China CGame (CCGM) 10-Q 2010 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Commission File Number

001-33709

CHINA ARCHITECTURAL ENGINEERING, INC.

(Exact name of small business issuer as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)	51-05021250 (I.R.S. Employer Identification No.)
Research Building, No.801 Wuzhong Road, Changzhou Science and Education Industrial Park Wujin District, Changzhou, Jiangsu, People’s Republic of China
(Address of principal executive offices)	213164 (Zip Code)

+86-519-86339908

(Registrant’s telephone number, including area code)

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

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

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

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

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

There were 80,156,874 shares outstanding of registrant’s common stock, par value $0.001 per share, as of November 21, 2010.

CHINA ARCHITECTURAL ENGINEERING, INC.

FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS	1
	Consolidated Balance Sheet as of September 30, 2010 (unaudited) and December 31, 2009	2
	Unaudited Interim Consolidated Statements of Income for the three and nine months ended September 30, 2010 and 2009	4
	Unaudited Interim Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009	5
	Unaudited Consolidated Statements of Stockholders’ Equity from January 1, 2010 to September 30, 2010	6
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION	26
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	38
ITEM 4.	CONTROLS AND PROCEDURES	38
PART II - OTHER INFORMATION		41
ITEM 1.	LEGAL PROCEEDINGS	41
ITEM 1A.	RISK FACTORS	41
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	46
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	46
ITEM 4.	REMOVED AND RESERVED	46
ITEM 5.	OTHER INFORMATION	46
ITEM 6.	EXHIBITS	46
SIGNATURES		47

2

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying unaudited financial statements reflect all adjustments that, in the opinion of management, are considered necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The accompanying unaudited financial statements should be read in conjunction with the audited financial statements of China Architectural Engineering, Inc. as contained in its Annual Report for the fiscal year ended December 31, 2009 on Form 10-K/A, as filed with the Securities and Exchange Commission on June 2, 2010.

1

CHINA ARCHITECTURAL ENGINEERING, INC.

CONSOLIDATED BALANCE SHEETS

AS OF SEPTEMBER 30, 2010 (UNAUDITED) AND DECEMBER 31, 2009

(STATED IN US DOLLARS)

	Notes	September 30, 2010		December 31, 2009
		(unaudited)
ASSETS
Current assets
Cash and cash equivalents		$	3,009,063	$	740,125
Restricted cash			1,080,415		3,033,819
Contract receivables, net	(3)		84,434,212		89,189,103
Costs and earnings in excess of billings			3,436,002		8,100,580
Job disbursements advances			2,526,634		2,696,794
Other receivables	(4)		24,577,249		30,768,067
Inventories	(5)		172,882		727,499
Deferred income taxes, current			112,988		113,033
Other current assets			306,235		297,838
Total current assets			119,655,680		135,666,858
Non-current assets
Plant and equipment, net	(6)		3,197,473		2,539,457
Intangible assets	(7)		175,514		70,610
Goodwill			23,771,636		7,995,896
Other non-current asset			393,701		287,586
TOTAL ASSETS		$	147,194,004	$	146,560,407
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Short-term bank loans	(8)	$	6,903,751	$	9,529,880
Accounts payable			26,664,322		26,614,484
Billings over costs and estimated earnings			1,595,284		6,098,666
Amount due to shareholder			9,098,900		10,080,345
Other payables			14,253,808		9,360,314
Business and other taxes payable			4,659,759		4,923,771
Customers’ deposits			5,741,681		6,392,676
Other Accrual			4,065,003		4,324,011
Total current liabilities			72,982,508		77,324,147

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

2

CHINA ARCHITECTURAL ENGINEERING, INC.

CONSOLIDATED BALANCE SHEETS (Continued)

AS OF SEPTEMBER 30, 2010 (UNAUDITED) AND DECEMBER 31, 2009

(STATED IN US DOLLARS)

		September 30, 2010			December 31, 2009
		(unaudited)
Non-current liabilities
Long term bank loans	(8)	$	51,386		$	109,239
Convertible bond payable, net	(9)		27,688,956			24,564,161
TOTAL LIABILITIES		$	100,722,850		$	101,997,547
STOCKHOLDERS’ EQUITY
Preferred stock, $0.001 par value, 10,000,000 shares authorized, 0 shares issued and outstanding at September 30, 2010 and December 31, 2009;
Common stock, $0.001 par value, 150,000,000 shares authorized, 80,156,874 shares issued and outstanding at September 30, 2010 and 53,256,874 shares issued at and outstanding December 31, 2009		$	80,157		$	53,257
Additional paid in capital			43,820,878			26,495,876
Statutory reserves			3,040,595			3,040,595
Accumulated other comprehensive income			4,020,091			3,868,437
Retained earnings			(4,205,083	)		11,131,084
Total Company shareholders’ equity			46,756,638			44,589,249
Noncontrolling interests			(285,484	)		(26,389	)
Total shareholders’ equity			46,471,154			44,562,860
TOTAL LIABILITIES AND
STOCKHOLDERS’ EQUITY		$	147,194,004		$	146,560,407

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

3

CHINA ARCHITECTURAL ENGINEERING, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(STATED IN US DOLLARS) (UNAUDITED)

	Notes	Three Months Ended September 30,						Nine Months Ended September 30,
		2010			2009			2010			2009
Contract revenues earned	(10)	$	4,442,495		$	25,558,074		$	21,623,035		$	92,500,112
Cost of contract revenues earned			(5,452,809	)		(25,082,910	)		(20,734,794	)		(73,892,287	)
Gross profit/(loss)		$	(1,010,314	)	$	475,164		$	888,241		$	18,607,825
Selling, general and administrative expenses			(5,609,538	)		(5,548,946	)		(11,678,113	)		(17,619,775	)
Income/(loss) from operations		$	(6,619,852	)	$	(5,073,782	)	$	(10,789,872	)	$	988,050
Interest income			3,668			4,835			8,951			54,800
Interest expense			(1,779,371	)		(1,741,368	)		(5,273,367	)		(4,524,936	)
Other expenses			(350,764	)		-			(359,694	)		-
Other income			4,001			335,104			827,929			495,560
Loss before taxation on continuing operations		$	(8,742,318	)	$	(6,475,211	)	$	(15,586,053	)	$	(2,986,526	)
Income tax	(11)		-			(114,113	)		(9,575	)		(114,113	)
Discontinued operation loss, net of tax			-			(1,829,971	)		-			(1,829,971	)
Net loss including non-controlling interests			(8,742,318	)		(8,419,295	)		(15,595,628	)		(4,930,610	)
Loss attributable to non-controlling interest			256,371			38,009			259,461			36,604
Net loss attributable to the Company		$	(8,485,947	)	$	(8,381,286	)	$	(15,336,167	)	$	(4,894,006	)
Loss per share:
Basic		$	(0.13	)	$	(0.16	)	$	(0.26	)	$	(0.09	)
Diluted		$	(0.13	)	$	(0.16	)	$	(0.26	)	$	(0.09	)
Weighted average shares outstanding:
Basic			66,970,061			53,256,874			58,969,374			53,256,874
Diluted			66,970,061			53,256,874			58,969,374			53,256,874

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

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CHINA ARCHITECTURAL ENGINEERING, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(STATED IN US DOLLARS) (UNAUDITED)

	Nine Months Ended September 30,
	2010			2009
Cash flows from operating activities
Net/(Loss) income	$	(15,336,167	)	$	(4,894,006	)
Noncontrolling interest		(259,095	)		(40,831	)
Depreciation expense		610,220			710,901
Bad debts expenses		3,366,552			-
Amortization expense on intangible assets		42,082			78,461
Amortization expense on convertible bond		3,124,795			2,194,418
Stock compensation expenses		1,976,902			-
Loss on disposal of fixed assets		882			1,998,634
Deferred income taxes		45			(109,842	)
Decrease in inventories		554,617			17,209
(Increase) / Decrease in receivables		12,243,735			(12,456,959	)
(Increase) / Decrease in other assets		55,648			(6,339,445	)
Increase / (Decrease) in payables		(734,065	)		7,656,923
Net cash provided by / (used in) operating activities	$	5,646,151		$	(11,184,537	)
Cash flows from investing activities
Purchases of assets	$	(1,240,869	)	$	(161,420	)
Purchase of intangible assets		(146,986	)		(103,405	)
Proceeds from disposal of fixed assets		-			342,095
Purchases of goodwills		(15,775,740	)		-
Decrease in restricted cash		1,953,404			7,448,458
Net cash provided by/(used in) investing activities	$	(15,210,191	)	$	7,525,728
Cash flows from financing activities
Proceeds from / (Repayments) of short-term loans		(2,626,129	)		9,533,975
Repayment of notes Payable		-			(10,193,088	)
Repayment of long-term loans		(57,853	)		(199,686	)
Proceeds from / (Repayments) of shareholders loans		(981,445	)		3,710,741
Net cash provided by financing activities	$	(3,665,427	)	$	2,851,942
Net decrease in cash and cash equivalents	$	(13,229,467	)	$	(806,867	)
Effect of foreign currency translation on cash and cash equivalents		123,405			(2,191,366	)
Cash and cash equivalents - beginning of period		740,125			9,516,202
		(12,365,937	)		6,517,969
Cash and cash equivalents - end of period	$	3,009,063		$	6,517,969
Non-cash transactions
Issuance of stock for subsidiary acquisition		15,375,000			-
Other supplementary information:
Cash paid during the period for:
Interest paid	$	2,794,277		$	-
Income tax paid	$	9,575		$	143,306

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

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CHINA ARCHITECTURAL ENGINEERING, INC.

UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE PERIOD FROM JANUARY 1, 2010 TO SEPTEMBER 30, 2010

(STATED IN US DOLLARS)

	Total  Number of shares		Common stock		Additional paid in capital		Statutory reserves		Accumulated other comprehensive income		Retained earnings			Noncontrolling interests			Total
Balance, January 1, 2010		53,256,874	$	53,257	$	26,495,876	$	3,040,595	$	3,868,437	$	11,131,084		$	(26,389	)	$	44,562,860
Net Loss including non-controlling interests												(15,336,167	)		(259,461	)		(15,595,628	)
Additional paid-in capital from grant of stock option to employee						19,902												19,902
Value of stock grants to employees		1,900,000		1,900		1,955,100												1,957,000
Value of stock issued for acquisition of subsidiary		25,000,000		25,000		15,350,000												15,375,000
Foreign currency translation adjustment										151,654					366			152,020
Total comprehensive income																		1,908,294
Balance, September 30, 2010		80,156,874	$	80,157	$	43,820,878	$	3,040,595	$	4,020,091	$	(4,205,083	)	$	(285,484	)	$	46,471,154

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

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CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

1. ORGANIZATION AND PRINCIPAL ACTIVITIES

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

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

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

On August 18, 2010, pursuant to a stock purchase agreement that was entered into on August 11, 2010 by and among the Company, First Jet Investments Limited (“First Jet”), New Crown Technology Limited, First Jet’s wholly-owned subsidiary (“New Crown”) and Mr. Jun Tang, the principal of First Jet and New Crown, the Company completed an acquisition of 60% of the issued and outstanding shares of New Crown, which is the holder of 100% of the equity interests of Shanghai ConnGame Network Ltd. (“ConnGame”).  In exchange for the 60% equity interest of New Crown, the Company issued 25,000,000 shares of the Company’s common stock, $0.001 par value per share, to First Jet.  ConnGame is a company organized under the laws of the People’s Republic of China with a registered capital of RMB 10,000,000.  ConnGame is a developer and publisher of MMORPG (Massively Multiplayer Online Role Playing Game).  In connection with the foregoing transaction, the Company transferred to New Crown 100% of the equity interests of China Architectural Engineering (Shenzhen) Co., Ltd., which had immaterial operations and assets at the time of transfer.

In August 2010, connection with the acquisition of ConnGame and the issuance of 25,000,000 shares of the Company's common stock, the Company increased its authorized shares of common stock from 100,000,000 to 150,000,000 shares of common stock.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Method of accounting

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

(b) Consolidation

The consolidated financial statements include the accounts of the Company and its 17 subsidiaries. Significant inter-company transactions have been eliminated in consolidation. The consolidated financial statements include 100% of the assets and liabilities of these majority-owned subsidiaries, and the ownership interests of minority investors are recorded as noncontrolling interests.

