 )   $ 2,229,801  
                         
Interest income
            2,416       3,706  
Interest expense
            (1,626,111 )     (1,311,733 )
Other income
            7,514       21,837  
Other expenses
            (849 )     -  
                         
Income/(Loss) before taxation on Continuing Operations
          $ (3,511,781 )   $ 943,611  
                         
Income tax / tax benefit
 
(11)
      9,575       -  
Net earnings/(Loss) including non-controlling interest
            (3,521,356 )     943.611  
                         
Loss attributable to non-controlling interests
            1,471       -  
                         
Net earnings/(Loss) attributable to the Company
          $ (3,519,885 )   $ 943,611  
                         
Earnings per share:
                       
Basic
          $ (0.06 )   $ 0.02  
Diluted
          $ (0.06 )   $ 0.02  
                         
Weighted average shares outstanding:
                       
Basic
            54,729,908       53,256,874  
Diluted
            54,729,908       53,256,874  

The accompanying notes are an integral part of these financial statements.

 
6

 

CHINA ARCHITECTURAL ENGINEERING, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE-MONTH PERIODS ENDED MARCH 31, 2010 AND 2009
(STATED IN US DOLLARS)
 
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Cash flows from operating activities
           
Net income/(loss)
  $ (3,521,356 )   $ 943,611  
Noncontrolling interest
    1,471       -  
Depreciation expense
    178,043       252,852  
Bad debt expense
    193,753       -  
Amortization expense on intangible assets
    10,623       22,000  
Stock compensation expenses
    1,964,464       -  
Amortization expense on convertible bond
    911,006       674,087  
Loss/(Gain) on disposal of fixed assets
    519       (11,450 )
Deferred income taxes
    -       3,264  
Decrease in inventories
    565,153       17,441  
Decrease in receivables
    3,567,823       16,848,651  
Decrease in other assets
    790,817       980  
Increase/(decrease) in payables
    2,236,390       (14,489,451 )
Net cash provided by operating activities
  $ 6,898,706     $ 4,261,985  
                 
Cash flows from investing activities
               
Purchases of assets
  $ (439 )   $ (64,262 )
Proceeds from disposal of fixed assets
    -       76,190  
Decrease in restricted cash
    1,009,739       1,320,226  
Net cash provided by investing activities
  $ 1,009,300     $ 1,332,154  
                 
Cash flows from financing activities
               
Repayment of short-term loans
  $ (1,673,326 )   $ (4,542,187 )
Repayment of long-term loans
    (19,389 )     (73,434 )
Repayment of shareholder loans
    (6,576,189 )     (1,952,809 )
Net cash used in financing activities
  $ (8,268,904 )   $ (6,568,430 )
                 
Net decrease in cash and cash equivalents
  $ (360,898 )   $ (974,291 )
Effect of foreign currency translation on cash and cash equivalents
    118,121       257,501  
                 
Cash and cash equivalents - beginning of period
    740,125       9,516,202  
                 
Cash and cash equivalents - end of period
  $ 497,348     $ 8,799,412  
                 
Other supplementary information:
               
Cash paid during the period for:
               
Interest paid
  $ 1,260,000     $ 120,000  
Income tax paid
  $ -     $ 21,151  

 The accompanying notes are an integral part of these financial statements.

 
7

 

CHINA ARCHITECTURAL ENGINEERING, INC.
UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
FOR THE PERIOD FROM JANUARY 1, 2010 TO MARCH 31, 2010
(STATED IN US DOLLARS)

   
Total
Number of
shares
   
Common
stock
   
Additional paid
in capital
   
Statutory
reserves
   
Accumulated
other
comprehensive
income
   
Retained
earnings
   
Noncontrolling
interests
   
Total
 
                                                 
Balance, January 1, 2010
    53,256,874     $ 53,257     $ 26,495,876     $ 3,040,595     $ 3,868,437     $ 11,131,084     $ (26,389 )   $ 44,562,860  
Net Loss including non-controlling interests
                                            (3,521,356 )     1,471       (3,519,885 )
Additional paid-in capital from grant of stock option to employee
                    7,464                                       7,464  
Value of stock grants to employees
    1,900,000       1,900       1,955,100                                       1,957,000  
Foreign currency translation adjustment
                                    118,121                       118,121  
                                                                 
Total comprehensive income
                                                            (1,437,300 )
                                                                 
Balance, March 31, 2010
    55,156,874     $ 55,157     $ 28,458,440     $ 3,040,595     $ 3,986,558     $ 7,609,728     $ (24,918 )   $ 43,125,560  

The accompanying notes are an integral part of these financial statements.

 
8

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

1. 
ORGANIZATION AND PRINCIPAL ACTIVITIES

China Architectural Engineering, Inc. (the “Company”) formerly SRKP 1, Inc., was incorporated in the State of Delaware, United States on March 16, 2004. The Company’s common stock was initially listed for trading on the American Stock Exchange on September 28, 2007.  The Company transferred its listing to The NASDAQ Stock Market LLC on June 10, 2008.

The Company through its subsidiaries conducts its principal activity as building envelope systems contractors, specializing in the design, engineering, fabrication and installation of curtain wall systems, roofing systems, steel construction systems and eco-energy saving building conservation systems, throughout China, Australia, Southeast Asia, the Middle East, and the United States.

The Company's work is performed under cost-plus-fee contracts, fixed-price contracts, and fixed-price contracts modified by incentive and penalty provisions. These contracts are undertaken by the Company or its wholly owned subsidiaries. The length of the Company's contracts varies but is typically about one to two years.

2. 
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 
(a)
Method of accounting

The Company maintains its general ledger and journals with the accrual method accounting for financial reporting purposes. The consolidated financial statements and notes are representations of management.  Accounting policies adopted by the Company conform to generally accepted accounting principles in the United States of America and have been consistently applied in the presentation of consolidated financial statements, which are compiled on the accrual basis of accounting.

 
(b)
Consolidation

The consolidated financial statements include the accounts of the Company and its 14 subsidiaries. Significant inter-company transactions have been eliminated in consolidation. The consolidated financial statements include 100% of the assets and liabilities of these majority-owned subsidiaries, and the ownership interests of minority investors are recorded as noncontrolling interests.

The Company owned the subsidiaries through its reverse-merger on October 17, 2006 and through direct investments or acquisitions after October 17, 2006.  As of March 31, 2010, detailed identities of the consolidating subsidiaries are as follows:

Name of Company
 
Place of
Incorporation
 
Attributable Equity
interest %
 
Full Art International Limited
 
Hong Kong
    100  
Zhuhai King Glass Engineering Co., Ltd.
 
PRC
    100  
Zhuhai King General Glass Engineering Technology Co., Ltd.
 
PRC
    100  
King General Engineering (HK) Limited
 
Hong Kong
    100  
KGE Building System Limited
 
Hong Kong
    100  
KGE Australia Pty Limited
 
Australia
    55  
Zhuhai Xiangzhou District Career Training School
 
PRC
    72  
Techwell Engineering Limited
 
Hong Kong
    100  
Techwell International Limited
 
Macau
    100  
Techwell Building System (Shenzhen) Co., Ltd.
 
PRC
    100  
CAE Building Systems, Inc.
 
USA
    100  
China Architectural Engineering (Shenzhen) Co., Ltd.
 
PRC
    100  
Techwell International (SEA) Pte Ltd.
 
Singapore
    100  
CAE Building Systems (Singapore) Pte Ltd
 
Singapore
    100  

 
9

 
CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

(c)
Use of estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however, actual results could differ materially from those estimates.

(d)
Plant and equipment

Plant and equipment are carried at cost less accumulated depreciation.  Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of the plant and equipment are as follows:

Building
20 years
Machinery and equipment
5 - 10 years
Furniture and office equipment
5 years
Motor vehicle
5 years

The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of income. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.

(e)
Accounting for the impairment of long-lived assets

The long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes.  Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets.

If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
During the reporting periods, there was no impairment loss.

(f)
Goodwill and Intangible Assets

In accordance with ASC 350, “Goodwill and Other Intangible Assets.” the Company does not amortize goodwill or intangible assets with indefinite lives.
 
Upon indication that the carrying values of such assets may not be recoverable, the Company recognizes an impairment loss as a charge against current operations.
 
