UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO ___________
COMMISSION FILE NO. 333-114622
CHINA ARCHITECTURAL ENGINEERING, INC.
(Exact Name Of Registrant As Specified In Its Charter)
Delaware | | 51-05021250 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | | |
105 Baishi Road, Jiuzhou West Avenue, Zhuhai 519070 People’s Republic of China | | N/A |
(Address of principal executive offices) | | (Zip Code) |
REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: 0086-756-8538908
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes x No o
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o No x
Our shares of common stock are not currently listed or quoted for trading on any national securities exchange or national quotation system. There were 50,000,000 shares of common stock outstanding as of April 1, 2007
Documents Incorporated by Reference: None.
CHINA ARCHITECTURAL ENGINEERING, INC.
TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2006
ITEM | | | | | Page |
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PART I | | | | | |
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| Item 1. | | Business | | | 2 |
| Item 1A. | | Risk Factors | | | 12 |
| Item 1B. | | Unresolved Staff Comments | | | 24 |
| Item 2. | | Properties | | | 24 |
| Item 3. | | Legal Proceedings | | | 24 |
| Item 4. | | Submission of Matters to a Vote of Security Holders | | | 24 |
| | | | | | |
PART II | | | | | |
| | | | | | |
| Item 5. | | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | | | 25 |
| Item 6. | | Selected Financial Data | | | 27 |
| Item 7. | | Management's Discussion and Analysis of Financial Condition and Results of Operations | | | 28 |
| Item 7A. | | Quantitative and Qualitative Disclosures about Market Risk | | | 38 |
| Item 8. | | Financial Statements and Supplementary Data | | | 38 |
| Item 9. | | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | | | 38 |
| Item 9A. | | Controls and Procedures | | | 38 |
| Item 9B. | | Other Information | | | 39 |
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PART III | | | | | |
| | | | | | |
| Item 10. | | Directors, Executive Officers and Corporate Governance | | | 40 |
| Item 11. | | Executive Compensation | | | 42 |
| Item 12. | | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | | | 44 |
| Item 13. | | Certain Relationships and Related Transactions, and Director Independence | | | 46 |
| Item 14. | | Principal Accounting Fees and Services | | | 46 |
| | | | | | |
PART IV | | | | | |
| | | | | | |
| Item 15. | | Exhibits and Financial Statement Schedules | | | 47 |
| | Signatures | | | 48 |
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The information contained in this report, including in the documents incorporated by reference into this report, includes some statement that are not purely historical and that are “forward-looking statements.” Such forward-looking statements include, but are not limited to, statements regarding our and their management’s expectations, hopes, beliefs, intentions or strategies regarding the future, including our financial condition, results of operations, and the expected impact of the Share Exchange on the parties’ individual and combined financial performance. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,” “should,” “will,” “would” and similar expressions, or the negatives of such terms, may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking.
The forward-looking statements contained in this report are based on current expectations and beliefs concerning future developments and the potential effects on the parties and the transaction. There can be no assurance that future developments actually affecting us will be those anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond the parties’ control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements, including the following:
| · | Our dependence on government contracts; |
| · | Fluctuation and unpredictability of costs related to our products and services; |
| · | Changes in the laws of the PRC that affect our operations; |
| · | Our failure to meet or timely meet contractual performance standards and schedules; |
| · | Any recurrence of severe acute respiratory syndrome (SARS) or Avian Flu; |
| · | Reduction or reversal of our recorded revenue or profits due to “percentage of completion” method of accounting; |
| · | Our dependence on the steel and aluminum markets; |
| · | Exposure to product liability and defect claims; |
| · | Our ability to obtain all necessary government certifications and/or licenses to conduct our business; |
| · | Development of a public trading market for our securities; |
| · | The cost of complying with current and future governmental regulations and the impact of any changes in the regulations on our operations; and |
| · | The other factors referenced in this report, including, without limitation, under the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Full Art’s Financial Condition and Results of Operations,” and “Business.” |
These risks and uncertainties, along with others, are also described above under the heading “Risk Factors.” Should one or more of these risks or uncertainties materialize, or should any of the parties’ assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.
PART I
Overview
We specialize in the design, engineering and installation of high-end specialty curtain wall systems, including glass curtain walls, stone curtain walls, metal curtain walls, roofing systems, and related products, for public works projects and commercial real estate. We have designed and installed nearly one hundred projects throughout China, including the National Grand Theater, Exhibition Conservatory of Beijing Botanical Garden, The COSCO Tower at Changlian Avenue Beijing, and the Wumen Exhibition Hall in Beijing’s Forbidden City, and a number of commercial structures in Southeast Asia. We believe that we compete on the strength of our reputation, track record, strong relationships with government clients and our ability to give expression to the vision of leading architects. By focusing on innovation while outsourcing commoditized manufacturing work, we believe we are able to add artistic and technological value to projects at cost-effective price points.
Corporate Information
We were incorporated in the State of Delaware on March 16, 2004. We were originally organized as a “blank check” shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. On October 17, 2006, we closed a share exchange transaction pursuant to which we (i) became the 100% parent of Full Art International, Ltd., a Hong Kong Company (“Full Art”), which has four subsidiaries, including its wholly-owned subsidiary Zhuhai King Glass Engineering Co., Ltd., a company formed under the laws of the People’s Republic of China (“PRC” or “China”), (ii) assumed the operations of Full Art and its subsidiaries and (iii) changed our name from SRKP 1, Inc. to China Architectural Engineering, Inc. Our corporate offices are located at 105 Baishi Road, Jiuzhou West Avenue, Zhuhai, 519070, People’s Republic of China.
Market Opportunities
The continuing expansion of the Chinese economy has spurred the substantial growth of China’s construction industry, especially in the commercial and public works sectors. As architectural designs for these buildings have become more complex, challenging and modern in scope, there has been an increased need for technology driven companies providing high-end specialty curtain wall systems.
Increasingly, architects have come to favor designs that focus on improved natural lighting, active climate control and cost savings. Increasing demand for state-of-the-art curtain wall glass cladding has spurred technological innovation within the industry to provide new designs and engineering processes. Contractors are relying on firms that can work with architects to develop and enhance their vision and efficiently implement their design while maintaining high quality standards and cost control.
There is an increasing trend in the construction industry toward complex, fast-track, design-build projects. These projects require that all phases of construction be accomplished in accordance with compressed time schedules that involve the hired firm at early stages of the project. These projects also are characterized by numerous design changes requiring that all construction participants coordinate their efforts in order to respond quickly and efficiently in implementing these changes. Those firms capable of meeting this demand must have the ability to provide a total overall solution, from design and project management, to complete engineering services, through manufacturing, installation and servicing.
As China’s economy continues to develop, it is expected that increased construction will be required to accommodate growth in education, culture, social welfare and business. Libraries, museums, exhibition halls, stadiums, planetariums and science centers are among the types of structures increasingly needed in China today. These large public structures can be very costly in terms of energy consumption, calling for new ways to build efficient wall systems that actively conserve energy. In addition, governmental agencies and international regulators are becoming more environmentally conscious in the enactment of regulations governing new construction. Rising fuel costs and environmental concerns have resulted in regulation designed to ensure that new commercial and public works buildings have a low environmental impact. Technologies such as solar lighting, advanced shading systems and circulating sea water systems are constantly improving the ability of structures to interact with the environment by taking advantage of natural conditions, thus meeting the dual goals of reducing energy costs and lessening environmental impact. Currently, most innovative, cutting edge projects appear in the largest cities of China. Yet as development continues, it is expected that mid- and small-sized cities will increasingly move towards investing in these structures as well.
Products and Services
For over 10 years, we have implemented our technology-driven policy of design, manufacturing, and engineering excellence to meet the exacting architectural challenges of Chinese and international customers. We design and develop systems to offer custom-designed solutions for developers of commercial and public works projects with special architectural features. In terms of project management, we exercises overall project planning and control over key areas of activities such as design and engineering, procurement, production scheduling, quality control and site installation. Our comprehensive package of services allows us to offer customized engineering solutions at an affordable cost to meet the requirements of our clients.
Our primary business focus is on designing, engineering and installing specialty high-end curtain wall systems, including glass curtain walls, stone curtain walls, metal curtain walls, roofing systems, and related products. For the year ended December 31, 2006, approximately 35% of our sales came from new construction projects. The remainder is comprised primarily of projects where we add new glass skins to old buildings. A number of these projects have been done in Hong Kong, where the goal was to preserve the original style and features of the structure while applying a new skin which would protect the building and add new energy-saving and aesthetic features.
Concept and Project Management. Initially, we work with the architect to develop, clarify and enhance the overall creative vision for the project. In the design of a curtain wall system, architects are freely able to choose different structure systems to meet the requirements of various architectural models. All contracts awarded are assigned a project number, which is used to track each component and man-hour associated with the project through the entire construction process. All project drawings, specifications and completion schedules on a project are reviewed by our senior management team, and all projects are assigned to one or more project managers, who assume primary responsibility for all aspects of the project. Reporting to the project manager are construction supervisors, safety and administration staff, quality control staff and project engineering staff. Each of these project team members coordinates with internal functional departments and outside suppliers as appropriate. Often a project manager assigned to a given project will have significant experience in similar projects. A project manager generally will be responsible for a number projects in various stages of completion at any given time, depending on the scope, complexity, and geographic location of such projects. Each project is divided into critical sequences that follow the anticipated curtain wall construction path. Each sequence follows a timeline, the status of which is continually monitored. Project managers coordinate and manage design changes or other changes in scheduled completion deadlines in an effort to minimize overall project delays.
Design. Specific technical parameters of the concept are established as new design elements are created and combined with existing technologies. During the design phase, our engineers and technicians review preliminary and completed designs and make recommendations regarding types of connections, possible savings on fabrication techniques, and methods of installation. Operating state-of-the art computer-aided design (CAD) stations, these individuals provide customized design solutions in the form of structural calculations, drawings, fabrication and installation details, together with technical advice and consultancy on specifications, feasibility studies and material procurement. At the implementation stage of the project, detailed fabrications/shop-drawings are produced, discussed and agreed with the project architect/manager. These form the blueprint for project execution and scheduling. Every order is scheduled for production through CAD and computer-aided manufacturing (CAM) systems with progress tracked at each stage of the project process. Quality control and assurance programs are a combination of our specifications with quality inspectors working at all production stages.
Engineering. We maintain significant in-house structural engineering and detailing capabilities that enable us to implement and coordinate with our shop and field personnel original project specifications and changes to building and structural designs sought by our clients. These resources help influence critical determinations as to the most cost-effective systems, designs, connections, and installation procedures for a particular project. Our engineers work on-site with suppliers to machine our patented curtain wall elements and to procure the appropriate raw materials. Our detailers prepare detail shop drawings of the dimensions, positions, locations, and connections, and the fabrication and installation sequences, of each component utilized in a project, and continually update these drawings to accommodate design and other changes. Our automated detailing systems produce updated detail drawings electronically, which can be delivered to our domestic and foreign field locations. Detailers coordinate directly with customers and our suppliers and installation teams to determine and plan the order of fabrication and installation of a project and associated personnel and equipment requirements.
Fabrication. Although we are responsible for hiring suppliers and manufacturers, we subcontract the manufacture of parts made from glass, metal and other materials used in our curtain wall systems. Once parts have been manufactured by subcontracted factories, we will occasionally process them further. This processing takes place in our facilities in Beijing, Shanghai and Zhuhai and usually entails procedures such as adding metal frames to or drilling holes in glass panes, or cutting and bending steel rods into customized shapes. All of our products are fabricated in accordance with applicable industry and specific customer standards and specifications. We have developed project-specific and company-wide quality assurance and quality control programs, and utilize sophisticated systems to inspect all fabricated components. We prepare load lists that identify the sequence and date that each individual component is required on a project, a procedure that reduces the handling of and the need to store materials in the field. After the completion of processing to customer specifications, finished pieces are loaded for shipment to the construction site.
Installation. We have 165 full-time workers and supervisors who are engaged on our projects. Our installation teams consist of highly-trained, skilled and experienced field operatives with established lines of communication between the work site, the technical design department and the factory, ensuring that clients are provided with optimum and cost-effective practical solutions. Site installation is managed through our trained project management staff, and each project has a dedicated project team. On site there are a number of our supervisors who are each responsible for a different section of the curtain wall project. Each supervisor typically manages 30 to 50 of our workers. A small project may have just one work team while a very large project may have five or more. Because the workers are all trained by us and are familiar with the workflow process, they can work on any project in any location. Our project supervisors are often internally developed from our pool of workers. Occasionally, we will hire additional contract labor for specific sections of a very large project or if there are several projects being installed simultaneously, but these extra workers only supplement our core project team. The installation team coordinates its site delivery program with the main contract schedule to meet completion deadlines. The installation process typically consists of pre-assembly of metal and glass component parts at the project site, the lifting of components by crane to the appropriate location at the site and the final assembly of major components.
Customer Service. Our quality control and assurance department is comprised of trained technicians who are responsible for the quality assurance, including quality control of in-process fabrication and site installation by a detailed inspection as well as continued maintenance after project completion. We have adopted important safety policies that are administered and enforced by our senior management and provide training on safety procedures and techniques to our shop and field personnel.
Strategy
To reach the goal of being a preferred choice for Chinese and international government, contractor and architectural clients, we are focusing on the following strategies:
Emphasize Innovative Services. We are committed to meeting the demands of the market, both in China and internationally, through technical innovation and solutions. We focus our design, engineering, and installation expertise on distinct product segments requiring unique or innovative techniques as we have extensive experience in providing services requiring complex design and installation techniques and other unusual project needs. These service capabilities have enabled us to address design-sensitive projects such as stadiums, uniquely designed commercial buildings, and projects that typically carry higher margins than other commercial and public works buildings.
Provide Full Service Solutions. We meet the demand for fully integrated curtain wall contractors that can (i) avoid the coordination difficulties inherent in the use of multiple curtain wall subcontractors; and (ii) implement rapid and multiple design changes in a coordinated and timely manner, preventing project delays and reducing costs to the customer. We believe that a key factor in our success has been our ability to provide, through our in-house personnel, valuable input and assistance to our customers with respect to overall project design, engineering fabrication and installation sequences and other critical project decisions. This often results in overall project cost savings and efficiencies and helps to solidify key customer relationships. In addition to our centralized project management, we also uses a high percentage of skilled installation employees local to projects and utilize advanced scheduling systems to enhance our ability to provide project management services to customers complementary to our core engineering, detail drawing, shop fabrication, and field installation services.
Leverage Our Brand and Reputation. We believe that the strength of our brand is increasing in China and internationally as we build on our large range of projects and our offering of comparative cost advantages and supply-chain management for some of the most complex curtain wall systems in the world. We believe that we have gained a reputation in the industry as a reliable, fully integrated provider of design-build, engineering, installation services with the ability to complete large, complex projects on a timely, cost-efficient basis.
Geographic Expansion in China. Our objective is to achieve and maintain a leading position in the geographic regions and project segments that we serve by providing timely, high-quality services to our customers. We believe that our ability to offer design-build services and our project management capabilities make us a preferred source for complex, design-build projects in the geographic regions we serve. We believe that we have long-standing relationships with China’s top construction officials and leading international architects, having completed high profile projects in China, including the National Theater in Beijing, Shenzhen International Airport and the National Palace Museum. We plan to continue to meet the needs of government and private sector customers in the larger cities within China where we are able to leverage our relationships with national and regional accounts and where commercial and public works development has been more prevalent. We believe that as China’s economic growth continues to reach down to second and third tier cities across the country, governments of those cities will want to build their own high-end public works projects.
International Expansion. We intend to continue our efforts to perform work in other foreign countries. We have launched initiatives to expand sales outside of our traditional China-based markets. We intend to build more projects in Hong Kong and Macau, where demand continues to be brisk. We have also begun working on projects in Vietnam. In addition to building new projects, we intend to continue to add advanced curtain wall technology to existing structures, enabling owners and developers to modernize and improve cost efficiency. In the Middle East, we believe that demand will grow along with trade expansion and continued windfalls from ever-increasing oil prices. We are currently working on a project in Doha, Qatar.
Product Attributes
Our curtain wall products are highly engineered specialty wall systems consisting primarily of a series of glass panels set in metal frames, stone panels, or metal panels, as well as roofing systems and related products. A curtain wall is fixed to the commercial building by mechanical connection, either in a primarily inoperable mode or adjustable with special settings with spring or press systems. Glass panels are connected to the metal support system by metal clamps and fixing bolts. The support system of fixing bolts could be a steel, aluminum and or glass structure, with glass flank or spidery tension rod or cable.
We offer a variety of support systems:
Glass Fin Support System. The facial glass mixing with the glass fin provides facade with maximum transparence, which eliminates the differential expansion among glass metal structures.
Metal Structure Support System. This system utilizes both steel post and steel truss of aluminum post in a metal structure. One of our most popular support systems, its flexibility can fully meet the criteria of demanding modern architecture. At the same time, the combination of transparent glass and steady metal structure completely realizes a harmony between beauty and force, elegance and strength.
Spidery Tension Rod/Cable Support System. This system utilizes a stainless steel tension rod connector for connecting the tension rod or the tension cable to the steel structure in order to form a stable spidery structure for glass curtain wall supporting. A response to the challenge of modern architecture, architects are able to create a smooth and transparent facade.
We use a variety of clamping devices to integrate the glass frame to the support system. Metal “spider” clamps are cast from stainless or high-strength carbonic steel in and provide the features of high strength, simple installment and easy maintenance. Our metal clamps integrate the facial glass with the structure, enhancing the hardness of an entity. Transferable cabling structure makes the curtain wall stretch higher, meeting designers’ requirements for the larger size of vertical space. The combination of steel and glass embodies the feature of stability, lightness and transparency, expressing the majesty and originality of a building.
Our fixing bolts are made of stainless steel and are used for holding the glass glazing. These specifically designed bolts transfer the wind loads, deflection stress and the weight of glass itself to the metal support system which helps reduce the strain on the glass and ensure structural integrity. These bolts are offered in both countersink and flat head. Countersink head fixing bolts they provide a smooth surface when fit flush in the outward surfaces of the glass. They are typically utilized in single and double glazed glass structures. The cylindrical head of our flat head fixing bolts protrude from the surface of glass, which provides more strength against wind force and shear force and can use to fix laminated and insolated glass.
We offer a variety of glass panels allowing a diverse selection of styles to meet the architectural demands of our clients:
Insulating Glass. Increases a window’s thermal performance and sound insulation; constructed with two or more pieces of glass separated by a desiccant-filled spacer and sealed with an organic sealant. The desiccant absorbs the insulating glass unit’s internal moisture.
Laminated Glass. Consists of two or more pieces of glass fused with a vinyl or urethane interlayer and is used primarily for skylight, security and hurricane-resistant application.
Energy- Efficient Coated Glass. Provides solar control, both minimizing heat gain and controlling thermal transfer, by adding coatings to glass. In addition, coatings add color and varying levels of reflectively.
Spandrel Glass. The use of full coverage paint on insulated glass or polyester opacifier film backing on high performance coated glass for the non-vision areas of the building.
Stone or metal may also be used as paneling.
Projects
Our work is performed under cost-plus-fee contracts, fixed-price contracts, and fixed-price contracts modified by incentive and penalty provisions. The length of our contracts varies but typically have a duration of approximately two years.
Approximately 90% of our sales are from fixed price contracts, including one percent that are modified by incentive and penalty provisions. The remaining 10% of our sales are originated from are cost-plus-fee contracts. Under fixed-price contracts, we receive a fixed price regardless of what our actual costs will be. A disadvantage of these types of contracts is that we realize a profit only if we control our costs and prevent cost over-runs on the contracts, which can oftentimes be out of our control, such as cost of materials. An advantage of these contracts is that we could adjust the material and technology that we use in the project, as long as we satisfy the requirements of our customer, and there is a potential to benefit from lower costs of materials. Under fixed-price contracts modified by incentive and penalty provisions, we are paid a fixed price that may be increased or decreased based on incentive and provisions, such as meeting timeline and quality objectives.
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. An advantage of cost-plus-fee contracts is that the cost of materials has generally has no effect on our profit, since we are reimbursed for costs. A disadvantage is that the profit resulting from any cost savings on the materials goes to the contractor and not us.