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CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

The Company owned the subsidiaries through its reverse-merger on October 17, 2006 and through direct investments or acquisitions after October 17, 2006.  As of September 30, 2010, detailed identities of the consolidating subsidiaries are as follows:

Name of Company	Place of Incorporation	Attributable Equity interest %
Full Art International Limited	Hong Kong		100
Zhuhai King Glass Engineering Co., Ltd.	PRC		100
Zhuhai King General Glass Engineering Technology Co., Ltd.	PRC		100
King General Engineering (HK) Limited	Hong Kong		100
KGE Building System Limited	Hong Kong		100
KGE Australia Pty Limited	Australia		55
Zhuhai Xiangzhou District Career Training School	PRC		72
Faith Mount International Limited	Hong Kong		100
Techwell Engineering Limited	Hong Kong		100
Techwell International Limited	Macau		100
Techwell Building System (Shenzhen) Co., Ltd.	PRC		100
CAE Building Systems, Inc.	USA		100
Techwell International S.E.A.	Singapore		100
China Architectural Engineering (Shenzhen) Co., Ltd.	PRC		60
CAE Building Systems (Singapore) Pte Ltd	Singapore		100
New Crown Technology Limited	Hong Kong		60
Shanghai ConnGame Network Ltd.	PRC		60

(c) Use of estimates

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

(d) Plant and equipment

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

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

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

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CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

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

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

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

(f) Goodwill and Intangible Assets

In accordance with ASC 350, “Goodwill and Other Intangible Assets.” the Company does not amortize goodwill or intangible assets with indefinite lives.

Upon indication that the carrying values of such assets may not be recoverable, the Company recognizes an impairment loss as a charge against current operations.  

The Company performs an analysis on its goodwill balances to test for impairment on an annual basis and whenever events occur that indicate an impairment could exist.  Of the goodwill presented as September 30, 2010, approximately $23.8 million is attributable to  the acquired subsidiaries.

Approximately $15.4 million was attributed to ConnGame, which was acquired in August 2010, and approximately $8.0 million was attributed to Techwell Engineering Limited. There are several instances that may cause the Company to further test its goodwill for impairment between the annual testing periods including:  (i) continued deterioration of market and economic conditions that may adversely impact its ability to meet its projected results; (ii) declines in the Company’s stock price caused by continued volatility in the financial markets that may result in increases in its weighted-average cost of capital or other inputs to its goodwill assessment; (iii) the occurrence of events that may reduce the fair value of a reporting unit below its carrying amount, such as the sale of a significant portion of one or more of the Company’s reporting units. In the nine month periods ended September 30, 2010, the Company believes that no instance indicates that an impairment could exist in respect to Techwell.

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

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

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CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

(g) Inventories

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

(h) Contracts receivable

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

(i) Cash and cash equivalents

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

(j) Restricted cash

Restricted cash represents deposits in bank accounts to secure notes payables, bank loans, project performance bond and guarantee.

(k) Earnings per share

The Company computes earnings per share (“EPS’) in accordance with ASC260, “Earnings per Share”. ASC260 requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is measured as the income or loss available to common shareholders divided by the weighted average common shares outstanding for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options, and warrants) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.

The calculation of diluted weighted average common shares outstanding for the periods ended September 30, 2010 and 2009 is based on the estimate fair value of the Company’s common stock during such periods applied to warrants and options using the treasury stock method to determine if they are dilutive. The Convertible Bond is included on an “as converted” basis when these shares are dilutive.

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CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

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

	Three Months Ended September 30,							Nine Months Ended September 30,
	2010			2009				2010			2009
Net Income/(Loss)	$	(8,485,947	)		$	(8,381,286	)	$	(15,336,167	)	$	(4,894,006	)
Add: Interest expenses less income taxes		-				-			-			-
Adjusted income		(8,485,947	)			(8,381,286	)		(15,336,167	)		(4,894,006	)
Basic Weighted Average Shares Outstanding		66,970,061				53,256,874			58,969,374			53,256,874
Dilutive Shares:
-      Addition to Common Stock from Conversion of Bonds		-				-			-			-
-      Addition to Common Stock from Exercise of Warrants		-				-			-			-
Diluted Weighted Average Outstanding Shares:		66,970,061				53,256,874			58,969,374			53,256,874
Earnings/(Loss) Per Share
-    Basic	$	(0.13	)		$	(0.16	)	$	(0.26	)	$	(0.09	)
-    Diluted	$	(0.13	)		$	(0.16	)	$	(0.26	)	$	(0.09	)

(l) Revenue and cost recognition

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

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

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

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

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

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

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.

11

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

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

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

(m) Income taxes

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

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

In respect of the Company’s subsidiaries domiciled and operated in different tax jurisdictions, the taxation of these entities can be summarized as follows:

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

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

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

· Techwell Engineering Limited is subject to a Hong Kong profits tax rate of 16.5%. Techwell International Limited is a Macau registered company and therefore is subject to Macau profits tax rate of 12%.  Techwell Building System (Shenzhen) Co. Limited is located in Shenzhen and is subject to PRC corporate income tax rate of 20% in 2009 that will be gradually increased to the uniform rate of 25% by 2012 as according to the new EIT law.

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

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

· The Company, after a reverse-merger on October 17, 2006, revived to be an active business enterprise because of the operations with subsidiaries in the PRC and Hong Kong.  Based on the consolidated net income for the year ended December 31, 2009, the Company shall be taxed at the 34% tax rate.

12

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

· Techwell Engineering Limited has established a branch in Dubai, which has zero corporate income tax rate.

· New Crown Technology Limited is subject to a Hong Kong profits tax rate of 16.5%.

· Shanghai ConnGame Network Ltd. is located in Shanghai and is subject to a 25% income tax rate.

(n) Advertising

The Company expensed all advertising costs as incurred. Advertising expenses included in selling expenses were $3,668 and $nil for the three-month period, $3,668 and $11,032 for the nine-month period ended September 30, 2010 and 2009, respectively.

(o) Research and development

All research and development costs are expensed as incurred. Research and development costs included in general and administrative expenses were $362,677 and $nil for the three-month period, $362,677 and $2,926 for the nine-month period ended September 30, 2010 and 2009, respectively.

(p) Retirement benefits

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

(q) Foreign currency translation

The accompanying consolidated financial statements are presented in United States Dollars (US$). The Company’s functional currency is the US$, while certain domestic subsidiaries’ use the Renminbi (RMB) and Hong Kong and overseas subsidiaries use local currencies as their functional currency.   The consolidated financial statements are translated into US$ from RMB, Hong Kong Dollars (HKD), United Arab Emirate Dirham (AED) and other local currencies at September 30, 2010 exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred.

	September 30, 2010		December 31, 2009		September 30, 2009
Period end RMB : US$ exchange rate		6.6981		6.8372		6.8263
Average quarterly RMB : US$ exchange rate		6.7803		6.8331		6.8309

	September 30, 2010		December 31, 2009		September 30, 2009
Period end HKD : US$ exchange rate		7.7582		7.7551		7.7501
Average quarterly HKD : US$ exchange rate		7.7718		7.7518		7.7505

	September 30, 2010		December 31, 2009		September 30, 2009
Period end AED : US$ exchange rate		3.6736		3.6738		3.6700
Average quarterly AED : US$ exchange rate		3.6738		3.6710		3.6700

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

13

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

(r) Statutory reserves

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

(s) Comprehensive income

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

(t) Recent accounting pronouncements

On July 1, 2009, FASB issued FASB Statement No. 168, The “FASB Accounting Standards Codification” and the Hierarchy of Generally Accepted Accounting Principles.  The ASC has become the source of authoritative US GAAP recognized by the FASB to be applied by nongovernmental entities and provides that all such guidance carries an equal level of authority. The ASC is not intended to change or alter existing GAAP. The ASC is effective for interim and annual periods ending after September 15, 2009.

There was no new accounting pronouncements since the FASB Statement No. 168 issued on July 1, 2009.

14

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

3. CONTRACT RECEIVABLES

	September 30, 2010			December 31, 2009
Contract receivables	$	87,359,141		$	95,831,489
Less: Allowance for doubtful accounts		(2,924,929	)		(6,642,386	)
Net	$	84,434,212		$	89,189,103

Allowance for Doubtful Accounts	September 30, 2010			December 31, 2009
Beginning balance	$	6,642,386		$	5,215,701
Add: Allowance created		3,366,552			1,426,685
Less: Written off of receivables		(7,084,009	)		-
Ending balance	$	2,924,929		$	6,642,386

15

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

4. OTHER RECEIVABLES

Other receivables consisted of the following:

	September 30, 2010		December 31, 2009
Due from sellers of Techwell, the subsidiary (1)	$	11,371,563	$	11,333,253
Due from Kangbao Electrical Company Limited (Kangbao) , a related party  (2)		-		6,054,905
Drawdown of advance payment and performance bonds by client of the projects in Dubai (3)		9,410,636		9,414,397
Other related parties receivables		-		253,638
Deposits for site operations of projects in PRC		2,774,512		2,903,171
Other		1,020,538		808,703
Total	$	24,577,249	$	30,768,067

(1) On November 6, 2007, the Company, through Full Art International, Ltd. (“Full Art”), acquired all of the issued and outstanding shares in the capital of Techwell Engineering Limited, a limited liability company incorporated in Hong Kong (“Techwell”) pursuant to a Stock Purchase Agreement (the “Agreement”) dated November 6, 2007, entered into by and among Ng Chi Sum and Yam Mei Ling (each a “Shareholder” and collectively, the “Shareholders”), the Company and Full Art.  Pursuant to the terms and conditions of the Agreement, the Shareholders agreed that each of them would pay any and all accounts receivables of Techwell if not paid by the customers within 24 months of the acquisition date.  The 24 month period has expired and a total of $9,909,130 is due and payable from the Shareholders. The amount is included in the other receivable due from sellers of Techwell.

(2) The amount as at December 31, 2009 mainly represented the purchases advances to Kangbao Electrical Company Limited (Kangbao) for the supplies of materials for the projects of the Company.

(3) The Company believes that the client of the Dubai projects did not have proper grounds for the drawdown of the advance payment and performance bonds which the company issued for the projects.  The Company also believes that the client should not be entitled to the drawdown and is now proceeding the claim back of the amount.

5. INVENTORIES

	September 30, 2010		December 31, 2009
Raw materials at sites	$	172,882	$	727,499

16

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

6. PLANT AND EQUIPMENT

Plant and equipment consist of the following as of:

	September 30, 2010		December 31, 2009
At cost
Motor vehicle	$	1,256,072	$	1,242,928
Machinery and equipment		2,431,665		2,381,755
Furniture, software and office
equipment		2,287,313		1,795,595
Building		-		-
Leasehold improvement		1,040,039		267,038
	$	7,015,089	$	5,687,316
Less:   Accumulated depreciation
Motor vehicle	$	959,777	$	825,536
Machinery and equipment		1,585,480		1,420,536
Furniture, software and office
equipment		1,082,526		804,516
Building		-		-
Leasehold improvement		189,833		97,271
	$	3,817,616	$	3,147,859
	$	3,197,473	$	2,539,457

Depreciation expenses included in the selling and administrative expenses were $279,259 and $246,484 for the three-month periods, $610,220 and $710,901 for the nine-month periods ended September 30, 2010 and 2009, respectively.