The Company performs an analysis on its goodwill balances to test for impairment on an annual basis and whenever events occur that indicate an impairment could exist. The amount of its goodwill is fully attributable to a subsidiary, Techwell Engineering Limited. There are several instances that may cause the Company to further test its goodwill for impairment between the annual testing periods including:  (i) continued deterioration of market and economic conditions that may adversely impact its ability to meet its projected results; (ii) declines in the Company’s stock price caused by continued volatility in the financial markets that may result in increases in its weighted-average cost of capital or other inputs to its goodwill assessment; (iii) the occurrence of events that may reduce the fair value of a reporting unit below its carrying amount, such as the sale of a significant portion of one or more of the Company’s reporting units. In the three month periods ended March 31, 2010, no instance indicates that an impairment could exist.

 
10

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

Material assumptions include:  (1) The reporting unit continues to have the profitable operations for a period of next 10 years; (2) the revenue has the steady annual growth rate ranging from 5% to 8% as in line with the estimated growth rate of PRC economy; (3) costs of funds kept stable for the period of next 10 years resulting in a stable discount rate for the projection of estimated fair value; and (4) no material change in the prevailing payment terms of the construction industry that allowing the working capital requirement kept at a low level at 15%.  Uncertainties include: (1)  The ability of the reporting unit to continue as a  profitable operation may be affected by changes in technologies and the market of the construction industry; (2) the growth of the PRC economy may not be as steady as projected that in turn affect the steady growth of the revenue of the reporting unit, (3) it is also uncertain about the capital market that affect the costs of fund of the company; and (4) the prevailing payment terms used in the construction industry may be changed as a result of changes in the business environment for the construction industry. Potential events include (1) the appreciation of the value of RMB that would slow down the export and in turn the economic development of China that in turn have negative effect of property development industry in China; and (2) the controlling policies towards the property market by the PRC government.

For other intangible assets, impairment tests are performed annually and more frequently whenever events or changes in circumstances indicate carrying values exceed estimated reporting unit fair values.

 
(g)
Inventories

Inventories are raw materials, which are stated at the lower of weighted average cost or market value.

 
(h)
Contracts receivable

Contracts receivable from performing construction of industrial and commercial buildings are based on contracted prices.  The Company provides an allowance for doubtful accounts, which is based upon a review of outstanding receivables, historical collection information, and existing economic conditions.

 
(i)
Cash and cash equivalents

The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.

 
(j)
Restricted cash

Restricted cash represents time deposit accounts to secure notes payable and bank loans.

 
(k)
Earnings per share

The Company computes earnings per share (“EPS’) in accordance with ASC 260, “Earnings per Share”. ASC 260 requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is measured as the income or loss available to common shareholders divided by the weighted average common shares outstanding for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options, and warrants) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.

The calculation of diluted weighted average common shares outstanding for the three months periods ended March 31, 2010 and 2009 is based on the estimate fair value of the Company’s common stock during such periods applied to warrants and options using the treasury stock method to determine if they are dilutive. The Convertible Bond is included on an “as converted” basis when these shares are dilutive.

 
11

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

Components of basic and diluted earnings per share were as follows:

   
Three Months Ended March 31,
 
   
2010
   
2009
 
Net Income / (Loss)
  $ (3,519,885 )   $ 943,611  
                 
Basic Weighted Average Shares Outstanding
    54,729,908       53,256,874  
Dilutive Shares:
               
                 
-     Addition to Common Stock from Conversion of Bonds
    -       -  
-     Addition to Common Stock from Exercise of Options and Warrants
    -       -  
                 
Diluted Weighted Average Outstanding Shares:
    54,729,908       53,256,874  
                 
Earnings Per Share
               
-     Basic
  $ (0.06 )   $ 0.02  
-     Diluted
  $ (0.06 )   $ 0.02  

(l)
Revenue and cost recognition

Revenues from fixed-price and modified fixed-price construction contracts are recognized on the percentage-of-completion method, measured by the percentage of costs incurred to date to estimated total cost for each contract.

Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs, and depreciation costs.

Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues when their realization is reasonably assured. An amount equal to contract costs attributable to claims is included in revenues when realization is probable and the amount can be reliably estimated.

Selling, general, and administrative costs are charged to expense as incurred.

Total estimated gross profit on a contract, being the difference between total estimated contract revenue and total estimated contract cost, is determined before the amount earned on the contract for a period can be determined.

The measurement of the extent of progress toward completion is used to determine the amount of gross profit earned to date and that the earned revenue to date is the sum of the total cost incurred on the contract and the amount of gross profit earned.

 
12

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

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

a.
Earned Revenue is the amount of gross profit earned on a contract for a period plus the costs incurred on the contract during the period.

b.
Cost of Earned Revenue is the cost incurred during the period, excluding the cost of materials not unique to a contract that have not been used for the contract.

c.
Gross Profit earned on a contract is computed by multiplying the total estimated gross profit on the contract by the percentage of completion. The excess of that amount over the amount of gross profit reported in prior periods is the earned gross profit that should be recognized in the income statement for the current period.

Change orders are common for the changes in specifications or design.  Contract revenue and costs are adjusted to reflect change orders approved by the customer and the contractor regarding both scope and price.  Recognition of amounts of additional contract revenue relating to claims is appropriate only if it is probable that the claim will result in additional contract revenue and if the amount can be reliably estimated.

 
(m)
Income taxes

The Company uses the accrual method of accounting to determine and report its taxable reduction of income taxes for the year in which they are available.  The Company has implemented  ASC 740-270, Accounting for Income Taxes.

Income tax liabilities computed according to the United States, People’s Republic of China (PRC), Hong Kong SAR, Macau SAR and Australia tax laws are provided for the tax effects of transactions reported in the financial statements and consists of taxes currently due plus deferred taxes related primarily to differences between the basis of fixed assets and intangible assets for financial and tax reporting.  The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will be either taxable or deductible when the assets and liabilities are recovered or settled.  Deferred taxes also are recognized for operating losses that are available to offset future income taxes.  A valuation allowance is created to evaluate deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize that tax benefit, or that future realization is uncertain.

In respect of the Company’s subsidiaries domiciled and operated in China and Hong Kong, the taxation of these entities can be summarized as follows:

·
Zhuhai King Glass Engineering Co., Limited (“Zhuhai KGE”) and Zhuhai King General Glass Engineering Technology Co., Limited (“Zhuhai KGGET”) are located in Zhuhai and were subject to the PRC corporation income tax rate of 18% in 2008 and 20% in 2009. In accordance to China’s Enterprise Income Tax Law (“EIT Law”) effective from January 1, 2008, the tax rate for these two subsidiaries will be gradually increased to 25% by 2012.The Company anticipates that as a result of the EIT law, its income tax provision will increase, which could adversely affect Zhuhai KGE’s financial condition and results of operations.

·
China Architectural Engineering (Shenzhen) Co., Ltd. is located in Shenzhen and is subject to the 20% income tax rate that will be gradually increased to the uniform rate of 25% by 2012 as according to the new EIT law.

·
Full Art International Limited, King General Engineering (HK) Limited, and KGE Building System Limited are subject to the Hong Kong profits tax rate of 16.5%.

 
13

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

·
Techwell Engineering Limited is subject to a Hong Kong profits tax rate of 16.5%. Techwell International Limited is a Macau registered company and therefore is subject to Macau profits tax rate of 12%.  Techwell Building System (Shenzhen) Co. Limited is located in Shenzhen and is subject to PRC corporate income tax rate of 20% that will be gradually increased to the uniform rate of 25% by 2012 as according to the new EIT law.

·
KGE Australia Pty Limited is subject to a corporate income tax rate of 30%.

The Company is subject to United States Tax according to Internal Revenue Code Sections 951 and 957.

The Company, after a reverse-merger on October 17, 2006, revived to be an active business enterprise because of the operations with subsidiaries in the PRC and Hong Kong.  Based on the consolidated net earnings for the year ended December 31, 2009, the Company shall be taxed at the 35% tax rate.

Techwell Engineering Limited has established a branch in Dubai, which has zero corporate income tax rate except on oil companies and bank.

