CORRESP 1 filename1.htm Unassociated Document
[LETTERHEAD OF K&L GATES]



January 15, 2010

Via Edgar and Federal Express

John Cash
Accounting Branch Chief
Division of Corporation Finance
Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549-7010
 
 
China Architectural Engineering, Inc.
 
Form 10-K for the Fiscal Year Ended December 31, 2008
 
Form 10-Q for the Fiscal Quarter Ended March 31, 2008
 
Definitive Proxy Statement on Schedule 14A filed April 30, 2009
 
File No. 000-23539
 
Ladies and Gentlemen:
 
On behalf of China Architectural Engineering, Inc., a Delaware corporation (the “Company”), we are providing the Company’s responses to the Securities and Exchange Commission comment letter dated June 26, 2009.   The Company’s responses to the Staff’s comment letter, below, are in identical numerical sequence.  For the convenience of the Commission, each comment is repeated verbatim with the Company’s response immediately following.
 
Form 10-K for the Fiscal Year Ended December 31, 2008

General

1.
Comment:  In future filings, please disclose selected quarterly financial data as required by Rule 302(a) of Regulation S-K.

 
Response:  The Company notes your comment and confirms that it will provide the selected quarterly financial data disclosures in future Form 10-K filings, beginning with the Form 10-K for the year ended December 31, 2009.

2.
Comment:  In future filings, please disclose the information required by paragraphs 36-39 of SFAS 131, as applicable.

 
Response: The Company notes your comment and confirms that it will provide the referenced disclosures in future filings to the extent it is required under paragraphs 36 to 39 of SFAS 131.

Item 1A.  Risk Factors, page 10

We are currently a defendant in a lawsuit in Hone Kong…., page 14; Legal Proceedings.
page 22; Pending Litigation, page F-32

3.
Comment:  In future filings, state the amount of monetary damages, including punitive damages, if any, sought by the plaintiffs in the lawsuit filed on January 14, 2009.  See Item 103 of Regulation S-K and the item's instructions.

 
Response: The Company notes your comment and confirms that it will provide the referenced disclosures in future filings.  Please note that the Company added the following disclosure to its Quarterly Report on Form 10-Q for the periods ended September 30, 2009:  “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.”  The Company will continue to updated its disclosure and provide all information required by Item 103 of Regulation S-K in future filings.
 
 
John Cash
January 15, 2010
Page 2
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of
Operations, page 26

Critical Accounting Policies.  Estimates and Assumptions, page 27
Revenue and Cost Recognition, page 27

4.
Comment:  We note from your disclosures on page 11 that you are suing certain of your customers for overdue payments.  With a view towards future disclosure, please provide us with a specific and comprehensive discussion regarding how you have considered the length of your payment terms and the possibility of payment defaults in your revenue recognition policy.

 
Response:  The Company notes your comment and has provided below a comprehensive discussion of payment terms and possibility of default as it relates to the Company’s revenue recognition policy.

Payment terms are set forth in the Company’s contracts with its customers.  The lengths of payment terms are consistent with the industry.  In accordance to the SAB 104, collectibility is reasonably assured when the Company collects revenue.  Many of the projects that Company undertook were public works projects.  For example, the project in Dubai was an infrastructure project.  When the Company entered into this contract and extended credit to the customer, it was relying on the credit of the Dubai government.  Many projects in the PRC are also with government entities; therefore, when the Company enters into these projects and performs the required service, short of global financial crisis, it should receive payments on a timely basis.  Collection through legal process is inevitable; however, such kind of collection is quite limited; at this point these are six cases.  The Company believes that its revenue recognition policy is in line with the requirements set forth in SAB 104.

Selling, General, And Administrative Costs, page 27

5.
Comment:  With a view towards future disclosure, please provide us with a specific and comprehensive discussion regarding how you determined it was appropriate to include allowances for estimates losses on uncompleted contracts in your selling, general and administrative costs and what consideration you gave to including the amounts within the costs of contract revenues.