7. INTANGIBLE ASSETS

	September 30, 2010		December 31, 2009
At cost
Intangible Assets	$	245,659	$	98,673
Less: Accumulated amortization		70,145		28,063
	$	175,514	$	70,610

17

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

8. LOANS

A. SHORT-TERM BANK LOANS

	September 30, 2010		December 31, 2009
The Royal Bank of Scotland N.V., (formerly ABN Amro N.V.) Overdraft in Current Account at interest rate at 6.5% per annum		1,652,691		4,906,266
The Royal Bank of Scotland N.V., (formerly ABN Amro N.V.) Temporary Loan for the drawing of performance and advance payment bonds at interest rate at Bank's Cost of Fund + 6%		4,544,688		4,546,504
Automobile capital lease obligation (hire purchase),amount due within one year, last installment due November 9, 2012		77,079		77,110
The Hongkong and Shanghai Banking Corporation Overdraft in Current Account at interest rate at 1.5% over 3 months SIBOR per annum		629,293		-
	$	6,903,751	$	9,529,880

B. LONG-TERM BANK LOANS

	September 30, 2010		December 31, 2009
Automobile capital lease obligation (hire purchase),amount due after one year, last installment due November 9, 2012		51,386		109,239
	$	51,386	$	109,239

18

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

9. CONVERTIBLE BONDS AND BOND WARRANTS

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

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

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

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

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

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

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

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

The Convertible Bonds Payable, net consists of the following:

	September 30, 2010			December 31, 2009
Convertible Bonds Payable	$	28,000,000		$	28,000,000
Less: Interest discount – Warrants		(3,305,938	)		(3,305,938	)
Less: Interest discount – Beneficial conversion feature		(1,882,404	)		(1,882,404	)
Less: Bond discount		(760,069	)		(760,069	)
Accretion of interest discount		5,637,367			2,512,572
Net	$	27,688,956		$	24,564,161

Waiver of Conversion Price Adjustment on Convertible Bonds

On July 13, 2010, the Company and the holders of the Company’s outstanding Variable Rate Convertible Bonds due 2012 (the “2007 Bonds”), 12% Convertible Bonds due 2011 (the “2008 Bonds,” and collectively with the 2007 Bonds, the “Bonds”) and warrants to purchase 300,000 shares of common stock of the Company expiring 2013 (the “2008 Warrants”) entered a new Waiver Agreement (the “Waiver”) , which has a three month term subject to the terms and conditions contained therein. Pursuant to Waiver, the bondholders and warrantholder agreed to waive their right to a reduction in the conversion price of the Bonds and exercise price of the 2008 Warrants due to the Company’s proposed sale of the shares pursuant to the Purchase Agreement at a price per share less than the current conversion prices of the Bonds and exercise price of the 2008 Warrants.

19

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

The waivers contained in the Waiver Agreement are subject to numerous conditions.  Under the Waiver Agreement, the Company agreed to pay the Bondholders the interest on the Bonds in the amount of approximately $3.84 million on scheduled dates, of which the Company made a payment of approximately $1.26 million on March 31, 2010 and $1.32 million on April 15, 2010. Under the terms of the waiver, the Company agreed that the Company would pay to the bondholders all outstanding interests in arrears on the Bonds, plus all other applicable interest up until the payment date, within 30 days after the closing of the issuance of the shares to acquired ConnGame, but which in any event, would not be later than September 30, 2010.

The Company also agreed to repay an overdraft facility in the amount of approximately $4.91 million on three scheduled dates.  The Company made payment of approximately one-half of this amount and agreed to pay all unsettled amounts, which include all outstanding principal and interest amounts, within 30 days after the closing of the issuance of the Shares, but which in any event, would not be later than September 30, 2010.

The Company also agreed that the Company will not repay or prepay any debt prior to its currently scheduled due date until the Company make all of the payments specified in the Waiver and the Bonds have been redeemed in full and that any new indebtedness incurred by us for the purpose of repaying the overdraft facility shall (i) not exceed the outstanding amount due and payable under the overdraft facility and (ii) be subordinated to all amount owed under the Bonds (the “Waiver Covenants”).

As of September 30, 2010, the Company did not pay fully make the payments scheduled under the waivers and was negotiating with the Bondholders for extension of the date of the scheduled payments.  The Company was communicating with the Bondholders for the extension for the payment and adjustment of the conversion price under the terms of the Waiver Agreement. By the date of this report, the Bondholders did not make the request of payment and adjustment of the conversion price.

If the Company is unable to successfully to obtain an extension for the payment dates, then all rights of the holders of the Bonds and 2008 Warrants waived under the Waiver to or to be waived under the Waiver, shall not be waived and will be reinstated, and any previous waivers will be null and void.  In such case, appropriate adjustments will be made to the conversion prices of the Bonds and the exercise price of the 2008 Warrants and an event of default under the terms and conditions of the trust deed governing the 2008 Bonds shall exist, making the 2008 Bonds immediately due and payable.

Since the Company was unable to comply with the payment terms of the Waiver and unless the Company is able to successfully negotiate an extension of the scheduled payment dates, the issuance of the Shares could result in an adjustment of the conversion price of the Bonds and the 2008 Warrants pursuant to the governing Trust Deeds and warrant agreement, respectively, which could result in substantial dilution to the Company's shareholders. The 2007 Bonds are currently convertible at a per share price of $2.45 per share and the 2008 Bonds and 2008 Warrants are convertible and exercisable, respectively, at $6.35 per share.  If the Company is not able to obtain an extension for payment under the terms of the Waiver Agreement, an adjustment to the conversion and exercise prices could be adjustable downward to the value of the assets that the Company received for the issuance of the Shares, as calculated in accordance with the provisions of the Trust Deeds and the warrant agreement.

20

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

10. CONTRACT REVENUES EARNED

The contract revenues earned for the three-month and nine-month periods ended September 30, 2010 and 2009 consist of the following:

	Three Months Ended  September 30,				Nine Months Ended  September 30,
	2010		2009		2010		2009
Billed	$	1,506,302	$	16,670,961	$	17,919,264	$	60,073,588
Unbilled		2,936,193		8,887,113		3,703,771		32,426,524
	$	4,442,495	$	25,558,074	$	21,623,035	$	92,500,112

The unbilled contract  revenue  earned  represents  those  revenue  that  should  be  recognized according to the percentage of completion method for accounting for construction contract because the Company is entitled to receive payment from the customers for the amount of work that has been  rendered to and  completed  for  that  customer according  to  the  terms  and  progress  being made as stipulated under that contract between the Company and that customer. As an industrial practice, there are certain procedures that need to be performed, such as project account finalization, by both the customer and the Company before the final billing is issued; however this does not affect the Company’s  recognition of revenue and respective cost according to the terms of the contract with the consistent application of the percentage-of-completion method.

11. INCOME TAXES

On October 17, 2006, income from the Company’s foreign subsidiaries became subject to U.S. income tax liability; however, this tax is deferred until foreign source income is repatriated to the Company, which has not yet occurred.

The Company has also retained an U.S. tax-preparer firm to aide in preparation of its U.S. income tax returns in order to maintain a high level of compliance with U.S. tax laws.

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

Income before taxes and the provision for taxes for the periods ended September 30, 2010 and 2009 consists of the following:

	September 30,
	2010			2009
Continuing income/(Loss) before taxes:
U.S.	$	(9,739,149	)	$	(6,524,776	)
Singapore		(8,055	)		705,472
China		(8,516,335	)		(2,203,355	)
Australia		(10,185	)		(13,578	)
Hong Kong		2,680,316			(3,924,345	)
Dubai		9,633			9,032,158
Macau		(2,278	)		(58,102	)
Total continuing income before taxes		(15,586,053	)		(2,986,526	)
Provision for taxes expense/(benefit):
Current:
U.S. Federal		-			-
U.S. State		9,575			-
					-
Deferred:
U.S. Federal		-
Hong Kong		-			-
Currency Effect					-
Total provision for taxes		9,575
Effective tax rate		-0.06	%		0.00	%

21

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Significant components of our deferred tax assets and liabilities at September 30, 2010 and December 31, 2009 are as follows:

	September 30, 2010		December 31, 2009
Deferred tax assets
Net operating loss	$	112,988	$	113,033
		112,988		113,033
Valuation allowance		-		-
Total deferred tax assets		112,988		113,033
Deferred tax liabilities
Total deferred tax liabilities		-		-
Net deferred tax assets		112,988		113,033
Reported as:
Current deferred tax assets		112,988		113,033
Non-current deferred tax assets		-		-
Non-current deferred tax liabilities		-		-
Net deferred taxes	$	112,988	$	113,033

Current deferred tax assets represents net operating loss of a subsidiary Techwell Engineering Limited in Hong Kong. The losses can be carried forward to set-off future assessable profits in Hong Kong without expiry date. The differences between the U.S. federal statutory income tax rates and the Company’s effective tax rate for the periods ended September 30, 2010 and 2009 is shown in the following table:

22

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

	2010			2009
U.S. federal statutory income tax rate		34.00	%		34.00	%
Lower rates in PRC, net		-9.00	%		-9.00	%
Accruals in foreign jurisdictions		-0.06	%		-0.00	%
Tax Holiday		-25.00	%		-25.00	%
		-0.06	%		0.00	%

The following table accounts for the differences between the actual tax provision and the amounts obtained by applying the relevant applicable corporation income tax (see tax rates discussed above) before tax for the periods ended September 30, 2010 and 2009:-

	2010			2009
Income/(loss) before tax		(15,586,053	)		(4,816,497	)
Taxes at the applicable income tax rates		9,558			114,113
Miscellaneous non taxable income and non-deductible expenses		17			-
Current income tax expense	$	9,575		$	114,113

Effective January 1, 2008, the PRC government implemented a new 25% tax rate across the board for all enterprises regardless of whether domestic or foreign enterprise without any tax preferences which is defined as “two-year exemption followed by three-year half exemption” enjoyed by tax payers. As a result of the tax law, a standard 15% tax preference terminated as of December 31, 2007. The PRC government has established a set of transition rules to allow enterprises using tax preferences before January 1, 2008 to continue using the tax preferences on a transitional basis until being the new tax rates are fully implemented over a five year period.

12. COMMITMENTS AND CONTINGENCIES

(a) Operating lease commitments

The Company leases certain administrative and production facilities from third parties. Rental expenses were $144,602 and $800,981 for the three-month periods ended and $526,267 and $2,402,943 for the nine-month periods ended September 30, 2010 and 2009, respectively.

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

For the 12 months ending September 30,
2011		69,666
2012		-
2013		-
2014 or after		-
	$	69,666

23

CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

(b) Pending Litigation

Techwell litigation

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

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

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

The Company intends to vigorously defend this pending lawsuit; however, no assurance can be given that the lawsuit will be resolved in the Company’s favor. Even if the Company successfully defends the lawsuit, the Company may incur substantial costs defending or settling the lawsuit, in addition to a possible diversion of the time and attention of the Company’s management from its business. If the Company is unsuccessful in defending the lawsuit, it may be required to pay a significant amount of damages and/or it may potentially lose ownership of Techwell, which will have a material adverse effect on the Company’s business, financial condition or results of operations. In the last quarter of 2009, Mr. Ng made a settlement proposal to the Company for consideration and the Company is still under negotiation of the settlement agreement with Mr. Ng as of September 30, 2010.

Dubai Metro Rail Project Dispute

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

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CHINA ARCHITECTURAL ENGINEERING, INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Stated in US Dollars)

In July 2010, the Company met the master contractor and the master contractor agreed to arrange a further meeting to explore the possibility of settlement. No such meeting was arranged by date of this report.  The Company’s counsel in Dubai was preparing the legal documents for the claims as of September 30, 2010. On November 8, 2010 the Company issued a notice informing the master contractor that the Company would seek resolution through arbitration with 56 day waiting period for the master contractor to respond. The Company intends to commence arbitration proceedings after expiration of the 56 day waiting period in the event that no positive responses are received from the master contractor.

13. RELATED PARTY TRANSACTIONS

The account balance with shareholders at September 30, 2010 was payables of $9,098,900, while at December 31, 2009 it was $10,080,345. The payables balance was mainly loans from the two largest shareholders, with such loans being interest-free, fee-free and has no fixed repayment schedule.

During the nine months period ended September 30, 2010, the Company purchased construction materials amounting to $3.2 million from Guangdong Canbo Electrical Co., Ltd. (Canbo), a subsidiary of the Company’s major shareholder, KGE Group Limited. Canbo is a preferred supplier of the Company as it is able to procure materials at favorable price levels due to its purchased quantities. More important, application of certain of the Company’s patented technology is preferably routed through Canbo to prevent undesired distribution of this technology. As of September 30, 2010, the Company’s payable to Canbo was $0.4 million.

The transactions with related parties during the periods were carried out in the ordinary course of business and on normal commercial terms.

14. SUBSEQUENT EVENTS

On October 21, 2010, the Company’s Board of Directors approved and recommended that its stockholders approve an amendment to our Certificate of Incorporation (the “Amendment”), subject to stockholder approval (i) to effect a reverse stock split of all issued and outstanding shares of the Company’s common stock at an exchange ratio of not less than 1-for-2 and no more than 1-for-4 (the “Reverse Stock Split”) and (ii) following the reverse stock split, if implemented, to reduce the number of authorized shares of common stock from 150,000,000 to 100,000,000 at the discretion of the Board of Directors.  The Board of Directors has authorized the proposed Amendment to the Company’s Certificate of Incorporation, subject to the Board’s discretion after receipt of stockholder approval, to effect the Reverse Stock Split and to reduce the number of authorized shares of common stock.  The stockholder meeting is scheduled for December 7, 2010 (China time).  If approved by the stockholders and implemented by the Board, proportionate adjustments will be required to be made to the per share exercise price and the number of shares issuable upon the exercise or conversion of all outstanding options, warrants, convertible or exchangeable securities entitling the holders to purchase, exchange for, or convert into, shares of the Company's Common Stock.

