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China Architectural Engineering, Inc. (NASDAQ:CAEI)

2Q 2008 Earnings Call Transcript

August 11, 2008 11:00 am ET

Executives

John Anderson – COO

Ken Yi Luo – Chairman and CEO

Haris Tajyar – Managing Partner, Investor Relations International

Analysts

Michael Cox – Piper Jaffray

Jay Brothmahan [ph]

Alice Ku [ph] from Brussels Capital [ph]

Ken Hartman [ph]

Operator

Greetings, and welcome to the second quarter earnings conference call for China Architectural Engineering, Incorporated. At this time, all participants are in a listen-only mode. A brief 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, Mr. John Anderson, Chief Operating Officer for China Architectural Engineering, Incorporated. Thank you, Mr. Anderson. You may begin.

John Anderson

Thank you. Again, good morning, and welcome to today’s second quarter earnings conference. As our operator indicated, my name is John Anderson. I serve as China Architectural Engineering’s Chief Operating Officer. Also with me today is Ken Yi Luo, CAE’s Chairman and Chief Executive Officer; in addition to some other members of our senior management.

I will shortly be presenting China Architectural Engineering’s second quarter financial results, discuss our new project’s sales pipeline, provide an outlook for the second half of 2008, and then open the call to questions.

Please note that any statements made during today’s call and webcast may include forward-looking statements that could involve a number of risks and uncertainties. Actual results could differ materially from any forward-looking statements we make on today’s call. The risks and factors that may cause differences in our actual results versus our expected results are discussed in greater detail in the company’s reports and other filings with the Securities and Exchange Commission.

Now, following as a summary of China Architectural Engineering’s results for the second quarter ending June 30th, 2008, in the second quarter, we recorded record revenues of $41.4 million, representing an increase of approximately 113% of revenues of $19.5 million from the second quarter of 2007. Perhaps, more importantly, represented a sequential increase over 63% of revenues of $25.4 million from our first quarter of 2008.

Net income for the second quarter of 2008 was $7.6 million or $0.14 per fully diluted share, up 75% on a per share basis of $4.3 million or $0.08 per fully diluted share in the second quarter of 2007, sequentially, nearly 46% higher than our earnings of $5.2 million in the first quarter of 2008.

These strong and consistent growth rates are a clear testament to successful execution of our growth strategy of solidifying our market share in China while aggressively pursuing our international expansion strategy. Our success in both markets continues to be driven by the industry’s increasing demand for our patented architectural design capabilities and growing reputation as one of the highest quality, yet still cost effective providers of glass curtain wall systems in the world. All these adds up to continued revenue and earnings growth, along with steadily improving profit margins as the higher margin global business continues to gain a larger share of the company’s overall revenue.

On the balance sheet, we recorded cash and cash equivalents of $7.8 million on June 30th, 2008, up from $5.2 million at the end of the first quarter. Long term debt in the form of bank loans, convertible bonds, and minority interest totaled approximately $26 million, up from approximately $8 million at the end of the first quarter of 2008.

It’s very clear that China Architectural Engineering has delivered another record quarter across all of the financial metrics, revenues, earnings, and earnings per share. We are especially pleased that the high gross margins from projects outside China are producing the necessary cash flow to more than make up for the additional expansion costs inherent with our global growth strategy, including costs related to interest expense, staffing, and new offices.

Looking ahead, we are currently bidding on $300 million to $400 million in new projects, the majority of which are overseas. Considering our growth rate as well as the architects and locations of these projects, we expect to add at least another $100 million in backlog between now and the end of this year.

In summary, we would like to reiterate that China Architectural Engineering has never been on a stronger position or in its history, and we look forward to (inaudible) you, our shareholders, informed of our progress as we continue to execute our global expansion strategy. Now, we would like to take any questions that you might have.

Question-and-Answer Session

Operator

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

Michael Cox – Piper Jaffray

Good morning, gentlemen, and congratulations on a very nice quarter.

John Anderson

Thank you.

Ken Yi Luo

Thank you.