Noteworthy or recently completed or awarded projects include the following:
Beijing Botanical Garden Greenhouse [PHOTO] | | Bringing the theme, “remembering roots”, to life, the greenhouse was constructed with 8,000 pieces of irregular double glazed toughened glass panes and a steel structure to create a three-dimensional image of roots and stems intertwining. The spider and fixed-point glass curtain wall system automatically adjusts for temperature, humidity, sun shading, UV exposure and irrigation. The structure is comprised of an elliptical atrium (bud) and a double -curved radiated sector (leaf). The “bud” is set on the outside surface of the steel truss, and the “leaf” is on the inside, both protecting the steel from the rain forest conditions inside and expressing the theme. |
National Grand Theater - Beijing [PHOTO] | | · The titanium roof and glass curtain wall form a multi-layered, color shifting elliptical shell. · Changes in light and temperature will produce unpredictable color effects. |
Palace Museum, Wumen Exhibition Hall Forbidden City, Beijing | | |
| [PHOTO] | | Using patented point fixture glass technology, we created an installation which will at once preserve the ancient hall and offer maximum visibility and enjoyment for visitors. |
Skyscraper in Doha, Qatar [PHOTO] | | · In June 2005, we were awarded the contract for construction of the glass curtain wall and solar protection system of the Qatar high-rise office tower, which will be located in West Bay, Doha and will be the tallest building in Qatar when completed. · The design evokes the geometric complexity of the oriental moucharabieh, a typical Islamic style of interlaced wooden screenwork, while also functioning as a form of solar protection. · The curtain wall is composed of four “butterfly” aluminum elements of different scales. This overall pattern changes in order to provide maximal protection from the strong east and west sun. The inside layer is a reflective glass skin, which complements protection. A system of roller-blinds can also be used when needed. |
Shenzhen International Airport “Flying Eagle” [PHOTO] | | · Reflecting its location at an airport, the structure was designed to give the impression of a great bird in flight. · Transparent laminated toughened glass panes were fixed to the columns by spider and point-supported devices. |
Zhongguancun Software Park, Beijing [PHOTO] | | · The “Disc”, with a diameter of 85 meters, is hung 20 meters in the air by radial steel cables and tension cables fixed to four cone-shaped steel columns. · The “Disc” utilizes a high-tech photoelectric system for environmental protection and conservation. Sunlight is converted to electrical energy and stored in photoelectric boards in the laminated glass. · Spider and point-fixed toughened laminated glass shows off the intricate steel structure. |
Sales and Marketing
Sales
Sales managers lead our sales and marketing efforts through our headquarters in Zhuhai, China, and our regional sales offices in Beijing, Shanghai, Nanjing, Guangzhou and Hangzhou, China. Each sales manager is responsible primarily for our estimates, sales, and marketing efforts in defined geographic areas. In addition, we employ full-time project estimators and chief estimators. Our sales representatives attempt to maintain relationships with the Chinese government, general contractors, architects, engineers, and other potential sources of business to determine potential new projects under consideration. Our sales efforts are further supported by our executive officers and engineering personnel, who have substantial experience in the design, fabrication, and installation of high-end specialty curtain walls.
We compete for new project opportunities through our relationships and interaction with our active and prospective customer base, which we believe provides us with valuable current market information and sales opportunities. In addition, we are often contacted by governmental agencies in connection with public construction projects, and by large private-sector project owners and general contractors and engineering firms in connection with new building projects.
Upon selection of projects to bid or price, our estimating division reviews and prepares projected costs of shop, field, detail drawing preparation, raw materials, and other costs. On bid projects, a formal bid is prepared detailing the specific services and materials we plans to provide, payment terms and project completion timelines. Upon acceptance, our bid proposal is finalized in a definitive contract. We experience an average accounts settlement period ranging from three months to as high as one year from the time we provide services to the time we receive payment from our customers. In contrast, we typically need to place certain deposit with our suppliers on a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. We are typically paid by the contractor the entire amount due to us for our services and products once the entire project is completed, which could be significantly after we complete the curtain wall portion of the project. National policy requires the contractor to pay 85% of our total contract value to us before the project is completed, and the remainder may be paid when the contractor completes the entire project. Because our payment cycle is considerably shorter than our receivable cycle, we may experience working capital shortages. We have used short-term bank loans, cash provided by operations and financings to fund our operations.
Marketing
Management believes that we have developed a reputation for innovative technology and quality in the specialty high-end curtain wall industry. Marketing efforts are geared towards advancing us as a brand of choice for building the world’s most modern and challenging projects.
The focus of our marketing plan is print advertising, participation in tradeshows and exhibitions and lecture and technology briefings to designers and property owners. In 2005 and 2006, we maintained an annual advertising budget of approximately $300,000.
With a targeted approach, our print ads appear regularly in popular Chinese consumer and industry publications and trade journals. To better showcase our diverse products to potential customers, we regularly exhibit at the leading trade shows and exhibitions. Our dynamic, state-of-the-art trade show exhibits are developed internally to showcase our latest product offerings.
Production
Supplier Selection
We procure high quality glass panes, metal support beams, and other curtain wall components from a number of regional and international suppliers, depending on the requirements of the contract. Once the suppliers are chosen, our engineers work with them to configure their production processes to manufacture anything from a standard glass pane to a patented fixing bolt or connector. All manufacturing is monitored and approved by our quality control and engineering departments.
Component Processing and Delivery
Once the curtain wall components are produced, they are either shipped directly to the site or sent to one of our facilities for further processing. Such processing typically involves drilling holes in glass panes, affixing metal frame pieces to glass panes, and cutting steel rods and bending them into customized shapes. The project manager and project engineer jointly approve all factory purchases.
Quality Control
Our manufacturing production facilities are designed and maintained with a view towards conforming with good practice standards. To comply with the strict requirements of our customer base, we have implemented a quality assurance plan setting forth our quality assurance procedures. Our quality control department is responsible for maintaining quality standards throughout the production process. Quality control executes the following functions:
| · | setting internal controls and regulations for semi-finished and finished products; |
| · | implementing sampling systems and sample files; |
| · | maintaining quality of equipment and instruments; |
| · | auditing production records to ensure delivery of quality products; |
| · | articulating the responsibilities of quality control staff; and |
| · | on-site evaluation of supplier quality control systems. |
We have received the following certifications in recognition of our production and quality assurance program:
| · | ISO 9001 – International Quality System Certification, February 2005; |
| · | ISO 14001 – International Environmental System Certification, April, 2005; and |
| · | ISO 18001 – International Safety System Certification, June 2005. |
Research and Development
Companies such as us are under pressure from customers to respond more quickly with new designs and product innovations to support rapidly changing consumer tastes and regulatory requirements. We believe that the engineering and technical expertise of our management and key personnel, together with our emphasis on continuing research and development in support of our high-end curtain wall technologies, allows us to efficiently and timely identify and bring new, innovative products to market for our customers using the latest technologies, materials and processes. We believe that continued research and development activities are critical to maintaining our offering of technologically-advanced products to serve a broader array of our customers.
For example, in an effort to add value and create new markets, we are working to develop high performance systems that reduce the need for air conditioning in the summer and heat in the winter. Our products under development are designed to both reduce the direct light and heat coming into the building and, through the use of photovoltaic cells, to harness the energy collected from the sun and further reduce external energy costs by generating power for use in other areas of the building. Other features are designed to add a level of programmed intelligence, automatically adjusting louvers/blinds and other façade controls to achieve predetermined levels for user comfort. These efforts are made to meet the demand for self-sustaining buildings and clean, renewable power in response to climbing energy prices and declining energy reserves.
Our research and development strategy relies primarily on internal innovation and development, supplemented with collaboration with academic and research institutions. For example, we have been appointed by the Chinese Ministry of Construction to lead the committee tasked with establishing national standards for the fixing bolt glass curtain wall technology industry. Luo Ken Yi, our Chief Executive Officer and Chief Operating Officer, will be the Editor-in-Chief for the new standard code. Also, in recognition of our contributions to the curtain wall industry, Luo Ken Yi and two other of our engineers were appointed to senior posts at the Architectural Glass and Metal Structure Institute of Qinghua University in Beijing, one of the most prestigious research institutions in China. We actively track research developmental trends and government regulations, and continually seek to both improve and perfect existing products and develop new ones in accelerated product development cycles. In addition, we seek to recruit and retain qualified Chinese and foreign technical personnel. As of August 24, 2006, we employed 92 designers and engineers and 5 additional research and development personnel.
We expended approximately $50,117, $58,865, and $nil on research and development activities for each of the years ended December 31, 2006, 2005 and 2004, respectively. These amounts exclude design and construction of customized molds used to manufacture the pieces used for a particular project, as well as sample and testing costs.
Backlog
At December 31, 2006, our total backlog of orders considered to be firm was approximately $3.5 million, compared with $0.5 million at December 31, 2005. Of these amounts, approximately $2.5 million, or 71%, of our backlog is expected to be produced and shipped in fiscal 2007 compared to $0.5 million, or 100%, in the fiscal 2006. We view backlog as an important statistic in evaluating the level of sales activity and short-term sales trends in our business. However, as backlog is only one indicator, and is not an effective indicator of the ultimate profitability of our sales, we do not believe that backlog should be used as the sole indicator of our future earnings.
Competition
The markets that we serve are highly competitive, price and lead-time sensitive and are impacted by changes in the commercial construction industry, including unforeseen delays in project timing and workflow. In addition, competition in the markets of the building industry is intense. It is based primarily on:
| · | ability to provide added value in the design and engineering of buildings; |
| · | speed of construction in buildings and components; and |
| · | personal relationships with customers. |
We compete with several large integrated glass manufacturers, numerous specialty, architectural glass and window fabricators, and major contractors and subcontractors. We also compete with a number of other manufacturers of engineered building systems ranging from small local firms to large national firms. Many of our competitors have greater financial or other resources than we do. In addition, we and other manufacturers of engineered high-end curtain walls compete with alternative methods of building construction. If these alternative building methods compete successfully against us, such competition could adversely affect us. Demand for our services is cyclical and vulnerable to economic downturns. If the economy weakens, then our revenues, profits and financial condition may deteriorate.
Government Regulation
China’s construction industry is heavily regulated by the national government. On November 1, 1997, the National Government of the PRC published the Construction Law of the PRC, Presidential Order No. 91, which is the basic construction law of China. This law outlines the basic requirements and rules for all construction activity in China. Underneath the National Government, the Ministry of Construction also writes laws. On March 14, 2001, the Ministry of Construction published Rule No. 87, which puts forth licensing requirements for all construction companies operating in China. The Ministry of Construction also writes specific standards for all different types of construction. The two standards from the Ministry of Construction which are most relevant to our business are: (i) the Curtain Wall Engineering and Design Licensing Standard, and (ii) the Light-Duty Steel Building Structure Engineering and Design Licensing Standard. These standards stipulate the basic requirements for construction companies in China in such areas as registered capital, tangible assets, liability insurance, employee regulations and engineering certifications. The standards also have graded levels of qualification. We have first class certification for the Curtain Wall Standard and Second Class Certification for the Light Steel Structure Standard. In addition, Provincial and municipal governments may also enact regulations through their own construction bureaus.
Employees
As of December 31, 2006, we had 323 full-time employees and an additional 315 part-time on-site employees. Substantially all of our employees are located in China. We believe that our relationship with our employees is good.
We our required to contribute a portion of our employees’ total salaries to the Chinese government’s social insurance funds, including medical insurance, unemployment insurance and job injuries insurance, and a housing assistance fund, in accordance with relevant regulations. In the last three years, Zhuhai contributed approximately $119,897, $106,280 and $72,462 for the years ended December 31, 2006, 2005 and 2004, respectively. We expect the amount of Zhuhai’s contribution to the government’s social insurance funds to increase in the future as we expand our workforce and operations.
Any investment in our common stock involves a high degree of risk. Investors should carefully consider the risks described below and all of the information contained in this report before deciding whether to purchase our common stock. Our business, financial condition or results of operations could be materially adversely affected by these risks if any of them actually occur. Our shares of common stock are not currently listed or quoted for trading on any national securities exchange or national quotation system. If and when our common stock is traded, the trading price could decline due to any of these risks, and an investor may lose all or part of his investment. Some of these factors have affected our financial condition and operating results in the past or are currently affecting our company. This report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks we face as described below and elsewhere in this report. With respect to this discussion, the terms, “we,” “us,” or “our” refer to China Architectural Engineering, Inc., and our 100%-owned subsidiary Full Art International, Ltd. (“Full Art”).
RISKS RELATED TO OUR OPERATIONS
Because we depend on governmental agencies for a significant portion of our revenue, our inability to win or renew government contracts could harm our operations and significantly reduce or eliminate our profits.
Revenues from Chinese government contracts represented approximately 95% of our revenues for the year ended December 31, 2006. Our inability to win or renew Chinese government contracts could harm our operations and significantly reduce or eliminate our profits. Chinese government contracts are typically awarded through a regulated procurement process. Some Chinese government contracts are awarded to multiple competitors, causing increases in overall competition and pricing pressure. The competition and pricing pressure, in turn may require us to make sustained post-award efforts to reduce costs in order to realize revenues under these contracts. If we are not successful in reducing the amount of costs we anticipate, our profitability on these contracts will be negatively impacted. Finally, Chinese government clients can generally terminate or modify their contracts with us at their convenience.
If we are unable to accurately estimate and control our contract costs and timelines, then we may incur losses on our contracts, which may result in decreases in our operating margins and in a significant reduction or elimination of our profits.
If we do not control our contract costs, we may be unable to maintain positive operating margins or experience operating losses. We generally enter into three principal types of contracts with our clients: cost-plus-fee contracts, fixed-price contracts, and fixed-price contracts modified by incentive and penalty provisions. Approximately 90% of our sales are from fixed price contracts, including one percent that are modified by incentive and penalty provisions. The remaining 10% of our sales are originated from are cost-plus-fee contracts. Under fixed-price contracts, we receive a fixed price regardless of what our actual costs will be. Consequently, we realize a profit on fixed-price contracts only if we control our costs and prevent cost over-runs on the contracts. Under fixed-price contracts modified by incentive and penalty provisions, we are paid a fixed price that may be increased or decreased based on incentive and provisions in our contracts. Under cost-plus-fee contracts, which may be subject to contract ceiling amounts, we are reimbursed for allowable costs and fees, which may be fixed or performance-based. If our costs exceed the contract ceiling or are not allowable under the provisions of the contract or any applicable regulations, we may not be reimbursed for all our costs. Under each type of contract, if we are unable to estimate and control costs and/or project timelines, we may incur losses on our contracts, which may result in decreases in our operating margins and in a significant reduction or elimination of our profits.
If we fail to timely complete, miss a required performance standard or otherwise fail to adequately perform on a project, then we may incur a loss on that project, which may affect our overall profitability.
We may commit to a client that we will complete a project by a scheduled date. We may also commit that a project, when completed, will achieve specified performance standards. If the project is not completed by the scheduled date or subsequently fails to meet required performance standards, we may either incur significant additional costs or be held responsible for the costs incurred by the client to rectify damages due to late completion or failure to achieve the required performance standards. The uncertainty of the timing of a project can present difficulties in planning the amount of personnel needed for the project. If the project is delayed or canceled, we may bear the cost of an underutilized workforce that was dedicated to fulfilling the project. In addition, performance of projects can be affected by a number of factors beyond our control, including unavoidable delays from weather conditions, unavailability of vendor materials, changes in the project scope of services requested by clients or labor disruptions. In some cases, should we fail to meet required performance standards, we may also be subject to agreed-upon financial damages, which are determined by the contract. To the extent that these events occur, the total costs of the project could exceed our estimates and we could experience reduced profits or, in some cases, incur a loss on that project, which may affect our overall profitability.
Our use of the “percentage-of-completion” method of accounting could result in reduction or reversal of previously recorded revenues and profits.
A substantial portion of our revenues and profits are measured and recognized using the “percentage-of-completion” method of accounting, which is discussed further in Note 2, “Summary Of Significant Accounting Policies” to our “Financial Statements.” Our use of this method results in recognition of revenues and profits ratably over the life of a contract, based generally on the proportion of costs incurred to date to total costs expected to be incurred for the entire project. The effect of revisions to revenues and estimated costs is recorded when the amounts are known or can be reasonably estimated. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program and construction management or construction contracts in process, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates, including reductions or reversals of previously recorded revenues and profits.
Our future revenues depend on our ability to consistently bid and win new contracts and renew existing contracts and, therefore, our failure to effectively obtain future contracts could adversely affect our profitability.
Our future revenues and overall results of operations require us to successfully bid on new contracts and renew existing contracts. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which is affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. If negative market conditions arise, or if we fail to secure adequate financial arrangements or the required governmental approval, we may not be able to pursue particular projects, which could adversely affect our profitability.
Our results could be adversely impacted by product quality and performance.
We manufacture or install products based on specific requirements of each of our customers. We believe that future orders of our products or services will depend on our ability to maintain the performance, reliability and quality standards required by our customers. If our products or services have performance, reliability or quality problems, we may experience delays in the collection of accounts receivables, higher manufacturing or installation costs, additional warranty and service expense, and reduced, cancelled or discontinued orders. Additionally, performance, reliability or quality claims from our customers, with or without merit, could result in costly and time-consuming litigation that could require significant time and attention of management and involve significant monetary damages.
Continued price volatility and supply constraints in the steel and aluminum markets could prevent us from meeting delivery schedules to our customers or reduce our profit margins.
Our business is dependent on the prices and supply of steel and aluminum, which, along with glass, are the principal raw materials used in our products. The steel and aluminum industries are highly cyclical in nature, and steel and aluminum prices have been volatile in recent years and may remain volatile in the future. Our purchases of aluminum ranged from approximately $1.00 to $1.40 per pound between December 15, 2005 and 2006, a fluctuation of approximately 40%, and from $0.60 to $1.40 per pound during the five years ended December 15, 2006, a fluctuation of approximately 133%. The price we paid for steel also fluctuated. For the year ended December 31, 2006, prices for seamless steel tubes ranged from approximately RMB 4,730 to 5,700 RMB per ton (a difference of approximately 21%), prices for angled steel ranged from approximately RMB 3,143 to RMB 3,465 per ton (a difference of approximately 10%), and prices for steel plates ranged from approximately RMB 3,332 to RMB 4,688 per ton (a difference of approximately 41%).
Steel and aluminum prices are influenced by numerous factors beyond our control, including general economic conditions, competition, labor costs, production costs, import duties and other trade restrictions. In the past there have been unusually rapid and significant increases in steel and aluminum prices and severe shortages in the steel and aluminum industries due in part to increased demand from China’s expanding economy and high energy prices. We do not have any long-term contracts for the purchase of steel and aluminum and normally do not maintain inventories of steel and aluminum in excess of our current production requirements. We can give you no assurance that steel and aluminum will remain available or that prices will not continue to be volatile. If the available supply of steel and aluminum declines, we could experience price increases that we are not able to pass on to our customers, a deterioration of service from our suppliers or interruptions or delays that may cause us not to meet delivery schedules to our customers. Any of these problems could adversely affect our results of operations and financial condition.
Our business is characterized by long periods for collection from our customers and short periods for payment to our suppliers, the combination of which may cause us to have liquidity problems.
We experience an average accounts settlement period ranging from three months to as high as one year from the time we provide services to the time we receive payment from our customers. In contrast, we typically need to place certain deposit with our suppliers on a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. We are typically paid by the contractor the entire amount due to us for our services and products once the entire project is completed, which could be significantly after we complete the curtain wall portion of the project. National policy requires the contractor to pay 85% of our total contract value to us before the project is completed, and the remainder may be paid when the contractor completes the entire project. Because our payment cycle is considerably shorter than our receivable cycle, we may experience working capital shortages. Working capital management, including prompt and diligent billing and collection, is an important factor in our results of operations and liquidity. We cannot assure you that system problems, industry trends or other issues will not extend our collection period, adversely impact our working capital.
The industries in which we operate are highly competitive.
The markets we serve are very competitive, price and lead-time sensitive and are impacted by changes in the commercial construction industry, including unforeseen delays in project timing and work flow. In addition, competition in the markets of the building industry and in the metal coil coating industry is intense. It is based primarily on:
· quality;
· service;
· delivery;
· ability to provide added value in the design and engineering of buildings;
· price;
· speed of construction in buildings and components; and
· personal relationships with customers.
We compete with several large integrated glass manufacturers, numerous specialty, architectural glass and window fabricators, and major contractors and subcontractors. We also compete with a number of other manufacturers of engineered building systems ranging from small local firms to large national firms. Many of our competitors have greater financial or other resources than we. In addition, we and other manufacturers of engineered high-end curtain walls compete with alternative methods of building construction. If these alternative building methods compete successfully against us, such competition could adversely affect us. Demand for our services is cyclical and vulnerable to economic downturns. If the economy weakens, then our revenues, profits and our financial condition may deteriorate. Many of our competitors have greater financial or other resources than us.
Our business activities may require our employees to travel to and work in high security risk countries, which may result in employee death or injury, repatriation costs or other unforeseen costs.
As a multinational company, our employees often travel to and work in high security risk countries around the world that are undergoing political, social and economic upheavals resulting in war, civil unrest, criminal activity or acts of terrorism. For example, we will have had approximately 150 different employees working in Qatar from time to time and approximately 12 employees working in Vietnam from time to time. We have also had employees in Dubai. As a result, we may be subject to costs related to employee death or injury, repatriation or other unforeseen circumstances.
Force majeure events, including natural disasters and terrorists’ actions have negatively impacted and could further negatively impact the economies in which we operate, which may affect our financial condition, results of operations or cash flows.
Force majeure events, including natural disasters, such as Typhoon Pai Bi An that affected the Southeastern China Coast in August 2006 and terrorist attacks, such as those that occurred in New York and Washington, D.C. on September 11, 2001, could negatively impact the economies in which we operate.
We typically remain obligated to perform our services after a terrorist action or natural disaster unless the contract contains a force majeure clause that relieves us of our contractual obligations in such an extraordinary event. If we are not able to react quickly to force majeure, our operations may be affected significantly, which would have a negative impact on our financial condition, results of operations or cash flows.
We may suffer as a result of product liability or defective products.
We may produce products which injure or kill individuals despite proper testing. Existing PRC laws and regulations do not require us to maintain third party liability insurance to cover product liability claims. However, if a product liability claim is brought against us, it may, regardless of merit or eventual outcome, result in damage to our reputation, breach of contract with our customers, decreased demand for our products, costly litigation, product recalls, loss of revenue, and the inability to commercialize some products.