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

Forward-Looking Statements

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this quarterly report and the audited consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our annual report on Form 10-K/A for the year ended December 31, 2009 filed with the Securities and Exchange Commission on June 2, 2010.

This quarterly report contains forward-looking statements that involve substantial risks and uncertainties.  The words “anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, difficulties related to integration and management of the combined operations of the Company of the company and ConnGame; entrance into the highly competitive MMORPG online game industry and difficulties in developing, testing and launching games; identification and remediation of the Company's deficiencies and weaknesses in its internal controls over financial reporting, potential claims or litigation that may result from the occurrence of restatements; ability to identify and secure debt, equity, and/or other financing required to continue the operations of the Company; ability to obtain an extension for the required Company payments under the waiver agreement and ability to maintain the conditions of the bondholder; difficulties in moving into the online gaming market; reduction or reversal of the Company's recorded revenue or profits due to "percentage of completion" method of accounting and expenses; increasing provisions for bad debt related to the Company's accounts receivable; fluctuation and unpredictability of costs related to our products and services; adverse capital and credit market conditions; fluctuation and unpredictability of costs related to the Company's products and services; expenses and costs associated with its convertible bonds, regulatory approval requirements and competitive conditions; and various other matters, many of which are beyond our control.  Actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated should one or more of these risks or uncertainties occur or if any of the risks or uncertainties described below in this report or in the “Risk Factors” section of our 2009 annual report occur.  Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and there can be no assurance of the actual results or developments.

Overview

We have traditionally specialized in high-end curtain wall systems (including glass, stone and metal curtain walls), roofing systems, steel construction systems, eco-energy saving building conservation systems and related products, for public works and commercial real estate projects.

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

The recent trends in the global economy have had a significant adverse impact on our results of operations and on the commercial construction industry as a whole. The competitive environment in which we operate has become more competitive, increasing the number of re-bid construction projects and amount of time between bidding and award of a project, reducing selling prices, and causing competitors to modify the scope and type of projects on which they bid.

International Projects

In 2008 we increased the number of international construction projects, but in 2009 the spread of the global recession and reduction in the nature and scope of international construction projects has led us to primarily focus our attention on domestic projects in China.  Dubai, Doha, Kuwait and other middle east region have been suffered a great impact markedly under the global financial crisis.  Our projects have significantly suffered as well.

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Beginning in 2009, we experienced a significant decrease in the project turnover and an increase in costs and delays in customer payments.  This negative trend has continued during the first nine months of 2010. As a result, our results of operations have suffered.

We have also experienced significant difficulties with respect to our Dubai and Project, as discussed below under, "Dubai Metro Rail Project".

We do not believe that the international economy will experience a swift recovery in the near future and therefore its negative impact on construction industry still exists and will exist in the near future.  As a result, we ended the orders of the construction of international projects in 2009, and shifted the focus of our business to design and professional consulting services.  To develop projects and generate revenue, we have sought to join new projects in the position of design and project consultant and the role of material supplier.

In the past, the number and size of our international projects had been increasing, but during 2009 our management has moved to refocus our resources to projects in the mainland China.  During the second quarter of 2009, we decided to terminate our work on the project in Singapore and stop the guarantee related to the project.

Domestic Projects

During 2009, we believe that the Chinese market has fared better than most of the international markets.  With the strength of our reputation and history of notable projects in China, we have been focusing our resources and efforts in our domestic market.   We believe that we have long-standing relationships with leading Chinese and international architects, having completed high profile projects in China.  During the year 2009, we commenced certain landmark projects in China, which consisted of the Changsha Train Station, Changsha Museum, Guangzhou Science Town, and projects in Jinan and Inner Mongolia. These projects are expected to be completed in 2010. Through the third quarter of 2010, we signed the contracts for the projects of Beijing Jiangtai Business Centre, Wuhan Xinhaigeming Museum and Liuzhou Nanning Gymnasium and Natatorium. The total contract value of these projects are estimated to be approximately $18.9 million. These projects are expected to be completed in either 2010 or 2011.

We were also awarded a new contract by the Overseas Chinese Town ("OCT") Group during the third quarter 2010 for their Joy Coast project, with a total value of approximately $3.2 million. The Joy Coast project is the first large-scale, high-end integrated urban ecotourism project in China. We are responsible for implementing their design and construction of the Innovation Exhibition Center, one of the regional landmarks within Joy Coast. The structure uses the highly advanced technique of space arbitrarily curved surfaces with stainless steel plates.

Operations after Acquisition of ConnGame

As noted below, we acquired a 60% equity interest in Shanghai ConnGame Network Ltd. (“ConnGame”) on August 18, 2010.  We believe that our acquisition of ConnGame will permit us to refocus our core capabilities and facilitate our planned transformation into a high-end architectural design consultant and service provider, as we intend to leverage ConnGame’s design engines and virtual applications to broaden our service capabilities and scope of architectural collaborations.

We intend to utilize ConnGame's technology and online platform to provide technical consulting and advisory services to architects, real estate developers and governments. We believe our acquisition of ConnGame will enable us to strengthen our core architectural engineering and design abilities. We believe that our planned focus on design and construction will permit us to reduce our exposure to unpredictable operational risks that relate to construction projects, in addition to providing us with the tools to strengthen our ability to complete projects within budget limitations. We also believe that our acquisition of ConnGame and its technologies will enable us to better evaluate estimated profitable of construction projects before we enter into contracts. We believe that our technology profile will be strengthened, particularly with ConnGame’s virtual and online and graphic technologies, and that the technology and capabilities will permit us to render more animated, detailed, and interactive designs that could assist us in attaining highly desirable projects from our bidding competitors.

We believe that our acquisition will also enable us to enter China's large online game market, with ConnGame’s two to-be-released MMORPG games.  We believe that the online game industry and its related business model will be a growing market in China.  We will seek to divide our business services into the following:

· Construction consulting—We intend to continue to conduct our construction consultancy services within China.

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· Construction  design services—We believe that we will be able to utilize the technical skills and expertise of ConnGame to provide unique consulting services for the design and fabrication projects globally, with such services to include real-time and interactive capabilities.

· Online Games—ConnGame expects to launch its first game “The Warring State” in Q1 2011 and its second game “Revolution” in Q3 2011, subject to successful testing. “The Warring State” has undergone its fourth closed beta testing in early November 2010 with satisfactory results.

· Network Gaming and Home Decoration—We intend to develop a platform to provide services on home decoration through an interactive style, develop online games to provide to architects, other professionals, and individual consumers the ability to design and interact with other users.

ConnGame

Overview

ConnGame, a company formed under the laws of the People’s Republic of China, develops MMORPG (Massively Multiplayer Online Role Playing Game) for operation in China.  While utilizing its game engines, scalable development platforms, and production teams, ConnGame focuses on self-developed MMORPGs game titles that are based on China's iconic characters and nostalgic epochs.

ConnGame owns two self-developed game engines, "Turbo" and "Apocalypse".  ConnGame's online game-engines were created and developed independently by its research and development team.  Apocalypse provides a solution for development of MMORPG games and can be applied to game content development and enhancement of the standardization process.  The Turbo engine tool set is designed to facilitate the development of three dimensional MMORPG games, in conjunction with development of online role-playing games.  Turbo encompasses all parts of the client programming, including management of server and client-side resources.

Warring State Online is developed based on the Turbo engine.  We completed numerous closed beta tests for our first planned MMORPG game entitled "Warring State", a realistic MMORPG based on China's iconic characters and nostalgic epochs, featuring recreations of historically popular heroes and warlords set in dramatic backdrops and varied according to the four seasons. ConnGame conducted the fourth closed beta testing of Warring State in November 2010. During testing, thousands of players explored the game for three days to test their experience and performance of the game. The beta testing was viewed by our management as successful and management expects that, after one to two additional closed beta testing, "Warring State Online" could be launched to the marketing. It is anticipated that the open beta would occur in the first quarter of 2011.

During the third quarter of 2010, ConnGame completed a contract with the China Ministry of Public Security for development of a Safe Driving Game project based on its proprietary "Apocalypse" game engine. The Company has recognized revenues of approximately $0.2 million from this project during the period.

ConnGame is a start-up, development-stage company and has not yet generated or realized material revenues from its business operations.  We expect to incur significant expenses from ConnGame's operations primarily due to its continued research and development activities, the operations and marketing of its products.  Operations expenses related to ConnGame's operations for the nine months ended September 30, 2010 totaled approximately $2.8  million, with a substantial majority of this amount relating to research and development expenses.  ConnGame anticipates that during the next 12 months, it will incur additional expenses towards the operations and marketing of the products.

ConnGame anticipates that initial revenue, if any, from its MMORPG games will likely be generated through subscription fees paid by players of its MMORPG games and software licensing to third-party companies.  The revenue model of ConnGame’s MMORPG business is based on the item-based revenue model, meaning game players can play our games for free, but may choose to pay for virtual items, which are non-physical items that game players can purchase and use within an MMORPG.  Such items include gems, pets, fashion items, magic medicine, riding animals, hierograms, skill books and fireworks, all designed to enhance the game-playing experience. ConnGame intends to sell prepaid game cards to a range of regional distributors throughout China, who in turn sub-distribute them to numerous retail outlets, including Internet cafés and various Websites, newsstands, software stores, book stores and retail stores. ConnGame also intends to directly sell game points to players through our online sales platform. ConnGame’s ability to generate revenue and attain profitability depends upon its ability to develop quality products and the acceptance and popularity of its products by the end consumer.

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ConnGame plans to continue to improve its product quality through a various testing series to attain player feedback. If feedback of players indicates consumer desire for further improvement to game content and quality, it will take additional development efforts and the cost of research and development will increase, in addition to lengthening the time for ConnGame to generate revenue.

Acquisition of 60% Interest in ConnGame

In December 2009, we and First Jet Investments Limited (“First Jet”) entered into a letter of intent for the acquisition (“Letter of Intent”) that set forth the principal terms under which we would issue up to 25,000,000 shares of our common stock to First Jet to acquire 60% of the equity interest of ConnGame.  In January 2010, our board of directors and stockholders approved our acquisition of a 60% equity interest in ConnGame. On August 11, 2010, we entered into a stock purchase agreement (“Agreement”) with First Jet, New Crown Technology Limited, a wholly owned subsidiary of First Jet and the holder of 100% of the equity interests of ConnGame (“New Crown”), and Mr. Jun Tang, the principal of First Jet and New Crown.  Pursuant to the Agreement, we agreed to issue First Jet 25,000,000 shares of our common stock, $0.001 par value per share, in exchange for 60% of the equity interest of New Crown on the date of closing of the acquisition. The acquisition was completed on August 18, 2010.

Effective upon the closing of the acquisition, our Board of Directors appointed Mr. Jun Tang as a member and Chairman of the Board of Directors.   Immediately prior to the effective time of Mr. Jun Tang’s appointment, Luo Ken Yi resigned as the Chairman of the Board of Directors but remains as a member of the Board.  In addition, Mr. Tang Nianzhong resigned as a member of the Board of Directors to ensure that our company has a majority of independent directors on the Board in compliance with Nasdaq continued listing standards. In addition, on September 12, 2010, in relation to the acquisition of ConnGame, the following resignations and appointments occurred:

· Luo Ken Yi resigned as the Chief Executive Officer and Mr. Luo maintained his position as President of the Company and a member of the Board of Directors of the Company (the “Board”),

· Gene Michael Bennett resigned as the Company’s Chief Financial Officer,

· Zheng Jin Feng and Zhao Bao Jiang each resigned as a director,

· Wing Lun (Alan) Leung was appointed as the Chief Executive Officer and a director of the Company,

· Qin (Andy) Lu was appointed as the Acting Chief Financial Officer and Corporate Secretary,

· Ping Xu was appointed as an independent director and as a member of the Audit Committee and Nominating and Corporate Governance Committee, and

· Shibin Jo was appointed as an independent director and as a member of the Compensation committee and a member and chairman of the Nominating and Corporate Governance Committee, and

· Chen Huang was appointed as an independent director and as a member of the Audit Committee.