Subsidiaries in Singapore are subject a effective corporate income tax rate of 8.5% on taxable income amount in excess of Singapore dollar $100,000.

 
(n)
Advertising

The Company expensed all advertising costs as incurred. Advertising expenses included in selling expenses were $nil and $10,973 for the three-month periods ended March 31, 2010 and 2009, respectively.

(o)
Research and development

All research and development costs are expensed as incurred. Research and development costs included in general and administrative expenses were $nil and $2,926 for the three-month periods ended March 31, 2010 and 2009, respectively.

 
(p)
Retirement benefits

Retirement benefits in the form of contributions under defined contribution retirement plans to the relevant authorities are charged to the statements of income as incurred.

 
14

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

 
(q)
Foreign currency translation

The accompanying consolidated financial statements are presented in United States Dollars (US$). The Company’s functional currency is the US$, while certain domestic subsidiaries’ use the Renminbi (RMB) and Hong Kong and overseas subsidiaries use local currencies as their functional currency.   The consolidated financial statements are translated into US$ from RMB, Hong Kong Dollars (HKD), United Arab Emirate Dirham (AED) and other local currencies at March 31, 2010 exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred.

   
March 31,
2010
   
December 31,
2009
   
March 31,
2009
 
Period end RMB : US$ exchange rate
    6.8361       6.8372       6.8349  
Average quarterly RMB : US$ exchange rate
    6.8360       6.8331       6.8360  

   
March 31,
2010
   
December 31,
2009
   
March 31,
2009
 
Period end HKD : US$ exchange rate
    7.7647       7.7551       7.7506  
Average quarterly HKD : US$ exchange rate
    7.7639       7.7518       7.7542  
 
   
March 31,
2010
   
December 31,
2009
   
March 31,
2009
 
Period end AED : US$ exchange rate
    3.6739       3.6738       3.6700  
Average quarterly AED : US$ exchange rate
    3.6736       3.6710       3.6700  

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.  No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.

 
(r)
Statutory reserves

Statutory reserves for foreign investment enterprises are referring to the amount appropriated from the net income in accordance with laws or regulations, which can be used to recover losses and increase capital, as approved, and are to be used to expand production or operations.

 
(s)
Comprehensive income

Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners.  Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other consolidated financial statements.  The Company’s current components of other comprehensive income are the foreign currency translation adjustment.

 
15

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

 
(t)
Recent accounting pronouncements
 
In June 2009, FASB issued FASB Statement No. 166, Accounting for Transfers for Financial Assets (FASB ASC 860 Transfers and Servicing ) and FASB Statement No. 167 (FASB ASC 810  Consolidation ), a revision to FASB Interpretation No. 46 (Revised December 2003),  Consolidation of Variable Interest Entities  (FASB ASC 810 Consolidation ) .

Statement 166 is a revision to FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities  (FASB ASC 860  Transfers and Servicing ) ,  and will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. Statement No. 166 (FASB ASC 860  Transfers and Servicing ) must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. This Statement must be applied to transfers occurring on or after the effective date.  The Company is still evaluating the impact of the above pronouncement.

Statement 167 is a revision to FASB Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest Entities  (FASB ASC 810  Consolidation ) ,  and changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. Statement No. 167 (FASB ASC 810 Consolidation ) shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter.  Earlier application is prohibited. The Company is still evaluating the impact of the above pronouncement.

 
(u)
Stock-based compensation

Stock compensation accounting guidance (FASB ASC 718, “Compensation-Stock Compensation”) requires that the compensation cost related to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued. The stock compensation accounting guidance covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans.

Stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Scholes model is used to estimate the fair value of stock options while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards.

On October 5, 2009, the Company granted options to purchase a total of 100,000 shares of its common stock to an executive officer.  The stock options vest at the rate of 10,000 shares per month, with the first vesting of 10,000 options occurring on November 27, 2009 and with the last vesting of 10,000 options ending upon the total vested being 100,000.  The Company uses the Black-Scholes option-pricing model to value stock option awards and expensed the stock-based compensation based on the vesting periods.  The fair value of these options was calculated using the following assumptions: (1) risk-free interest rates of 4%, (2) an expected life of 1 to 5 years, (3) expected volatility of 41%, (4) expected forfeitures of 0%, and (5) a dividend yield of 0%. Based on the foregoing, the value of the options is a total of $24,878 and for the three-month periods ended March 31, 2010, $7,464 was expensed related to the grant of these options.

 
16

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

On January 18, 2010, the Board of Directors of the Company approved the issuance of a total of 1.9 million shares of restricted stock (the “Restricted Stock Grants”) to certain of its officers, directors, and key employees under the China Architectural Engineering, Inc. 2009 Omnibus Incentive Plan (the “Plan”), which was previously approved by our stockholders at the 2009 Annual Meeting of Stockholders.  As approved, the Restricted Stock Grants were subject to and contingent upon the Company’s filing of a registration statement on Form S-8 with the Securities and Exchange Commission, which occurred on January 21, 2010. As granted, the Restricted Stock Grants were set to vest such that ¼ would vest on March 31, 2010, ¼ would vest on June 30, 2010, ¼ would vest on September 30, 2010, and the remaining ¼ would vest on December 31, 2010, except for the Restricted Stock Grant for 200,000 shares of common stock that was made to a senior officer, which vested 100% upon the date of grant.  The vesting of the grants were subject to the terms and conditions of the Plan and the Restricted Stock Agreement entered into by and between the recipients and the Company.  In the first quarter of 2010, the Board of Directors of the Company accelerated vesting of the restricted stock awards such that all of the Restricted Stock Grants became fully vested immediately on March 9, 2010. The market price of the Company’s share closed on that date at $1.03. The transaction was recognized in accordance with the FASB ASC 718, Compensation-Stock Compensation and the value of the grants is a total of $1,957,000 as the stock compensation expense.

3. 
CONTRACT RECEIVABLES

   
March 31, 2010
   
December 31,
2009
 
             
Contract receivables
  $ 91,340,006     $ 95,831,489  
Less: Allowance for doubtful accounts
    (3,058,512 )     (6,642,386 )
                 
                 
Net
  $ 88,281,494     $ 89,189,103  

Allowance for Doubtful Accounts
 
March 31, 2009
   
December 31,
2009
 
             
Beginning balance
  $ 6,642,386     $ 5,215,701  
Add: Allowance created
    193,752       1,426,685  
Less: Written off of receivables
    (3,777,626 )     -  
                 
Ending balance
  $ 3,058,512     $ 6,642,386  

 
17

 
 
CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

4. 
OTHER RECEIVABLES

Other receivables consisted of the following:

   
March 31,
2010
   
December 31,
2009
 
Due from sellers of Techwell, the subsidiary (1)
  $ 11,112,555     $ 11,333,253  
Due from Kangbao Electrical Company Limited (Kangbao) , a related party  (2)
    847,135       6,054,905  
Drawdown of advance payment and performance bonds by client of the projects in Dubai (3)
    9,402,757       9,414,397  
Other related parties receivables
    -       253,638  
Deposits for site operations of projects in PRC
    3,986,828       2,903,171  
Other
    471,951       808,703  
                 
Total
  $ 25,821,226      $ 30,768,067   
 
(1)
On November 6, 2007, the Company, through Full Art International, Ltd. (“Full Art”), acquired all of the issued and outstanding shares in the capital of Techwell Engineering Limited, a limited liability company incorporated in Hong Kong (“Techwell”) pursuant to a Stock Purchase Agreement (the “Agreement”) dated November 6, 2007, entered into by and among Ng Chi Sum and Yam Mei Ling (each a “Shareholder” and collectively, the “Shareholders”), the Company and Full Art.  Pursuant to the terms and conditions of the Agreement, the Shareholders agreed that each of them would pay any and all accounts receivables of Techwell if not paid by the customers within 24 months of the acquisition date.  The 24 month period has expired and a total of $9,909,130 is due and payable from the Shareholders. The amount is included in the other receivable due from sellers of Techwell.
 
 
(2)
The amount mainly represents the purchases advances to Kangbao Electrical Company Limited (Kangbao) for the supplies of materials for the projects of the Company.
 