We incur costs to comply with environmental laws and have liabilities for environmental cleanups.
Because we have air emissions, discharge wastewater, and handle hazardous substances and solid waste at our fabrication facilities, we incur costs and liabilities to comply with environmental laws and regulations and may incur significant additional costs as those laws and regulations change in the future or if there is an accidental release of hazardous substances into the environment. The operations of our fabrication facilities are subject to stringent and complex environmental laws and regulations that regulate the cleanup of hazardous substances that may have been released at properties currently or previously owned or operated by us or locations to which we have sent waste for disposal. Failure to comply with these laws and regulations may trigger a variety of administrative, civil and criminal enforcement measures, including the assessment of monetary penalties, the imposition of remedial requirements, and the issuance of orders enjoining future operations.
If our partners fail to perform their contractual obligations on a project, we could be exposed to legal liability, loss of reputation or reduced profits.
We sometimes enter into subcontracts, joint ventures and other contractual arrangements with outside partners to jointly bid on and execute a particular project. The success of these joint projects depends upon, among other things, the satisfactory performance of the contractual obligations of our partners. If any of our partners fails to satisfactorily perform its contractual obligations, we may be required to make additional investments and provide additional services to complete the project. If we are unable to adequately address our partner’s performance issues, then our client could terminate the joint project, exposing us to legal liability, loss of reputation or reduced profits.
We are dependent on certain key personnel and loss of these key personnel could have a material adverse effect on our business, financial condition and results of operations.
Our success is, to a certain extent, attributable to the management, sales and marketing, and operational expertise of key personnel. Luo Ken Yi, our Chief Executive Officer and Chief Operating Officer, Tang Nianzhong, our Vice General Manager and Ye Ning, our Vice General Manager perform key functions in the operation of our business. There can be no assurance that we will be able to retain these managers after the term of their employment contracts expire. The loss of these managers could have a material adverse effect upon our business, financial condition, and results of operations. We must attract, recruit and retain a sizeable workforce of technically competent employees. Our ability to effectively implement our business strategy will depend upon, among other factors, the successful recruitment and retention of additional highly skilled and experienced management and other key personnel. We cannot assure you that we will be able to hire or retain such employees.
We cannot guarantee the protection of our intellectual property rights and if infringement or counterfeiting of our intellectual property rights occurs, our reputation and business may be adversely affected.
Our success depends in part on our ability to preserve our patents and trade secrets and operate without infringing the proprietary rights of third parties. We currently own approximately 32 patents in China. If we fail to maintain our patents and trade secret protections, we may not be able to prevent third parties from using our proprietary rights. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage. If a third party initiates litigation regarding our patents, and is successful, a court could revoke our patents or limit the scope of coverage for those patents. We also rely upon trade secrets, proprietary know-how and continuing technological innovation to remain competitive. We attempt to protect this information with security measures such as the use of confidentiality agreements with our employees, consultants and corporate collaborators. It is possible that these individuals will breach these agreements and that any remedies for a breach will be insufficient to allow us to recover our costs. Furthermore, our trade secrets, know-how and other technology may otherwise become known or be independently discovered by our competitors.
Furthermore, we have registered and applied for registration of our trademarks in the PRC, where we have a substantial business presence, to protect the reputation of our products. Our products are sold under these trademarks. There is no assurance that there will not be any infringement of our brand name or other registered trademarks or counterfeiting of our products in the future. Should any such infringement or counterfeiting occur, our reputation and business may be adversely affected. We may also incur significant expenses and substantial amounts of time and effort to enforce our intellectual property rights in the future. Such diversion of our resources may adversely affect our existing business and future expansion plans.
We enjoy certain preferential tax concessions and loss of these preferential tax concessions will cause our tax liabilities to increase and our profitability to decline.
We enjoy preferential tax concessions in the PRC as a high-tech enterprise. Pursuant to the State Council’s Regulations on Encouraging Investment in and Development, we were granted a reduction in our income tax rate to a rate of 15%. In addition, there is no assurance that the preferential tax treatment in the PRC will remain unchanged and effective. Our tax liabilities will increase and our profits may accordingly decline if our reduced income tax rate is no longer applicable and/or the tax relief on investment in PRC is no longer available.
Additionally, the PRC Enterprise Income Tax Law (the “EIT Law”) was enacted on March 16, 2007. Under the EIT Law, effective January 1, 2008, China will adopt a uniform tax rate of 25.0% for all enterprises (including foreign-invested enterprises) and cancel several tax incentives enjoyed by foreign-invested enterprises. However, for foreign-invested enterprises established before the promulgation of the EIT Law, a five-year transition period is provided during which reduced rates will apply but gradually be phased out. Since the PRC government has not announced implementation measures for the transitional policy with regards to such preferential tax rates, we cannot reasonably estimate the financial impact of the new tax law to us at this time. Further, any future increase in the enterprise income tax rate applicable to us or other adverse tax treatments, such as the discontinuation of preferential tax treatments for high and new technology enterprises altogether, would have a material adverse effect on our results of operations and financial condition.
Our actual results could differ from the estimates and assumptions that we use to prepare our financial statements, which may significantly reduce or eliminate our profits.
To prepare financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions as of the date of the financial statements, which affect the reported values of assets and liabilities and revenues and expenses and disclosures of contingent assets and liabilities. Areas requiring significant estimates by our management include:
| · | the application of the “percentage-of-completion” method of accounting, and revenue recognition on contracts, change orders, and contract claims; |
| · | provisions for uncollectible receivables and customer claims and recoveries of costs from subcontractors, vendors and others; |
| · | provisions for income taxes and related valuation allowances; |
| · | value of goodwill and recoverability of other intangible assets; and |
| · | accruals for estimated liabilities, including litigation and insurance reserves. |
Our actual results could differ from those estimates, which may significantly reduce or eliminate our profits.
RISKS RELATED TO US DOING BUSINESS IN CHINA
All of our assets are located in China and substantially all of our revenues are derived from our operations in China, and changes in the political and economic policies of the PRC government could have a significant impact upon the business we may be able to conduct in the PRC and the results of operations and financial condition.
Our business operations may be adversely affected by the current and future political environment in the PRC. The PRC has operated as a socialist state since the mid-1900s and is controlled by the Communist Party of China. The Chinese government exerts substantial influence and control over the manner in which we must conduct our business activities. The PRC has only permitted provincial and local economic autonomy and private economic activities since 1988. The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy, particularly the pharmaceutical industry, through regulation and state ownership. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.
Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
We are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some that may compete with us, are not subject to these prohibitions, and therefore may have a competitive advantage over us. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC, particularly in our industry since it deals with contracts from the Chinese Government, and our executive officers and employees have not been subject to the United States Foreign Corrupt Practices Act prior to the completion of the Share Exchange. We can make no assurance that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. Any changes in such PRC laws and regulations may have a material and adverse effect on our business.
The PRC’s legal system is a civil law system based on written statutes, in which system decided legal cases have little value as precedents unlike the common law system prevalent in the United States. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. The Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. We are considered a foreign persons or foreign funded enterprise under PRC laws, and as a result, we are required to comply with PRC laws and regulations. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses. If the relevant authorities find us in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including, without limitation:
| · | revoking our business and other licenses; |
| · | requiring that we restructure our ownership or operations; and |
| · | requiring that we discontinue any portion or all of our business. |
Inflation in the PRC could negatively affect our profitability and growth.
While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. During the past decade, the rate of inflation in China has been as high as approximately 20% and China has experienced deflation as low as approximately minus 2%. If prices for our products and services rise at a rate that is insufficient to compensate for the rise in the costs of supplies such as raw materials, it may have an adverse effect on our profitability. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. The implementation of such policies may impede economic growth. In October 2004, the People’s Bank of China, the PRC’s central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the Chinese economy. In April 2006, the People’s Bank of China raised the interest rate again. Repeated rises in interest rates by the central bank would likely slow economic activity in China which could, in turn, materially increase our costs and also reduce demand for our products and services.
Recent PRC regulations relating to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit our ability to operate, including our ability to pay dividends.
The PRC State Administration of Foreign Exchange, or SAFE, issued a public notice in January 2005 concerning foreign exchange regulations on mergers and acquisitions in China. The public notice states that if an offshore company controlled by PRC residents intends to acquire a PRC company, such acquisition will be subject to strict examination by the relevant foreign exchange authorities. The public notice also states that the approval of the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of a PRC company’s assets or equity interests to foreign entities for equity interests or assets of the foreign entities.
In April 2005, SAFE issued another public notice further explaining the January notice. In accordance with the April notice, if an acquisition of a PRC company by an offshore company controlled by PRC residents has been confirmed by a Foreign Investment Enterprise Certificate prior to the promulgation of the January notice, the PRC residents must each submit a registration form to the local SAFE branch with respect to their respective ownership interests in the offshore company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers and acquisitions, spin-off transaction or use of assets in China to guarantee offshore obligations. The April notice also provides that failure to comply with the registration procedures set forth therein may result in restrictions on our PRC resident shareholders and subsidiaries. Pending the promulgation of detailed implementation rules, the relevant government authorities are reluctant to commence processing any registration or application for approval required under the SAFE notices.
In addition, on August 8, 2006, the Ministry of Commerce (“MOFCOM”), joined by the State-Owned Assets Supervision and Administration Commission of the State Council, State Administration of Taxation, State Administration for Industry and Commerce, China Securities Regulatory Commission and SAFE, amended and released the Provisions for Foreign Investors to Merge and Acquire Domestic Enterprises, new foreign-investment rules which took effect September 8, 2006, superseding much, but not all, of the guidance in the prior SAFE circulars. These new rules significantly revise China’s regulatory framework governing onshore-offshore restructurings and how foreign investors can acquire domestic enterprises. These new rules signify greater PRC government attention to cross-border merger, acquisition and other investment activities, by confirming MOFCOM as a key regulator for issues related to mergers and acquisitions in China and requiring MOFCOM approval of a broad range of merger, acquisition and investment transactions. Further, the new rules establish reporting requirements for acquisition of control by foreigners of companies in key industries, and reinforce the ability of the Chinese government to monitor and prohibit foreign control transactions in key industries.
These new rules may significantly affect the means by which offshore-onshore restructurings are undertaken in China in connection with offshore private equity and venture capital financings, mergers and acquisitions. It is expected that such transactional activity in China in the near future will require significant case-by-case guidance from MOFCOM and other government authorities as appropriate. It is anticipated that application of the new rules will be subject to significant administrative interpretation, and we will need to closely monitor how MOFCOM and other ministries apply the rules to ensure its domestic and offshore activities continue to comply with PRC law. Given the uncertainties regarding interpretation and application of the new rules, we may need to expend significant time and resources to maintain compliance.
It is uncertain how our business operations or future strategy will be affected by the interpretations and implementation of the SAFE notices and new rules. Our business operations or future strategy could be adversely affected by the SAFE notices and the new rules. For example, we may be subject to more stringent review and approval process with respect to our foreign exchange activities.
Any recurrence of Severe Acute Respiratory Syndrome (SARS), Avian Flu, or another widespread public health problem, in the PRC could adversely affect our operations.
A renewed outbreak of Severe Acute Respiratory Syndrome, Avian Flu or another widespread public health problem in China, where all of our manufacturing facilities are located and where all of our sales occur, could have a negative effect on our operations. Such an outbreak could have an impact on our operations as a result of:
| · | quarantines or closures of some of our manufacturing facilities, which would severely disrupt our operations, |
| · | the sickness or death of our key officers and employees, and |
| · | a general slowdown in the Chinese economy. |
Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations.
We may have difficulty establishing adequate management, legal and financial controls in the PRC.
PRC companies have historically not adopted a Western style of management and financial reporting concepts and practices, which includes strong corporate governance, internal controls and, computer, financial and other control systems. In addition, we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any such deficiencies, weaknesses or lack of compliance could have a materially adverse effect on our business.
You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based upon U.S. laws, including the federal securities laws or other foreign laws against us or our management.
Most of our current operations are conducted in China. Moreover, almost all of our directors and officers are nationals and residents of China. All or substantially all of the assets of these persons are located outside the United States and in the PRC. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon these persons. In addition, uncertainty exists as to whether the courts of China would recognize or enforce judgments of U.S. courts obtained against us or our officers and/or directors predicated upon the civil liability provisions of the securities law of the United States or any state thereof, or be competent to hear original actions brought in China against us or such persons predicated upon the securities laws of the United States or any state thereof.
RISKS RELATED TO OUR CAPITAL STRUCTURE
There is no current trading market for our common stock, and there is no assurance of an established public trading market, which would adversely affect the ability of our investors to sell their securities in the public market.
Our common stock is not currently listed or quoted for trading on any national securities exchange or national quotation system. We are applying for the listing of our common stock on the American Stock Exchange (“AMEX”) in the future. There is no guarantee that the American Stock Exchange, or any other exchange or quotation system, will permit our shares to be listed and traded. If we fail to obtain a listing on the American Stock Exchange, we may seek quotation on the OTC Bulletin Board. The NASD has enacted changes that limit quotations on the OTC Bulletin Board to securities of issuers that are current in their reports filed with the Securities and Exchange Commission. The effect on the OTC Bulletin Board of these rule changes and other proposed changes cannot be determined at this time. The OTC Bulletin Board is an inter-dealer, over-the-counter market that provides significantly less liquidity than the NASDAQ Global Market or AMEX. Quotes for stocks included on the OTC Bulletin Board are not listed in the financial sections of newspapers as are those for the NASDAQ Global Market or AMEX. Therefore, prices for securities traded solely on the OTC Bulletin Board may be difficult to obtain and holders of common stock may be unable to resell their securities at or near their original offering price or at any price.
Shares eligible for future sale may adversely affect the market price of our common stock, as the future sale of a substantial amount of outstanding stock in the public marketplace could reduce the price of our common stock.
Pursuant to the terms of the Share Exchange, we agreed to file a registration statement with the Securities and Exchange Commission to register a total of 2,320,875 shares of common stock issued in an equity financing that was conducted in connection with the Share Exchange that closed on October 17, 2006. The investors in the Private Placement also entered into a lock-up agreement pursuant to which they agreed not to sell their shares until our common stock begins to be traded on the New York Stock Exchange, American Stock Exchange, NASDAQ Global Market, NASDAQ Capital Market or the OTC Bulletin Board, after which their shares will automatically be released from the lock up on a monthly basis. We also agreed to register the IR Securities, which consists of 100,000 shares of our common stock and common stock underlying a five-year warrant to purchase 232,088 shares, in the registration statement filed in connection with the Private Placement.
We also agreed to register all of the 2,275,000 shares of common stock held by our shareholders who were shareholders immediately prior to the Share Exchange. Because we issued shares to these shareholders that were issued shares while we were a “blank check” shell company with no operations, these shareholders are considered to be promoters or affiliates. It should be noted that these shares may not be sold by these promoters or affiliates, or their transferees, pursuant to Rule 144 of the Securities Act, regardless of technical compliance with the rule. Any such resale transaction under Rule 144 would appear to be designed to distribute or redistribute such shares to the public without coming within the registration requirements of the Securities Act. Therefore, these promoters or affiliates, or their transferees, can only resell their shares through a registration statement filed under the Securities Act. Of the 2,275,000 shares held by our shareholders prior to the Share Exchange, we agreed to register 1,312,675 shares in the registration statement filed in connection with the Private Placement. We agreed to register the remaining 962,325 shares, which are beneficially owned by affiliates of WestPark Capital, Inc., in a subsequent registration statement filed by us in a subsequent registration statement that we agreed to file by May 23, 2007, which is six months and ten days after the date on which we first filed the registration statement to register the shares issued in the Private Placement. We also agreed to register 2,000,000 shares of our common stock that were issued to FirstAlliance Financial Group, Inc., which received its shares as a designee of the sole shareholder of Full Art at the closing of the Share Exchange. The shares will be registered in the registration statement that is filed to register the shares held by the affiliates of WestPark. All of the shares included in an effective registration statement as described above may be freely sold and transferred except if subject to a lock up agreement.
Additionally, following the Share Exchange, the former stockholder of Full Art may be eligible to sell all or some of our shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144, promulgated under the Securities Act (“Rule 144”), subject to certain limitations. In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a one-year holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. As of the closing of the Share Exchange, 1% of our issued and outstanding shares of common stock was approximately 500,000 shares. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitations, by a non-affiliate that has satisfied a two-year holding period. Any substantial sale of common stock pursuant to any resale report or Rule 144 may have an adverse effect on the market price of our common stock by creating an excessive supply.
Following the Share Exchange, the former principal stockholder of Full Art has significant influence over us.
Our largest shareholder, KGE Group, Limited, or KGE Group, beneficially owns or controls approximately 75.5% of our outstanding shares as of the close of the Share Exchange. Luo Ken Yi, who is our Chief Executive Officer, Chief Operating Officer, and Chairman of the Board, and Ye Ning, who is our Vice General Manager and a director, are directors of KGE Group. In addition, Luo Ken Yi and Ye Ning own approximately 77.0% and 2.5%, respectively, respectively, of KGE Group’s issued and outstanding shares. As a result of its holding, KGE Group has controlling influence in determining the outcome of any corporate transaction or other matters submitted to our shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors, and other significant corporate actions. KGE Group also has the power to prevent or cause a change in control. In addition, without the consent of KGE Group, we could be prevented from entering into transactions that could be beneficial to us. The interests of KGE Group, and its control persons, may differ from the interests of our shareholders.
We recognized a charge to our earnings as a result of the Share Exchange and also may not be able to achieve the benefits we expect to result from the Share Exchange.
On August 21, 2006, we entered into the Exchange Agreement, as amended on October 17, 2006, with KGE Group, the sole shareholder of Full Art, pursuant to which we agreed to acquire 100% of the issued and outstanding securities of Full Art in exchange for shares of our common stock. On October 17, 2006, the Share Exchange closed, Full Art became our wholly-owned subsidiary, our sole business operations became that of Full Art, and the management and directors of Full Art became the management and directors of us.
We may not realize the benefits that we hoped to receive as a result of the Share Exchange, which includes:
| · | access to the capital markets of the United States; |
| · | the increased market liquidity expected to result from exchanging stock in a private company for securities of a public company that may eventually be traded; |
| · | the ability to use registered securities to make acquisition of assets or businesses; |
| · | increased visibility in the financial community; |
| · | enhanced access to the capital markets; |
| · | improved transparency of operations; and |
| · | perceived credibility and enhanced corporate image of being a publicly traded company. |
There can be no assurance that any of the anticipated benefits of the Share Exchange will be realized in respect to our new business operations. In addition, the attention and effort devoted to achieving the benefits of the Share Exchange and attending to the obligations of being a public company, such as reporting requirements and securities regulations, could significantly divert management’s attention from other important issues, which could materially and adversely affect our operating results or stock price in the future.
In addition, we issued 2,000,000 shares of common stock to FirstAlliance Financial Group, Inc. upon closing of the Share Exchange, and the shares were accounted as a non-reoccurring general and administrative expense and, as a result, reduced our earnings for the quarter and year ended December 31, 2006. As a result of the reduction in earnings, our results of operation for the quarter and year ended December 31, 2006 suffered and the value of our common stock and your investment may fall.
If we fail to maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected.
Our internal control over financial reporting may have weaknesses and conditions that need to be addressed, the disclosure of which may have an adverse impact on the price of our common stock. We are required to establish and maintain appropriate internal controls over financial reporting. Failure to establish those controls, or any failure of those controls once established, could adversely impact our public disclosures regarding our business, financial condition or results of operations. In addition, management’s assessment of internal controls over financial reporting may identify weaknesses and conditions that need to be addressed in our internal controls over financial reporting or other matters that may raise concerns for investors. Any actual or perceived weaknesses and conditions that need to be addressed in our internal control over financial reporting, disclosure of management’s assessment of our internal controls over financial reporting or disclosure of our public accounting firm’s attestation to or report on management’s assessment of our internal controls over financial reporting may have an adverse impact on the price of our common stock.
Our officers and directors have no experience in public company reporting and limited experience in financial accounting, which could impair our ability to satisfy public company filing requirements and increase our securities compliance costs.
Our officers and directors do not have any prior experience as officers and directors of a publicly traded company, or in complying with the regulatory requirements applicable to a public company. As a result, we could have difficulty satisfying the regulatory requirements applicable to public companies, which could adversely affect the market for our common stock. At present, we rely upon outside experts to advise us on matters relating to financial accounting and public company reporting. While we believe that it will be possible to satisfy our public company reporting requirements through the use of third party experts, our general and administrative costs will remain higher to the extent our officers alone are not able to satisfy our public company reporting requirements.
Standards for compliance with Section 404 of the Sarbanes-Oxley Act Of 2002 are uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could decline.
Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of our internal control over financial reporting, and attestation of this assessment by our company’s independent registered public accountants. The SEC extended the compliance dates for non-accelerated filers, as defined by the SEC. Accordingly, we believe that the annual assessment of our internal controls requirement will first apply to our annual report for the 2007 fiscal year and the attestation requirement of management’s assessment by our independent registered public accountants will first apply to our annual report for the 2008 fiscal year. The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. We may encounter problems or delays in completing activities necessary to make an assessment of our internal control over financial reporting. In addition, the attestation process by our independent registered public accountants is new and we may encounter problems or delays in completing the implementation of any requested improvements and receiving an attestation of our assessment by our independent registered public accountants. If we cannot assess our internal control over financial reporting as effective, or our independent registered public accountants are unable to provide an unqualified attestation report on such assessment, investor confidence and share value may be negatively impacted.