In connection with Mr. Leung’s appointment as Chief Executive Officer, we and Mr. Leung entered into a three-year employment agreement pursuant to which Mr. Leung will receive an annual base salary of $150,000.

Wavier Agreement

On February 24, 2010, we entered into an Amendment and Waiver Agreement (the “Waiver Agreement”) with the holders of our outstanding Variable Rate Convertible Bonds due 2012 (the “2007 Bonds”) and 12% Convertible Bonds due 2011 (the “2008 Bonds,” and collectively with the 2007 Bonds, the “Bonds”) and warrants to purchase 300,000 shares of our common stock expiring 2013 (the “2008 Warrants”).  Pursuant to the Waiver Agreement, the holders of the Bonds and the 2008 Warrants agreed to waive their right to a reduction in the conversion price of the Bonds and the exercise price of the 2008 Warrants upon our anticipated issuance of up to 25,000,000 shares for the acquisition of a 60% ownership interest in ConnGame.  Additionally, the holders of the 2008 Bonds agreed to waive any default under the terms and conditions of the trust deed governing the 2008 Bonds relating to the requirement that KGE Group Limited, our largest shareholder, own at least 45% of our issued and outstanding common stock.  The waiver had a term of three months and expired on May 24, 2010.  The parties entered into a new waiver on July 13, 2010, which has a three month term subject to the terms and conditions contained therein.  As indicated above, we closed the ConnGame acquisition during the three-month period.

The waivers contained in the Waiver Agreement are subject to numerous conditions.

· Under the Waiver Agreement, we agreed to pay the Bondholders the interest on the Bonds in the amount of approximately $3.84 million on scheduled dates, of which we made a payment of approximately $1.26 million on March 31, 2010 and $1.32 million on April 15, 2010.  Under the terms of the waiver, we agreed that we would pay to the bondholders all outstanding interests in arrears on the Bonds, plus all other applicable interest up until the payment date, within 30 days after the closing of the issuance of the shares to acquire ConnGame, but which in any event, would not be later than September 30, 2010.

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· We also agreed to repay an overdraft facility in the amount of approximately $4.91 million on three scheduled dates.  We made payment of approximately one-half of this amount and agreed to pay all unsettled amounts, which include all outstanding principal and interest amounts, within 30 days after the closing of the issuance of the Shares, but which in any event, would not be later than September 30, 2010.

· We also agreed that we will not repay or prepay any debt prior to its currently scheduled due date until we make all of the payments specified in the Waiver and the Bonds have been redeemed in full and that any new indebtedness incurred by us for the purpose of repaying the overdraft facility shall (i) not exceed the outstanding amount due and payable under the overdraft facility and (ii) be subordinated to all amount owed under the Bonds (the “Waiver Covenants”).

As of September 30, 2010, we did not pay fully make the payments required under the Waiver and we were negotiating with the Bondholders for extension of the scheduled payments dates.

If we are unable to successfully to obtain an extension for the payment dates, then all rights of the holders of the Bonds and 2008 Warrants waived under the Waiver to or to be waived under the Waiver, shall not be waived and will be reinstated, and any previous waivers will be null and void.  In such case, appropriate adjustments will be made to the conversion prices of the Bonds and the exercise price of the 2008 Warrants and an event of default under the terms and conditions of the trust deed governing the 2008 Bonds shall exist, making the 2008 Bonds immediately due and payable.

Since we were unable to comply with the payment terms of the Waiver and unless we are able to successfully negotiate an extension of the scheduled payment dates, the issuance of the Shares could result in an adjustment of the conversion price of the Bonds and the 2008 Warrants pursuant to the governing Trust Deeds and warrant agreement, respectively, which could result in substantial dilution to our shareholders.  The 2007 Bonds are currently convertible at a per share price of $2.45 per share and the 2008 Bonds and 2008 Warrants are convertible and exercisable, respectively, at $6.35 per share.  If we are not able to obtain an extension for payment under the terms of the Waiver Agreement, an adjustment to the conversion and exercise prices could be adjustable downward to the value of the assets that we received for the issuance of the Shares, as calculated in accordance with the provisions of the Trust Deeds and the warrant agreement.

Dubai Metro Rail Project Dispute

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

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

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

One of the primarily reasons that the aging of Company’s contract receivables have increased is the delay in payment by client of the Dubai projects since April 2009.  The underlying receivable as of September 30, 2010 from the Dubai projects was approximately $42.1 million, which represented 47% of the total contract receivables as of such date. The Company has employed a claim consultant, Hill International, to facilitate the Company’s claim for the back payment.  The Company currently expects that there will be progress and payments will be received as early as the fourth quarter of 2010.  However, due to the ongoing dispute, there is no guarantee that the Company will collect all or a portion of the contract receivable.  For receivables related to the Dubai Project, the client delayed payment to us since April 2009 by refusing to issue the Certificates for Value of Work Done.  No Certificates have been issued since April 2009.  The Certificates are pre-requisites to proceed with payment to the Company. The client paid for all work for Certificates for Value of Work Done issued in or before April 2009.  Such payments were made prior to December 31, 2009.  As a result, no account receivables at September 30, 2010 represent work for the above-referenced Certificates issued in or before April 2009. The receivables as of September 30, 2010 were recognized in accordance with the Percentage of Completion Method and based on the claim consultant’s report on the estimated final value of work done that the Company completed as of September 30, 2010.

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

In July 2010, the Company met the master contractor and the master contractor agreed to arrange a further meeting to explore the possibility of settlement. No such meeting was arranged by date of this report.  The Company’s counsel in Dubai was preparing the legal documents for the claims as of September 30, 2010. On November 8, 2010 the Company issued a notice informing the master contractor that the Company would seek resolution through arbitration with 56 day waiting period for the master contractor to respond. The Company intends to commence arbitration proceedings after expiration of the 56 day waiting period in the event that no positive responses are received from the master contractor.

Techwell Litigation

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

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

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

As of the date of this report, the Company, Mr. Ng, and Miss Yam, after several counter proposals among the parties, are still in discussions and negotiations to settle all disputes. However, there is no guarantee that the parties will reach an agreement to settle the dispute, in which case the Company intends to vigorously defend itself against the lawsuit.  There can be no assurance that the lawsuit will be resolved in the Company’s favor.  Even if the Company successfully defends the lawsuit, the Company may incur substantial costs defending or settling the lawsuit, in addition to a possible diversion of the time and attention of the Company’s management away from its business.  If the Company is unsuccessful in defending the lawsuit, its may be required to pay a significant amount of damages and/or it may potentially lose ownership of Techwell, which will have a material adverse effect on the Company’s business, financial condition or results of operations.  In the event we lose ownership of Techwell, we will lose the approximately $20.3 million of profit contribution since the acquisition of Techwell.

In the last quarter of 2009, Mr. Ng made a settlement proposal to the Company for consideration and the Company is still under negotiation of the settlement agreement with Mr. Ng as of September 30, 2010.

Proposed Reverse Stock Split and Decrease of Authorized Shares

On October 21, 2010, our Board of Directors approved and recommended that our stockholders approve an amendment to our Certificate of Incorporation (the “Amendment”), subject to stockholder approval (i) to effect a reverse stock split of all issued and outstanding shares of our common stock at an exchange ratio of not less than 1-for-2 and no more than 1-for-4 (the “Reverse Stock Split”) and (ii) following the reverse stock split, if implemented, to reduce the number of authorized shares of common stock from 150,000,000 to 100,000,000 at the discretion of the Board of Directors.  The Board of Directors has authorized the proposed Amendment to our Certificate of Incorporation, subject to the Board’s discretion after receipt of stockholder approval, to effect the Reverse Stock Split and to reduce the number of authorized shares of common stock.  The stockholder meeting is scheduled for December 7, 2010 (China time).  If approved by our stockholders and implemented by the Board, proportionate adjustments will be required to be made to the per share exercise price and the number of shares issuable upon the exercise or conversion of all outstanding options, warrants, convertible or exchangeable securities entitling the holders to purchase, exchange for, or convert into, shares of our Common Stock.

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Results of Operations

The following table sets forth statements of operations for the three and nine months ended September 30, 2010 and 2009 in U.S. dollars (unaudited):

	For Three Months Ended September 30,						For Nine Months Ended September 30,
	2010			2009			2010			2009
	(in thousands, except for share and per share amounts)
Contract revenues earned
	$	4,442		$	25,558		$	21,623		$	92,500
Cost of contract revenues earned		(5,452	)		(25,083	)		(20,735	)		(73,892	)
Gross profit / (loss)	$	(1,010	)	$	475		$	888		$	18,608
Selling, general and administrative expenses		(5,610	)		(5,549	)		(11,678	)		(17,620	)
Income / (loss) from operations	$	(6,620	)	$	5,074		$	(10,790	)	$	988
Interest income		4			5			9			55
Interest expenses		(1,779	)		(1,741	)		(5,273	)		(4,525	)
Other expenses		(351	)		-			(360	)		-
Other income		4			335			828			496
Loss before taxation on continuing operations	$	(8,742	)	$	(6,475	)	$	(15,586	)	$	(2,986	)
Income tax		-			(114	)		(9	)		(114	)
Discontinued operation loss, net of tax		-			1,830			-			1,830
Net loss including non-controlling interests		(8,742	)		(8,419	)		(15,595	)		(4,930	)
Loss attributable to non-controlling interests		256			38			259			36
Net loss attributable to the Company	$	(8,486	)	$	(8,381	)	$	(15,336	)	$	(4,894	)
Loss per share:
Basic	$	(0.13	)	$	(0.16	)	$	(0.26	)	$	(0.09	)
Diluted	$	(0.13	)	$	(0.16	)	$	(0.26	)	$	(0.09	)
Weighted average shares outstanding:
Basic		66,970,061			53,256,874			58,969,374			53,256,874
Diluted		66,970,061			53,256,874			58,969,374			53,256,874

Three Months Ended September 30, 2010 and 2009

Contract revenues earned for the three months ended September 30, 2010 were $4.4 million, a decrease of $21.2 million, or 83 %, from the contract revenues earned of $25.6 million for the comparable period in 2009. The primary reasons for the decrease in contract revenues earned was due to the decline in the global economy and construction industry and the resulting negative effects on our business operations, in addition to few new projects for our company in 2010 after our completion of international projects in 2009 such as the Dubai Metro Red Line and Doha High Rise Office Tower.  We believe our cessation of international projects contributed significantly to the decline in our revenue, as approximately 61% of our annual revenue came from international projects in 2009, while only 3 % of our annual revenue came from international projects in the first three quarters of 2010.  Of our total contract revenues earned, approximately $0.2 million was generated from operations through ConnGame.

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Cost of contract revenues earned for the three months ended September 30, 2010 was $5.5 million, a decrease of $19.6 million, or 78%, from $25.1 million for the comparable period in 2009. Cost of contract revenues earned consists of the raw materials, labor and other operating costs related to manufacturing.  The decrease in costs of contract revenues earned was primarily due to a reduction in the number of projects and thus, a decrease in the revenues earned, as stated above.  Provisions for estimated losses on uncompleted contracts are charged to cost of contract revenues earned in the period in which such losses are determined.  Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues when their realization is reasonably assured. An amount equal to contract costs attributable to claims is included in revenues when realization is probable and the amount can be reliably estimated. Cost of revenues related to our MMORPG gaming operations were approximately $0.5 million since acquisition.

Gross loss for the three months ended September 30, 2010 was $1.0 million, a decrease in profit of $1.5 million, or 300 %, from $0.5 million for the comparable period of 2009. Our gross margin for the three months ended September 30, 2010 was -23 % as compared with 2% for the three months ended September 30, 2009. The decrease in gross margin was primarily a result of increases in raw material, labor and administrative costs in our domestic market of China including effects of recent RMB appreciation, as well as adjustments made in accordance to the percentage-completion method for accounting of projects revenue. Such adjustments were made as a result of increases in the projects’ estimated costs, which reduced the projects’ estimated profits and the revenues.

Selling, general and administrative expenses were $5.6 million for the three months ended September 30, 2010, a decrease of approximately $0.1 million, or 2 %, from approximately $5.5 million for the comparable period in 2009. The change was due to combination of the decrease was due to decrease in revenue earned and the $3.2 million bad debts expenses for PRC projects.  Among the selling, general and administrative expenses and after the bad debts expenses, payroll and social securities was the second largest expenditure of the group, which accounted for approximately 33 % of the expense. Other major expenses included rental expenses 3% and depreciation expenses 5%.