 
(3)
The Company believes that the client of the Dubai projects did not have proper grounds for the drawdown of the advance payment and performance bonds which the company issued for the projects.  The Company also believes that the client should not be entitled to the drawdown and is now proceeding the claim back of the amount.
 
5. 
INVENTORIES

   
March 31, 2010
   
December 31,
2009
 
Raw materials at sites
  $ 162,346     $ 727,499  

 
18

 
 
CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

6. 
PLANT AND EQUIPMENT

Plant and equipment consist of the following as of:

   
March 31, 2010
   
December 31, 2009
 
At cost
           
Motor vehicle
  $ 1,242,453     $ 1,242,928  
Machinery and equipment
    2,383,096       2,381,755  
Furniture, software and office equipment
    1,794,223       1,795,595  
Building
    -       -  
Leasehold improvement
    266,773       267,038  
    $ 5,686,545     $ 5,687,316  
                 
Less: Accumulated depreciation
               
Motor vehicle
  $ 868,277     $ 825,536  
Machinery and equipment
    1,465,385       1,420,536  
Furniture, software and office equipment
    882,047       804,516  
Building
    -       -  
Leasehold improvement
    109,502       97,271  
    $ 3,325,211     $ 3,147,859  
                 
    $ 2,361,334     $ 2,539,457  

Depreciation expenses included in the selling and administrative expenses for periods ended March 31, 2010 and 2009 were $178,043 and $252,852, respectively.

7. 
INTANGIBLE ASSETS

   
March 31, 2010
   
December 31, 2009
 
At cost
           
Intangible Assets
  $ 98,673     $ 98,673  
Less: Accumulated amortization
    38,686       28,063  
                 
    $ 59,987     $ 70,610  

 
19

 
 
CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

8. 
LOANS

 
A.
SHORT-TERM BANK LOANS

   
March 31, 2010
   
December 31, 2009
 
             
ABN Amro N.V. Overdraft in Current Account at interest rate at 6.5% per annum
  $ 3,238,656     $ 4,906,266  
                 
ABN Amro N.V. Temporary Loan for the drawing of performance and advance payment bonds at interest rate at Bank's Cost of Fund + 6%
    4,540,883       4,546,504  
                 
Automobile capital lease obligation (hire purchase),amount due within one year, last installment due November 9, 2012
    77,015       77,110  
                 
                 
    $ 7,856,554     $ 9,529,880  
 
B.
LONG-TERM BANK LOANS
 
   
March 31, 2010
   
December 31,
2009
 
             
Automobile capital lease obligation (hire purchase),amount due after one year, last installment due November 9, 2012
    89,850       109,239  
    $ 89,850     $ 109,239  

Full Art International Limited borrowed a hire purchase (car) loan from DBS Bank.

 
20

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

9. 
CONVERTIBLE BONDS AND BOND WARRANTS

 
(a) 
$10,000,000 Variable Rate Convertible Bonds due in 2012

On April 12, 2007, the Company completed a financing transaction with The Royal Bank of Scotland, London Branch (formerly “ABN AMRO N.V., London Branch) (the “Subscriber”) issuing (i) $10,000,000 Variable Rate Convertible Bonds due in 2012 (the “Bonds”) and (ii) 800,000 warrants to purchase an aggregate of 800,000 shares of the Company’s common stock, subject to adjustments for stock splits or reorganizations as set forth in the warrant, that expire in 2010 (the “Warrants”).

On September 29, 2008, the Subscriber converted $2,000,000 into 571,428 shares at the conversion price of $3.50 per share. As of March 31, 2009, the face value of the bonds outstanding was $8,000,000.

Effective from April 12, 2009, the conversion price has been reset to $2.45, which is 70% of $3.50 as the average closing price of the Company’s shares for the period of 20 consecutive trading days immediately prior to April 12, 2009 was $0.94.  The reset of the conversion price resulted in additional $3.4 million of bonds discount and will be amortized over the remaining outstanding periods of the bonds.

On November 8, 2008, the Subscriber exercised all the 800,000 warrants into 800,000 shares at the exercise price of $0.01 per share.

(b)
$20,000,000 12% Convertible Bonds due in 2011

On April 15, 2008, the Company completed a financing transaction with the Subscriber, CITIC Allco Investments Limited (the “Subscribers,” and each a “Subscriber”), and CITIC Capital Finance Limited issuing (i) $20,000,000 12% Convertible Bonds due in 2011 (the “Bonds”) and (ii) 300,000 warrants to purchase an aggregate of 300,000 shares of the Company’s common stock, subject to certain adjustments as set forth in the warrant instrument, that expire in 2013 (the “Bond Warrants”). The transaction was completed in accordance with a subscription agreement entered into by the Company, Subscribers, and CITIC Capital Finance Limited, dated April 2, 2008 (the “Subscription Agreement”).

The above items (a) and (b) are to be amortized to interest expense over the term of the bonds by the effective interest method as disclosed in the table below.

The Convertible Bonds Payable, net consists of the following:

   
March 31,
2010
   
December
31, 2009
 
             
Convertible Bonds Payable
  $ 28,000,000     $ 28,000,000  
Less: Interest discount – Warrants
    (3,305,938 )     (3,305,938 )
Less: Interest discount – Beneficial conversion feature
    (1,882,404 )     (1,882,404 )
Less: Bond discount
    (760,069 )     (760,069 )
Accretion of interest discount
    3,423,578       2,512,572  
                 
Net
  $ 25,475,167     $ 24,564,161  

 
21

 
 
CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

The Company has failed to make interest payments as originally agreed upon under the Bonds, as follows:
 
$10,000,000 Variable Rate Convertible Bonds due in 2012
     
Interest for 6 months from April to October 2009, due October 4, 2009
  $ 120,000  
         
$20,000,000 12% Convertible Bonds due in 2011
       
Interest for 6 months from October 2008 to April 2009, due April 15, 2009
  $ 1,200,000  
Interest for 6 months from April 2009 to October 2009, due October 15, 2009
    1,200,000  
         
Total missed interest payments:
  $ 2,520,000  
 
 
(c) 
Waiver of Conversion Price Adjustment on Convertible Bonds

On February 24, 2010, the Company entered into an Amendment and Waiver Agreement (the “Waiver”) with the holders of its Bonds and warrants to purchase 300,000 shares of common stock of the Company expiring 2013 (the “2008 Warrants”). Pursuant to the Waiver, the holders of the Bonds and the 2008 Warrants agreed to waive their right to a reduction in the conversion price of the Bonds and the exercise price of the 2008 Warrants upon the Company’s anticipated issuance of up to 25,000,000 shares of its common stock (the “Shares”) for a proposed acquisition of a 60% ownership interest in Shanghai ConnGame Network Co. Ltd. (“ConnGame”). Additionally, the holders of the 2008 Bonds agreed to waive any default under the terms and conditions of the trust deed governing the 2008 Bonds relating to the requirement that KGE Group Limited own at least 45% of the Company’s issued and outstanding common stock.

The Waiver is subject to numerous conditions. The Company agreed to pay the Bondholders the interest in arrears owed on the Bonds as of March 31, 2010 in two equal payments on March 31, 2010 and May 31, 2010 of approximately $1.26 million USD each and to pay 100% of the interest payments on the Bonds that becomes due in April to be paid on April 15, 2010 of approximately $1.32 million USD. The foregoing interest payments, in aggregate, are equal to approximately $3.84 million USD. The Company also agreed to repay the principal and all accrued interest owed by the Company to ABN AMRO Bank (China) Co., Ltd., Shenzhen Branch (the “Overdraft Lender”) under an Overdraft Facility letter (the “Total Amount Owed”) in three separate installments. The first installment is due on the earlier of (a) within 30 days of the Company’s receipt of a payment, if any, in respect to a .claim in Dubai or (b) March 31, 2010. The second installment is due on April 30, 2010 and the third installment is due on May 31, 2010. The first installment equals 34% of the Total Amount Owed and the second and third installments each equal 33% of the Total Amount Owed. The Total Amount Owed is equal to approximately $4.91 million USD. The Company further agreed that it will not repay or prepay any debt prior to its currently scheduled due date until the Company makes all of the payments specified in the Waiver and the Bonds have been redeemed in full and that any new indebtedness incurred by the Company for the purpose of repaying the Overdraft Facility shall (i) not exceed the outstanding amount due and payable under the Overdraft Facility and (ii) be subordinated to all amount owed under the Bonds (the “Covenants”).  The Company paid USD1,260,000 of the outstanding amount as of March 31, 2010 in accordance with the Waiver.

