China Architectural Engineering, Inc. Q3 2008 Earnings Call Transcript

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 |  About: China Architectural Engineering, Inc (CAEI)
by: SA Transcripts

China Architectural Engineering, Inc. (NASDAQ:CAEI)

Q3 2008 Earnings Call Transcript

November 10, 2008, 11:00 am ET

Executives

Bert Grisel – CFO

Ken Yi Luo – Chairman and CEO

Analysts

Michael Cox – Piper Jaffray

Jeev Roshafan [ph] – Westpark [ph]

Matt Schwartz – JLF Asset Management

Operator

Greetings, and welcome to the China Architectural Engineering, Incorporated Third Quarter 2008 Earnings Conference Call for. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Bert Grisel for China Architectural Engineering, Incorporated. Thank you. You may begin.

Bert Grisel

Thank you very much, Diego. Good morning, ladies and gentlemen. First of all I would love to sort of introduce you to the host of this conference call, Mr. Ken Yi Luo, Chairman and CEO, China Architectural, and myself, Bert Grisel as the CFO of China Architectural.

May be a brief word of introduction is commensurate given the fact that I’ve been appointed as your CFO on the 29th of October, which is approximately 10 days ago. May be just a very brief introduction on myself. I spent 19 years in the banking industry and basically have a background in credit, in special credits, in structured credits, equity capital markets, M&A, and lastly was responsible ABN’s Global Real Estate Investment Banking franchise. I have now basically been able to be on the other side of the business and I am very happy to be able to present to you the result of China Architectural.

Before I get there, I’d like to shortly be presenting CA’s financial results and will take your questions thereafter. But first I will have to share with you the Safe Harbor statement, which is as follows.

This call may contain forward-looking statement, including, but not limited to, factors related to future sales. These forward-looking statements may involve a number of risks and uncertainties. Actual results may vary significantly based on a number of factors, including, without limited to, uncertainties in product demand, impact of competitive products and pricing, change in economic conditions around the world, release and sales of new products and other risk factors detailed in the Company’s most recent Annual Report and other filings with the expected results are discussed in greater detail in the Company’s reports and other filings with the Securities and Exchange Commission.

Having said that, I am very pleased to share with you the CAE results for the third quarter and nine months ended September 30, 2008. Following our order also used in our press release, I’d like to give the results basically line-by-line item, ranging from revenue to EPS, first for the quarter and then for the nine months of 2008. Where applicable or commensurate, I also like to share with you some trends that we see on a quarter-by-quarter basis and share observations on those trends.

For the third quarter of 2008, revenues totaled $55.98 million, which is up 107% from $27.08 million in the third quarter of ’07. The increase was primarily due to new projects in our international markets and especially in the Middle East.

The gross profit for the third quarter of 2008 was $17.38 million, up 166% from $6.55 million a year earlier. The gross margin rose year-over-year to 31%, up from 24%. This improvement again was largely due to the higher margins of our international projects, although partially set off by higher raw materials and labor cost as well as the appreciation of the yuan from 2007 to 2008. By the way, that appreciation of the yuan was approximately 10% over the past period.

The SG&A expenses totaled $6.27 million in the third quarter of 2008, up 226% from $1.88 in the third quarter of ’07. Even though that percentage looks very big, of course, in absolute amounts it is less so the case. The increase, by the way, was due to the growth in staff, office rental, and other startup cost associated with the expansion of our international operations.

Operating income for the third quarter of ’08 was $11.11 million, up 138% from $4.67 million in the third quarter of ’07. Interest expenses in the third quarter of ’08 rose 77% year-over-year to $1.36 million, primarily as a result of cash interest expense and non-cash amortization expenses associated with $20 million in convertible bonds and warrants issued in April 2008.

Income taxes for the third quarter fell year-over-year to $30,945, which is a small amount and can be explained by the fact that we have and enjoy zero corporate income tax rate coming from the revenues from Dubai Metro projects and other projects in Dubai.