Compliance with changing regulation of corporate governance and public disclosure will result in additional expenses.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and related SEC regulations, have created uncertainty for public companies and significantly increased the costs and risks associated with accessing the public markets and public reporting. Our management team will need to invest significant management time and financial resources to comply with both existing and evolving standards for public companies, which will lead to increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities.
Our common stock may be considered a “penny stock,” and thereby be subject to additional sale and trading regulations that may make it more difficult to sell.
Our common stock, which is not currently listed or quoted for trading, may be considered to be a “penny stock” if it does not qualify for one of the exemptions from the definition of “penny stock” under Section 3a51-1 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) once, and if, it starts trading. Our common stock may be a “penny stock” if it meets one or more of the following conditions (i) the stock trades at a price less than $5.00 per share; (ii) it is NOT traded on a “recognized” national exchange; (iii) it is NOT quoted on the Nasdaq Capital Market, or even if so, has a price less than $5.00 per share; or (iv) is issued by a company that has been in business less than three years with net tangible assets less than $5 million.
The principal result or effect of being designated a “penny stock” is that securities broker-dealers participating in sales of our common stock will be subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9 promulgated under the Exchange Act. For example, Rule 15g-2 requires broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document at least two business days before effecting any transaction in a penny stock for the investor’s account. Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult and time consuming for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.
The ability of our Chinese operating subsidiaries to pay dividends may be restricted due to foreign exchange control regulations of China.
The ability of our Chinese operating subsidiaries to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balance of the Chinese operating subsidiaries. Because substantially all of our operations are conducted in China and a majority of our revenues are generated in China, all of our revenue being earned and currency received are denominated in Renminbi (RMB). RMB is subject to the exchange control regulation in China, and, as a result, we may unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict our ability to convert RMB into US Dollars.
We do not foresee paying cash dividends in the foreseeable future.
We do not plan to declare or pay any cash dividends on our shares of common stock in the foreseeable future and we currently intend to retain any future earnings for funding growth. As a result, you should not rely on an investment in our securities if you require dividend income. Capital appreciation, if any, of our shares may be your sole source of gain for the foreseeable future. Moreover, you may not be able to resell your shares in our company at or above the price you paid for them.
Not applicable.
We have offices and processing factories in six cities in China. All buildings and land are leased. The leases end around 2010, and we have the right to renew. The central office is in Zhuhai, where the majority of design and engineering staff are located. The Beijing and Shanghai offices have smaller design teams as well. All offices are sales centers for the area. The three factories are used for further processing certain curtain wall components before they are shipped to the construction site.
Zhuhai | | | |
| Jiuzhou Avenue, 105 West Baishi Road | | 1,080 square meters (office) | |
| | 1,700 square meters (factory) | |
| | | | |
Beijing | | | |
Jianwei Building Room 302 – 305, 66 South Lishi Road | | 393 square meters (office) | |
Caiyu Economic Development Zone, East Part, Caiyu Town, Daxing District, Beijing | | 3,380 Square meters (factory) | |
| | | | |
Shanghai | | | |
Room 701 – 702, Yataiqiye Building, Zhaojiabin Road No. 333 | | 451 square meters (office) | |
| Tairi Town, Fengxian District, Shangha | | 8,811 square meters (factory) | |
| | | | |
Nanjing | | | |
| Dongpei Building Room 1509, 199 Jianye Road | | 149 square meters (office) | |
| | | | |
Guangzhou | | | |
Chengjian Building, 10th Floor, West Tiyu Road | | 231 square meters (office) | |
| | | | |
Hangzhou | | | |
| Xiandai Yayuan No. 21, Block 2, Room 204, Chaowang Road | | 158 square meters (office) | |
We are not a party to any material legal proceedings.
No matters were submitted to the security holders to be voted on during the fourth quarter of 2006.
PART II.
There has never been a public trading market for our common stock and our shares of common stock are not currently listed or quoted for trading on any national securities exchange or national quotation system. We are applying for the listing of our common stock on the American Stock Exchange. As of April 1, 2007, we had 71 registered shareholders.
If and when our common stock is listed or quoted for trading, the price of our common stock will likely fluctuate in the future. The stock market in general has experienced extreme stock price fluctuations in the past few years. In some cases, these fluctuations have been unrelated to the operating performance of the affected companies. Many companies have experienced dramatic volatility in the market prices of their common stock. We believe that a number of factors, both within and outside of our control, could cause the price of our common stock to fluctuate, perhaps substantially. Factors such as the following could have a significant adverse impact on the market price of our common stock:
| · | Our ability to obtain additional financing and, if available, the terms and conditions of the financing; |
| · | Our financial position and results of operations; |
| · | Concern as to, or other evidence of, the reliability and efficiency of our proposed products and services or our competitors’ products and services; |
| · | Announcements of innovations or new products or services by us or our competitors; |
| · | U.S. federal and state governmental regulatory actions and the impact of such requirements on our business; |
| · | The development of litigation against us; |
| · | Period-to-period fluctuations in our operating results; |
| · | Changes in estimates of our performance by any securities analysts; |
| · | The issuance of new equity securities pursuant to a future offering or acquisition; |
| · | Changes in interest rates; |
| · | Competitive developments, including announcements by competitors of new products or services or significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; |
| · | Investor perceptions of our company; and |
| · | General economic and other national conditions. |
Dividend Policy
We do not expect to declare or pay any cash dividends on our common stock in the foreseeable future, and we currently intend to retain future earnings, if any, to finance the expansion of our business. The decision whether to pay cash dividends on our common stock will be made by our board of directors, in their discretion, and will depend on our financial condition, operating results, capital requirements and other factors that the board of directors considers significant. We paid cash dividends of $1,576,796, $2,571,396, and $4,108,226 during the years ended December 31, 2006, 2005, and 2004, respectively.
Recent sales of unregistered securities
On October 17, 2006, pursuant to the terms of the Exchange Agreement entered into between us, Full Art International, Ltd. (“Full Art”) and the sole shareholder of Full Art (as described in Item 2.01 above), we issued 45,304,125 shares of common stock to the shareholder, which is KGE Group, Limited, and its designees in exchange for all of the issued and outstanding securities of Full Art. The securities were offered and issued to KGE Group and its designees in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder. Each of KGE Group and its designees qualified as an accredited investor (as defined by Rule 501 under the Securities Act of 1933, as amended).
On October 17, 2006, immediately following the closing of the Share Exchange, we received gross proceeds of $3,713,400 in a private placement transaction. Pursuant to subscription agreements entered into with the investors, we sold an aggregate of 2,320,875 shares of our common stock at a price of $1.60 per share. We agreed to file a registration statement covering the common stock sold in the private placement within 30 days of the closing of the Share Exchange pursuant to the subscription agreement with each investor. The securities were offered and sold to investors in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder. Each of the persons and/or entities receiving the our securities qualified as an accredited investor (as defined by Rule 501 under the Securities Act of 1933, as amended).
On October 17, 2006, at the closing of the Share Exchange, we issued to an investor relations firm 100,000 shares of our common stock and a five-year warrant to purchase 232,088 shares of our common stock at a per share exercise price of $1.60 for investor relations services. The securities were offered and sold to an investor relations firm in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder. The investor relations firm qualified as an accredited investor (as defined by Rule 501 under the Securities Act of 1933, as amended).
Transfer Agent
The transfer agent and registrar for our common stock is U.S. Stock Transfer Corporation.
Equity Compensation Plan Information
As of December 31, 2006, we did not have an equity compensation plan.
| | | | | | | | |
| | | # of securities to be issued upon exercise of outstanding options, warrants and rights | | Weighted-average exercise price of outstanding options, warrants and rights | | # of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |
| Equity compensation plans approved by security holders | | | - | | | - | | | - | |
| Equity compensation plans not approved by securities holders | | | 232,088 | (1) | $ | 1.60 | | | - | |
Total | | | 232,088 | | $ | 1.60 | | | - | |
(1) Upon the closing of the Share Exchange on October 17, 2006, we issued five-year warrants to purchase 232,088 shares of our common stock at a per share exercise price of $1.60 for services rendered by an investor relations firm.
Additional Information
Copies of our annual reports, quarterly reports, current reports, and any amendments to those reports, are available free of charge on the Internet at www.sec.gov. All statements made in any of our filings, including all forward-looking statements, are made as of the date of the document in which the statement is included, and we do not assume or undertake any obligation to update any of those statements or documents unless we are required to do so by law.
Item 6. Selected Financial Data
The following selected consolidated statement of operations data for each of the years in the five-year period ended December 31, 2006 and the consolidated balance sheet data as of year-end for each of the years in the five-year period ended December 31, 2006 were derived from the audited consolidated financial statements, except for December 31, 2002. Such selected financial data should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements starting on page F-1 and with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
| | Year Ended December 31, | |
Consolidated Statements of Operations | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 | |
| | | | | | | | | | | (unaudited) | |
| | | (in thousands, exepct share amounts and earnings per share) | |
| Contract revenues earned | | $ | 64,032 | | $ | 49,978 | | $ | 28,816 | | $ | 22,480 | | $ | 16,554 | |
| | | | | | | | | | | | | | | | | |
| Cost of contract revenues earned | | | (46,796 | ) | | (36,368 | ) | | (21,419 | ) | | (14,730 | ) | | (11,138 | ) |
| | | | | | | | | | | | | | | | | |
| Gross profit | | | 17,235 | | $ | 13,610 | | $ | 7,397 | | $ | 7,750 | | $ | 5,416 | |
| | | | | | | | | | | | | | | | | |
| Selling and administrative expenses | | | (5,989 | ) | | (6,463 | ) | | (4,636 | ) | | (3,564 | ) | | (1,844 | ) |
| | | | | | | | | | | | | | | | | |
| Non-recurring general and administrative expenses | | | (3,806 | ) | | — | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Income from operations | | $ | 7,440 | | $ | 7,147 | | $ | 2,761 | | $ | 4,186 | | $ | 3572 | |
| | | | | | | | | | | | | | | | | |
| Interest expenses, net | | | - | | | (117 | ) | | (260 | ) | | (116 | ) | | (12 | ) |
| | | | | | | | | | | | | | | | | |
| Other income, net | | | 28 | | | 37 | | | 199 | | | 145 | | | 2 | |
| | | | | | | | | | | | | | | | | |
| Income before taxes | | | 7,468 | | $ | 7,068 | | $ | 2,700 | | $ | 4,215 | | $ | 3,562 | |
| | | | | | | | | | | | | | | | | |
| Income tax | | | (1,318 | ) | | (1,157 | ) | | (491 | ) | | (739 | ) | | (564 | ) |
| | | | | | | | | | | | | | | | | |
| Net income | | $ | 6,150 | | $ | 5,910 | | $ | 2,209 | | $ | 3,476 | | $ | 2,998 | |
| | | | | | | | | | | | | | | | | |
| Basic and diluted net income per common share | | | 0.14 | | | 0.14 | | | 0.05 | | | 0.08 | | | 0.07 | |
| Basic and diluted dividend paid per common share | | | 0.04 | | | 0.06 | | | 0.10 | | | 0.02 | | | | |
| | | | | | | | | | | | | | | | | |
| Basic weighted average common shares outstanding | | | 44,679,990 | | | 43,304,125 | | | 43,304,125 | | | 43,304,125 | | | 43,304,125 | |
| Diluted weighted average common shares outstanding | | | 44,679,990 | | | 43,304,125 | | | 43,304,125 | | | 43,304,125 | | | 43,304,125 | |
| | | December 31, | |
Consolidated Balance Sheets | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 | |
| | | | | | | | | | | (unaudited) | |
| | | (in thousands) | |
| | | | | | | | | | | | |
| Current Assets | | $ | 43,821 | | $ | 21,712 | | $ | 17,454 | | $ | 15,054 | | $ | 98,020 | |
| Total Assets | | | 44,861 | | | 22,320 | | | 18,642 | | | 15,394 | | | 100,774 | |
| Current Liabilities | | | 21,784 | | | 14,016 | | | 13,916 | | | 8,774 | | | 60,848 | |
| Total Liabilities | | | 24,349 | | | 14,016 | | | 13,916 | | | 8,774 | | | 61,232 | |
| Total Stockholders' Equity | | | 20,513 | | | 8,304 | | | 4,725 | | | 6,621 | | | 39,542 | |
Forward-Looking Statements
The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. This report contains forward-looking statements. The words “anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, general economic and business conditions, changes in foreign, political, social, and economic conditions, regulatory initiatives and compliance with governmental regulations, the ability to achieve further market penetration and additional customers, and various other matters, many of which are beyond our control. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and there can be no assurance of the actual results or developments.
Overview
We were incorporated in the state of Delaware on March 16, 2004. We were originally organized as a “blank check” shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. On October 17, 2007, we closed a share exchange transaction described below, pursuant to which we (i) became the 100% parent of Full Art International, Ltd., a Hong Kong Company (“Full Art”), which has four subsidiaries, including its wholly-owned subsidiary, Zhuhai King Glass Engineering Co., Ltd., a company formed under the laws of the People’s Republic of China (“PRC” or “China”), (ii) assumed the operations of Full Art and its subsidiaries and (iii) changed our name from SRKP 1, Inc. to China Architectural Engineering, Inc. Full Art was incorporated in Hong Kong on July 30, 1992 under the Companies Ordinance of Hong Kong.
We specialize in the design, engineering and installation of high-end specialty curtain wall systems, including glass curtain walls, stone curtain walls, metal curtain walls, roofing systems, and related products, for public works projects and commercial real estate. We have designed and installed nearly one hundred projects throughout China, including the National Grand Theater, Exhibition Conservatory of Beijing Botanical Garden, The COSCO Tower at Changlian Avenue Beijing, and the Wumen Exhibition Hall in Beijing’s Forbidden City, and a number of commercial structures in Southeast Asia. We compete on the strength of our reputation, track record, strong relationships with government clients and our ability to give expression to the vision of leading architects. By focusing on innovation while outsourcing commoditized manufacturing work, we are able to add artistic and technological value to projects at cost-effective price points.
Our work is performed under cost-plus-fee contracts, fixed-price contracts, and fixed-price contracts modified by incentive and penalty provisions. The length of our contracts varies but typically have a duration of approximately two years. Approximately 90% of our sales are from fixed price contracts, including one percent that are modified by incentive and penalty provisions. The remaining 10% of our sales are originated from are cost-plus-fee contracts. Under cost-plus-fee contracts, which may be subject to contract ceiling amounts, we are reimbursed for allowable costs and fees, which may be fixed or performance-based. If our costs exceed the contract ceiling or are not allowable under the provisions of the contract or any applicable regulations, we may not be reimbursed for all our costs. Under fixed-price contracts, we receive a fixed price regardless of what our actual costs will be. Consequently, we realize a profit on fixed-price contracts only if we control our costs and prevent cost over-runs on the contracts. Under fixed-price contracts modified by incentive and penalty provisions, we are paid a fixed price that may be increased or decreased based on incentive and provisions in our contracts.
Recent Events
Completion of the Share Exchange
On August 21, 2006, we entered into a share exchange agreement with KGE Group, Limited, a Hong Kong corporation and the sole shareholder of Full Art. On October 17, 2006, we entered into Amendment No. 1 to the share exchange agreement. Pursuant to the share exchange agreement, as amended (the “Exchange Agreement”), we agreed to issue an aggregate of 45,304,125 shares of our common stock in exchange for all of the issued and outstanding securities of Full Art (the “Share Exchange”). Upon the closing of the Share Exchange on October 17, 2006, we issued an aggregate of 45,304,125 shares of our common stock to the sole shareholder of Full Art and its designees in exchange for all of the issued and outstanding securities of Full Art. Also at the closing of the Share Exchange, we issued 100,000 shares of our common stock and a five-year warrant to purchase 232,088 shares of our common stock at a per share exercise price of $1.60 for investor relations services (the “IR Securities”). In addition, immediately prior to the closing of the Share Exchange and the Private Placement, as described below, we and certain of our shareholders agreed to cancel an aggregate of 3,125,000 shares of common stock such that there were 2,275,000 shares of common stock outstanding immediately prior to the Share Exchange and Private Placement. We issued no fractional shares in connection with the Share Exchange.
Immediately after the closing of the Share Exchange and Private Placement, we had 50,000,000 outstanding shares of common stock and outstanding warrants to purchase 232,088 shares of our common stock. Upon the closing of the Share Exchange, the sole shareholder of Full Art and its designees owned approximately 90.6% of our issued and outstanding common stock, the pre-existing shareholders of the Company owned 4.7% and investors in the Private Placement that closed concurrently with the Share Exchange, as described below, owned 4.6% of our outstanding common stock.
In connection with the Share Exchange, we agreed to register the IR Securities and 1,312,675 shares held by our shareholders who were shareholders immediately prior to the Share Exchange in the registration statement that we filed to register the shares issued in the Private Placement, as described below. We also agreed to register shares of common stock in a subsequent registration statement that we agreed to file by May 23, 2007, which is six months and ten days after the date on which we first filed the registration statement to register the shares issued in the Private Placement, as follows: (i) 962,325 shares held affiliates of WestPark Capital, Inc. (“WestPark”) who were shareholders immediately prior to the Share Exchange, and (ii) 2,000,000 shares of common stock that were issued at the closing of the Share Exchange to FirstAlliance Financial Group, Inc. (“FirstAlliance”) as a designee of Full Art’s sole shareholder.
We agreed to a penalty provision with respect to our obligations to register the 962,325 shares of common stock held by the WestPark affiliates and the 2,000,000 shares that were issued to FirstAlliance. We must use our reasonable best efforts to cause the registration statement to become effective within 120 days after the required filing date or the actual filing date, whichever is earlier, or 150 days after the required filing date or the actual filing date, whichever is earlier, if the registration statement is subject to a full review by the SEC. In addition, we must use our reasonable best efforts to maintain the registration statement effective for a period of 24 months at our expense. If we fail to register these shares due to failure on our part, we must issue additional shares of our common stock to the respective shareholders in the amount of 0.0333% of their respective shares for each calendar day until the registration becomes effective. There is no maximum number of shares that we may be required to issue in connection with any potential failure to meet these registration obligations. There is no penalty associated with the IR Securities.
The Private Placement
On October 17, 2006, concurrently with the close of the Share Exchange, we received gross proceeds of $3,713,400 in a private placement transaction (the “Private Placement”). Pursuant to subscription agreements entered into with the investors, we sold an aggregate of 2,320,875 shares of common stock at $1.60 per share. We were required to file a registration statement no later than 30 days after the closing of the Share Exchange, which we met, and we must use our reasonable best efforts to cause the registration statement to become effective within one hundred and 150 days after the closing or 180 days after the closing if the registration statement is subject to a full review by the SEC. We are also required to use our reasonable best efforts to maintain the registration statement effective for a period of 24 months at our expense. If we fail to register the shares, we are obligated to pay to the investors a cash payment equal to 0.0333% of the purchase price of their respective shares for each business day of the failure. There is no maximum potential consideration to be transferred in respect to the potential penalty.
The investors in the Private Placement also entered into a lock up agreement pursuant to which they agreed not to sell their shares until our common stock begins to be traded on the New York Stock Exchange, American Stock Exchange, NASDAQ Global Market, NASDAQ Capital Market or the OTC Bulletin Board, after which their shares will automatically be released from the lock up on a monthly basis pro rata over a nine months period. After commissions and expenses, we received net proceeds of approximately $3,267,792 in the Private Placement. WestPark Capital, Inc. acted as placement agent in connection with the Private Placement. For its services as placement agent, WestPark received an aggregate fee of approximately $445,608, which consisted of a commission equal to 9.0% of the gross proceeds from the financing and a non-accountable fee of 3% of the gross proceeds. Some of the controlling shareholders and control persons of WestPark were also, prior to the completion of the Share Exchange, controlling shareholders and control persons of our company, including Richard Rappaport, who is the Chief Executive Officer of WestPark and was the President and a significant shareholder of our company prior to the Share Exchange, and Anthony C. Pintsopoulos, who is the Chief Financial Officer of WestPark and an officer and director our company prior to the Share Exchange. Each of Messrs. Rappaport and Pintsopoulos resigned from all of their executive and director positions with us upon the closing of the Share Exchange.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. We believe the following are the critical accounting policies that impact the financial statements, some of which are based on management’s best estimates available at the time of preparation. Actual experience may differ from these estimates.
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Consolidation - The consolidated financial statements include our accounts and the accounts of our subsidiaries. Significant inter-company transactions have been eliminated in consolidation.
Concentrations and Credit Risks - For the years ended December 31, 2006, 2005 and 2004, substantially all of our sales were to companies located in the PRC and all of our assets were located in the PRC. Our operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the Chinese government has pursued economic reform policies in the past, we cannot assure you that the Chinese government will continue to pursue such policies or that such policies will not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affect China’s political, economic and social conditions. We can give no assurance that the Chinese government’s pursuit of economic reforms will be consistent or effective.