In addition, the Company entered into an Amendment and Waiver Agreement with the Bondholders on August 6, 2009 pursuant to which the Bondholders agreed to extend interest payments under the Bonds.  The Company then entered into another Amendment and Waiver Agreement with the Bondholders, other creditors and other interested parties as specified in the agreement dated February 24, 2010 pursuant to which that the Bondholders extended the payment of overdue interest of $2,520,000 to March 31, 2010 and April 15, 2010.  The convertible bonds are classified as long term debt due to the waivers, but the Company may be required to reclassify the bonds as a current liability if the Company is not required to the covenants that must be met under the Bonds.  The Company may be required to reclassify the Bonds as a current liability if (i) a covenant violation that gives the bondholders the right to call the debt has occurred at the balance sheet date or would have occurred absent a loan modification, and (ii) it is probable that the Company will not be able to cure the default (comply with the covenant) at measurement dates that are within the next 12 months. The Company believed that it is not probable that the Company will not be able to cure the default at measurement dates that are within the next 12 months.

 
22

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

10. 
CONTRACT REVENUES EARNED

The contract revenues earned for the three-month periods ended March 31, 2010 and 2009 consist of the following:

   
March 31, 2010
   
March 31, 2009
 
Billed
  $        10,173,136     $         28,279,372  
Unbilled
    1,298,987       8,063,692  
                 
    $ 11,472,123     $ 36,343,064  
 
The unbilled contract  revenue  earned  represents  those  revenue  that  should  be  recognized according to the percentage of completion method for accounting for construction contract because the Company is entitled to receive payment from the customers for the amount of work that has been  rendered to and  completed  for  that  customer according  to  the  terms  and  progress  being made as stipulated under that contract between the Company and that customer. As an industrial practice, there are certain procedures that need to be performed, such as project account finalization, by both the customer and the Company before the final billing is issued; however this does not affect the Company’s  recognition of revenue and respective cost according to the terms of the contract with the consistent application of the percentage-of-completion method.

A single customer accounted for 40.4% of the Company’s contract revenues for the three months ended March 31, 2010. No other customer accounts for 10% or more of the Company’s contract revenues in the period.

11. 
INCOME TAXES

On October 17, 2006, income from the Company’s foreign subsidiaries became subject to U.S. income tax liability; however, this tax is deferred until foreign source income is repatriated to the Company, which has not yet occurred.
The Company has also retained an U.S. tax-preparer firm to aide in preparation of its U.S. income tax returns in order to maintain a high level of compliance with U.S. tax laws.

Effective January 1, 2008, the PRC income tax rules were changed.  The PRC government implemented a new 25% tax rate for all enterprises whether domestic or foreign enterprise, and abolished the tax holiday.

 
23

 
 
CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

Income before taxes and the provision for taxes for the periods ended March 31, 2010 and 2009 consists of the following:

   
March 31,
 
   
2010
   
2009
 
Continuing income before taxes:
           
U.S.
  $ (4,093,545 )   $ (2,025,063 )
Singapore
    (388 )     (651 )
China
    356,519       (1,881,006 )
Australia
    (3,100 )     (3,673 )
Hong Kong
    (140,794 )     (672,728 )
Dubai
    371,631       5,568,937  
Macau
    (2,104 )     (42,205 )
Total continuing income before taxes
    (3,511,781 )     943,611  
                    
Provision for taxes expense/(benefit):
               
Current:
               
U.S. Federal
    -       -  
U.S. State
    9,575       -  
      9,575       -  
Deferred:
               
U.S. Federal
    9,575       -  
Hong Kong
    -       -  
Currency Effect
    -       -  
                 
                 
Total provision for taxes
    9,575       -  
                 
Effective tax rate
    -0.29 %     0.00 %

 
24

 
 
CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Significant components of our deferred tax assets and liabilities at March 31, 2010 and December 31, 2009 are as follows:

   
March 31, 2010
   
December 31, 2009
 
             
Deferred tax assets
           
Net operating loss
  $ 112,893     $ 113,033  
      112,893       113,033  
                 
Valuation allowance
    -       -  
Total deferred tax assets
    112,893       113,033  
                 
Deferred tax liabilities
               
Total deferred tax liabilities
    -       -  
                   
Net deferred tax assets
    112,893       113,033  
                 
Reported as:
               
Current deferred tax assets
    112,893       113,033  
Non-current deferred tax assets
    -       -  
Non-current deferred tax liabilities
    -       -  
                   
                   
Net deferred taxes
  $ 112,893     $ 113,033  

Current deferred tax assets represents net operating loss of a subsidiary Techwell Engineering Limited in Hong Kong. The losses can be carried forward to set-off future assessable profits in Hong Kong without expiry date. The differences between the U.S. federal statutory income tax rates and the Company’s effective tax rate for the periods ended March 31, 2010 and 2009 is shown in the following table:

   
2010
   
2009
 
U.S. federal statutory income tax rate
    34.00 %     34.00 %
Lower rates in PRC, net
    -9.00 %     -9.00 %
Accruals in foreign jurisdictions
    -0.29 %     -0.00 %
Tax Holiday
    -25.00 %     -25.00 %
      -0.29 %     0.00 %

 
25

 
 
CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

The following table accounts for the differences between the actual tax provision and the amounts obtained by applying the relevant applicable corporation income tax (see tax rates discussed above) before tax for the periods ended March 31, 2010 and 2009:-
 
   
2010
   
2009
 
Income/(loss) before tax
    (3,511,781 )     943,611  
Taxes at the applicable income tax rates
    9,558       -  
Miscellaneous non taxable income
    17       -  
and non-deductible expenses
               
  $ 9,575     $ -  
 
Effective January 1, 2008, the PRC government implemented a new 25% tax rate across the board for all enterprises regardless of whether domestic or foreign enterprise without any tax preferences which is defined as “two-year exemption followed by three-year half exemption” enjoyed by tax payers. As a result of the tax law, a standard 15% tax preference terminated as of December 31, 2007. The PRC government has established a set of transition rules to allow enterprises using tax preferences before January 1, 2008 to continue using the tax preferences on a transitional basis until being the new tax rates are fully implemented over a five year period.

12.
COMMITMENTS AND CONTINGENCIES

(a) Operating lease commitments

The Company leases certain administrative and production facilities from third parties.  Accordingly, for the three-month periods ended March 31, 2010 and 2009, the Company incurred rental expenses of $267,036 and $829,465 respectively.

The Company has commitments with respect to non-cancelable operating leases for these offices, as follows:

For the 12 months ending March 31,
     
2011
    716,481  
2012
    -  
2013
    -  
2014 or after
    -  
    $ 716,481  

(b) Pending Litigation

  Techwell litigation
 
Pursuant to a Stock Purchase Agreement dated November 7, 2007, the previous shareholders of Techwell Engineering Limited (“Techwell”), Mr. Ng, Chi Sum and Miss Yam, Mei Ling Maria agreed to sell 100% of the shares in Techwell to the Company for approximately $11.7 million in cash and shares of common stock of the Company. Subsequent to the said acquisition, Mr. Ng and Miss Yam were employed by Techwell.

 
26

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)
 
On January 14, 2009, the board of directors of Techwell passed a board resolution, to dismiss both Mr. Ng and Miss Yam with immediate effect and remove Mr. Ng from the board of Techwell (the “Resolution”). On January 16, 2009, Mr. Ng and Miss Yam filed a lawsuit in the High Court of Hong Kong against the Company and its subsidiary, Full Art International Limited. The lawsuit alleges that, inter alia, (i) the Company misrepresented to them the financial status of the Company and operations during the course the acquisition of Techwell was being negotiated; (ii) the Company failed to perform its obligations under a settlement agreement alleged to be agreed by the Company in January 2009; and (iii) the dismissal of Mr. Ng was unlawful and invalid. The lawsuit filed by Mr. Ng and Miss Yam requests the court for specific performance of the settlement agreement that was allegedly entered into, which would require the return of the Techwell company to Mr. Ng and Miss Yam, and in the absence of such grant of relief, Mr. Ng and Miss Yam request unspecified damages lieu of return of the Techwell company.