 
Response:  The Company notes your comment and responds that the cost of estimated uncompleted contract losses were included in SG&A because these are costs outside of the Company’s normal expenditure cycles that flow downstream into its GL accounts.  They are management assertions made after careful review of each contract.  The Company also believes that given the nature of its business, the costs recorded in cost of contract revenue bear a direct relationship on the recognition of revenue; therefore, such cost related to losses should be handled separately.  The Company also believes that the SG&A is direct reflection of management’s performance, where the cost of contract revenue is reflection of the Company overall cost budgeting and operations effectiveness.

Results of Operations, page 29

6.
Comment:  In future filings, please provide a more specific and comprehensive qualitative and quantitative discussion of the reasons for the significant changes in your results from period-to-period.  Your discussion should include, but not be limited to, the following items:

 
—
Disclose the number of the increase in projects and quantify the resulting increase in the amount of contract revenue generated,
 
 
John Cash
January 15, 2010
Page 3
 
 
—
Discuss any negative factors impacting your profitability such as decreases in contract pricing or contract losses;

 
—
Quantify the increase in costs of raw materials, project set-up costs and labor costs since these were the primary reasons for the fluctuation in cost of contract revenue;

 
—
Quantify the significant reasons you have identified for the increase in selling, general and administrative expenses and ensure that you explain the majority of the increase or decrease in your discussion; and

 
—
Discuss the impact of any acquisitions on your results.

We remind you that management's discussion and analysis should include meaningful information to enhance overall financial disclosure, provide narrative explanation of the company's financial statements, enabling investors to see the company through the eyes of management, and provide information about the quality of, and potential variability of, the company's earnings and cash flow so that investors can ascertain the likelihood that past performance is indicative of future performance.  Please refer to Release No. 33-8350, Interpretation - Commission's Guidance Regarding Management's Discussion and Analysis of Financial Condition and Results of Operations for more guidance.

 
Response:  The Company notes your comment and confirms that in future filings the Company will provide a more specific and comprehensive qualitative and quantitative discussion of the reasons for the significant changes in results of operations, including, but not limited to, the bullet-pointed items referenced in your comment.  The Company has commenced to include increased disclosures in its Quarterly Report on Form 10-Q for the periods ended September 30, 2009, starting on page 22, as filed with the Commission on November 16, 2009:  http://www.sec.gov/Archives/edgar/data/1287668/000114420409059977/v166361_10q.htm

Liquidity and Capital Resources, page 30

7.
Comment:  Given the importance of available funding to your business, please revise future filings to include a more specific and comprehensive discussion of the terms of any significant covenants within your debt agreements.  In addition, if you believe that it is reasonably likely that you will not meet any significant debt covenant, please revise future filings to also present, for your most significant covenants, your actual ratios and other actual amounts versus the minimum/maximum ratios/amounts permitted as of each reporting date.  Such presentation will allow an investor to easily understand your current status in meeting your financial covenants.

 
Response:   The Company notes your comment and confirms that it will provide the referenced disclosures in future filings, including the Annual Report on Form 10-K for the year ended December 31, 2009.

Financial Statements, page F-1

General

8.
Comment:  Please clarify for us how you have presented the acquisition of Techwell Engineering Limited on your statement of cash flows and statement of stockholders' equity.

 
Response: The acquisition of Techwell Engineering Ltd. was closed on November 6, 2007 at a Purchase Price of $11,654,566 payable by equal proportion of cash $5,827,283 and Company shares of common stock issued to the Sellers, Ng Chi Sum and Yam Mei Ling, valued $5,827,283 and representing 703,778 shares at $8.28 per share.
 
 
John Cash
January 15, 2010
Page 4
 
Please refer to the Consolidated Statement of Stockholders’  Equity at December 31, 2007.
 