Interest expenses and finance expenses were $1.8 million for the three months ended September 30, 2010, an increase of $0.1 million, from approximately $1.7 million for the comparable period in 2009. The expenses mainly represented interests on the convertible bonds. The increase was primarily due to the additional interest expense related to borrowing by short-term bank loans.

Income tax expenses were both $nil for the three months ended September 30, 2010 as compared to $114,000 for the comparable period of 2009.  The primary reason was losses incurred by the operations of the Company as still suffering from the effects of the recent international financial crises.

Net loss for the three months ended September 30, 2010 was $8.7 million, an increase in income of $0.3 million, or 4%, from net loss of $8.4 million for the comparable period in 2009 mainly due to the decrease in contract revenues earned.

Nine months Ended September 30, 2010 and 2009

Contract revenues earned for the nine months ended September 30, 2010 were $21.6 million, a decrease of $70.9 million, or 77 %, from the contract revenues earned of $92.5 million for the comparable period in 2009. The primary reasons for the decrease in contract revenues earned are the same as those stated for the decrease in revenues in the three months ended September 30, 2010. Of our total contract revenues earned, approximately $0.2 million was generated from operations through ConnGame.

Cost of contract revenues earned for the nine months ended September 30, 2010 was $20.8 million, a decrease of $53.1 million, or 72 %, from $73.9 million for the comparable period in 2009. Cost of contract revenues earned consists of the raw materials, labor and other operating costs related to manufacturing. The decrease in costs of contract revenues earned was primarily due to a reduction in the number of projects and thus, a decrease in the revenues earned. Cost of revenues related to our MMORPG gaming operations were approximately $0.5 million since acquisition

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

Gross profit for the nine months ended September 30, 2010 was $0.9 million, a decrease of $17.7 million, or 95 %, from $18.6 million for the comparable period of 2009. Our gross margin for the nine months ended September 30, 2010 was 4% as compared with 20% for the nine months ended September 30, 2009. The decrease in gross margin was primarily a result of increases in raw material, labor and administrative costs in our domestic market of China including effects of recent RMB appreciation as well as the adjustments in accordance to the percentage-completion method for accounting of projects revenue. Such adjustments were made as a result of increases in the projects’ estimated costs, which reduced the projects’ estimated profits and the revenues.

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Selling, general and administrative expenses were $11.7 million for the nine months ended September 30, 2010, a decrease of approximately $6.0  million, or 34 %, from approximately $17.6 million for the comparable period in 2009. The decrease was due to decrease in revenue in earned.  Among the selling, general and administrative expenses which included $2.0 million stock compensation granted and $3.4 million bad debts expenses, payroll and social securities was the largest expenditure of the group, which accounted for approximately 64 % of the expenses during the first nine months of 2010. Other major expenses included rental expenses 5% and depreciation expenses 5%.

Interest expenses and finance expenses were $5.3 million for the nine months ended September 30, 2010, an increase of $0.8 million, from approximately $4.5 million for the comparable period in 2009.  The increase was primarily due to the additional interest expense in the first nine months of 2010 related to borrowing by short-term bank loans.

Income tax expenses were $9,575 for the nine months ended September 30, 2010 at an effective tax rate of -0.06%, compared with $114,000 in taxes for the same period of 2009 at an effective tax rate of -3.8%.  The primary reason was losses incurred by the operations of the Company as still suffering from the effects of the recent international financial crises.

Net loss for the nine months ended September 30, 2010 was $15.6 million, a increase in income of $10.7 million, or 218%, from net loss of  $4.9 million for the comparable period in 2009.

Liquidity and Capital Resources

At September 30, 2010, we had cash and cash equivalents of $3.0 million.

Prior to October 17, 2006, we financed our business operations through short-term bank loans, cash provided by operations, and credit provided by suppliers. On October 17, 2006, concurrently with the close of our Share Exchange, we received gross proceeds of $3.7 million in a private placement transaction.   In October 2007, we completed an initial public offering consisting of 847,550 shares of our common stock. Our sale of common stock, which was sold indirectly by us to the public at a price of $3.50 per share, resulted in net proceeds of approximately $2.0 million.

We have also financed our operations through the issuance of convertible bonds.  On April 12, 2007, we completed a financing transaction pursuant to which we issued the 2007 Bonds in the principal amount of $10 million. The 2007 Bonds bear cash interest at the rate of 6% per annum for the first year after April 12, 2007 and 3% per annum thereafter, of the principal amount of the 2007 Bonds. Each 2007 Bond is convertible at an initial conversion price of $3.50 per share.  At any time after April 12, 2010, holders of the 2007 Bonds can require us to redeem the 2007 Bonds at 126.51% of the principal amount. We are required to redeem any outstanding 2007 Bonds at 150.87% of its principal amount on April 4, 2012.  In September 2008, $2 million worth of bonds were converted into shares of common stock pursuant to which we issued 571,428 shares of common stock.

On April 15, 2008, we completed a financing transaction pursuant to which we issued the 2008 Bonds in the principal amount of $20 million. The 2008 Bonds bear cash interest at the rate of 12% per annum. Interest is payable semi-annually in arrears on April 15 and October 15 of each year (each an “Interest Payment Date”). On any Interest Payment Date on or after April 15, 2010, the holders of the Bonds can require us to redeem the Bonds at 116.61% of the principal amount. We are required to redeem any outstanding Bonds at 116.61% of its principal amount on April 15, 2011.

On July 13, 2010, we entered into the Waiver Agreement with the holders of our 2007 Bonds and 2008 Bonds and 2008 Warrants.  Under the Waiver Agreement, we agreed to pay the Bondholders the interest on the Bonds in the amount of approximately $3.84 million on scheduled dates, of which we made a payment of approximately $1.26 million on March 31, 2010 and $1.32 million on April 15, 2010.  Under the terms of the waiver, we agreed that we would pay to the bondholders all outstanding interests in arrears on the Bonds, plus all other applicable interest up until the payment date, within 30 days after the closing of the issuance of the shares to acquire ConnGame, but which in any event, would not be later than September 30, 2010. We also agreed to repay an overdraft facility in the amount of approximately $4.91 million on three scheduled dates.  We made payment of approximately one-half of this amount and agreed to pay all unsettled amounts, which include all outstanding principal and interest amounts, within 30 days after the closing of the issuance of the Shares, but which in any event, would not be later than September 30, 2010. We also agreed that we will not repay or prepay any debt prior to its currently scheduled due date until we make all of the payments specified in the Waiver and the Bonds have been redeemed in full and that any new indebtedness incurred by us for the purpose of repaying the overdraft facility shall (i) not exceed the outstanding amount due and payable under the overdraft facility and (ii) be subordinated to all amount owed under the Bonds.  The closing of the ConnGame acquisition was not completed on August 18, 2010.

As of September 30, 2010, the Company did not pay make the required payments scheduled under the waivers and was negotiating with the Bondholders for extension of the date of the scheduled payments. If we are required to repurchase all or a portion of the outstanding amount of $28.0 million in bonds and we do not have sufficient cash to make the repurchase, we will be required to obtain third party financing to do so, and there can be no assurances that we will be able to secure financing in a timely manner and on favorable terms, which could have a material adverse effect on our financial performance, results of operations and stock price.

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Full Art International Limited incurred an automobile capital lease obligation due November 9, 2012 that had an outstanding amount of $128,465 as of September 30, 2010.

On February 19, 2008, we and Techwell Engineering Limited were granted a bond facility by the Hong Kong Branch of ABN AMRO Bank N.V. The facility amount was $10,000,000, at a tenor of up to one year with 2% flat interest rate on the issued amount of bonds such as bank guarantees, performance bonds, advanced payment bonds and standby letters of credit. ABN AMRO required guarantees as follows: (i) an irrevocable and unconditional guarantee executed by Zhuhai King Glass Engineering Co. Limited and (ii) share charge over the shares of us for a minimum value of $5,000,000 or equivalent, executed by KGE Group Limited. On May 2, 2008, the facility was increased to $12,000,000 with additional cash collateral of $2,000,000, which is also the total amount of cash collateral for the facility. All cash collateral was then fully used to off-set a portion of the calling of the bonds for projects in Dubai by the beneficiary. As of September 30, 2010, the facility was converted into the temporary loan of $4,544,688 resulted from the calling of performance and advance payment bonds at interest rate at Bank's Cost of Fund + 6%.

On March 28, 2008, we, Full Art and Techwell Engineering Limited were granted a bonding facility by the Hong Kong Branch of HSBC. The facility amount was $10,000,000, at a tenor of up to one year with 1% flat interest rate on the issued amount of bonds such as bank guarantees, performance bonds, advanced payment bonds and standby letters of credit. HSBC required guarantees as follows: (i) an unlimited guarantee among China Architectural Engineering, Inc., Full Art International Limited and Techwell Engineering Limited; and (ii) an “all monies” securities deposits with 15% margin. On August 18, 2008, the facility was increased to $20,000,000 with additional cash collateral of $1,500,000 that increased the total amount of cash collateral to $3,000,000. In September 2009, $2,818,440 of the cash collateral was used to off-set of the calling of the bonds for projects in Dubai by the beneficiary. As of September 30, 2010, the facility amount was reduced to $910,000 and was fully utilized.

On July 19, 2008, Zhuhai King Glass Engineering Co., Ltd. (“Zhuhai KGE”), our wholly-owned subsidiary was granted a Bank Accepted Draft facility by the Shenzhen Branch of ABN AMRO Bank N.V. The facility amount is RMB70,000,000 (US$10,218,978).  On September 30, 2009, the facility was amended to allow Open Account Financing – Accounts Receivable against invoices from acceptable buyers up to RMB21,000,000 and Open Account Financing and Overdraft in Current Account up to RMB16,800,000.  ABN AMRO requires irrevocable and unconditional guarantee from us and cash collateral of 20% of bank’s acceptance bill issued and Open Account Financing.  As of September 30, 2010, Zhuhai KGE utilized RMB nil (US$nil million) of Bank Accepted Draft and RMB16,094,080 (US$2,363,787) of Overdraft in Current Account.

In September 2009, the beneficiary of a performance bond and advance payment bonds for the projects in Dubai demanded the drawing of approximately $9.4 million in total from the two issuing banks, ABN AMRO Bank NV and HSBC. The calling of the bonds was based on the beneficiary’s belief that it had paid in excess of the construction work performed. We do not believe that the beneficiary had the proper basis for calling the bonds and intend to vigorously defend all of their rights and remedies related to the dispute. As of September 30, 2010, after an offset against collateral accounts that we held with the banks, there was approximately  $4.5 million in a shortfall amount due to ABN AMRO Bank NV by us that was not paid off.  Such amount is currently outstanding as the temporary loan from the bank at the interest rate at the bank’s cost of funds plus 6%.

Working capital management, including prompt and diligent billing and collection, is an important factor in our results of operations and liquidity. When we are awarded construction project, we work according to the percentage-of-completion method which matches the revenue streams with the relevant cost of construction based on the percentage-of-completion of project as determined based on certain criteria, such as, among other things, actual cost of raw material used compared to the total budgeted cost of raw material and work certified by customers. There is no guarantee that the cash inflow from these contracts is being accounted for in parallel with the cash outflow being incurred in the performance of such contract. In addition, a construction project is usually deemed to be completed once we prepare a final project account, the account is agreed upon by our customers, and all amounts related to the contract must be settled according to the account within three months to a year from the customer’s agreement on the final project account. As there may be different time intervals to reach a consensus on the amount as being accounted for in the projects before the project finalization account is being mutually agreed by each other. We experience an average accounts settlement period ranging from three months to as high as one year from the time we provide services to the time we receive payment from our customers. Below is a summary of typical steps in our processing of accounts:

· It takes approximately one month for our client to collect the payment application from contractors for the contract work completed.

· Thereafter, it takes approximately one to two months for the verification, agreement and certification of work completed, with timing to largely depend on whether there is disagreement in the calculation of certified value between the parties.

· Moreover, if it is the case that the application is to finalize the project account, it may take up to three months.

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· Additionally, in the event that the client is not the owner of the project, it normally requires an additional one to two months for processing and obtaining the funds from the owner.

· One to two months the client to pay the contractors.

In contrast to collection times, we typically need to place certain deposit with our suppliers on a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. We attempt to maintain a credit policy of receiving certain amounts of deposit from customers before we begin a new project.