On January 23, 2009 an ex-parte injunction order was granted to Mr. Ng, restraining the Company from implementing the Resolution, which was eventually dismissed with immediate effect on February 25, 2009 after a court session in the High Court of Hong Kong. Mr. Ng was also ordered to bear the costs of the various court proceedings in connection with the said injunction order. On March 27, 2009, Mr. Ng and Miss Yam filed a summons in the High Court of Hong Kong seeking a court order for leave to join the Company’s principal shareholder, KGE Group Limited, as a defendant of the said lawsuit, which was granted on April 9, 2009. As a result, KGE Group Limited became one of the defendants of the lawsuit. On May 12, 2009, the Company filed a Defense and Counterclaim at the High Court of Hong Kong in response to a Statement of Claim served by Mr. Ng and Miss Yam on the Company on April 7, 2009.
 
The Company intends to vigorously defend this pending lawsuit; however, no assurance can be given that the lawsuit will be resolved in the Company’s favor. Even if the Company successfully defends the lawsuit, the Company may incur substantial costs defending or settling the lawsuit, in addition to a possible diversion of the time and attention of the Company’s management from its business. If the Company is unsuccessful in defending the lawsuit, its may be required to pay a significant amount of damages and/or it may potentially lose ownership of Techwell, which will have a material adverse effect on the Company’s business, financial condition or results of operations. In the last quarter of 2009, Mr. Ng made a settlement proposal to the Company for consideration and the Company is negotiating the settlement agreement with Mr. Ng as of March 31, 2010.
 
Dubai Metro Rail Project Dispute
 
On September 9, 2009, the Red Line, or first phase, of the Dubai Metro was officially opened. The Company, through its subsidiary, had been working towards completion of its external envelopes for stations along the Red Line of the Dubai Metro System.  According to the Company’s original construction blueprint, the majority of its construction work was completed at the end of June 2009, and final construction milestones were scheduled for completion in the third quarter of 2009.  With less than 5% of its contract remaining to be completed, Techwell was removed by the master contractor of the project, which also called for and received payment of $2.1 million in performance bonds and $7.3 million in advance payment bonds that were issued on Techwell's behalf for the project. The calling of the advance payment bonds was based on the master contractor's belief that it had paid in excess of the construction work performed.  The Company and certain of its subsidiaries are guarantor of the bonds that were paid by the banks, and the Company is liable under the guarantee agreements for such amounts paid by the banks.  The Company does not believe that the master contractor had a proper basis for calling the bonds and intend to vigorously defend all of its legal rights and remedies related to the dispute.  The Company has engaged a construction claims consultant to facilitate resolution of the dispute.  The Company and its construction claims consultant, based on a review of the facts, documents, and materials available, believes that it has a reasonable opportunity to collect the amounts due to Techwell from the master contractor, less appropriate credits as its final amount due for work performed through September 2009.  The Company, with the assistance of its claims consultant, will continue to evaluate the dispute and probability of success on this dispute going forward and make the appropriate adjustments; however, no assurance can be given that the dispute will be resolved in the Company’s and Techwell’s favor. The Company’s counsel in Dubai is preparing the legal documents for the claims as of March 31, 2010.

 
27

 

CHINA ARCHITECTURAL ENGINEERING, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTH-PERIODS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(Stated in US Dollars)

13.
RELATED PARTIES TRANSACTIONS

The account balance with shareholders at March 31, 2010 was payables of $3,504,156, while at December 31, 2009 it was $10,080,345. The payables balance was mainly loans from the largest shareholder, with such loans being interest-free, fee-free and has no fixed repayment schedule.

During the three months period ended March 31, 2010, the Company purchased construction materials amounting to $0.3 million from Guangdong Canbo Electrical Co., Ltd. (Canbo), a subsidiary of the Company’s major shareholder, KGE Group Limited. Canbo is a preferred supplier of the Company as it is able to procure materials at favorable price levels due to its purchased quantities. More important, application of certain of the Company’s patented technology is preferably routed through Canbo to prevent undesired distribution of this technology. The Company at times provides advance payment to Canbo in order to obtain a more favorable pricing. As of March 31, 2010, the Company’s advance to Canbo was $0.8 million.
 
The transactions with related parties during the periods were carried out in the ordinary course of business and on normal commercial terms.

 
28

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Forward-Looking Statements

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this quarterly report and the audited consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our annual report on Form 10-K for the year ended December 31, 2009.

This quarterly report contains forward-looking statements that involve substantial risks and uncertainties.  The words “anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, identification and remediation of the Company's deficiencies and weaknesses in its internal controls over financial reporting, potential claims or litigation that may result from the occurrence of restatements, the negotiation and execution of a definitive acquisition agreement for the proposed acquisition of ConnGame and satisfactory completion of related due diligence and closing conditions, including but not limited to regulatory approvals; ability to identify and secure debt, equity, and/or other financing required to continue the operations of the Company, particularly in the event that the Company is not able to conduct the proposed acquisition of ConnGame; required Company payments under the waiver agreement and ability to obtain an extension; difficulties related to integration and management of the combined operations; reduction or reversal of the Company's recorded revenue or profits due to "percentage of completion" method of accounting and expenses; the Company's ability to obtain a modification for the Waiver agreement with the bondholders applicable to the proposed acquisition of ConnGame; increasing provisions for bad debt related to the Company's accounts receivable; fluctuation and unpredictability of costs related to our products and services; the Company's plans to enter into real estate development projects such as the Nine Dragons Project; adverse capital and credit market conditions; fluctuation and unpredictability of costs related to the Company's products and services; expenses and costs associated with its convertible bonds, regulatory approval requirements and competitive conditions; and various other matters, many of which are beyond our control.  Actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated should one or more of these risks or uncertainties occur or if any of the risks or uncertainties described elsewhere in this report or in the “Risk Factors” section of our 2009 annual report occur.  Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and there can be no assurance of the actual results or developments.

Overview


The recent trends in the global economy have had a significant adverse impact on the commercial construction industry as a whole. As a result, the competitive environment in which we operate has become more competitive, increasing the number of re-bid construction projects and amount of time between bidding and award of a project, reducing selling prices, and causing competitors to modify the scope and type of projects on which they bid.  In 2008 we increased the number of international construction projects, but in 2009 the spread of the global recession and reduction in the nature and scope of international construction projects has led us to primarily focus our attention on domestic projects in China.  Dubai, Doha, Kuwait and other middle east region have been suffered a great impact markedly under the global financial crisis.  Our projects suffered a certain degree of impact as well.  During 2009, we have experienced a decrease in the project turnover and an increase in costs and delays in customer payments. As a result, our results of operations have suffered.  However, we conducted our Dubai and Doha Projects construction under the original schedule, and executed the design for Kuwait project.  After the completion of “soft-open” of Dubai Metro Rail Project in September 2009, the contractor called bonds and refused to sign and pay for the project payments, which have resulted in a cash flow difficulties for our company.  As described below, we dispute the contractor’s rights to call the bonds and seeking remedies for its actions.  In addition, after a thorough review and analysis of the feasibility and profitability of the Singapore Project, we determined that it was in the best interests of our company to withdraw from the project.

We do not believe that the international economy will experience a swift recovery in the near future and therefore its negative impact on construction industry still exists and will exist in the near future.  As a result, we suspended the orders of the construction of international projects, and shifted the focus of our business to design and professional consulting services. We have taken steps to continue our development and research of new technologies and to maintain our company’s position in the industry.   To develop projects and generate revenue, we have sought to join new projects in the position of design and project consultant and the role of material supplier.

 
29

 

In the past, the number and size of our international projects had been increasing, but during 2009 our management has moved to refocus our resources to projects in the mainland China.  During the second quarter of 2009, we decided to terminate our work on the project in Singapore and stop the guarantee related to the project. Our management reviewed and created updated forecasts for the project and concluded that there will be major differences between the design concept as originally contemplated and the final site structures. As a result, we decided to terminate our work on the project since we did not receive approval for our improvement proposal, and resources related to the project were moved to projects in China.
 