IPO issuance:
      
847,550 shares at 3.50 per share
   $ 2,966,425  
         
Issue to Warrant Holders:
        
232,088 shares at 1.60 per share
   $ 371,340  
         
Issue to Ng Chi Sum and Yam Mei Ling
        
Of Techwell Engineering Ltd.:
        
703,778 shares at 8.28 per share
   $ 5,827,283  
         
Total shares: 1,783,416
   $ 9,165,048  

Cash of $5,827,283 was paid to the Sellers on April 17, 2008 by Full Art International Ltd., the Company’s subsidiary:
 
-Ng, Chi Sum
   $ 5,244,554.70  
-Yam, Mei Ling
   $ 582,728.30  
    $ 5,827,283.00  

Since the disbursements were classified as Accounts Payable to the Sellers in the books of Full Art International Ltd., the transactions were not explicitly reflected in the Investing Activities of Cash Flows Statement, but rather included as part of Accounts Payable in the Operating Activities.
 
Mr. Ng used $2,500,000 to buy 3.16% of the issued and outstanding shares of KGE Group Ltd., which is the holding company of the Company.
 
Enclosed is the substantiation of the cash paid to the Sellers for your review.  (Exhibits 1, 2, and 3)

Note 8 - Convertible Bonds and Bond Warrants, page F-24

9.
Comment:  We note your disclosure that you determined the value of the warrants and the beneficial conversion feature of your $10 million variable rate convertible bonds were $3,207,790 and $3,507,791, respectively.  Please help us understand how these amounts reconcile to your disclosures on pages 20, F-26 and F-29.

 
Response: Value of the warrants and beneficial conversion feature of the $10 Million Bond will be revised to $1,746,400 and $1,746,400 respectively.  In the matter of reconciling the warrants value of $10 million bonds and $20 million bonds as reflected on page F-29, the respective amounts are:
 
$10 M. Bonds Warrant Value
   $ 1,746,400  
$20 M. Bonds Warrant Value
   $ 1,413,503  
    $ 3,159,903  
 
Please also see the analysis of components comprised in the $10 million and $20 million bonds to reconcile to the amounts reported in each period presented for 2007 and 2008 (Exhibit 5).

10.
Comment:  Please provide us with a specific and comprehensive discussion regarding how you determined that your $20 million convertible bonds did not contain a beneficial conversion feature.

 
Response:  We enclose a calculation worksheet (Exhibit 4) of the $20 million Bonds, which shows the conversion price at $6.35 is higher than the fair market value at the issuance date and, therefore, there is no beneficial conversion feature.
 
 
John Cash
January 15, 2010
Page 5
 
11.
Comment:  Please help us understand why the interest discount for your beneficial conversion feature decreased from $4,342,857 at December 31, 2007 to $1,737,143 at December 3 1,2008.

 
Response:  As disclosed in Exhibit 5 addressed in the response to SEC Comment No. 9, above, the beneficial conversion feature (BCF) of December 31, 2007 was determined to be $4,342,857. By applying the amortization rate over the bond life, the BCF Discount is being amortized gradually to leave a balance of BCF Discount $1,737,143 at December 31, 2008.

12.
Comment:  Please supplementally provide us with the detail of the accretion of interest discount and accrual of interest payable disclosed on page F-29.

 
Response:  As disclosed in Exhibit 5 addressed in the response to SEC Comment No. 9, above, details of the accretion of interest discount and accrual of interest payable disclosed on Page F-29, are shown in the tabulation at each reporting period.

Note 11 - Commitments and Contingencies, page F-32
B. Pending Litigation, page F-32

13.
Comment:  Based on your current disclosures, it is unclear whether you believe a material loss is possible related to the Techwell lawsuit.  If a material loss is reasonably provide the additional disclosures required by SAB 5:Y and SFAS 5.

 
Response:  The Company respectfully notes your comment and responds that after consultation with its Hong Kong legal counsel engaged to represent the litigation and after considering all the facts and circumstances of the matter, management does not believe that there will be any possibility of material loss incurred because the plaintiff’s claims will not be successful.  The estimated loss will probably be the shortfall between legal costs incurred and our counterclaim recovered.

14.
Comment:  Please supplementally provide us, and include in future filings, a quantitative discussion of the impact of Techwell on your operations for each period presented.