Michael Cox – Piper Jaffray

My first question is on the composition of the $240 million backlog that you reported at the end of the June quarter. Could you give a breakdown of how much is in China versus international? And then also, could you provide an update or a breakdown as to how much you would expect to record over the next 12 months versus 13 months and beyond?

John Anderson

Well I can answer the first part of your question and that is the China portion of that backlog is about 32%, internationally it’s 68%. I’m going to ask you to repeat the second part of the question.

Michael Cox – Piper Jaffray

Sure. I’m curious how much of the $240 million backlog you expect to record over the next four quarters, over the next 12 months.

Haris Tajyar

Michael, this is Haris. How are you?

Michael Cox – Piper Jaffray

Good.

Harris

Of the $240 million, how much we expect to record over the next 12 months, we can’t – and actually, stipulated to provide that number. However, we can say that a number of that backlog, a large quantity of that backlog, should be recorded, actually, during the next second half.

Michael Cox – Piper Jaffray

Okay. That’s great, that’s great.

Haris Tajyar

In addition, I think it’s important to note that of the $400 million in the short term pipeline, I think it’s fair to say that we are likely to announce new backlog numbers shortly, which would essentially mean that we’re close to winning a nice portion of that $400 million.

Michael Cox – Piper Jaffray

Okay. That’s excellent. Within that project pipeline, are there specific geographic regions that make up a large portion of that or is it spread out through the market?

Haris Tajyar

Of the international portion, it’s specifically the Middle East and the US.

Michael Cox – Piper Jaffray

Okay.

Haris Tajyar

And the remainder would be still China. But the majority is still in the international versus China. It has the (inaudible) towards the international.

Michael Cox – Piper Jaffray

Got you. The SG&A moved higher sequentially, which I assume is tied to the new sales office and just overall sales growth. Is there a level of SG&A spend that we should expect on a quarterly basis on the second half of the year? Is $4.5 million to $5 million per quarter a reasonable run rate?

Haris Tajyar

We don’t have a specific number yet. The biggest driver of the SG&A growth was not only due to new offices, but also additional staff. We hired an additional 100 to 200 engineers since the beginning of the year to handle the growth. So that number is expected to continue to grow giving the staff at number as a continued expansion.

Ken Yi Luo

Haris, Haris. I think –

Haris Tajyar

Yes, Ken.

Ken Yi Luo

I think about $100 million decreased –

John Anderson

We expect to drop back, on your questions, we expect to build out another $100 million this year on the backlog.

Michael Cox – Piper Jaffray

Okay, okay. I see, I see. And then the – from a competition standpoint, has there been any sort of change from what you’re seeing from your competitors now that your company is getting more aggressively on the international projects? They may not have seen you before. Are they responding in any way?

John Anderson

We haven’t noticed that.

Michael Cox – Piper Jaffray

Okay. And then, just one last question, if I could on the balance sheet, accounts receivable jumped up pretty significantly in the cost and excess of – in earnings in excess of billings dropdown. Was there a change in the way something was put – classified there? Or is that just a normal flow through of a percentage of completion accounting?

Ken Yi Luo

Actually that’s (inaudible). No change, nothing’s changing our business.

Michael Cox – Piper Jaffray

Okay.

Ken Yi Luo

Our business is not changing (inaudible) this year (inaudible) in the countries (inaudible) –

Michael Cox – Piper Jaffray

I’m sorry. I think we might have a bad connection there.

Ken Yi Luo

We’re saying that nothing’s changing our business, effectively, accounting and the accounting of building our customers.

Michael Cox – Piper Jaffray

Okay, okay. Great. Well, thank you very much.

Haris Tajyar

Thank you.

Operator

(Operator instructions) Our next question comes from Jay Brothmahan [ph], a private investor. Please proceed with your question.

Jay Brothmahan

Good morning, and congratulations on the quarter. Can you talk to me a little bit about the new regions that you’re looking to get into?