Revenue and Cost Recognition - Revenues from fixed-price and modified fixed-price construction contracts are recognized on the percentage-of-completion method, measured by the percentage of cost incurred to date to the estimated total cost for each contract. The revenue earned in a period is based on the ratio of costs incurred to the total estimated costs required by the contract. Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs, and depreciation costs. Total estimated gross profit on a contract, being the difference between total estimated contract revenue and total estimated contract cost, is determined before the amount earned on the contract for a period can be recognized. The measurement of the extent of progress toward completion are used to determine the amount of gross profit earned to date; the earned revenue to date is the sum of the total cost incurred on the contract and the amount of gross profit earned.
Earned revenue, cost of earned revenue, and gross profit are determined as follows:
i. Earned Revenue is the amount of gross profit earned on a contract for a period plus the costs incurred on the contract during the period.
ii. Cost of Earned Revenue is the cost incurred during the period, excluding the cost of materials not unique to a contract that have not been used for the contract.
iii. Gross Profit earned on a contract are computed by multiplying the total estimated gross profit on the contract by the percentage of completion. The excess of that amount over the amount of gross profit reported in prior periods is the earned gross profit that should be recognized in the income statement for the current period.
Selling, General, And Administrative Costs - Selling, general, and administrative costs are charged to expense as incurred. Allowances for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues when their realization is reasonably assured. An amount equal to contract costs attributable to claims is included in revenues when realization is probable and the amount can be reliably estimated.
Contract Receivable - Contract receivable represents billings to customers on the percentage of work completed and recognized to date based on contract price. An allowance is provided for doubtful collections which is based upon a review of outstanding receivables, historical collection information, and existing economic conditions. We record an allowance for doubtful collections for our outstanding contract receivable at the end of the period in accordance with generally accepted accounting principles in the Untied States, and we consider that allowance to be reasonable at December 31, 2006, December 31, 2005 and December 31, 2004.
Comprehensive Income - Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other consolidated financial statements. Our current components of other comprehensive income are the foreign currency translation adjustment.
Income Taxes - We use the accrual method of accounting to determine and report its taxable income and use the flow through method to account for tax credits, which are reflected as a reduction of income taxes for the year in which they are available. We have implemented Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Income tax liabilities computed according to the United States, People’s Republic of China (PRC) and Hong Kong SAR 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 either be 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 we are able to realize that tax benefit, or that future realization is uncertain.
Advertising - Advertising costs are expensed as incurred.
Research and Development - All research and development costs are expensed as incurred. The costs of material and equipment acquired or constructed for research and development and having alternative future uses are classified as property and equipment and depreciated over their estimated useful lives.
Retirement Benefits- We make monthly contributions to various employee retirement benefit plans organized by provincial governments in the PRC in accordance with rates prescribed by them. The provincial governments undertake to assume the retirement benefit obligations of all existing and future retired employees of our company. Contributions to these plans are charged to expense as incurred. The retirement expense for the years ended December 31, 2006, 2005, and 2004, were $118,856, $109,941, and $85,604, respectively.
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. 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.
Land Use Rights - Land use rights are stated at cost less accumulated amortization. Amortization is provided over the respective useful lives, using the straight-line method.
Accounting for the Impairment of Long-Lived Assets - Long-lived assets 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 years, there was no impairment loss.
Inventories - Inventories are raw materials which are stated at the lower of weighted average cost or market value.
Advances to Suppliers - Advances to suppliers represent the cash paid in advance for purchasing raw materials.
Cash and Cash Equivalents - All highly liquid investments purchased with original maturities of three months or less to be cash equivalents. We maintain bank accounts only in the PRC and Hong Kong. We do not maintain any bank accounts in the United States of America.
Restricted Cash - Restricted cash represents time deposit accounts to secure notes payable and bank loans.
Foreign Currency Translation - The consolidated financial statements are presented in United States dollars. Our functional currencies as well as the functional currencies of our subsidiaries are the Hong Kong Dollar (HKD) and Renminbi (RMB). The consolidated financial statements are translated into United States dollars from HKD and RMB at year-end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred. The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.
Statutory Reserves - Surplus reserves for foreign investment enterprises are referring to the amount appropriated from the net income in accordance with 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.
Intangibles - Under the Statement of Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” all goodwill and certain intangible assets determined to have indefinite lives will not be amortized, but will be tested for impairment at least annually. Other intangible assets will be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144 “Accounting for Impairment or Disposal of Long-Lived Assets.”
Results of Operations
The following table sets forth our statements of operations for the years ended December 31, 2006, 2005 and 2004 in U.S. dollars:
| | | Year Ended December 31, | |
| | | 2006 | | 2005 | | 2004 | |
| | | (in thousands, except share amounts and earnings per share) | |
| | | | | | | | |
| Contract revenues earned | | $ | 64,032 | | $ | 49,978 | | $ | 28,816 | |
| | | | | | | | | | | |
| Cost of contract revenues earned | | | (46,796 | ) | | (36,368 | ) | | (21,419 | ) |
| | | | | | | | | | | |
| Gross profit | | | 17,235 | | $ | 13,610 | | $ | 7,397 | |
| | | | | | | | | | | |
| Selling, administrative and other operating expenses | | | (5,989 | ) | | (6,463 | ) | | (4,636 | ) |
| | | | | | | | | | | |
| Non-recurring general and administrative expenses | | | (3,806 | ) | | — | | | — | |
| | | | | | | | | | | |
| Income from operations | | $ | 7,440 | | $ | 7,147 | | $ | 2,761 | |
| | | | | | | | | | | |
| Interest expenses, net | | | — | | | (117 | ) | | (260 | ) |
| | | | | | | | | | | |
| Other income, net | | | 28 | | | 37 | | | 199 | |
| | | | | | | | | | | |
| Income before taxes | | $ | 7,468 | | $ | 7,068 | | $ | 2,700 | |
| | | | | | | | | | | |
| Income tax | | | (1,318 | ) | | (1,157 | ) | | (491 | ) |
| | | | | | | | | | | |
| Net income | | $ | 6,150 | | $ | 5,910 | | $ | 2,209 | |
| | | | | | | | | | | |
| Basic and diluted net income per common share | | | 0.14 | | | 0.14 | | | 0.05 | |
| Basic and diluted dividend paid per common share | | | 0.04 | | | 0.06 | | | 0.10 | |
| | | | | | | | | | | |
| Basic weighted average common shares outstanding | | | 44,679,999 | | | 43,304,125 | | | 43,304,125 | |
| Diluted weighted average common shares outstanding | | | 44,679,999 | | | 43,304,125 | | | 43,304,125 | |
Years Ended December 31, 2006 and 2005
Contract revenues earned for year ended December 31, 2006 were $64.0 million, an increase of $14.0 million, or 28.1%, from the contract revenues earned of $50.0 million for the year ended December 31, 2005. The primary reason for the increase in contract revenues earned was an increase in the number of projects for the year ended December 31, 2006. In addition, we also experienced a general increase in the amount of revenue generated per project in 2006 as compared to 2005.
Cost of contract revenues earned for the year ended December 31, 2006 was $46.8 million, an increase of $10.4 million, or 28.7%, from $36.4 million for the year ended December 31, 2005. The increase in costs of contract revenues earned was primarily due to the increased number of projects for the year ended December 31, 2006. Gross profit for the year ended December 31, 2006 was $17.2 million, an increase of $3.6 million, or 26.6%, from $13.6 million for the year ended December 31, 2005. Our gross margin for the year ended December 31, 2006 was 26.9% as compared with 27.2% for the year ended December 31, 2005.
Selling and administrative expenses were $6.0 million for the year ended December 31, 2006, a decrease of approximately $0.5 million, or 7.3%, from $6.5 million for the year ended December 31, 2005. The decrease was primarily due to the implementation of internal controls on operating expenses during the year ended December 31, 2006, including stricter control on staff costs, entertainment expenses, and traveling expenses.
Non-recurring general and administrative expenses for the year ended December 31, 2006 were $3.8 million as compared to $nil for the year ended December 31, 2005. The non-recurring general and administrative expense resulted from our payment, through issuance of securities or payment of cash, to service providers that rendered services in connection with the consummation of the Share Exchange and the related transactions. Included in the non-recurring general and administrative expenses was the issuance at the closing of the Share Exchange of 2,000,000 shares of common stock to First Alliance Financial Group for financing services, issuance of 100,000 shares of common stock, and payment of $445,608 to brokers for services related to the private placement that closed concurrently with the Share Exchange. Each of the shares that were issued for services were valued at $1.60 per share, which is the per share sales price in the private placement.
Income tax was $1.3 million for the year ended December 31, 2006, an effective tax rate of 17%, compared with $1.2 million taxes for the year ended December 31, 2005, an effective tax rate of 16%. The primary reason for the increase in the dollar amount of the tax was due to the increase in income before taxes. Through two of our subsidiaries, Zhuhai King Glass Engineering Co., Ltd and Zhuhai King General Glass Engineering Technology Co., Ltd, we are generally subject to a PRC income tax rate of 33%; however, in accordance with the relevant tax laws and regulations of PRC, the corporation income tax rate is currently 15%. In addition, we and two of our subsidiaries are subject to Hong Kong profits tax rate of 17.5%.
Net income for the year ended December 31, 2006 was $6.2 million, an increase of $0.3 million, or 4.1%, from $5.9 million for the comparable period in 2005.
Years Ended December 31, 2005 and 2004
Contract revenues earned for year ended December 31, 2005 were $50.0 million, an increase of $21.2 million, or 73.4%, from the contract revenues earned of $28.8 million for the year ended December 31, 2004. The primary reason for the increase in contract revenues earned was an increase in the number of projects for the year ended December 31, 2005. In addition, we also experienced a general increase in the amount of revenue generated per project in 2005 as compared to 2004.
Cost of contract revenues earned for the year ended December 31, 2005 was $36.4 million, an increase of $15.0 million, or 69.8%, from $21.4 million for the year ended December 31, 2004. The increase in costs of contract revenues earned was primarily due to the increased number of projects for the year ended December 31, 2005. Gross profit for the year ended December 31, 2005 was $13.6 million, an increase of $6.2 million, or 84.0%, from $7.4 million for the year ended December 31, 2004. Our gross margin for the year ended December 31, 2005 was 27.2% as compared with 25.7% for the year ended December 31, 2004.
Selling and administrative expenses were $6.5 million for the year ended December 31, 2005, an increase of approximately $1.8, or 39.4%, from $4.6 million for the year ended December 31, 2004. The increase was primarily due to growth in operations and related increases in staff costs and project-related expenses, such as insurance, professional fees, and general expenses of onsite offices.
There were no non-recurring general and administrative expenses for the years ended December 31, 2005 and 2004.
Income tax was $1.2 million for the year ended December 31, 2005, an effective tax rate of 16%, compared with $491,000 taxes for the year ended December 31, 2004, an effective tax rate of 18%. The primary reason for the increase in the dollar amount of the tax was due to the increase in income before taxes.
Net income for the year ended December 31, 2005 was $5.9 million, an increase of $3.7 million, or 167.5%, from $2.2 million for the comparable period in 2004.
Liquidity and Capital Resources
At December 31, 2006, we had cash and cash equivalents of $2,115,966. Prior to October 17, 2006, we have historically financed our business operations through short-term bank loans, cash provided by operations, and credit provided by suppliers.
We borrowed funds through short-term notes during the year ended December 31, 2004 in the amounts of $3.6 million and $1.2 million that were due and repaid by us during the 2005 fiscal year. The notes carried interest rates of 5.04% and 6.786%, respectively, per annum. We also borrowed funds through a short-term notes during the year ended December 31, 2005 in the amount of $743,000 that we repaid in 2006. The notes had an interest rate of 6.1065%.
In October 2006, we opened a line of credit facility with the Zhuhai branch of Bank of East Asia for up to a maximum of $2,564,979, which is RMB 20,000,000. We established and borrowed the full amount available under the line of credit to replace a 2005 short term loan from another bank that was expiring. The interest expense for the line of credit was $ 18,678 for the year ended December 31, 2006. The credit facility is in effect and does not require renewal until October 2011. In order to facilitate the extension of the credit facility to us by the Zhuhai brank of Bank of East Asia, we agreed to deposit the same amount on fixed deposit terms into the Hong Kong branch of Bank of East Asia.
On October 17, 2006, concurrently with the close of the Share Exchange, we received gross proceeds of $3,713,400 in a private placement transaction (the “Private Placement”). For its services as placement agent, WestPark Capital, Inc. received an aggregate fee of approximately $445,608, which consisted of a commission equal to 9.0% of the gross proceeds from the financing and a non-accountable fee of 3% of the gross proceeds. We also incurred legal and accounting expenses of approximately $150,000. After commissions and expenses, we received net proceeds of approximately $3,117,792.
Working capital management, including prompt and diligent billing and collection, is an important factor in our results of operations and liquidity. When we are awarded construction project, we work according to the percentage-of-completion method which matches the revenue streams with the relevant cost of construction based on the percentage-of-completion of project as determined based on certain criteria, such as, among other things, actual cost of raw material used compared to the total budgeted cost of raw material and work certified by customers. There is no guarantee that the cash inflow from these contracts is being accounted for in parallel with the cash outflow being incurred in the performance of such contract. In addition, a construction project is usually deemed to be completed once we prepare a final project account, the account is agreed upon by our customers, and all amounts related to the contract must be settled according to the account within three months to a year from the customer’s agreement on the final project account. As there may be different time intervals to reach a consensus on the amount as being accounted for in the projects before the project finalization account is being mutually agreed by each other. We experience an average accounts settlement period ranging from three months to as high as one year from the time we provide services to the time we receive payment from our customers. In contrast, we typically need to place certain deposit with our suppliers on a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. We attempt to maintain a credit policy of receiving certain amounts of deposit from customers before we begin a new project. Coupled with the return of retention money and deposits from other previously-completed projects and credit granted by suppliers, we have been able to maintain an overall net cash position in our operations in last two years, but there is no guarantee that we will be able to maintain a positive net cash flow position in the future.
Net cash used in operating activities for the year ended December 31, 2006 was $3.0 million, as compared to $3.5 million provided by operating activities in the same period in 2005. The decrease in cash provided from operating activities is primarily the result of a significant increase in receivables from $6.6 million to $18.3 million, partially offset by an increase in net income and payables during the year ended December 31, 2006, both of which was the result of an increase in sales. We experienced an increase of revenue of $14.1 million for the year ended December 31, 2006 compared to an increase of $20.7 million for the same period in 2005. Contracts receivables as of December 31, 2006 was $7.6 million, an increase of $3.3 million, or 76.1%, over contracts receivables of $4.3 million as of December 31, 2005. The increase in contracts receivables reflected an increase in contract revenue earned. We received eight new projects of total contract sum of approximately $12.4 million in the year ended December 31, 2005, which account for approximately $6.3 million contract receivables for such period.
Net cash used by investing activities was $2.9 million for the year ended December 31, 2006, as compared to net cash provided by investing activities of $1.0 million for the year ended December 31, 2005. The change was primarily a result of an increase in restricted cash from $0.6 million in 2005 as compared to $2.2 million in 2006. The increase in restricted cash resulted from our deposit of such amount on fixed deposit terms with the Hong Kong branch of Bank of East Asia to facilitate a line of credit facility in the same amount from the Zhuhai branch of Bank of East Asia. We established and borrowed the full amount available under the line of credit to replace a 2005 short term loan from another bank that was expiring.
Net cash provided by financing activities was $6.9 million for the year ended December 31, 2006 compared to cash used by financing activities of $7.2 million for the year ended December 31, 2005. The increase in cash provided was primarily to $7.1 million received in 2006 from the issuance of common stock and $2.6 million received as proceeds from a long term loan, whereas there were no such cash provided in 2005. In addition, we had $4.8 million in repayment of short term loans in 2005 and only repayment amounts of $743,742 in 2006.
As of December 31, 2006, contracts receivables were $7.6 million, an increase of $3.3 million, or 76.1%, over contracts receivables of $4.3 million as of December 31, 2005. The increase in contracts receivable reflected an increase in contract revenue earned. In addition, the increase in contracts receivable reflects not only the increase in sales but also the long collection period because the collection period typically runs from three months to one year before we receive full payment for our services and products. Since we require an average of one to two months to receive products we order from the date of our order, we have been increasing our inventories in order to enable us to meet anticipated increases in sales. In addition, our payment cycle is considerably shorter than our receivable cycle, since we typically pay our suppliers all or a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. We are currently involved in three lawsuits in which we are suing other parties for overdue payments. The total amount involved is $1,292,520. We obtained judgment in our favor on one of the lawsuits and anticipate full payment on all of the overdue amounts in the near future.
At December 31, 2006, we had no material commitments for capital expenditures other than for those expenditures incurred in the ordinary course of business. During the 2007, we intend to expend approximately $65 to $70 million to purchase materials and serve as deposits for performance bonds for new projects that we have obtained. Additional capital for this objective would be required that is in excess of our liquidity, requiring us to raise additional capital through an equity offering or secured or unsecured debt financing. The availability of additional capital resources will depend on prevailing market conditions, interest rates, and our existing financial position and results of operations.
The following table describes our contractual commitments and obligations as of December 31, 2006:
| | | Payments due by period | |
Contractual obligations | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years | |
| Operating Lease Obligations | | $ | 582,821 | | $ | 282,795 | | $ | 150,013 | | $ | 150,013 | | $ | — | |
Off-Balance Sheet Arrangements
None.
Change in Accountants
On October 17, 2006, we dismissed AJ. Robbins, PC ("AJ. Robbins") as our independent registered public accounting firm following the change in control of the Company on the closing of the Share Exchange. We engaged AJ. Robbins to audit our financial statements for the year ended December 31, 2005 and the period from March 16, 2004 to December 31, 2005 and 2004. The decision to change accountants was approved and ratified by our Board of Directors. The report of AJ. Robbins on our financial statements for the fiscal year ended December 31, 2005 and for the period from March 16, 2004 to December 31, 2005 and 2004 did not contain any adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principle, except for an explanatory paragraph relative to the our ability to continue as a going concern. While AJ. Robbins was engaged by the us, there were no disagreements with AJ. Robbins on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure with respect to us, which disagreements if not resolved to the satisfaction of AJ. Robbins would have caused it to make reference to the subject matter of the disagreements in connection with its report on our financial statements for the fiscal year ended December 31, 2005 and the period from March 16, 2004 to December 31, 2005 and 2004.
We engaged Samuel H. Wong & Co., LLP, Certified Public Accountants, as our independent registered public accounting firm as of October 17, 2006. Samuel H. Wong & Co., LLP, Certified Public Accountants, served as Full Art’s independent registered certified public accountants for the fiscal years ended December 31, 2005 and 2004.
New Accounting Pronouncements
In May 2005, the FASB issued a SFAS 154, “Accounting Changes and Error Corrections” to replace APB Opinion No. 20, “Accounting Changes” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements” requiring retrospective application to prior periods consolidated financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, SFAS 154 requires the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, SFAS 154 requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. The effective date for this statement is for accounting changes and corrections of errors made in fiscal year beginning after December 15, 2005.
We do not anticipate that the adoption of this standard will have a material impact on these consolidated financial statements.
Credit Risk. We are exposed to credit risk from our cash at bank, fixed deposits and contract receivables. The credit risk on cash at bank and fixed deposits is limited because the counterparts are recognized financial institutions. Contract receivables are subject to credit evaluations. We periodically record a provision for doubtful collections based on an evaluation of the collectibility of contract receivables by assessing, among other factors, the customer’s willingness or ability to pay, repayment history, general economic conditions and our ongoing relationship with the customers. We are currently involved in three lawsuits in which we are suing other parties for overdue payments. The total amount involved is $1,292,520.
Foreign Currency Risk. The functional currencies of our company are the Hong Kong Dollar (HKD) and Renminbi (RMB). Substantially all of our operations are conducted in the PRC. Our sales and purchases are conducted within the PRC in RMB. Conversion of RMB into foreign currencies is regulated by the People’s Bank of China through a unified floating exchange rate system. Although the PRC government has stated its intention to support the value of the RMB, there can be no assurance that such exchange rate will not again become volatile or that the RMB will not devalue significantly against the U.S. dollar. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from our operations in the PRC. In addition, the RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.
Country Risk. Substantial portion of our business, assets and operations are located and conducted in China. While China’s economy has experienced significant growth in the past twenty years, growth has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall economy of China, but may also have a negative effect on us. For example, our operating results and financial condition may be adversely affected by government control over capital investments or changes in tax regulations applicable to us. If there are any changes in any policies by the Chinese government and our business is negatively affected as a result, then our financial results, including our ability to generate revenues and profits, will also be negatively affected.
The information required by this Item 8 is incorporated by reference to China Architectural Engineering, Inc.’s Consolidated Financial Statements and Independent Auditors’ Report beginning at page F-1 of this Form 10-K
Not Applicable
(a) Evaluation of disclosure controls and procedures
As of December 31, 2006, our management, with the participation of our Chief Executive Officer, or “CEO,” and Chief Financial Officer, or “CFO,” performed an evaluation of the effectiveness and the operation of our disclosure controls and procedures as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the “Exchange Act.” Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures were effective as of December 31, 2006.