We believe that the Chinese market has faired much better than most of the international markets.  With the strength of our reputation and history of notable projects in China, we are focusing our resources and efforts in our domestic market.   We believe that we have long-standing relationships with leading Chinese and international architects, having completed high profile projects in China.  During the year 2009, we commenced certain landmark projects in China, which consisted of the Changsha Train Station, Changsha Museum, Guangzhou Science Town, and projects in Jinan and Inner Mongolia.  These projects are expected to be completed in 2010.

Revenues and earnings recognition on many construction contracts are measured based on progress achieved as a percentage of the total project effort or upon the completion of milestones or performance criteria rather than evenly or linearly over the period of performance.  Our work is performed under cost-plus-fee contracts and fixed-price contracts. The length of our contracts varies but typically has a duration of approximately one to two years. Approximately 95% of our sales are from-fixed price contracts. The remaining sales are from cost-plus-fee contracts. Under fixed-price contracts, we receive a fixed price. Consequently, we realize a profit on fixed-price contracts only if we control our costs and prevent cost over-runs on the contracts. Approximately 70% of contracts are modified after they begin, usually to accommodate requests from clients to increase project size and scope. In cases where fixed-price contracts are modified, the fixed price is renegotiated and adjusted upwards accordingly. Under cost-plus-fee contracts, which may be subject to contract ceiling amounts, we are reimbursed for allowable costs and fees, which may be fixed or performance-based. If our costs exceed the contract ceiling or are not allowable under the provisions of the contract or any applicable regulations, we may not be reimbursed for all our costs.

Recent Events

Proposed Acquisition of 60% Equity Interest in ConnGame

In December 2009, we and First Jet entered into a letter of intent for the Acquisition (“Letter of Intent”) that set forth the principal terms under which we would issue up to 25,000,000 shares of our common stock to First Jet to acquire 60% of the equity interest of Shanghai ConnGame Network Co. Ltd., a company formed under the laws of the People’s Republic of China (“ConnGame”), which is a developer and publisher of MMORPG (Massively Multiplayer Online Role Playing Game).  In January 2010, our board of directors and stockholders approved our acquisition of a 60% equity interest in ConnGame.  We believe our acquisition of ConnGame will enable us to strengthen our core architectural engineering and design abilities, in addition to enabling us to enter China's large online game market, with ConnGame’s two to-be-released MMORPG games.  We believe that the online game industry and its related business model will be a growing market in China.

Pursuant to the terms of the Letter of Intent, we would issue the total 25,000,000 shares of common stock to First Jet if an independent valuation firm determined that the value of ConnGame was equal or greater to $50 million.  We received an appraisal report dated January 17, 2010 from Shanghai Xinda Asset Appraisal Co., Ltd.  According to the appraisal, subject to its assumptions and limitations, the fair market value of ConnGame on January 15, 2010 was approximately $52 million (RMB 357 million), based on a discounted cash flow model.  In addition, the proposed acquisition and the issuance of the shares will be subject to numerous closing conditions, including the execution of a waiver of reduction to conversion price of our outstanding Bonds or exercise price of the 2008 Warrants.  As described below, we and the bondholders, in addition to other parties, entered into a waiver agreement on February 24, 2010.

Upon the consummation of the acquisition, if and when it shall occur, it is anticipated that Luo Ken Yi will resign as Chairman of the Board of Directors.  Mr. Luo will remain as a member of the Board.  Upon Mr. Luo’s resignation as the Chairman of the Board, the Board will appoint Mr. Jun Tang, the sole shareholder of First Jet, as Chairman of the Board.  Mr. Jun Tang, 47, currently serves as the President and Chief Executive Officer of New Huadu Group, Fujian.  From 2004 to 2008, Mr. Tang served as President of Shanghai SNDA (Nasdaq: SNDA), a interactive entertainment media company in China.  Prior to that, he served as President of Microsoft China Co., Ltd from 2002 to 2004.  From 1997 to 2002, he served as General Manager of Microsoft Global Technical Engineering Center, and from 1994 to 1997 he served as Senior Project Manager for Microsoft US.    Mr. Tang received his doctorate degree, master’s degree and bachelor’s degree in the U.S., Japan and China, respectively.

 
30

 

Completion of the proposed acquisition is subject to negotiation and execution of a definitive equity transfer agreement, regulatory approvals, and other customary closing conditions.  Therefore, there can be no guarantee that the acquisition will be consummated.

Wavier Agreement

On February 24, 2010, we entered into an Amendment and Waiver Agreement (the “Waiver Agreement”) with the holders of our outstanding Variable Rate Convertible Bonds due 2012 (the “2007 Bonds”) and 12% Convertible Bonds due 2011 (the “2008 Bonds,” and collectively with the 2007 Bonds, the “Bonds”) and warrants to purchase 300,000 shares of our common stock expiring 2013 (the “2008 Warrants”).  Pursuant to the Waiver Agreement, the holders of the Bonds and the 2008 Warrants agreed to waive their right to a reduction in the conversion price of the Bonds and the exercise price of the 2008 Warrants upon our anticipated issuance of up to 25,000,000 shares for the proposed acquisition of a 60% ownership interest in ConnGame.  Additionally, the holders of the 2008 Bonds agreed to waive any default under the terms and conditions of the trust deed governing the 2008 Bonds relating to the requirement that KGE Group Limited, our largest shareholder, own at least 45% of our issued and outstanding common stock.

 The waivers contained in the Waiver Agreement are subject to numerous conditions.  We agreed to pay the Bondholders the interest in arrears owed on the Bonds as of March 31, 2010 in two equal payments on March 31, 2010 and May 31, 2010 of approximately $1.26 million each and to pay 100% of the interest payments on the Bonds that becomes due in April 2010 to be paid on April 15, 2010 of approximately $1.32 million, for aggregate payments of approximately $3.84 million.  We also agreed to repay the principal and all accrued interest that we owe to ABN AMRO Bank (China) Co., Ltd., Shenzhen Branch (the “Overdraft Lender”) under an Overdraft Facility letter in three equal separate installments. The total amount owed to the Overdraft Lender is equal to approximately $4.91 million. The first installment is due no later than March 31, 2010, the second installment is due on April 30, 2010 and the third installment is due on May 31, 2010.  We also agreed that we will not repay or prepay any debt prior to its currently scheduled due date until we make all of the payments specified in the Waiver Agreement and the Bonds have been redeemed in full and that any new indebtedness incurred by us for the purpose of repaying the Overdraft Facility will (i) not exceed the outstanding amount due and payable under the Overdraft Facility and (ii) be subordinated to all amount owed under the Bonds.   The Company paid USD1,260,000 of the outstanding amount as of March 31, 2010 in accordance with the Waiver.

If we fail to make any of the payments specified in the Waiver Agreement, then all rights of the holders of the Bonds and 2008 Warrants waived under the Waiver Agreement to or to be waived under the Waiver Agreement, will not be waived and will be reinstated, and any previous waivers will be null and void.  In such case, appropriate adjustments may be made to reduce the conversion and exercise price of the Bonds and 2008 Warrants. In addition, the bondholders may declare a default under the Bonds and require us to pay the Bonds, which could result in bankruptcy or otherwise impair our ability to maintain sufficient liquidity to continue our operations.

Dubai Metro Rail Project

On September 9, 2009, the Red Line, or first phase, of the Dubai Metro was officially opened. We, through our subsidiary Techwell Engineering Limited, had been working towards completion of our external envelopes for stations along the Red Line of the Dubai Metro System.  According to our original construction blueprint, the majority of our construction work was completed at the end of June 2009, and final construction milestones were scheduled for completion in the third quarter of 2009.  With less than 5% of our contract remaining to be completed, Techwell was removed by the master contractor of the project, who also called for and received payment of $2.1 million in performance bonds and $7.3 million in advance payment bonds that were issued on Techwell's behalf for the project. The calling of the advance payment bonds was based on the master contractor's belief that it had paid in excess of the construction work performed.  We and certain of our subsidiaries are guarantors of the bonds that were paid by the banks, and we are liable under the guarantee agreements for such amounts paid by the banks.  We do not believe that the master contractor had a proper basis for calling the bonds and intend to vigorously pursue and defend all of our legal rights and remedies related to this dispute.  We have engaged a construction claims consultant to facilitate resolution of this dispute.  We and our construction claims consultant, based on a review of the facts, documents, and materials available, believe that we have a reasonable opportunity to collect the amounts due to Techwell from the master contractor, less appropriate credits as our final amount due for work performed through September 2009.  We, with the assistance of our claims consultant, have been continuously evaluating the dispute and probability of success on this dispute going forward and make the appropriate adjustments; however, no assurance can be given that the dispute will be resolved in our and Techwell’s favor. The Company’s counsel in Dubai is preparing the legal documents for the claims by the time of this report.