The net income for the third quarter of 2008 was $9.91 million, or $0.18 per fully diluted share, which is actually a tripling on a per-share basis from $3.13 million, or $0.06 per share fully diluted basis, in the third quarter of 2007.

All in all, I think results that we are happy with, but I think it’s more important to put them in perspective of the full year-to-date, the nine months ended September 30 wherein we saw revenues totaling $122.71 million, up 101% from $60 million in the first nine months of ‘07. As with the third quarter results here, this increase was primarily due to our growth in international projects.

The gross profit for the first nine months of 2008 was $39.17 million, up 131% from $16.94 million a year earlier. The gross profit margin improved to 32% in the firs nine months of 2008, up from 28% in the comparable period of 2007.

As with the quarterly results, the improvement in gross margin reflected the impact of higher project margins of our international projects. It’s probably fair to say that our gross profit has slightly come down, but is still rather be stable at around 31% now and in the previous quarter around 32%-33%. So the trend, you could say, is slightly down. On the other hand, I think it is important to take into account the fact that the cost of raw materials, which were up in the previous quarters and the revenue mix – the revenue mix has basically largely offset the increased cost of again commodities and yuan related cost and the revenue mix basically is the mix between domestic and international projects.

The SG&A expenses for the first nine months of 2008, reflecting expansion costs and expenses related to our international strategy, rose 213%, up to $13.88 million, up from $4.44 million in the first nine months of ‘07.

It is important also, by the way, to realize that a subsidiary of ours, Techwell, was acquired in the last quarter of ’07 last year, which has also contributed basically to our international sort of cost base, which can easily be of course explained since it was not in the comparable period of the third quarter of ’07. So that should be factored in if you want to make a fair comparison.

The SG&A as a percentage to revenue actually, which I think is probably the best way to look at it, has actually declined a bit and stands now at 11.1% for the third quarter. The SG&A as a percentage to revenues shows actually a consistent trend regardless of the increase of 213% that we just mentioned and shows a consistent trend of approximately 11% to 12%.

Operating income for the first nine months of 2008 was $25.29 million, which is up 102% from $12.50 million a year earlier.

Interest expenses rose $2.89 million in the first nine months of 2008 from $1.34 million a year earlier, while income taxes fell to $147,925, down basically from $2.05 million. The rising interest cost reflected the April 2008 bond issue as well as a $10 million issue of convertible bonds a year before that. The drop in income taxes again reflects the zero-corporate tax treatments that we have in Middle Eastern projects.

The net income for the nine months ended September 30, 2008 was a record $22.66 million, or $0.42 per fully diluted share, which up 133% on a per-share basis from $9.11 million, or $0.18 per fully diluted share a year earlier.

All in all, net income is 17.7% of revenue and somewhat lower compared to especially the first quarter, which again can be explained by the higher cost of financing that we have incurred throughout the year. I think it is still probably fair to say that 17.7% net income compared to revenue is still above industry standard, which we are very happy with.

On the balance sheet, cash and cash equivalents the position totaled $6.54 million as of September 30, 2008, which was up from $4 million for year-end, 2007. Long-term debt totaled $25.96 million on September 30, up from $3.96 million at the end of 2007. The increase in long-term debt was primarily due to the April 2008 bond issue.

It’s probably fair to say that if we are mentioning long-term financing we should also look into – and cash positions – we should also look into receivables. It is important to share that our receivables basically should be looked at on a combined basis account receivables and at the line item called ‘cost in excess of billings.’ The combination of that is also what management looks at and it’s probably fair to say that we should basically be looking at the conversion cycles that come with the domestic and international markets.

If we look at the turnover days that comes with the combined account receivables and cost in excess of billings, the turnover days have actually come down slightly in – for the end of ’07, or in average – sorry, no for the end of ’07, we had 211 days outstanding of receivables. For the first quarter this year that went up to 277, the second quarter on average was 194 and the third quarter is 168.