We experienced revenue of $21.6 million for the nine months ended September 30, 2010 compared to revenue of $92.5 million for the same period in 2009. Construction contract related receivables, including contract receivables and costs and earnings in excess of billings as of September 30, 2010 were $87.9 million, a decrease of $20.8 million from construction related receivables of $108.7 million as of September 30, 2009. The decrease was a result of the reduction in projects revenue.

The collection period typically runs from two months to one year, the long aging of receivables reflects the long collection period.  In addition, our payment cycle is considerably shorter than our receivable cycle, since we typically pay our suppliers all or a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders.

Among the $87.4 million contract receivables as of September 30, 2010, $14.0 million (16.0%) was outstanding over 365 days and $13.6 million (15.6%) over 730 days, in total of $27.6 million which including $10.6 million (12.1%) million of retention money which would only be settled after the retention periods of two or three years. The Company periodically prepares the aging of the receivables information and reviews the balances with consideration of the background of each client for assessing the realizable value of the balances and would make provision when appropriate.  The Company notes that its account receivables that are 365 and 720 days old are primarily related to the Company’s PRC operations, and the payment cycle in the PRC commonly entails a receivable being outstanding for over one to two years before collection.  Such situations are particularly common in the construction market and with the clients from government. Since the Company’s older outstanding receivables are mainly of government projects, the final accounts and payments are required to be processed through a lengthy bureaucratic process in the PRC government.

Based on the foregoing, and despite the receivables being outstanding from 365 to 720 days, the Company considers them to be realizable because the Company believes that there is a remote chance that the PRC Government will go into bankruptcy or otherwise refuse to make payment on the receivables. In addition, the Company has the policy of conducting a comprehensive review the aging of account receivables on a regular basis every three months.  Furthermore, the Company has a designated staff member from one of its PRC subsidiaries to remain in constant communication with the Company’s various departments regarding PRC receivables collection status, and allowances for doubtful accounts is made, as necessary, based on the collection status updates. As of September 30, 2010, the contract receivables under aging of 121 to 365 days amounted to $55.1 (63 %) million including the receivables of the projects in Dubai which were recognized at the end of the year at $42.1 (48.2%) million.

We provide for bad debts principally based upon the aging of accounts receivable, in addition to collectability of specific customer accounts, our history of bad debts, and the general condition of the industry. We effected a direct write off of $7.1 million provisions to the account receivables during the nine months ended September 30, 2010.  We recorded additional provision for doubtful accounts of $3.4 million in the nine months ended September 30, 2010.  As of September 30, 2010, our provision for doubtful accounts was $2.9 million, which was 3.2% of our gross construction contract related receivables of $90.8 million. We believed our current reserve for doubtful accounts is commensurate to cover the associated credit risk in the portfolio of our construction contract related receivables.  Due to the difficulty in assessing future trends, we could be required to further increase our provisions for doubtful accounts.  As our accounts receivable age and become uncollectible our cash flow and results of operations are negatively impacted.

In addition to the foregoing, we had a provision for contracts receivables that was reclassified as “Other receivable” in the amount of approximately $9.9 million that represented account receivables of a subsidiary, Techwell Engineering Ltd. (Techwell).  The receivables were acquired through our acquisition of the Techwell in 2007 and have been outstanding since acquisition.   The receivables are guaranteed by previous shareholders of Techwell if not paid within 24 months of the acquisition.  Accordingly, the provision was made and the receivable amount was transferred to amount due from the shareholders under other receivable balances.

We have also funded our operations through loans made to us by our two largest shareholders. All of these loans are interest-free, fee-free and have no fixed repayment schedule. As of September 30, 2010, the balance of these loans was approximately $9.1 million, as compared to $10.1 million as of December 31, 2009.

At September 30, 2010, we had no material commitments for capital expenditures other than for those expenditures incurred in the ordinary course of business.

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Net cash provided by operating activities for the nine months ended September 30, 2010 was approximately $5.6 million, as compared to $11.2 million net cash used in the same period in 2009. The change was primarily due to differences in changes in receivables $6.8 million, other assets $6.3 million and stock compensation expenses $2.0 million.

Net cash used in investing activities was approximately $15.2 million for the nine months ended September 30, 2010 compared to approximately $7.5 million net cash provided for the nine months ended September 30, 2009. The change was mainly a result of the difference in change in restricted cash $ 5.5 million and the acquisition of goodwill in 2010.

Net cash used in financing activities was $3.7 million for the nine months ended September 30, 2010 compared to $2.9 million provided by for the nine months ended September 30, 2009. The change was primarily due to difference in changes of shareholders loan $4.7 million and notes payables $10.2 million.

Off-Balance Sheet Arrangements

None.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues, expenses and allocated charges during the reporting period. Actual results could differ from those estimates.

We describe our significant accounting policies in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K/A as of and for the year ended December 31, 2009, as filed with the Securities and Exchange Commission on June 2, 2010. We discuss our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K/A as of and for the year ended December 31, 2009.  Other than as indicated in this quarterly report, there have been no material revisions to the critical accounting policies as filed in our Annual Report for the fiscal year ended December 31, 2009 on Form 10-K/A as filed with the SEC on June 2, 2010.

Recent Accounting Pronouncements

See Note 2(t) of the accompanying unaudited interim consolidated financial statements included in this Form 10-Q for a discussion of recent accounting pronouncements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

There have been no material changes in market risk from the information provided in Part II, Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report for the fiscal year ended December 31, 2009 on Form 10-K/A as filed with the SEC June 2, 2010.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

As of the end of the period covered by this Quarterly Report, we conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures identified certain material weaknesses, as described below, that caused our controls and procedures to be ineffective.  Notwithstanding the existence of the material weaknesses described below, management has concluded that the interim consolidated financial statements in this Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods and dates presented.

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These material weaknesses primarily related (i) our restatements that we conducted in May 2010 and (ii) one of our material operating subsidiaries, Techwell Engineering Limited. (“Techwell”) that we acquired in November 2007.

Restatements

In May 2010, we discovered that certain of our previously filed quarterly and annual reports contained errors that required correction and restatement. The errors related to the timing of the interest expense related to the Company’s outstanding $8,000,000 Variable Rate Convertible Bonds due 2012 and $20,000,000 12% Convertible Bonds due 2011 that resulted in overstatements and understatements of the interest expenses related to the bonds during various quarters before the second quarter of 2008. Due to the accounting errors, the interest expense was overstated by approximately $0.3 million, $0.5 million, and $0.7 million for the second, third, and fourth quarters of fiscal year 2007, respectively, for a total overstatement of approximately $1.5 million for fiscal 2007. The interest expense was overstated by approximately $0.1 million in the first quarter of 2008 and all the overstatements, approximately $1.6 million, were reversed in the second quarter of 2008. For the year ended December 31, 2009, there was an overstatement of the interest expense of $8,000 in the second quarter and an understatement of $6,000 during the third quarter, for a total of overstatement of $2,000 for fiscal year 2009. The net bonds payable amounts were presented correctly in the Company’s financial statements as of December 31, 2008 and 2009, and it was only the components of the Convertible Bonds that were restated, while the net payable amounts as of December 31, 2007 was stated with correction of errors.

Additionally, a correction was needed for the addition of an equity compensation charge in the amount of $4,976 related to a portion of options granted in October 2009 that the Company inadvertently omitted in the original Form 10-K filing. Together with the overstatement of interest expenses of $2,000, the loss for the year ended December 31, 2009 was understated by 2,983 and the retained earnings as of December 31, 2009 was overstated by 2,983. Additionally, $1.5 million of consolidation exchange loss resulted from the inter-company investments elimination was incorrectly included in the additional paid in capital instead of the accumulated comprehensive income presented in the Stockholders’ Statement of Equity and Comprehensive Income for the year ended December 31, 2009.

We believe that the accounting errors were caused by lack of personnel with expertise in US generally accepted accounting principles and SEC rules and regulations, in addition to inadequate staffing and supervision that lead to the untimely identification and resolution of accounting and disclosure matters and failure to perform timely and effective reviews. We intend to take action to remediate these deficiencies going forward.

Techwell

On November 6, 2007, we acquired Techwell and its wholly owned subsidiaries, Techwell Building Systems (Shenzhen) Ltd. in China and Techwell International Ltd. in Macau.  At the time, Techwell was a privately-held company and its financial systems were not designed to facilitate the external financial reporting required of a publicly held company under the Sarbanes-Oxley Act of 2002.  In addition, Techwell’s accounting records were historically maintained using accounting principles generally accepted in the People's Republic of China, its personnel was not fully familiar with accounting principles generally accepted in the United States of America.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected in a timely basis.  We identified the following material weaknesses:

1. Techwell lacked the technical expertise and processes to ensure compliance with our policies and did not maintain adequate controls with respect to (a) timely updating engineering budget and analysis, (b) coordination and communication between Corporate Accounting and Engineering Staffs, and (c) timely review and analysis of corporate journals recorded in the consolidation process.

2. Techwell did not maintain a sufficient complement of personnel with an appropriate knowledge and skill to comply with our specific engineering financial accounting and reporting requirements and low materiality thresholds.  This was evidenced by a number of documents missing or not matching with the records and contributed to the adjustment of financial results.  As evidenced by the significant number and magnitude of out-of-period adjustments identified from Techwell during the period-end closing process, management has concluded that the controls over the period-end financial reporting process were not operating effectively. Specifically, controls were not effective to ensure that significant accounting estimates and other adjustments were appropriately reviewed, analyzed, and monitored on a timely basis.

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3. Techwell did not comply with our authorization policy. This was evidenced by a number of expenses incurred without appropriate authorization. This material weakness resulted in an unauthorized and significant increase of expenses, which significantly impacted our operating results.

Remediation Efforts

We are in the process of developing and implementing remediation plans to address our material weaknesses.

Restatements

We have taken and intend to take the following actions to address the material weaknesses and improve our internal controls over financial reporting:

1. We are seeking to improve supervision, education, and training of our accounting staff. We are also considering engaging third-party financial consultants to review and analyze our financial statements and assist us in improving our reporting of financial information.

2 Management intends to hire additional personnel with technical knowledge, experience and training in the application of generally accepted accounting principles commensurate with our financial reporting and U.S. GAAP requirements.

3. We will continue to monitor the effectiveness of these improvements. We are also considering working with outside consultants in assessing and improving our internal controls and procedures when necessary.

4. An internal SOX 404 task force was set up in order to help the company strengthening its controls and procedures on the financial reporting.

5. In September 2009, we hired a new Vice President of Finance who was later appointed as our Acting Chief Financial Officer in November 2009.  This person served as the sensible financial officer of our company until his resignation in September 2010.

6. In December 2009, our then-Acting Chief Financial Officer lead an extensive review of the controls and procedures of our company and developed a detailed remediation and implementation plan for Sarbanes-Oxley Act of 2002 Section 404 compliance to be carried out starting in 2010.

7. The remediation and implementation plan is being carried out which including the drafting up of the details internal control documents for SOX compliance. With the additions of new subsidiaries in the third quarter of 2010, the company currently is considering to further develop the internal controls and procedures in responses to the new group structure.

Techwell

One key change for us going forward will be the design and implementation of internal controls over the accounting and oversight of all subsidiaries, including enhanced accounting systems, processes, policies and procedures.  We have taken the following actions to address the material weaknesses and improve our internal controls over financial reporting:

1. On January 14, 2009, the board of directors of Techwell passed a board resolution to replace management of Techwell.  We have appointed a new general manager to Techwell, as well as three experienced project managers to the Dubai Metro project.

2. Management has initiated a Sarbanes-Oxley Act of 2002 Section 404 Compliance Assistance Project, which is intended to meet all requirements required by SEC in our company and all of our subsidiaries. We engaged a consulting firm to assist in the set-up of project and our staff thereafter continued with its implementation.

3. We have established a dedicated and qualified internal control and audit team to implement the policies and procedures to the standard of a US public company.

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4. In June 2009, we reorganized and restructured Techwell’s Corporate Accounting by (a) modifying the reporting structure and establishing clear roles, responsibilities, and accountability, (b) hiring skilled technical accounting personnel to address our accounting and financial reporting requirements, and (c) assessing the technical accounting capabilities in the operating units to ensure the right complement of knowledge, skills, and training.