Response:  Since acquiring Techwell on November 6, 2007, its operation had very minimal impact in year 2007.  Revenue and net income of that year attributed to merely 3% and 1%, respectively.  Basically, Techwell operates one job i.e. Dubai Project, which started in early 2008 and will be completed before the end of 2009.
 
The following tabulation outlines the impact of Techwell on the Company’s overall operations for each period presented below.

Reporting Period
2008
Q1
2008
Q2
2008
Q3
2008
Q4
2008
Total
2009
Q1
2009
Q2
2009
Q3
2009
YTD
Total Revenue
$25,349,306
$41,380,189
$55,978,184
$28,957,993
$151,665,672
$36,343,064
$30,598,974
$25,558,074
$92,500,112
Dubai’s Revenue
$11,621,790
13,830,488
28,510,189
3,222,6824
57,185,117
21,155,723
14,423,085
7,880,632
43,459,440
Dubai’s %
45.8
33.4
50.9
11.1
37.7
58.2
47.1
30.8
47.0
Total Net Income (Loss)
$ 5,173,718
$7,577,783
$9,909,524
$<28,534,446>
$<5,873,415>
$ 943,611
$ 2,543,670
$<8,381,286>
$<4,894,005>
Dubai’s Net Income
$7,340,747
8,186,268
14,733,790
<11,224,660>
19,036,145
5,348,101
5,045,497
1,776,842
12,170,440
Dubai’s %
141.9
108.0
148.7
39.3
  
568.8
198.4
    

The Dubai project’s revenue contribution attributes to a significant but volatile trend throughout 2008 and three quarters in 2009 as depicted in the tabulation.  The fourth quarter of 2008 experienced a serious contraction caused by global financial Tsunami. The first, second, and third quarter of 2009 reflected the final phase of the project pushing work to be completed before the job comes to a termination.  Dubai’s overwhelmingly exceeds those conventional jobs in PRC.
 
 
John Cash
January 15, 2010
Page 6
 
Form 10-O for the period ended March 31, 2009

Note 8 - Convertible Bonds and Bond Warrants, page 18

15.
Comment:  With a view towards future disclosure, please tell us how you are accounting for the reset of the conversion price of your $10 million Variable Rate Bonds.

Response:  The $10 Million Variable Convertible Bond had a reset feature as a protection to the bondholders for a low stock price.  The reset feature is accounted for under EITF 00-27, whereby a beneficial conversion feature is calculated at the commitment date of the Bond Issuance, and in the event that the Company’s stock price falls below a certain threshold set forth in the terms and conditions of the Securities Agreement

The Beneficial Conversion Feature (“BCF”) is accounted for as a discount to the bond that is being accreted over the remaining life of the bond.  As of April 12, 2009, the reset feature has come into effect; the Company started to record the discount accordingly.  The BCF of the Bond amounted to $3,428,571 as determined by the enclosed calculation worksheet. (Exhibit 6)

Because of the inclusion of the reset of conversion price, we have revised the calculation of BCF Value and Interest Expense (Exhibit 6)

Definitive Proxy Statement on Schedule 14A filed April 30, 2009

Information Concerning Director Nominees, page 9

16.
Comment:  In future filings, specify the dates of Mr. Charles John Anderson's employment as a senior consultant with Israel Berger & Associates, LLC.  Item 401(e)(l) of Regulation S-K.

 
Response:  The Company notes your comment and confirms that it will provide the referenced disclosures in future filings.

Employment Agreements, page 16

17.
Comment:  Disclosures indicate that the employment agreement with Li Guoxing expired on January 1, 2009 and the employment agreements with Wang Zairong and Feng Shu expired on December 31, 2008.  As appropriate, update the disclosures in future filings.

 
Response:  The Company notes your comment and confirms that it will provide the referenced disclosures in future filings.  The agreements are generally renewed annually.

Please do not hesitate to contact the undersigned at (310) 552-5083 or with any questions.
 
Sincerely,

/s/  Anh Q. Tran, Esq.

Anh Q. Tran, Esq.

cc: 
Luo Ken Yi, China Architectural Engineering, Inc.
Dale Welcome, U.S. Securities and Exchange Commission