We are, as management, not saying that this is the industry standard for us. We actually want to sort of see this number coming down, but it is clear that we also see the impact of our revenue mix and it is clear that our turnover days in China are basically longer than our turnover days in the international projects. So with the changing of the revenue mix going forward we would expect to see this number coming down as well.

To sum up, we are reporting a very impressive quarter and nine months. Revenue doubled year-over-year and net income tripled. Both top line and bottom line numbers are at record levels.

Economic outlook. It is clear that after September the markets have changed almost irrationally, but certainly significantly. In these turbulent times, we are very fortunate to be armed with a backlog that stretched out into 2010 and we can share with you that our goal for the fourth quarter is to realize revenue of between $45 million to $50 million, and net profit of between $6 million to $9 million, and EPS of between $0.11 to $0.16.

A triple-digit growth like we’ve seen in the past, of course, will be difficult to realize going forward, but we do believe that our global strategy and the widening reach of our reputation for state-of-the-art engineering, manufacturing, and installation will continue to give us a growth rate considerably above that of the construction business in general.

Our revenue and profit visibility remains high well into 2009, and our margins should be above the industry averages. As evidence of (inaudible) is working for us right now amid challenging economic conditions you probably will have seen that we have announced two major contract wins in Singapore and Dubai totaling approximately $80 million of contract values, going forward. These have clearly helped bring our backlog to a new record of $245 million at the end of October.

It is good to mention here that we have improved our definition of the backlog and only take into account agreed revenue not yet realized of signed contract and awarded tenders and that means that we take a conservative approach, which we will handle strictly going forward.

On the projects, may be a quick word. The Dubai project is more additional work on the new Dubai Metro System. We have – we are still working on three projects on so-called Red Line and we are very happy to have won the first station envelope system for the Green Line. With this new project in Dubai, which we expect to complete in 2010, the total value of our contracts so far in the Dubai Metro System totals over $100 million.

The other project that we have mentioned and made public to the market is a project in Singapore and has been awarded by the National Parks Board of Singapore. The award includes the design, engineering, fabrication, and installation of a glazed facade for the Conservatory Complex at Gardens by the Bay. We expect this work, our first major project in South East Asia, to be completed in two years.

One of the reason why we are exceptionally happy with the Singapore win is that is a difficult project that really caters to an plays to the core strength of this Company, which is the design and engineering of high-end architecturally complex buildings, and we really look forward to working on this project.

These projects along with others in Doha, and New York have proven to us that we can win major contracts shortly after entering new market. This fact also testifies to our unique ability to combine advanced design and engineering capabilities, which again is our core strength and capability.

There are many architectural and engineering firms in the world, but CAE stands out as a one-stop shop for the creation of striking curtain walls and similar elements systems from otherwise ordinary business into genuine landmarks.

Talking about our revenue mix again, this year we expect our international revenue to outstrip our domestic revenue for the first time in a ratio of about 55%-45% and it doesn’t mean that we are basically leaving China and our domestic market behind us and are focusing completely on the international markets. What we will be doing going forward and have already done in the past is really looking for optimal allocation of our resources, which also takes into account our premium design capabilities for which we demand a premium and the cost of capital related with doing business in the respective markets.

A number of governments have around the world announced stimulus packages, including China. We hope this will lead to not only many buildings, but also beautifully designed buildings so that China Architectural can take further advantage of its core strength going forward.

This is actually what I want to share with you on the numbers and briefly on sort of core strength of the Company. I am very happy to take any questions if you have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Michael Cox with Piper Jaffray. Please state your question.

Michael Cox – Piper Jaffray

Thank you and congratulations on a very nice quarter.

Bert Grisel

Thank you, Michael.

Michael Cox – Piper Jaffray

My first question is on the backlog. I was hoping you could provide an update on the mix of the backlog between domestic and international, does it mimic those 55% to 45% split that you’d noted or is it more heavily skewed towards international?