5. In 2009, we also reorganized and restructured the budgeting process by (a) centralizing the procurement function to our company to ensure budgets and analyses of Techwell are timely prepared and properly reviewed; (b) implementing new policies and procedures to ensure that appropriate communication and collaboration protocols among our Engineering, Procurement and Corporate Accounting departments; and (c) hiring the necessary technical procurement personnel to support complex procurement activities.    We have hired two experienced technical procurement managers and expect to increase the headcount in the purchase department in the future if necessary.

6. We strengthened the period-end closing procedures of our operating subsidiaries by (a) requiring all significant estimate transactions to be reviewed by Corporate Accounting, (b) ensuring that account reconciliations and analyses for significant financial statement accounts are reviewed for completeness and accuracy by qualified accounting personnel, (c) implementing a process that ensures the timely review and approval of complex accounting estimates by qualified accounting personnel and subject matter experts, where appropriate, and (d) developing better monitoring controls at Corporate Accounting and the operating units.

7. In September 2009, we hired a new Vice President of Finance who was later appointed as our Acting Chief Financial Officer in November 2009, who served as our principal financial officer until his resignation in September 2010.

8. In December 2009, our Acting Chief Financial Officer lead an extensive review of the controls and procedures of our company and developed a detailed remediation and implementation plan for Sarbanes-Oxley Act of 2002 Section 404 compliance to be carried out starting in 2010, which includes the internal control for Techwell. With the additions of new subsidiaries in the third quarter of  2010, the company currently is considering to further develop the internal controls and procedures in responses to the new group structure.

We believe that we are taking the steps necessary for remediation of the material weaknesses identified above, and we will continue to monitor the effectiveness of these steps and to make any changes that our management deems appropriate.

Changes in internal control over financial reporting

Based on the evaluation of our management as required by paragraph (d) of Rule 13a-15 of the Exchange Act, we believe that there were changes in our internal control over financial reporting that occurred during the third quarter of 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  The changes include our acquisition of ConnGame in August 2010, the related appointment of a new Chief Executive Officer and Acting Chief Financial Officer, and such other actions as described above under “Remediation Efforts.”

PART II-OTHER INFORMATION

ITEM 1.                   LEGAL PROCEEDINGS

See Note 12(b) of the accompanying unaudited interim consolidated financial statements included in this Form 10-Q for a discussion of our current legal proceedings.

ITEM 1A.                RISK FACTORS

Any investment in our common stock involves a high degree of risk. Investors should carefully consider the risks described below and all of the information contained in our public filings before deciding whether to purchase our common stock. Except as set forth below, there have been no material revisions to the “Risk Factors” as filed in our Annual Report for the fiscal year ended December 31, 2009 on Form 10-K/A as filed with the Securities and Exchange Commission on June 2, 2010.

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RISKS RELATED TO OUR ACQUISITION OF CONNGAME

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

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

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

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

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

The success of the acquisition of ConnGame will be dependent in large part on the success of our management in integrating the operations, technologies and personnel of the two companies. Our failure to meet the challenges involved in successfully completing the integration of the operations of ConnGame or to otherwise realize any of the anticipated benefits of the acquisition, including additional revenue opportunities, could impair our results of operations.  The challenges may be particularly difficult for our company because we have never been engaged in the MMORPG industry prior to the acquisition.

Challenges involved in this integration include, without limitation:

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

· reducing the costs associated with operations;

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

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

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

Our shareholders suffered immediate and substantial dilution.

Because we issued 25,000,000 shares of our common stock as consideration in the Acquisition, our shareholders suffered immediate dilution.  Following the issuance of the Shares, holders of our outstanding common stock prior to such issuance owned approximately 68.8% of our outstanding common stock after the Stock Issuance.

If we do not increase our per-share stock trading price, the Nasdaq Stock Market may delist our securities, which could limit investors’ ability to trade in our securities.

Nasdaq Listing Rule 5550(a)(2) (the “Rule”) requires that our common stock maintain a minimum bid price of $1.00 per share for 30 consecutive business days.  As of November 18, 2010, our stock price closed at $0.70.  If we do not meet the requirement, our securities may become subject to delisting.  If our common stock is delisted by Nasdaq, the trading market for our common stock would likely be adversely affected, as price quotations may not be as readily obtainable, which would likely have a material adverse effect on the market price of our common stock.

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FirstJet became our largest shareholder and the interests of First Jet may conflict with the interests of our other shareholders.

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

We may be subject to intellectual property claims.

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

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

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

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

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

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

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

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

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

Our inability to comply with the terms of the Waiver, including payments required to be made by us, the waiver of the adjustment rights may become voided and the conversion and exercise prices of the bonds and warrants may adjust down, resulting in substantial dilution to our securities and immediate repayment of the Bonds.

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One of the conditions to the Acquisition was that we obtain a waiver from our bondholders related to their rights to have the conversion and exercise price of the Bonds and 2008 Warrants, respectively, adjusted downward as a result of ours issuance of the 25,000,000 Shares.  We obtained the Waiver on February 24, 2010.  The Waiver had a three month term from the execution date, and therefore expired on May 24, 2010.  The parties entered into a new waiver on July 13, 2010, which has a three month term subject to the terms and conditions contained therein.   We close the transaction within the three-month period.  We have failed to make certain payments specified in the Waiver and are currently negotiating with the bondholders to amend the Waiver.  If we are not able to reach an agreement with the bondholders, all rights of the holders of the Bonds and 2008 Warrants waived under the Waiver to or to be waived under the Waiver, shall not be waived and will be reinstated, and any previous waivers will be null and void.

There are restrictive covenants in the Waiver relating to our ability to incur future indebtedness.

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

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

Prior to the consummation of the acquisition, ConnGame was not subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Sarbanes-Oxley Act of 2002 and the rules and regulations of any stock exchange. As a subsidiary of ours, ConnGame is subject to such rules and regulations. As described in Item 4— Controls and Procedures, it was determined that our controls and procedures were not effective as of September 30, 2010. In addition, we have historically had difficulties in establishing effective internal controls on past acquisitions, namely Techwell. Integrating and maintaining appropriate internal controls and procedures for the combined business will require specific compliance training of certain officers and employees, will entail substantial costs in order to modify existing accounting systems, and will take a significant period of time to complete. We may not be able to demonstrate compliance with Section 404 of the Sarbanes-Oxley Act in a timely manner, or that our internal controls are perceived as inadequate, or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and our stock price could decline.

RISKS RELATED TO OUR OPERATIONS

Almost one-half of our contracts receivables are attributable to a Dubai project for which we may never be paid.

One of the primarily reasons that the aging of Company’s contract receivables have increased is the delay in payment by client of the Dubai projects since April 2009.  The underlying receivable as of September 30, 2010 from the Dubai projects was approximately $42.1 million, which represented 47% of the total contract receivables as of such date. The Company has employed a claim consultant, Hill International, to facilitate the Company’s claim for the back payment.  The Company currently expects that there will be progress and payments will be received as early as the fourth quarter of 2010.  However, due to the ongoing dispute, there is no guarantee that the Company will collect all or a portion of the contract receivable.  If we are not able to collect the receivable, our results of operations and financial condition will be materially adversely impacted.  See “ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION—Dubai Metro Rail Project”  in this report for more information.

The restatement of certain of our historical consolidated financial statements may have an adverse effect on us.

In May 2010, our management concluded that our consolidated audited financial statements for the years ended December 31, 2009, 2008 and 2007 and our consolidated unaudited interim financial statements for the periods ended September 30, 2007, September 30, 2007, March 31, 2008 and September 30, 2008 needed to be restated and should not be relied upon.  For a more detailed discussion of the restatements, amendments and their underlying circumstances, please refer to the Explanatory Note at the beginning of our Annual Report on Form 10-K/A for the year ended December 31, 2009 (the “Amended 2008 Form 10-K”) and Note 1 of the Notes to the consolidated financial statements included in the Amended 2009 Form 10-K.  As a result of the restatements, the Company may become subject to a number of significant risks, which could have an adverse effect on its business, financial condition and results of operations, including potential civil litigation (including stockholder class action lawsuits and derivative claims made on behalf of the Company), and regulatory proceedings or actions, the defense of which may require significant management attention and significant legal expense and which litigation, proceedings or actions, if decided against us, could require us to pay substantial judgments, settlements or other penalties.

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We identified material weaknesses in our internal control over financial reporting and concluded that such controls were not effective.  If we fail to maintain effective internal control over financial reporting, we may not be able to accurately report our financial results.  We can provide no assurance that we will at all times in the future be able to report that our internal control is effective.

Because we have reporting obligations under the Exchange Act, we are required to report, among other things, control deficiencies that constitute material weaknesses or changes in internal control that, or that are reasonably likely to, materially affect internal control over financial reporting.  A “material weakness” is a significant deficiency or combination of significant deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.  Based on the restatements to our financial statements referenced above, our management concluded that our system of internal control over financial reporting was not effective as of September 30, 2010, in addition to prior period end dates, which were the cause of our restatements as described above.  Although management does not anticipate making any further restatements to the financial statements for subsequent periods, management believes that our weakness in internal controls continued during such periods.  Management has identified internal control deficiencies which, in management’s judgment, represent material weaknesses in internal control over financial reporting.  The control deficiencies related to controls over the accounting and disclosure for transactions to ensure such transactions were recorded as necessary to permit preparation of financial statements and disclosure in accordance with GAAP. If we fail to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 or report a material weakness, we might be subject to regulatory sanction and investors may lose confidence in our financial statements, which may be inaccurate if we fail to remedy such material weakness.

RISKS ASSOCIATED WITH OUR PROPOSED REVERSE STOCK SPLIT

There can be no assurance that the total market capitalization of our common stock (the aggregate value of all CAE common stock at the then market price) after the implementation of the Reverse Stock Split  will be equal to or greater than the total market capitalization before the Reverse Stock Split or that the per share market price of our common stock following the Reverse Stock Split will increase in proportion to the reduction in the number of shares of our common stock outstanding before the Reverse Stock Split.

There can be no assurance that the market price per share of our common stock after the Reverse Stock Split will remain unchanged or increase in proportion to the reduction in the number of old shares of our common stock outstanding before the Reverse Stock Split. For example, based on the closing price of our common stock on October 21, 2010 of $0.78 per share, if the Board were to implement the Reverse Stock Split and utilize a ratio of 1-for-3, we cannot assure you that the post-split market price of our common stock would be $2.34 (that is, $0.78 × 3) per share or greater. In many cases, the market price of a company’s shares declines after a reverse stock split.

Accordingly, the total market capitalization of our common stock after the Reverse Stock Split, when and if implemented, may be lower than the total market capitalization before the Reverse Stock Split. Moreover, in the future, the market price of our common stock following the Reverse Stock Split may not exceed or remain higher than the market price prior to the Reverse Stock Split.

The Reverse Stock Split may not increase our stock price over the long-term, which may prevent us from maintaining our listing with NASDAQ.

While we expect that the Reverse Stock Split will enable our shares to qualify for listing with NASDAQ and that we will be able to continue to meet on-going quantitative and qualitative listing requirements, we cannot be sure that this will be the case. Negative financial results, adverse clinical trials developments, or market conditions could adversely affect the market price of our common stock and jeopardize our ability to meet or maintain applicable NASDAQ listing requirements. Furthermore, in addition to its enumerated listing and maintenance standards, NASDAQ has broad discretionary authority over the initial and continued listing of securities, which it could exercise with respect to our shares.

A decline in the market price of our common stock after the Reverse Stock Split is implemented may result in a greater percentage decline than would occur in the absence of the Reverse Stock Split, and the liquidity of our common stock could be adversely affected following the Reverse Stock Split.

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If the Reverse Stock Split is effected and the market price of our common stock declines, the percentage decline may be greater than would occur in the absence of the Reverse Stock Split. The market price of our common stock will, however, also be based on our performance and other factors, which are unrelated to the number of shares of common stock outstanding. Furthermore, the liquidity of our common stock could be adversely affected by the reduced number of shares that would be outstanding after the Reverse Stock Split.

ITEM 2.          UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3.          DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.          REMOVED AND RESERVED

None.

ITEM 5.          OTHER INFORMATION

None.

ITEM 6.	EXHIBITS
21.1	List of subsidiaries.
31.1	Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

* This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	CHINA ARCHITECTURAL ENGINEERING, INC. (Registrant)
November 22, 2010	By:	/s/ Wing Lun (Alan) Leung
		Wing Lun (Alan) Leung
		Chief Executive Officer

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