With the use of “percentage-of-completion” method, the revenue to be recognized for each period will included both (1) the revenue earned for the current period and (2) the adjustment to previously recognized revenue that is required because of the changes in estimated total revenue, costs and profitability of projects from which the previous revenue had been recognized. The changes in the estimates may be the result of, for example, increased costs or overhead expenses of the projects, changes of the scope of the works of the contract as well as the changes of technologies used which in turn affect the costs of the project.  Under these circumstances, the estimated revenue and costs can change and as a result the estimated profitability of the project can change, which affects the profit elements in the revenue previously recognized and may be required to be revised accordingly.  The “adjustments” or “revisions” are made via adjustment to the current period revenue because it is the changes in estimates that are requiring the revisions and not a restatement of the previous period figures.

 
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With respect to the Dubai Metro Rail Project, which was the primary focus of Techwell, an adjustment under the percentage-of-completion method described above may be required if, for example, the Company and the Company’s claim consultant modifies its evaluation of the Company’s claims such that the Company is not likely to recover its claims as currently anticipated, if the Company encounters any unexpected difficulties in the claiming process which making the increase of claiming costs, and if a commercial settlement between the parties is reached on a amounts different from current value estimates.  In such scenarios, the final project revenue or estimated costs may be changed to affect the revenue recognition of the project.  However, neither of the situations is considered to exist at the moment of the reporting that affects the accounting estimates of revenue and costs used for the period.  As such, the Company believes that the revenue recognized to date is appropriate as there were periodic reviews of the estimates of the project revenue and costs by the Company to reflect the latest profitability of the project for revenue recognition.

One of the primarily reasons that the Company’s contract receivables have increased is the delay in payment by client of the Dubai projects since April 2009.  The underlying receivable as of September 30, 2009 from the Dubai projects was equal to approximately $19.2 million, which represented 23% of the total contract receivables as of such date. The Company has employed a claim consultant, Hill International, to facilitate the Company’s claim for the back payment.  The Company currently expects that there will be progress and payments will be received as early as the third quarter of 2010.  However, due to the ongoing dispute, there is no guarantee that the Company will collect all or a portion of the contract receivable.  For receivables related to the Dubai Project, the client delayed payment to us since April 2009 by refusing to issue the Certificates for Value of Work Done.  No Certificates have been issued since April 2009.  The Certificates are pre-requisites to proceed with payment to the Company. The client paid for all work for Certificates for Value of Work Done issued in or before April 2009.  Such payments were made prior to December 31, 2009.  As a result, no account receivables at March 31, 2010 represent work for the above-referenced Certificates issued in or before April 2009.  The receivables as of March 31, 2010 were recognized in accordance with the Percentage of Completion Method and based on the claim consultant’s report on the estimated final value of work done that the Company completed as of March 31, 2010.

The Company has not recorded an allowance for doubtful accounts related to the Dubai project.  The Company has engaged a construction claims consultant to facilitate resolution of the dispute.  The Company and its construction claims consultant, based on a review of the facts, documents, and materials available, believe that the Company has a reasonable opportunity to collect the amounts due to Techwell from the master contractor, less appropriate credits as its final amount due for work performed through September 2009.  The Company, with the assistance of its claims consultant, have been continuously evaluating the dispute and probability of success on this dispute going forward and make the appropriate adjustments; however, no assurance can be given that the dispute will be resolved in the Company’s and Techwell’s favor.  In the report of the claim consultant, there are the high and low estimates for the final total value of work done for the Dubai project. The Company started with the low estimates with prudence and adjusted such amounts with the amounts that the claim consultant’s expressed that there was an excellent opportunity for the Company to be recovered.  Furthermore, as the client of the projects being the joint venture of two reputable Japanese corporations and one Turkish corporation with long operating histories, the Company believes that the possibility of default in payment is considered not likely to occur.  Based on these supporting documents and analysis, the Company believes that the receivables will be collected and no allowance is required.  However, the Company will be required to account for doubtful collection of the receivables related to the Dubai Project in the event it concludes that it is not likely that the Company will be able to collect the receivables.

Techwell Litigation

Pursuant to a Stock Purchase Agreement dated November 7, 2007, the previous shareholders of Techwell Engineering Limited (“Techwell”), Mr. Ng, Chi Sum and Miss Yam, Mei Ling Maria, agreed to sell 100% of the shares in Techwell to the Company for approximately $11.7 million in cash and shares of common stock of the Company. Subsequent to the acquisition, Mr. Ng and Miss Yam were employed by Techwell.

On January 14, 2009, the board of directors of Techwell passed a board resolution, to dismiss both Mr. Ng and Miss Yam with immediate effect and remove Mr. Ng from the board of Techwell (the “Resolution”).   On January 16, 2009, Mr. Ng and Miss Yam filed a lawsuit in the High Court of Hong Kong against the Company and its subsidiary, Full Art International Limited.  The lawsuit alleges that, inter alia, (i) the Company misrepresented to them the financial status of the Company and its operations during the course the negotiations of the Techwell acquisition; (ii) the Company failed to perform its obligations under a settlement agreement alleged to have been agreed to by the Company in January 2009; and (iii) the dismissal of Mr. Ng was unlawful and invalid.  The lawsuit filed by Mr. Ng and Miss Yam requests the court for specific performance of the settlement agreement that was allegedly entered into, which would require the return of the Techwell company to Mr. Ng and Miss Yam, and in the absence of such grant of relief, Mr. Ng and Miss Yam request unspecified damages in lieu of return of the Techwell company.

 
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On January 23, 2009 an ex-parte injunction order was granted to Mr. Ng, restraining the Company from implementing the Resolution, which was eventually dismissed with immediate effect on February 25, 2009 after a court session in the High Court of Hong Kong. Mr. Ng was also ordered to bear the costs of the various court proceedings in connection with the injunction order. On March 27, 2009, Mr. Ng and Miss Yam filed a summons in the High Court of Hong Kong seeking a court order for leave to join the Company’s principal shareholder, KGE Group Limited, as a defendant in the lawsuit, which was granted on April 9, 2009.  As a result, KGE Group Limited became one of the defendants of the lawsuit. On May 12, 2009, the Company filed a Defense and Counterclaim at the High Court of Hong Kong in response to a Statement of Claim served by Mr. Ng and Miss Yam on the Company on April 7, 2009.

As of the date of this report, the Company, Mr. Ng, and Miss Yam are in discussions and negotiations to settle all disputes between the parties.  However, there is no guarantee that the parties will reach an agreement to settle the dispute, in which case the Company intends to vigorously defend itself against the lawsuit.  There can be no assurance that the lawsuit will be resolved in the Company’s favor.  Even if the Company successfully defends the lawsuit, the Company may incur substantial costs defending or settling the lawsuit, in addition to a possible diversion of the time and attention of the Company’s management away from its business.  If the Company is unsuccessful in defending the lawsuit, its may be required to pay a significant amount of damages and/or it may potentially lose ownership of Techwell, which will have a material adverse effect on the Company’s business, financial condition or results of operations.  In the event we lose ownership of Techwell, we will lose the approximately $17.3 million of profit contribution since the acquisition of Techwell.

Results of Operations

The following table sets forth statements of operations for the three months ended March 31, 2010 and 2009 in U.S. dollars (unaudited):

   
For Three Months Ended March 31,
 
   
2010
   
2009
 
   
(in thousands, except for share
and per share amounts)
 
Contract revenues earned
  $ 11,472     $ 36,343  
                 
Cost of contract revenues earned
    (9,144 )     (28,162 )
                 
Gross profit
  $ 2,328     $ 8,181  
                 
Selling, general and administrative expenses
    (4,223 )     (5,951 )