(b) Changes in internal control over financial reporting
On August 21, 2006, we entered into a share exchange agreement with KGE Group, Limited, a Hong Kong corporation (“KGE Group”) and the sole shareholder of Full Art International, Ltd., a Hong Kong Company (“Full Art”). On October 17, 2006, we entered into Amendment No. 1 to the share exchange agreement. Pursuant to the share exchange agreement, as amended (the “Exchange Agreement”), we agreed to issue an aggregate of 45,304,125 shares of our common stock in exchange for all of the issued and outstanding securities of Full Art (the “Share Exchange”). The Share Exchange closed on October 17, 2006. Following the Share Exchange, the sole business conducted by our company is the business conducted by Full Art prior to the Share Exchange, and all of the officers and directors of Full Art became the officers and directors of our company. Also, as a result of the Share Exchange, the internal control over financial reporting utilized by Full Art prior to the Share Exchange became the internal control over financial reporting of our company.
Based on the evaluation of our management as required by paragraph (d) of Rule 13a-15 or 15d-15 of the Exchange Act, we believe that, other then the changes described above, there were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
None.
PART III
Executive Officers, Directors and Key Employees
The following individuals constitute our board of directors and executive management:
| Name | | Age | | Position |
| Luo Ken Yi | | 49 | | Chief Executive Officer, Chief Operating Officer and Chairman of the Board |
| Tang Nianzhong | | 43 | | Vice General Manager and Director |
| Ye Ning | | 49 | | Vice General Manager and Director |
| Li Guoxing | | 32 | | Vice General Manager of Design |
| Bai Fei | | 34 | | Vice General Manager of Marketing |
| Wang Zairong | | 53 | | Chief Technology Officer and General Engineer |
| Feng Shu | | 69 | | Research and Development Supervisor |
| Wang Xin | | 44 | | Chief Financial Officer |
Luo Ken Yi has been Chief Executive Officer, Chief Operating Officer and Chairman of the Board since 1992. Luo Ken Yi studied Medicine, Mechanical Engineering and Engineering Management in China (1978 to 1983), the U.S (1986 to 1988), Australia (1996-1998) and Hong Kong and obtained a Master’s Degree 1997. He served as Project Manager and Production Manager at P.X. Engineering, Inc. in the U.S from 1989 to 1991, Mr. Luo founded the Kangbao Electronics Co., Ltd. in 1988 in Shunde, Guangdong, China, where he served as Chief Engineer, Technical Manager, Vice Manager General and Deputy President from 1986 to 1989. Mr. Luo founded us in 1992 and served as Chief Managing Director. Later, he studied steel supported glass curtain wall design in the U.S. and Europe 1992 to 1994. He was appointed Vice President of the Architectural Glass and Metal Structure Institute of Qinghua University in 1999. In 2000 he was appointed by the Chinese Ministry of Construction to head the committee on creating national standards for the glass curtain wall industry. Mr. Luo owns over thirty patents related to point fixed glass technology. He was honored as one of the “Ten Great Leaders in Technology” and has published numerous books and articles.
Tang Nianzhong has been Vice General Manager and a Director since 1995. Tang Nianzhong graduated from the Guangzhou University of Chinese Medicine, Department of Medicine, in 1986. In 1999 he received his MBA from Murdoch University in Australia. From 1986 to 1994, he worked in the bone surgery department of the Nanhai People’s Hospital in Foshan. From 1994 to 1995 he was Vice General Manager of Foshan Xinhua Advertising Co., Ltd. In 1995 he joined us, where he has served as Production Manager, Sales Manager, Project Manager, Administration Manager and Vice General Manager.
Ye Ning has been Vice General Manager and a Director since 1995. Ye Ning graduated from the Guangzhou University of Chinese Medicine, Department of Medicine in 1983. From 1983 to 1988 he served on the staff of the Guangzhou Institute of Physical Education. From 1988 to 1993 he worked in the orthopedics department of the Nanhai People’s Hospital in Foshan. In 1993 he joined us, where he has served as Project Manager, Operations Manager, Purchasing Manager and Vice General Manager.
Li Guoxing has been Vice General Manager of Design since 2001. Li Guoxing graduated from Guizhou Technology University, Department of Construction, in 1996. In 2003 he received his MBA from the Royal Canadian College. From 1996 to 1998 he was a designer at the Guizhou Chemical Design Institute. In 1998 he joined us, where he has worked and served as Designer, Chief Engineer, Leader of the Design Institute and Vice General Manager of Design.
Bai Fei has been Vice General Manager of Marketing since 2004. Bai Fei graduated from Guizhou Broadcasting and Television University with a major in construction in 1994. In 1994 he worked briefly as a designer for the Guizhou Institute of Architectural Science and Research before moving on to work as a Manager of Decoration and Construction in the Aerospace department of the Liyang Group Decorated Project Company until 1995. In 1995 he joined us, where he has served as Technical Department Manager prior to becoming Vice General Manager of Marketing in 2004.
Wang Zairong has been Chief Technology Officer and General Engineer since 2004. Wang Zairong graduated from the Qinghua University School of Mechanical Engineering in 1977. From 1977 to 1979 he was a mechanical designer at Xi’an Research Institute of Mechanical Engineering. From 1980 to 1982 he was a mechanical designer at Xi’an Physics and Space Research Institute. From 1982 to 1993 Mr. Wang was a System Structure Designer at the Xi’an Aerospace Ministry. From 1993 to 1997 he was Senior Engineer and Vice General Manager of Technology at Yuantongqiao (Huizhou) Industrial Co., Ltd. In 1997 he joined us, where he has served as Marketing Manager, Production Manager, General Engineer prior to becoming Chief Technology Officer in 2004.
Feng Shu has been Research and Development Supervisor since 2000. She graduated from the Civil Engineering Department of National Qinghua University in 1960. She is a member of the Construction Glass and Metal Structure Research Committee of National Qinghua University and is a professor at the Civil Engineering Academy of Nanchang University. Feng Shu joined us in 1998, where she has served as Supervisor of Research and Development. She is also Administrative Director and Secretary General of Jiangxi Mechanics Academy and Vice Superintendent of Jiangxi Huajie Architecture Design Co., Ltd.
Wang Xin has been Chief Financial Officer since 2001. Wang Xin graduated from the Yunnan Finance and Economics University, Finance Department in 1984. From 1984 to 1988 she was Vice Section Chief at the Yunnan Province Finance Bureau. From 1988 to 1995 she was an instructor at Yunnan Economics and Management College, where she taught industrial accounting, financial management and other business courses. From 1995 to 2000 she was a Financial Manager at Zhuhai Advertising and Trade Exhibition Company. From 2000 to 2001 she was Financial Manager at Zhuhai Jingyu Science and Technology Equipment Company. She joined us in 2001, where she has served as Chief Financial Officer.
Family Relationships
None
The Board of Directors and Committees
Our Board of Directors does not maintain a separate audit, nominating or compensation committee. Functions customarily performed by such committees are performed by our Board of Directors as a whole. We are not required to maintain such committees under the rules applicable to companies that do not have securities listed or quoted on a national securities exchange or national quotation system. We intend to create board committees, including an independent audit committee, in the near future. We also are not currently required to maintain independent members of our Board of Directors. If we are successful in listing our common stock on the American Stock Exchange, we would be required to have, prior to listing, an independent audit committee formed, in compliance with the requirements for listing on the American Stock Exchange and in compliance with Rule 10A-3 of the Securities Exchange Act of 1934.
Section 16(a) Beneficial Ownership Reporting Compliance
Our securities are not currently registered under Section 12 of the Securities Exchange Act of 1934, as amended. As a result, and pursuant to Rule 16a-2, our directors and officers and holders of 10% or more of our common stock are not currently required to file statements of beneficial ownership with regards to their ownership of our equity securities under Sections 13 or 16 of the Exchange Act. At such time as our shares are registered under Section 12 of the Exchange Act, our officers, directors and 10% or more stockholders will be required to file such statements of beneficial ownership.
Code of Ethics
Prior to the Share Exchange in October 2006, we had a Code Of Ethics For Principal Executive and Financial Officers. Subsequent to the Share Exchange, after which we began our current operations, we have not yet adopted a code of business conduct and ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. We intend to adopt a code in the near future.
Item 11. Executive Compensation
Compensation Discussion and Analysis
Prior to the Share Exchange on October 17, 2006, we were a “blank check” shell company that was formed to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. The officers and directors of our company prior to the Share Exchange are no longer employed by or affiliated with our company. Richard Rappaport and Anthony Pintsopolous, our President and Chief Financial Officer, respectively, during 2006 prior to Share Exchange, received no compensation or other perquisites for serving in such capacity.
Our Chief Executive Officer, Chief Operating Officer and Chairman of the Board, Luo Ken Yi, determined the compensation for our current executive officers that was earned and paid in fiscal 2006 and our Board of Directors approved the compensation. Compensation for our current executive officers, which currently consists of Luo Ken Yi, Wang Xin, Ye Ning and Tang Nianzhong, is determined with the goal of attracting and retaining high quality executive officers and encouraging them to work as effectively as possible on our behalf. Key areas of corporate performance taken into account in setting compensation policies and decisions are growth of sales, cost control, profitability, and innovation. The key factors may vary depending on which area of business a particular executive officer’s work is focused on. Compensation is designed to reward executive officers for successfully meeting their individual functional objectives and for their contributions to our overall development. For these reasons, the elements of compensation of our executive officers are salary and bonus. Salary is paid to cover an appropriate level of living expenses for the executive officers and the bonus is paid to reward the executive officer for individual and company achievement. With respect to the amount of a bonus, Luo Ken Yi evaluates our company’s achievements for the fiscal year based on performance factors and results of operations such as revenues generated, cost of revenues, net income, and whether we obtain significant contracts. Luo Ken Yi also conducts a monthly and annual evaluation of the achievement level of an executive based on individual performance measurements, such as contribution to the achievement of the company’s goals and individual performance metrics based on their positions and responsibilities. Bonus are paid at the end of each fiscal year.
We believe that the salaries paid to our executive officers during 2006, 2005, and 2004 are indicative of the objectives of our compensation program and reflect the fair value of the services provided to our company, as measured by the local market in China. We determine market rate by conducting a comparison with the local geographic area averages and industry averages in China. Currently, we have no specific plans to provide raises after we have become a company with securities publicly traded in the United States. Although no specific plans have yet been discussed, we may adopt such a plan to provide raises to our executive officers in the future. Adopting higher compensation in the future may be based on the increased amount of responsibilities to be assumed by each of the executive officers after we become a publicly listed company. Executive compensation for 2007 will follow the same evaluation methods as were used for 2006. If we successfully complete our proposed listing on the American Stock Exchange and offering in 2007, we may adjust our bonus evaluations upwards, but, in such case, we do not intend to increase it by more than 10%. That determination would likely be made towards the end of the fiscal year. We may also expand the scope of our compensation, such as the possibility of granting options to executive officers and tying compensation to predetermined performance goals.
Our board of directors does not currently have a compensation committee. We anticipate that our board of directors will establish a compensation committee in fiscal 2007 that will be comprised of non-employee members of our board of directors. Our current expectation is that the compensation committee of our board of directors will perform, at least annually, a strategic review of the compensation program for our executive officers to determine whether it provides adequate incentives and motivation to our executive officers and whether it adequately compensates our executive officers relative to comparable officers in other companies with which we compete for executives. Those companies may or may not be public companies or companies located in the PRC or even, in all cases, companies in a similar business.
Until such time as a formal compensation program and committee is established, which we expect will occur in 2007, Ken Luo Yi will structure compensation and bonus levels and our board of directors will approve the structure. After the compensation committee is formed, it will determine the structure. Our board has established a compensation program for executive officers for 2007 that is designed to attract, as needed, individuals with the skills necessary for us achieve our business plan, to motivate those individuals, to reward those individuals fairly over time, and to retain those individuals who continue to perform at or above the levels that we expect. For 2007, bonuses for executive officers will be based on company and individual factors, as described above, and will be set up formulaically such that the amount of the bonus will be equal to the lower of a preset dollar amount or a percentage of revenues and net income. Luo Ken Yi’s bonus will be determined on overall company performance, business development, sales, and strategy, and the amount of his bonus will be the lower of $220,000 or 0.1% of sales plus 2.5% of net income. Bonus determination for Ye Ning and Tang Nianzhong is based on individual measurements for them and will be in an amount that is the lower of $120,000 or 0.1% of sales plus 1.0% of net income.
Summary Compensation Tables
The following table sets forth information concerning the compensation for the three fiscal years ended December 31, 2006, 2005, and 2004 of the principal executive officer, principal financial officer, in addition to our three most highly compensated officers whose annual compensation exceeded $100,000, and up to two additional individuals for whom disclosure would have been required but for the fact that the individual was not serving as an executive officer of the registrant at the end of the last fiscal year.
Name and Position | | Year | | Salary | | Bonus | | Total | |
| | | | | | | | | | |
| Luo Ken Yi | | | 2006 | | $ | 53,786 | | $ | 159,245 | | $ | 213,031 | |
| Chief Executive Officer, Chief Operating Officer | | | 2005 | | | 52,500 | | | 24,783 | | | 77,283 | |
| and Chairman of the Board | | | 2004 | | | 36,231 | | | 24,154 | | | 60,385 | |
| | | | | | | | | | | | | | |
| Wang Xin | | | 2006 | | | 11,679 | | | 8,743 | | | 20,422 | |
| Chief Financial Officer | | | 2005 | | | 11,301 | | | 6,196 | | | 17,497 | |
| | | | 2004 | | | 7,971 | | | 6,039 | | | 14,010 | |
| | | | | | | | | | | | | | |
| Ye Ning | | | 2006 | | | 46,102 | | | 72,354 | | | 118,456 | |
| Vice General Manager and Director | | | 2005 | | | 22,305 | | | 9,193 | | | 31,498 | |
| | | | 2004 | | | 14,493 | | | 9,662 | | | 24,153 | |
| | | | | | | | | | | | | | |
| Tang Nianzhong | | | 2006 | | | 38,418 | | | 79,402 | | | 117,820 | |
| Vice General Manager and Director | | | 2005 | | | 22,305 | | | 12,392 | | | 34,697 | |
| | | | 2004 | | | 21,793 | | | 9,662 | | | 31,455 | |
| | | | | | | | | | | | | | |
| Richard Rappaport(1) | | | 2006 | | | — | | | | | | | |
| Former Chief Executive Officer and Former Director | | | 2005 | | | | | | | | | | |
| | | | 2004 | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Anthony Pintsopoulos(1) | | | 2006 | | | | | | | | | | |
| Former Chief Financial Officer and Former Director | | | 2005 | | | | | | | | | | |
| | | | 2004 | | | | | | | | | | |
| Messrs. Rappaport and Pintsopoulos resigned from all positions with the Company upon the close of the Share Exchange on October 17, 2006. |
Grants of Plan-Based Awards in 2006
There were no option grants in 2006.
Outstanding Equity Awards at 2006 Fiscal Year-End
There were no option exercises or options outstanding in 2006.
Option Exercises and Stock Vested in Fiscal 2006
There were no option exercises or stock vested in 2006.
Employment Agreements
We have employment agreements with the following persons and terms:
| · | Luo Ken Yi is paid $52,500 annually pursuant to a three-year agreement that expires on December 31, 2009; |
| · | Tang Nianzhong is paid $41,250 annually pursuant to a three-year agreement that expires on December 31, 2009; |
| · | Ye Ning is paid $41,250 annually pursuant to a five-year agreement that expires on December 31, 2009; |
| · | Li Guoxing is paid $37,500 annually pursuant to a three-year agreement that expires on January 1, 2009; |
| · | Bai Fei is paid $22,500 annually pursuant to a five-year agreement that expires on December 31, 2009; |
| · | Wang Zairong is paid $10,500 annually pursuant to a one-year agreement that expires on December 31, 2007; |
| · | Feng Shu is paid $11,400 annually pursuant to a three-year agreement that expires on December 31, 2008; and |
| · | Wang Xin is paid $11,400 annually pursuant to a one-year agreement that expires on December 31, 2007. |
None of the agreements provide for severance upon termination.
Director Compensation
| Name | | Fees Earned or Paid in Cash ($) | | Stock Awards ($) | | Option Awards ($) | | Non-Equity Incentive Plan Compensation ($) | | Change in Pension Value and Nonqualified Deferred Compensation Earnings | | All Other Compensation ($) | | Total ($) | |
| All Directors (total of 3 persons) | | | - | | | - | | | - | | | - | | | - | | | - | | | - | |
For the year ended December 31, 2006, none of the members of our Board of Directors received compensation for his or her service as a director. We do not currently have an established policy to provide compensation to members of our Board of Directors for their services in that capacity. We intend to develop such a policy in the near future.
Beneficial ownership is determined in accordance with the rules of the SEC. In computing the number of shares beneficially owned by a person and the percentage of ownership of that person, shares of common stock subject to options and warrants held by that person that are currently exercisable or become exercisable within 60 days of April 1, 2007 are deemed outstanding even if they have not actually been exercised. Those shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of any other person.
The following table sets forth as of April 1, 2007 certain information with respect to beneficial ownership of our common stock based on 50,000,000 issued and outstanding shares of common stock, by:
| · | Each person known to be the beneficial owner of 5% or more of the outstanding common stock of our company; |
| · | Each executive officer; |
| · | All of the executive officers and directors as a group. |
Unless otherwise indicated, the persons and entities named in the table have sole voting and sole investment power with respect to the shares set forth opposite the stockholder’s name, subject to community property laws, where applicable. Unless otherwise indicated, the address of each stockholder listed in the table is c/o China Architectural Engineering, Inc., 105 Baishi Road, Jiuzhou West Avenue, Zhuhai, 519070, People’s Republic of China.
Name and Address of Beneficial Owner | | Title | | Beneficially Owned Prior to and After the Offering | | Percent of Class Beneficially Owned | |
| | | | | | | | |
| Luo Ken Yi | | Chief Executive Officer, Chief Operating Officer and Chairman of the Board | | 37,736,452 | (1) | 75.5 | % |
| | | | | | | | |
| Bai Fei | | Vice General Manager of Marketing | | — | | | |
| | | | | | | | |
| Tang Nianzhong | | Vice General Manager and Director | | 37,736,452 | (1) | 75.5 | |
| | | | | | | | |
| Ye Ning | | Vice General Manager and Director | | 37,736,452 | (1) | 75.5 | |
| | | | | | | | |
| Li Guoxing | | Vice General Manager of Design | | | | | |
| | | | | | | | |
| Wang Zairong | | Chief Technology Officer and General Engineer | | | | | |
| | | | | | | | |
| Feng Shu | | Research and Development Supervisor | | | | | |
| | | | | | | | |
| Wang Xin | | Chief Financial Officer | | | | | |
| | | | | | | | |
| Officers and Directors as a Group (total of 7 persons) | | | | 37,736,452 | (1) | 75.5 | |
| | | | | | | | |
| KGE Group Limited | | | | 37,736,452 | (1) | 75.5 | |
| Represents shares of common stock in our company held by KGE Group, Limited, a Hong Kong corporation, of which Luo Ken Yi and Ye Ning are directors and may be deemed to have voting and investment control over the shares owned by KGE Group, Limited. In addition, Luo Ken Yi and Ye Ning own approximately 77.0% and 2.5%, respectively, of KGE Group, Limited’s issued and outstanding shares. In addition, KGE Holding Limited owns approximately 18.0% of the issued and outstanding shares of KGE Group, Limited. KGE Holding Limited is owned by Luo Ken Yi, 32.5%, Tang Nianzhong, 30.5%, and Ye Ning, 30.5%. As a result, Tang Nianzhong may bee deemed to be a beneficial owner of the shares held by KGE Group Limited. Each of the foregoing persons disclaims beneficial ownership of the shares held by KGE Group Limited except to the extent of his pecuniary interest. |
Full Art International, Ltd.
Full Art International, Ltd. (“Full Art”) is our wholly-owned subsidiary and has interlocking executive and director positions with China Architectural Engineering, Inc.
October 2006 Share Exchange
On October 17, 2006, we completed the Share Exchange pursuant to the share exchange agreement entered into with Full Art and KGE Group, Limited, which was the sole shareholder of Full Art. At the closing, Full Art became our wholly-owned subsidiary and 100% of the issued and outstanding securities of Full Art were exchanged for shares of our common stock. An aggregate of 45,304,125 shares of our common stock were issued to KGE Group and its designees. KGE Group owns 37,736,452 shares, which is approximately 75.5% of our issued and outstanding stock. Luo Ken Yi, who is our Chief Executive Officer, Chief Operating Officer and Chairman of the Board, and Ye Ning, who is our Vice General Manager and director, are directors of KGE Group. In addition, Luo Ken Yi and Ye Ning own approximately 77.0% and 2.5%, respectively, respectively, of KGE Group’s issued and outstanding shares. Moreover, concurrent with the closing of the Share Exchange, our board appointed Luo Ken Yi as Chief Executive Officer and Chief Operating Officer, Wang Zairong as Chief Technology Officer and General Engineer, and Wang Xin as Chief Financial Officer. Luo Ken Yi, Tang Nianzhong, Ye Ning, Wang Zairong and Wang Xin are officers and/or directors of Full Art and Zhuhai, and were also appointed as our executive officers and/or directors upon closing of the Share Exchange.
WestPark Capital, Inc.