Bert Grisel

What you see is in overall this year we will probably around 55%-45% revenue split. Going forward I think it’s fair to say that if we are at the end of the year 2009 it’s very likely that we will see the split more skewed towards 60%:40% international-domestic, or may be even 65%:35%.

Michael Cox – Piper Jaffray

Okay, that’s very helpful. Could you also describe the impact of the significant commodity price volatility that we have seen? You noted this to some extent in your prepared remarks, but to what extent is this having an impact on project pricing or your expectation for margins going forward?

Bert Grisel

Typically the Company has not entered into any commodity hedging especially on the metal hedging on the metal futures. So what has happened and this is what I explained a little bit in the comments just a minute ago is that our margin has slightly eroded if you want on the back of higher commodity cost increase. Typically if the Company takes on a project it calculates the commodity prices at the moment of tendering, which means that in the, let’s say, past six to nine months, we have incurred the increased price of commodities. The flip side of that is that actually for the project that we have recently won, the benefit now is basically for us and those sort of prices have been fixed at a moment where commodity prices were still higher than they are today.

Michael Cox – Piper Jaffray

Okay. That’s very helpful. And if you don’t mind, a coupe of additional questions. And the – could you provide a mix of government funded project sales of your revenue is in projects that are funded by governments, globally? And then what impact do you see from a project delay perspective that seems to plaguing several construction markets?

Bert Grisel

Okay. First question on let’s say the government sponsored, directly or indirectly, I think it’s fair to say that our international projects are almost all, if not all, government sponsored. In China that makes it slightly lower. To give you a relatively accurate number I think it’s fair to say that on our total portfolio, probably 75% and I could be off by 5%, but – and that’s probably 75% to 80% to be exact will be at the end of the day directly or indirectly government sponsored.

Michael Cox – Piper Jaffray

Okay. That’s fair and my last question, on the U.S. side, if you could provide an update on the project pipeline or bidding activity, as your building presence in the United States.

Bert Grisel

Yes. Look, it’s – this Company is almost like investment banking that I was in until recent meaning that you have to build credentials basically before you become credential in new markets. I think it is clear that if we have done all sorts of projects in China or in the Middle East, the response from parties that we talk to in the United States is that’s all very nice and interesting, but we first want to see a project that’s actually in the States. Hence, as a matter of fact, we have of course won our first project in New York, New York 100 and on the back of that we have at the moment very good pipeline visibility. What I can say on this is that we hope to follow up with an announcement before the year ends that will highlight the fact that we have further strengthened our foothold in the United States, which clearly is a core market for us, going forward.

Michael Cox – Piper Jaffray

That’s great. Thank you very much.

Operator

Our next question comes from Jeev Roshafan [ph] with Westpark [ph]. Please state your question.

Jeev Roshafan – Westpark

Hi, good quarter guys. I wanted to see if I can get a little breakdown on the backlog from 2009-2010, going forward basis.

Bert Grisel

Yes, 2009, just to give you a rough feel, will provide us with more revenues than 2008 already altogether including our goals for the last quarter. If you break it down, it’s probably fair to say that around 20% of our backlog now stretches out into 2010.

Jeev Roshafan – Westpark

Okay, great. And then as you look at your comparatively lower priced offering, how will this benefit you going forward in the tighter credit markets?

Bert Grisel

Well, let me sort of answer that question in maybe a slightly different fashion. It is not our intention to completely use our cost advantage or lower cost base compared to our competitors to win projects just on price. We really command a premium certainly for the international markets that we are into. And the reason why we are adamant on commanding a premium is that we are an asset-light Company. We don’t have our own production. We only have designer and engineers and a finance and admin staff. So from that perspective we are pretty flexible, which we also regard as a key competitive element. In other words, it is not that we take on the project at a very low cost, because we have a gap in our resources or profits of resources. It is really because we feel we want to do that project and we want to be – or in a decent margin on that. Having said that, it clearly is of course a core flexibility that we have in terms of our lower cost base. And when – and when sort of let’s say the backlog number would dry up a little bit going forward, it would give us more flexibility and dry powder to move around with the price and the margins. But as evidenced by the backlog that we’ve built up, that is not necessary for the time being.