WestPark Capital, Inc. was the placement agent for the $3,713,400 equity financing conducted by us on the close of the Share Exchange. For its services as placement agent, WestPark received an aggregate fee of approximately $445,608, which consisted of a commission equal to 9.0% of the gross proceeds from the financing and a non-accountable fee of 3% of the gross proceeds. Richard Rappaport, our President and one of our controlling stockholders prior to the Share Exchange, indirectly holds a 100% interest in WestPark Capital, Inc., an NASD member. Anthony C. Pintsopoulos, an officer and director prior to the Share Exchange, is the Chief Financial Officer of WestPark Capital, Inc. Debbie Schwartzberg, one of our controlling stockholders prior to the Share Exchange, is a noteholder of the parent company of WestPark Capital, Inc.; her note entitles her to a 1.5% interest in the net profits of the parent company of WestPark Capital, Inc. Each of Messrs. Rappaport and Pintsopoulos resigned from all of their executive and director positions with us upon the closing of the Share Exchange.
Loans to and from Insiders
We have made loans to one of our officers. Advances from KGE Group Limited to us for the years ended December 31, 2006, 2005 and 2004 were $1,735, $420,556, and $205,095, respectively. Advances to Luo Ken Yi by us for the years ended December 31, 2006, 2005, and 2004 were $nil, $nil, and $1,889,091, respectively. All amounts due by Mr. Luo were repaid prior to completion of the transactions contemplated by the Share Exchange Agreement. All of the advances were unsecured, interest free, and have no fixed repayment terms.
Director Independence
See Item 10 “Directors, Officers and Corporate Governance” for a discussion of board member independence.
Policy for Approval of Related Party Transactions
We do not currently have a formal related party approval policy for review and approval of transactions required to be disclosed pursuant to Item 404 (a) of Regulation S-K. We intend to adopt such a policy once we establish an audit committee, which we anticipate occurring in 2007.
Item 14. Principal Accounting Fees and Services.
During the fiscal years ended December 31, 2006 and 2005, we retained Samuel H. Wong & Co., LLP, Certified Public Accountants to provide services as follows:
| | | Fees for the Year Ended December 31 | |
Services | | 2006 | | 2005 | |
| Audit fees(1) | | $ | 55,000 | | $ | 55,000 | |
| Audit-related fees | | | - | | | - | |
| Tax fees | | | - | | | - | |
| All other fees | | | - | | | - | |
| | | | | | | | |
| Total audit and non-audit fees | | $ | 55,000 | | $ | 55,000 | |
| (1) | These are fees for professional services performed by Samuel H. Wong & Co., LLP, Certified Public Accountants for the audit of our annual financial statements, review of our quarterly reports, and review of our Registration Statement on Form S-1. |
Pre-Approval Policy
We do not currently maintain an audit committee. Our Board as a whole pre-approves all services provided by Samuel H. Wong & Co., LLP and has concluded that such services are compatible with Samuel H. Wong & Co., LLP's independence as our auditors.
PART IV
1. Financial Statements: See “Index to Consolidated Financial Statements” in Part II, Item 8 of this annual report on Form 10-K.
2. Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” below in this Item 15 of this annual report on Form 10-K.
3. Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-K.
SCHEDULE IIChina Architectural Engineering, Inc.
Valuation and Qualifying Accounts and Reserves Years Ended December 31, 2006, 2005 and 2004 |
| Allowance for Doubtful Accounts: | | Balance at the Beginning of the Year | | Charge to Cost and Expenses | | Deductions | | Balance at the End of the Year | |
| | | | | | | | | | |
| | | | | | | | | | |
| Year ended December 31, 2004 | | $ | 143,014 | | $ | 284,654 | | $ | - | | $ | 427,668 | |
| Year ended December 31, 2005 | | | 427,668 | | | - | | | (24,073 | ) | | 403,595 | |
| Year ended December 31, 2006 | | | 403,595 | | | 14,053 | | | - | | | 417,648 | |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Zhuhai, People’s Republic of China, on April 17, 2007.
| | | |
| | China Architectural Engineering, Inc. |
|
|
|
| | /s/ Luo Ken Yi |
| |
Luo Ken Yi |
| | Chief Executive Officer, Chief Operating Officer
and Chairman of the Board |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| SIGNATURE | | TITLE | | DATE |
| | | | | |
| | | | | |
| /s/ Luo Ken Yi | | Chief Executive Officer, Chief Operating Officer | | April 17, 2007 |
| Luo Ken Yi | | and Chairman of the Board (Principal Executive Officer) | | |
| | | | | |
| | | | | |
| /s/ Wang Xin | | Chief Financial Officer (Principal Financial | | April 17, 2007 |
| Wang Xin | | and Accounting Officer) | | |
| | | | | |
| | | | | |
| /s/ Tang Nianzhong | | Vice General Manager and Director | | April 17, 2007 |
| Tang Nianzhong | | | | |
| | | | | |
| | | | | |
| /s/ Ye Ning | | Vice General Manager and Director | | April 17, 2007 |
| Ye Ning | | | | |
Exhibit Index
| 2.1 | | Share Exchange Agreement, dated as of August 21, 2006, by and among the Registrant, KGE Group, Limited, and Full Art International, Ltd. (incorporated by reference from Exhibit 2.1 to Current Report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2006). |
| | | |
| 2.1(a) | | Amendment No. 1 to the Share Exchange Agreement, dated as of October 17, 2006, by and among the Registrant, KGE Group, Limited, and Full Art International, Ltd. (incorporated by reference from Exhibit 2.1(a) to Current Report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2006). |
| | | |
| 3.1 | | Certificate of Incorporation of China Architectural Engineering, Inc. (incorporated by reference from Exhibit 3.1 to Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on April 20, 2004). |
| | | |
| 3.1(a) | | Certificate of Amendment of Certificate of Incorporation dated July 8, 2005 (incorporated by reference to Registrant's Quarterly Report on Form 10-QSB filed August 11, 2005) |
| | | |
| 3.2 | | Bylaws of the Registrant (incorporated by reference from Exhibit 3.2 to Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on April 20, 2004, and incorporated herein by reference). |
| | | |
| 3.3 | | Articles of Merger Effecting Name Change (incorporated by reference from Exhibit 3.3 to Current Report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2006). |
| | | |
| 4.1 | | Specimen Certificate of Common Stock (incorporated by reference to Exhibit 4. 1 of the Registrant's Registration Statement on Form SB-2 filed August 20, 2004). |
| | | |
| 4.2 | | Form of Escrow Agreement dated July 30, 2004 (incorporated by reference to Exhibit 4.2 of the Registrant's Registration Statement on Form SB-2 filed August 20, 2004). |
| | | |
| 4.3 | | Form of Registration Rights Agreement dated July 23, 2004 (incorporated by reference to Exhibit 4.3 of the Registrant's Annual Report on Form 10-KSB filed March 30, 2005). |
| | | |
| 10.1 | | Form of Subscription Agreement dated October 17, 2006 (incorporated by reference to Exhibit 1.1 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 10.2 | | Form of Subscription Agreement dated October 2004 (incorporated by reference to Exhibit 10.2 of the Registrant's Registration Statement on Form SB-2 filed October 1, 2004). |
| | | |
| 10.3 | | Employment Agreement dated December 30, 2005 by and between the Registrant and Luo Ken Yi (translated to English) (incorporated by reference from Exhibit 10.3 to Current Report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2006). |
| | | |
| 10.4 | | Employment Agreement dated January 11, 2004 by and between the Registrant and Tang Nianzhong (translated to English) (incorporated by reference to Exhibit 10.4 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 10.5 | | Employment Agreement by and between the Registrant and Ye Ning (translated to English) (incorporated by reference from Exhibit 10.5 to Current Report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2006). |
| | | |
| 10.6 | | Employment Agreement dated January 1, 2006 by and between the Registrant and Li Guoxing (translated to English) (incorporated by reference to Exhibit 10.6 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 10.7 | | Employment Agreement dated January 1, 2005 by and between the Registrant and Bai Fai (translated to English) (incorporated by reference to Exhibit 10.7 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 10.8 | | Employment Agreement dated December 26, 2005 by and between the Registrant and Wang Zairong (translated to English) (incorporated by reference to Exhibit 10.8 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 filed (File No. 333-138603) February 5, 2007). |
| | | |
| 10.9 | | Employment Agreement dated December 20, 2005 by and between the Registrant and Feng Shu (translated to English) (incorporated by reference to Exhibit 10.9 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 10.10 | | Employment Agreement dated December 26, 2006 by and between the Registrant and Wang Xin (translated to English) (incorporated by reference to Exhibit 10.10 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 10.11 | | Office and Factory Lease Agreement dated July 13, 2005 by and between the Registrant and Zhuhai Yuping Kitchen Equipment Co., Ltd. (translated to English) (incorporated by reference to Exhibit 10.11 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 10.12 | | Lease Agreement by and between the Registrant and Beijing Aoxingyabo Technology Development Co., Ltd (translated to English) (incorporated by reference to Exhibit 10.12 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 10.13 | | Property Rental Contract by and between the Registrant and Shanghai Sandi CNC equipment Ltd. Co (translated to English) (incorporated by reference to Exhibit 10.13 of Amendment No. 1 to the Registrant’s Registration Statement on Form S-1 (File No. 333-138603) filed February 5, 2007). |
| | | |
| 16.1 | | Letter from AJ. Robbins, PC to the Securities and Exchange Commission dated October 18, 2006 (incorporated by reference from Exhibit 16.1 to Current Report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2006). |
| | | |
| 21.1 | | List of Subsidiaries (incorporated by reference from Exhibit 21.1 to Current Report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2006). |
| | | |
| 31.1 | | Certification of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 31.2 | | Certification of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 32.1* | | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| * | This exhibit shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings. |
CHINA ARCHITECTURAL ENGINEERING, INC.
FINANCIAL STATEMENTS
DECEMBER 31, 2006, 2005, AND 2004
(Stated in US dollars)
| CONTENTS | | PAGES |
| | | |
| REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM | | F-2 |
| | | |
| CONSOLIDATED BALANCE SHEETS | | F-3 to F-4 |
| | | |
| CONSOLIDATED STATEMENTS OF INCOME | | F-5 |
| | | |
| CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY | | F-6 |
| | | |
| CONSOLIDATED STATEMENTS OF CASH FLOWS | | F-7 |
| | | |
| NOTES TO CONSOLIDATED FINANCIAL STATEMENTS | | F-8 to F-21 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To: The Board of Directors and Stockholders of
China Architectural Engineering, Inc.
We have audited the accompanying consolidated balance sheets of China Architectural Engineering, Inc. as of December 31, 2006, 2005, and 2004 and the related consolidated statements of income, stockholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Architectural Engineering, Inc. as of December 31, 2006, 2005, and 2004 and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
| South San Francisco, California | Samuel H. Wong & Co., LLP |
| March 9, 2007 | Certified Public Accountants |
| | |
South San Francisco Head Office: 400 Oyster Point Boulevard, Suite 122 So. San Francisco, CA 94080, U.S.A. Tel: (415) 732-1288 Fax: (415) 397-9028 | | Shanghai Representative Office: 1266 Nan Jing West Road, 39/F., Plaza 66, Shanghai, PRC 200040 Tel: (8621) 6288-0058 Fax: (8621) 6288-0058 | | Hong Kong Office: Room 703, 7th Floor, Nan Dao Commercial Building, 359-361 Queen’s Road Central, H.K. Tel: (852) 2526-9262 Fax: (852) 2511-3538 |
Internet: http://www.swongcpa.com
CHINA ARCHITECTURAL ENGINEERING, INC. |
| |
CONSOLIDATED BALANCE SHEETS |
AT DECEMBER 31, 2006, 2005 AND 2004 |
(Stated in US Dollars) |
| | | Note | | 2006 | | 2005 | | 2004 | |
ASSETS | | | | | | | | | |
| Current assets | | | | | | | | | | | | | |
| Cash and cash equivalents | | | | | $ | 2,115,966 | | $ | 511,817 | | $ | 2,988,271 | |
| Restricted cash | | | | | | 2,743,142 | | | 518,359 | | | 1,118,606 | |
| Contract receivables | | | 3 | | | 7,573,913 | | | 4,300,672 | | | 2,373,783 | |
| Costs and earnings in excess of billings | | | | | | 22,487,792 | | | 13,557,127 | | | 5,514,924 | |
| Job disbursements advances | | | | | | 5,236,327 | | | 516,914 | | | 504,478 | |
| Tender and other site deposits | | | | | | 3,427,490 | | | 2,235,752 | | | 3,049,942 | |
| Other receivables | | | | | | 213,257 | | | 48,397 | | | 866 | |
| Advances to a Director | | | | | | | | | | | | 1,889,091 | |
| Inventories | | | 5 | | | 23,108 | | | 23,389 | | | 15,023 | |
Total current assets | | | | | $ | 43,820,995 | | $ | 21,712,427 | | $ | 17,454,984 | |
| | | | | | | | | | | | | | |
| Plant and equipment, net | | | 6 | | | 474,498 | | | 607,672 | | | 503,805 | |
| Security deposit | | | | | | 565,795 | | | - | | | - | |
| Land Use Rights | | | 7 | | | - | | | - | | | 682,721 | |
TOTAL ASSETS | | | | | $ | 44,861,288 | | $ | 22,320,099 | | $ | 18,641,510 | |
| | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | |
| Short-term bank loan | | | 8 | | $ | - | | $ | 743,742 | | $ | 4,838,992 | |
| Notes Payable | | | 9 | | | - | | | - | | | 700,488 | |
| Accounts payable | | | | | | 15,202,029 | | | 6,365,517 | | | 2,721,503 | |
| Advances from shareholder | | | 4 | | | 1,735 | | | 420,556 | | | 205,095 | |
| Other payables | | | | | | 1,091,382 | | | 16,155 | | | 4,344 | |
| Income tax payable | | | | | | 1,263,491 | | | 744,258 | | | 33,837 | |
| Business and other taxes payable | | | | | | 2,058,327 | | | 1,454,644 | | | 591,551 | |
| Customers’ deposits | | | | | | 1,272,312 | | | 3,879,246 | | | 4,489,722 | |
| Job disbursements payable | | | | | | - | | | 75,880 | | | 98,848 | |
| Accruals | | | | | | 894,329 | | | 315,547 | | | 231,813 | |
Total current liabilities | | | | | $ | 21,783,605 | | $ | 14,015,545 | | $ | 13,916,193 | |
| | | | | | | | | | | | | | |
| Long-term bank loan | | | 10 | | | 2,564,979 | | | - | | | | |
TOTAL LIABILITIES | | | | | $ | 24,348,584 | | $ | 14,015,545 | | $ | 13,916,193 | |
See notes to consolidated financial statements
CHINA ARCHITECTURAL ENGINEERING, INC. |
| |
CONSOLIDATED BALANCE SHEETS |
AT DECEMBER 31, 2006, 2005, AND 2004 |
(Stated in US Dollars) |
| | | Note | | 2006 | | 2005 | | 2004 | |
STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | |
| Preferred stock, $0.001 par value, 10,000,000 shares authorized, 0 shares issued and outstanding at December 31, 2006; | | | | | | | | | | | | | |
| Common stock, $0.001 par value, 100,000,000 shares authorized, 50,000,000 shares issued and outstanding at December 31, 2006, and 43,304,125 shares issued and outstanding at December 31, 2005 and 2004 | | | 11 | | $ | 50,000 | | $ | 43,304 | | $ | 43,304 | |
| Additional paid in capital | | | | | | 7,106,561 | | | - | | | - | |
| Statutory reserves | | | | | | 1,437,223 | | | 1,403,699 | | | 1,299,156 | |
| Accumulated other comprehensive income | | | | | | 469,964 | | | (51,957 | ) | | (292,312 | ) |
| Retained earnings | | | | | | 11,448,956 | | | 6,909,508 | | | 3,675,169 | |
| | | | | | | | | | | | | | |
| | | | | | $ | 20,512,704 | | $ | 8,304,554 | | $ | 4,725,317 | |
| | | | | | | | | | | | | | |
TOTAL LIABILITIES AND | | | | | | | | | | | | | |
STOCKHOLDERS’ EQUITY | | | | | $ | 44,861,288 | | $ | 22,320,099 | | $ | 18,641,510 | |
See notes to consolidated financial statements
CHINA ARCHITECTURAL ENGINEERING, INC. |
| |
CONSOLIDATED STATEMENTS OF INCOME |
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 |
(Stated in US Dollars) |
| | | Note | | 2006 | | 2005 | | 2004 | |
| | | | | | | | | | |
| Contract revenues earned | | | 12 | | $ | 64,031,788 | | $ | 49,978,301 | | $ | 28,815,687 | |
| | | | | | | | | | | | | | |
| Cost of contract revenues earned | | | | | | (46,796,419 | ) | | (36,368,231 | ) | | (21,418,751 | ) |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Gross profit | | | | | $ | 17,235,369 | | $ | 13,610,070 | | $ | 7,396,936 | |
| | | | | | | | | | | | | | |
| Selling and administrative expenses | | | | | | (5,989,328 | ) | | (6,463,252 | ) | | (4,635,605 | ) |
| Non-recurring general and administrative expenses | | | 13 | | | (3,805,608 | ) | | - | | | - | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Income from operations | | | | | $ | 7,440,433 | | $ | 7,146,818 | | $ | 2,761,331 | |
| | | | | | | | | | | | | | |
| Interest expenses | | | | | | - | | | (116,750 | ) | | (260,271 | ) |
| Other income | | | 14 | | | 27,556 | | | 37,481 | | | 199,198 | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Income before taxation | | | | | $ | 7,467,989 | | $ | 7,067,549 | | $ | 2,700,258 | |
| | | | | | | | | | | | | | |
| Income tax | | | 15 | | | (1,318,221 | ) | | (1,157,271 | ) | | (490,957 | ) |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Net income | | | | | $ | 6,149,768 | | $ | 5,910,278 | | $ | 2,209,301 | |
| | | | | | | | | | | | | | |
| Basic net income per common share | | | | | $ | 0.14 | | $ | 0.14 | | $ | 0.05 | |
| Diluted net income per common share | | | | | $ | 0.14 | | $ | 0.14 | | $ | 0.05 | |
| | | | | | | | | | | | | | |
| Basic weighted average common shares outstanding | | | | | | 44,679,990 | | | 43,304,125 | | | 43,304,125 | |
| Diluted weighted average common shares outstanding | | | | | | 44,679,990 | | | 43,304,125 | | | 43,304,125 | |
See notes to consolidated financial statements
CHINA ARCHITECTURAL ENGINEERING, INC. |
| |
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY |
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004 |
(Stated in US Dollars) |
| | | Total number of shares | | Common stock | | Additional paid in capital | | Statutory reserves | | Accumulated other comprehensive income | | Retained earnings | | Total | |
| | | | | | | | | | | | | | | | |
| Balance, January 1, 2004 | | | 43,304,125 | | $ | 43,304 | | | - | | | 896,563 | | | (295,941 | ) | | 5,976,687 | | | 6,620,613 | |
| Net income | | | | | | | | | | | | | | | | | | 2,209,301 | | | 2,209,301 | |
| Dividend paid | | | | | | | | | | | | | | | | | | (4,108,226 | ) | | (4,108,226 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
| Appropriations to statutory revenue reserves | | | | | | | | | | | | 402,593 | | | | | | (402,593 | ) | | - | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Foreign currency translation adjustment | | | | | | | | | | | | | | | 3,629 | | | | | | 3,629 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Balance, December 31, 2004 | | | 43,304,125 | | $ | 43,304 | | | - | | | 1,299,156 | | | (292,312 | ) | | 3,675,169 | | | 4,725,317 | |
| Balance, January 1, 2005 | | | 43,304,125 | | $ | 43,304 | | | - | | | 1,299,156 | | | (292,312 | ) | | 3,675,169 | | | 4,725,317 | |
| Net income | | | | | | | | | | | | | | | | | | 5,910,278 | | | 5,910,278 | |
| Dividend paid | | | | | | | | | | | | | | | | | | (2,571,396 | ) | | (2,571,396 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
| Appropriations to statutory revenue reserves | | | | | | | | | | | | 104,543 | | | | | | (104,543 | ) | | - | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Foreign currency translation adjustment | | | | | | | | | | | | | | | 240,355 | | | | | | 240,355 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Balance, December 31, 2005 | | | 43,304,125 | | $ | 43,304 | | | - | | | 1,403,699 | | | (51,957 | ) | | 6,909,508 | | | 8,304,554 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Balance, January 1, 2006 | | | 43,304,125 | | $ | 43,304 | | | - | | | 1,403,699 | | | (51,957 | ) | | 6,909,508 | | | 8,304,554 | |
| Net income | | | | | | | | | | | | | | | | | | 6,149,768 | | | 6,149,768 | |
| Dividend paid | | | | | | | | | | | | | | | | | | (1,576,796 | ) | | (1,576,796 | ) |
| Issuance of Common Stock | | | 6,695,875 | | | 6,696 | | | | | | | | | | | | | | | 6,696 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Additional paid in capital from issuance of common stock in cash | | | | | | | | | 7,106,561 | | | | | | | | | | | | 7,106,561 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Appropriations to statutory revenue reserves | | | | | | | | | | | | 33,524 | | | | | | (33,524 | ) | | - | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Foreign currency translation adjustment | | | | | | | | | | | | | | | 521,921 | | | | | | 521,921 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Balance, December 31, 2006 | | | 50,000,000 | | $ | 50,000 | | | 7,106,561 | | | 1,437,223 | | | 469,964 | | | 11,448,956 | | | 20,512,704 | |
See notes to consolidated financial statements
CHINA ARCHITECTURAL ENGINEERING, INC. |
| |
CONSOLIDATED STATEMENTS OF CASH FLOWS |
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004 |
(Stated in US Dollars) |
| | | 2006 | | 2005 | | 2004 | |
Cash flows from operating activities | | | | | | | | | | |
| Net income | | $ | 6,149,768 | | $ | 5,910,278 | | $ | 2,209,301 | |
| Depreciation | | | 222,424 | | | 200,793 | | | 220,954 | |
| Profit on disposal of land use rights | | | - | | | (15,248 | ) | | - | |
| (Increase)/decrease in inventories | | | 281 | | | (8,366 | ) | | (854 | ) |
| Increase in receivables | | | (18,279,917 | ) | | (6,631,038 | ) | | (1,642,306 | ) |
| Increase/(decrease) in payables | | | 8,930,623 | | | 4,059,391 | | | 3,057,684 | |
| Net cash provided by operating activities | | $ | (2,976,821 | ) | $ | 3,515,810 | | $ | 3,844,779 | |
| | | | | | | | | | | |
Cash flows from investing activities | | | | | | | | | | |
| Disposals/(purchases) of land use rights | | $ | - | | $ | 694,946 | | $ | (672,842 | ) |
| Decrease/(increase) in restricted cash | | | (2,224,783 | ) | | 600,247 | | | (965,146 | ) |
| Increase in security deposit | | | (565,795 | ) | | - | | | - | |
| Purchases of plant and equipment | | | (89,250 | ) | | (304,659 | ) | | (375,958 | ) |
| | | | | | | | | | | |
| Net cash provided by investing activities | | $ | (2,879,828 | ) | $ | 990,534 | | $ | (2,013,946 | ) |
Cash flows from financing activities | | | | | | | | | | |
| Net (repayment)/proceeds from | | | | | | | | | | |
| short-term loans | | $ | (743,742 | ) | $ | (4,795,738 | ) | $ | 1,814,767 | |
| Proceeds from long-term loan | | | 2,564,979 | | | - | | | - | |
| Amount due to shareholder | | | (418,821 | ) | | 132,570 | | | 205,095 | |
| Issuance of common stock | | | 6,696 | | | - | | | - | |
Increase in additional paid in capital from issuance of common stock | | | 7,106,561 | | | - | | | - | |
| Dividends paid | | | (1,576,796 | ) | | (2,571,395 | ) | | (4,108,226 | ) |
| | | | | | | | | | | |
| Net cash used in financing activities | | $ | 6,938,877 | | $ | (7,234,563 | ) | $ | (2,088,364 | ) |
| Net (decrease)/increase in cash and cash | | | | | | | | | | |
| Equivalents | | $ | 1,082,228 | | $ | (2,728,219 | ) | $ | (257,531 | ) |
| Effect of foreign currency translation on cash and cash equivalents | | | 521,921 | | | 251,765 | | | 33,619 | |
| | | | | | | | | | | |
| Cash and cash equivalents - beginning of year | | | 511,817 | | | 2,988,271 | | | 3,212,183 | |
| | | | | | | | | | | |
| Cash and cash equivalents - end of year | | $ | 2,115,966 | | $ | 511,817 | | $ | 2,988,271 | |
| | | | | | | | | | | |
| Other supplementary information | | | | | | | | | | |
| Interest paid | | $ | 71,656 | | $ | 116,750 | | $ | 232,330 | |
| Income tax paid | | $ | 798,988 | | $ | 446,850 | | $ | - | |
See notes to consolidated financial statements
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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.