Jeev Roshafan – Westpark

Last question. Have you seen any other areas – obviously you have done really well moving into the Middle East – as possible growth opportunities?

Bert Grisel

I think clearly the Middle East is not one Emirate. It’s a relatively big area. We have been successful in obtaining mandates in Dubai, and Doha, Qatar, and we also think that we are – we stand a decent chance to add one or two other countries in the Middle East next to the two just mentioned. Clearly, the U.S. is a market that we have put a lot of emphasis and we actually that the combination of China, the U.S., and the Middle East for the time being is really what the Company should be focusing on. If I can just take that one step further, for instance, if we would go into Eastern Europe, Western Europe, what you will see is that more than in the Middle East and in the U.S. you basically have to build up your credentials almost city by city, country by country. If you do a nice project in France it doesn’t mean that you are going to be successful in London or in Moscow or other cities. So, in other words, the penetration of those markets is a bit more fragmented and will be more difficult. And given the fact that we are in a tight credit environment, we have to allocate our resources as efficiently as possible. We will focusing really on the three core markets we just discussed. That doesn’t mean that we are not looking at Western – Eastern Europe altogether. It is a market that we would love to sort of go into, but at the moment it’s probably fair to say that we have our hands full on the three market we just discussed.

Jeev Roshafan – Westpark

Thank you very much.

Bert Grisel

Thank you.

Operator

Our next question comes from Matt Schwartz with JLF Asset Management. Please state your question

Matt Schwartz – JLF Asset Management

Hi, good morning.

Bert Grisel

Good morning.

Matt Schwartz – JLF Asset Management

Given the move over the weekend to I guess close to $600 billion stimulus package coming out of China and the focus that they claim it’s going to have some infrastructure spend, is it fair to say that you guys could benefit significantly from this?

Bert Grisel

I would love to sort of say that, but I think before I answer the question I need to sort of take back one of those stuff. China has announced approximately $600 billion in a stimulus package. It has indicated that it would love to see basically low-cost housing benefiting from that stimulus package as well as infrastructure. Clearly, our Company is not uniquely positioned nor do we want to for the residential sector and/or for the low-cost housing sector. On infrastructure, infrastructure is of course broader than what we do, but we – yes, we will encourage the Chinese government to continue with it’s also spending on the high-end architectural design and on that front I am not sure that we can say that we will sort of significantly benefit from that, but what we do see and what we can share with you is that we have seen increased, let’s say, enquiry activity around certain projects and have been approached for certain projects to assist them on, let’s say, the future designs gong forward. But I think to be perfectly honest and to be conservative, it is too soon to tell if we are going to really benefit from that. We are not sort of calculating or budgeting a tremendous uptick from that.

Matt Schwartz – JLF Asset Management

Okay. Thank you.

Bert Grisel

Thank you.

Operator

Ladies and gentlemen, there are not further questions at this time. I will turn the conference back over to Mr. Grisel for closing comments.

Bert Grisel

Very good. Thank you, ladies and gentlemen very much for listening to the results of China Architectural. One thing that I want to share with you is that we would love to have an open dialog with investors. We think some times it’s difficult for us to convey the right story or to get the right sort of a lending air from investors to mention why this Company is perfectly unique and it’s difficult to encourage other companies. We will make ourselves available for face-to-face meetings in the first week of December if investors are happy to sit down with us and have us talk (inaudible) the coordination together with Piper Jaffray for these meetings. So I am only looking forward to seeing you in person and sharing basically the information and knowledge that we have on the market and the Company with you to increase transparency and visibility from our side.

I wanted to thank you very much for staying tuned on this conference call and again if there are further questions, please refer to Haris Tajyar from IR International or to myself directly. Thank you very much.

Ken Yi Luo

Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect.

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