On October 17, 2006, the Company underwent a reverse-merger with Full Art International Ltd. (a Hong Kong company) and its four wholly-owned subsidiaries as detailed in 2(b) Consolidation below, involving an exchange of shares whereby the Company issued an aggregate of 43,304,125 shares of common stock in exchange for all of the issued and outstanding shares of Full Art. For financial reporting purposes, this transaction is classified as a recapitalization of China Architectural Engineering, Inc. and the historical financial statements of Full Art. The accompanying audited consolidated financial statements, the share, and per share amounts were retroactively adjusted to reflect the effects of the recapitalization.
The Company, through its subsidiaries, conducts its principal business activity in the People’s Republic of China, the Middle East, and the United States as glass wall contractors, specifically specializing in the design, manufacturing, installation and maintenance of structural glass and other light structure building systems.
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 subsidiary. The lengths of the company’s contracts vary, but they are typically about two years.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
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.
The consolidated financial statements include the accounts of China Architectural Engineering, Inc. (the Company) and its wholly-owned subsidiaries. Significant inter-company transactions have been eliminated in consolidation.
The Company is the 100% owner of Full Art International Ltd, which owned the four subsidiaries found in the following table for the entire reporting periods ended December 31, 2006, 2005, and 2004.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
| (b) | Consolidation (Cont’d) |
Name of company | | Place of incorporation | | Attributable equity interest % | |
| | | | | | |
| Zhuhai King Glass Engineering Co., Ltd | | | PRC | | | 100 | |
| Zhuhai King General Glass Engineering Technology Co., Ltd. | | | PRC | | | 100 | |
| King General Engineering (HK) Ltd. | | | Hong Kong | | | 100 | |
| KGE Building System Ltd. | | | Hong Kong | | | 100 | |
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) | Economic and political risks |
The Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic, and legal environment in the PRC, and by the general state of the PRC economy.
The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.
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: -
| Motor vehicle | | | 5 years | |
| Machinery and equipment | | | 5 - 10 years | |
| Furniture and office equipment | | | 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.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D) |
Land use rights are stated at cost less accumulated amortisation. Amortisation is provided over the respective useful lives, using the straight-line method.
| (g) | 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 years, there was no impairment loss.
Inventories are raw materials, which are stated at the lower of weighted average cost or market value.
Contracts receivable from performing construction of industrial and commercial buildings are based on contracted prices. The Company provides an allowance for doubtful collections, which is based upon a review of outstanding receivables, historical collection information, and existing economic conditions.
| (j) | Advances to suppliers |
Advances to suppliers represent the cash paid in advance for purchasing raw materials.
| (k) | Cash and cash equivalents |
The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. The Company maintains bank accounts only in the PRC and Hong Kong. The Company does not maintain any bank accounts in the United States of America.
Restricted cash represents time deposit accounts to secure notes payable and bank loans.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
| (m) | 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 time cost 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.
Selling, general, and administrative costs are charged to expense as incurred. 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.
Total estimated gross profit on a contract, the difference between total estimated contract revenue and total estimated contract cost, are 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.
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 while claims are uncommon. 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.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
The Company uses the accrual method of accounting to determine and report its taxable income and uses the flow through method to account for tax credits, which are reflected as a reduction of income taxes for the year in which they are available. The Company has implemented Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes.
Income tax liabilities computed according to the United States, People’s Republic of China (PRC) and Hong Kong SAR 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 either be 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. Ltd. (Zhuhai KGE) and Zhuhai King General Glass Engineering Technology Co. Ltd. are located in the City of Zhuhai and are subject to the corporation income tax rate of 33%. However, in accordance with the relevant tax laws and regulations of PRC, the Zhuhai local corporation income tax rate is 15%. Zhuzhai KGE (HK) is presently dormant, and from the time that it has its first profitable tax year, it is exempt from corporate income tax for its first two years and is then entitled to a 50% tax reduction for the succeeding three years. Zhuhai KGE has enjoyed this tax incentive in the previous years. |
| · | Full Art International Limited, King General Engineering (HK) Ltd, and KGE Building System Ltd are subject to Hong Kong profits tax rate of 17.5%. Currently, Full Art has around US$360,000 tax losses carried forward. KGE Building System has around US$33,000 tax losses carried forward. And for KGE (HK), it does not have any material tax losses. |
The Company is subject to United States Tax according to Internal Revenue Code Sections 951 and 957. Corporate income tax is imposed on graduated rates in the range of: -
| | | Taxable Income | | | |
Rate | | Over | | But not over | | Of Amount Over | |
| 15% | | | 0 | | | 50,000 | | | 0 | |
| 25% | | | 50,000 | | | 75,000 | | | 50,000 | |
| 34% | | | 75,000 | | | 100,000 | | | 75,000 | |
| 39% | | | 100,000 | | | 335,000 | | | 100,000 | |
| 34% | | | 335,000 | | | 10,000,000 | | | 335,000 | |
| 35% | | | 10,000,000 | | | 15,000,000 | | | 10,000,000 | |
| 38% | | | 15,000,000 | | | 18,333,333 | | | 15,000,000 | |
| 35% | | | 18,333,333 | | | - | | | 0 | |
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
The Company, after a reverse-merger on October 17, 2006, revived to be an active business enterprise because of the operations of its subsidiaries in China and Hong Kong. Based on the consolidated net income of 2006, the Company shall be taxed at the 34% tax rate. Please refer to Note 13 for provision of United States and PRC Income Taxes.
The Company expensed all advertising costs as incurred. Advertising expenses included in selling expenses were $151,821 and $114,731 for the years ended December 31, 2006 and 2005, respectively.
| (p) | Research and development |
All research and development costs are expensed as incurred. Research and development costs included in general and administrative expenses were $50,117, $58,865, and $nil for the years ended December 31, 2006, 2005, and 2004, respectively.
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. The retirement expense for the years ended December 31, 2006, 2005, and 2004, were $118,856, $109,941, and $85,604, respectively.
| (r) | Foreign currency translation |
The accompanying consolidated financial statements are presented in United States dollars. The functional currencies of the Company are the Hong Kong Dollar (HKD) and Renminbi (RMB). The consolidated financial statements are translated into United States dollars from HKD and RMB at year-end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred.
| | | 2006 | | 2005 | | 2004 | |
| Year end HKD : US$ exchange rate | | | 7.7794 | | | 7.7535 | | | 7.7760 | |
| Average yearly HKD : US$ exchange rate | | | 7.7690 | | | 7.7779 | | | 7.7893 | |
| | | 2006 | | 2005 | | 2004 | |
| Year end RMB : US$ exchange rate | | | 7.8175 | | | 8.0734 | | | 8.2865 | |
| Average yearly RMB : US$ exchange rate | | | 7.9819 | | | 8.2033 | | | 8.2872 | |
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.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
Surplus 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.
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.
| (u) | Recent accounting pronouncements |
In May 2005, the FASB issued a SFAS 154, “Accounting Changes and Error Corrections” to replace APB Opinion No. 20, “Accounting Changes” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements” requiring retrospective application to prior periods consolidated financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, SFAS 154 requires the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, SFAS 154 requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. The effective date for this statement is for accounting changes and corrections of errors made in fiscal year beginning after December 15, 2005.
The Company does not anticipate that the adoption of this standard will have a material impact on these consolidated financial statements.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
| | | 2006 | | 2005 | | 2004 | |
| Contract receivables | | $ | 7,991,561 | | $ | 4,704,267 | | $ | 2,801,451 | |
| | | | | | | | | | | |
Less: Allowance for doubtful accounts | | | (417,648 | ) | | (403,595 | ) | | (427,668 | ) |
| | | | | | | | | | | |
| Net | | $ | 7,573,913 | | $ | 4,300,672 | | $ | 2,373,783 | |
| 4. | ADVANCES FROM SHAREHOLDER |
All advances from shareholder are unsecured, interest free, and without fixed repayment terms. Advances from/to employee are related to for business traveling and sundry purchasing.
| | | 2006 | | 2005 | | 2004 | |
| Raw materials | | $ | 23,108 | | $ | 23,389 | | $ | 15,023 | |
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
Plant and equipment consist of the following as of December 31:
| | | | 2006 | | | 2005 | | | 2004 | |
| At cost | | | | | | | | | | |
| Motor vehicle | | $ | 453,917 | | $ | 453,281 | | $ | 442,042 | |
| Machinery and equipment | | | 1,417,256 | | | 1,326,559 | | | 1,227,552 | |
| Furniture and office | | | | | | | | | | |
| Equipment | | | 669,480 | | | 605,297 | | | 410,914 | |
| | | $ | 2,540,653 | | $ | 2,385,137 | | $ | 2,080,478 | |
Less:Accumulated depreciation | | | | | | | | | | |
| Motor vehicle | | $ | 401,862 | | $ | 338,663 | | $ | 250,279 | |
| Machinery and equipment | | | 1,190,795 | | | 1,141,698 | | | 1,130,467 | |
| Furniture and office | | | | | | | | | | |
| Equipment | | | 473,498 | | | 297,104 | | | 195,927 | |
| | | $ | 2,066,155 | | $ | 1,777,465 | | $ | 1,576,673 | |
| | | $ | 474,498 | | $ | 607,672 | | $ | 503,805 | |
Depreciation expenses included in the selling and administrative expenses for the years ended 2006, 2005 and 2004 were $222,424, $159,641 and $144,305, respectively.
7. LAND USE RIGHTS
| | | 2005 | | 2005 | | 2004 | |
| Cost of land use rights | | $ | - | | $ | - | | $ | 696,654 | |
Less: Accumulated amortization | | | - | | | - | | | (13,933 | ) |
| Land use rights, net | | $ | - | | $ | - | | $ | 682,721 | |
Amortization expenses included in selling and administrative expenses for the years ended 2006, 2005, and 2004 were nil, nil, and $13,948, respectively.
The entire land use right was disposed of during the year ended December 31, 2005. Gain in disposal, included in other income for the year ended December 31, 2005 amounted to $15,248.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
| | | 2006 | | 2005 | | 2004 | |
Loan from China Ever Bright Bank, interest rate at | | | | | | | |
5.04% per annum | | | | | | | |
| Due February 27, 2004 | | $ | - | | $ | - | | $ | - | |
| Due May 21, 2005 | | | - | | | - | | | 3,629,244 | |
| | $ | - | | $ | - | | $ | 3,629,244 | |
Loan from Industrial Bank Co., Ltd, interest rate at 6.7860%, 6.1065%, and 5.8410% respectively per annum | | | | | | | | | | |
| Due August 12, 2004 | | $ | - | | $ | - | | $ | - | |
| Due August 20, 2005 | | | - | | | - | | | 1,209,748 | |
| Due June 6, 2006 | | | - | | | 743,742 | | | - | |
| | | $ | - | | $ | 743,742 | | $ | 1,209,748 | |
| | $ | - | | $ | 743,742 | | $ | 4,838,992 | |
All of the short-term bank loans due in 2006 and in 2005 were paid on their due dates. Interest expense was nil, $116,750 and $260,271 in 2006, 2005, and 2004, respectively. The principal amounts of the short-term bank loans are paid at the due dates.
| | | 2006 | | 2005 | | 2004 | |
| Notes to China Everbright Bank, | | | | | | | |
| Due March 13, 2005 | | $ | - | | $ | - | | $ | 195,929 | |
| Due March 20, 2005 | | | - | | | - | | | 96,779 | |
| Due March 24, 2005 | | | - | | | - | | | 48,390 | |
| Due March 29, 2005 | | | - | | | - | | | 224,276 | |
| Due June 13, 2005 | | | - | | | - | | | 96,780 | |
| Due June 16, 2005 | | | - | | | - | | | 38,334 | |
| | | $ | - | | $ | - | | $ | 700,488 | |
| | | | | | | | | | | |
All of the notes due in 2005 were paid on their due date.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
| | | | 2006 | | | 2005 | | | 2004 | |
Line of Credit from Bank of East Asia Ltd. at an interest rate at 5.508% subject to variation every 6 months (RMB 20,000,000) | | | | | | | | | | |
| Due October 25, 2011 | | $ | 2,564,979 | | $ | - | | $ | - | |
The Company obtained a line of credit facility up to a maximum of RMB 20,000,000, which does not need to renew until October 25, 2011.
Interest expense was $ 18,678 for 2006.
| 11. | COMMON STOCK AND ADDITIONAL PAID IN CAPITAL |
As a result of the reverse-merger on October 17, 2006 involving an exchange of shares between China Architectural Engineering, Inc. and its subsidiaries led by Full Art International Limited as well as issuance of shares to entities involved in the deal, total capitalization of the Company by common stock and related additional paid-in capital at December 31, 2006 is depicted in the following table: -
| | | December 31, 2006 | | December 31, 2005 & 2004 | |
Name of Shareholder | | Number of Shares | | Common Stock Capital | | Additional Paid-in Capital | | % of Equity Holdings | | Common Stock Capital | | % of Equity Holdings | |
| KGE Group Ltd. | | | 43,304,125 | | | 43,304 | | | - | | | 86.61 | % | | 43,304 | | | 100.00 | % |
| Investor Relations Firm | | | 100,000 | | | 100 | | | 159,900 | | | 0.20 | % | | | | | | |
| First Alliance Financial Group | | | 2,000,000 | | | 2,000 | | | 3,198,000 | | | 4.00 | % | | | | | | |
| Former CAEI shareholders | | | 2,275,000 | | | 2,275 | | | - | | | 4.55 | % | | | | | | |
| Various private investors | | | 2,320,875 | | | 2,321 | | | 3,711,079 | | | 4.64 | % | | | | | | |
| Conversion of original capital from Full Art International, Ltd. to additional paid-in capital | | | | | | | | | 37,582 | | | | | | | | | | |
| | | | 50,000,000 | | | 50,000 | | $ | 7,106,561 | | | 100.00 | % | | 43,304 | | | 100.00 | % |
On March 12, 2007, the Company filed a registration statement with the SEC to register 300,000 shares of Common Stock at a price between US$3.00 and US$4.00 per share.
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
| 12. | CONTRACT REVENUES EARNED |
| | | 2006 | | 2005 | | 2004 | |
| | | | | | | | |
| Billed | | $ | 41,906,743 | | $ | 37,825,662 | | $ | 26,408,726 | |
| Unbilled | | | 22,125,045 | | | 12,152,639 | | | 2,406,961 | |
| | | | | | | | | | | |
| | | $ | 64,031,788 | | $ | 49,978,301 | | $ | 28,815,687 | |
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 needs 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.
| 13. | NON-RECURRING GENERAL AND ADMINISTRATIVE EXPENSE |
These expenses are related to the following service providers that rendered valuable services to the Company in consummating the reverse-merger plan: -
| (1) | First Alliance Financial Group for financing services by issuance of 2,000,000 shares at $1.60 per share | | $ | 3,200,000 |
| (2) | Brokers to sell 2,320,875 shares to investors by private placement at $ 1.60 per share, compensated by cash | | | 445,608 |
| (3) | Investors Relations Firm for investor relationship services by issuance of 100,000 shares at $ 1.60 per share | | | 160,000 |
| | | $ | 3,805,608 |
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
| | | 2006 | | 2005 | | 2004 | |
| Net exchange gains | | | 2,209 | | | 1,501 | | | - | |
| Interest income | | | 25,347 | | | 20,732 | | | 63,108 | |
| Profit on disposal of land use rights | | | - | | | 15,248 | | | - | |
| | | | | | | | | | | |
| Tax refund from reinvestment of earnings in a subsidiary | | | - | | | - | | | 136,090 | |
| | | $ | 27,556 | | $ | 37,481 | | $ | 199,198 | |
The following table accounts for the differences between the actual tax provision and the amounts obtained by applying the relevant applicable corporation income tax rate to income before tax for the year ended December 31, 2006 and 2005:
| | | 2006 | | 2005 | | 2004 | |
| Income before tax | | $ | 7,467,989 | | $ | 7,067,549 | | $ | 2,700,258 | |
| Tax at the domestic income tax rate | | $ | 2,464,436 | | $ | 2,332,291 | | $ | 891,085 | |
| Effect of government grants | | | (1,146,215 | ) | | (1,175,020 | ) | | (400,128 | ) |
| Current income tax expense for PRC | | $ | 1,318,221 | | $ | 1,157,271 | | $ | 490,957 | |
| Hong Kong income tax provision | | | - | | | - | | | - | |
| U.S. income tax provision | | | - | | | - | | | - | |
| | | $ | 1,318,221 | | $ | 1,157,271 | | $ | 490,957 | |
CHINA ARCHITECTURAL ENGINEERING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Stated in US Dollars)
The Company leases certain administrative and production facilities from third parties. Accordingly, for the year ended December 31, 2006, 2005 and 2004, the Company incurred rental expenses of $385,386, $411,468, and $399,053 respectively.
The Company has commitments with respect to non-cancelable operating leases for these offices, as follows:
Commitments Due | | 2006 | | 2005 | | 2004 | |
| | | | | | | | |
| Less than 1 year | | $ | 282,795 | | $ | 384,985 | | $ | 243,860 | |
| Between 1 and 3 years | | | 300,026 | | | 2,406,586 | | | 53,571 | |
| | | | | | | | | | | |
| Greater than 3 years | | | - | | | 72,527 | | | - | |
| | | $ | 582,821 | | $ | 2,864,098 | | $ | 297,431 | |
17. RELATED PARTIES TRANSACTIONS
The following material transactions with related parties during the years were in the opinion of the directors, carried out in the ordinary course of business and on normal commercial terms:
The advances to/(from) Luo Yi, the director for the years ended December 31, 2006, 2005, and 2004 were nil, nil, and $1,889,091, respectively.
The advances from KGE Group Limited, the holding company for the years ended December 31, 2006, 2005, and 2004 were $1,735, $420,556, $205,095 respectively.
All of the above amounts due with a director and the holding company are unsecured, interest free, and have no fixed repayment terms.