John Anderson

Two regions, consist specifically of the Middle East by the long ways and the United States. We’re also looking at (inaudible) Europe, and more specifically, London or (inaudible). We also have Singapore (inaudible) market area. (inaudible) Did that answer your question?

Jay Brothmahan

Yes, it does. And also, on the contract pipeline, is it safe to assume that all those are for work to be done in 2009?

John Anderson

Yes. Some of those projects will actually extend beyond 2009.

Jay Brothmahan

Well, thank you very much, and congratulations on the quarter.

John Anderson

Thank you very much.

Operator

There are no further questions in queue at this time. I would like to turn the call back over to Mr. John Anderson for closing comments.

John Anderson

I’d like to thank everyone for calling in today, and wish you all the best.

Operator

Excuse me, Mr. Anderson.

John Anderson

We have a question that just came into queue from Ms. Alice Ku [ph] from Brussels Capital [ph]. Please proceed with your question.

Alice Ku – Brussels Capital

Yes, hi. Hello.

John Anderson

Yes, hello.

Ken Yi Luo

Hello.

Alice Ku – Brussels Capital

Yes, hi. Hi. Thank you for taking my question. I have some questions on your gross margin. Can you help me understand why in the first quarter, gross margin improved so dramatically? And then in this quarter, we see a one percentage drop. And I think, when I look at your third quarter guidance, the low end of the revenue is actually higher than the second quarter. But then, the low end of the EPS is flat sequentially. Does that mean gross margin could further decline sequentially?

John Anderson

Haris, would you address them.

Haris Tajyar

Sure. Hi, Alice. How are you?

Alice Ku – Brussels Capital

Hi. Good.

Haris Tajyar

Hi. The first quarter of this year, gross margin had been jumping now because of international revenue contributions, in particular, from our Doha project. As far as the quarter-to-quarter to meet as related to the last quarter, meaning the second quarter gross margin to drop (inaudible). But that doesn’t deal with the mix. It has more to do with pricing. And as far as the third quarter goes, margins could stabilize here or should stabilize here. But will be impacted largely due to the continued expansion, meaning again, more actually related to new offices and/or additional staffing. But as far as the mix goes, we’re still looking to continue to pursue more international business and domestic subtle margins as we continue to focus towards the international side.

Alice Ku – Brussels Capital

Okay. Just a follow on the margins, I understand that – so the international portion is accounting for a bigger and a bigger portion of the revenue base. And you are generating a higher margin from international projects, right? So if I had to look at 2009 and beyond, should the gross margin go up directionally?

Haris Tajyar

It should stay largely between say 30% and 34%. The specific number we don’t know yet and that’s because of the number of new offices that we expect opening, and then the number of staff that we’ve been adding; including a potential CFO, which should be added on the next quarter.

Alice Ku – Brussels Capital

Okay. And another question on the tax rate, when do you start to pay the full tax? When’s your marginal tax rate to end or just add some general comments?

Haris Tajyar

Sure. Well the tax rate was extremely low this past quarter that’s primarily because most – a lot of the revenue from Dubai. As far as continued tax rates going forward, an effective tax rate would be – Jeff [ph], do we have – do you have any comments on tax rates going forward.

Ken Yi Luo

This is Ken. For the tax rate in China, it’s going to be increased from 18% to 25% in five years. So it continues (inaudible) 18% in the year 2008. And then, in another three years, we will (inaudible) to 25%.

John Anderson

This is John. So let’s say that in four years you have the effective tax rate of 25% (inaudible). Therefore, for our international markets, the bond to the tax rate is zero. And that won’t change. I mean it’s the (inaudible).

Alice Ku – Brussels Capital

Okay. Great.

John Anderson

Okay?

Alice Ku – Brussels Capital

Yes. Thank you very much.

Haris Tajyar

Thank you, Alice.

Operator

Our next question comes from Ken Hartman, a private investor. Please proceed with your questions.

Ken Hartman

Yes. How are you doing, guys? Great quarter.

John Anderson

Thank you.

Haris Tajyar

Thank you.

Ken Hartman

I just got one simple question for you, guys. You got to give me all these crazy numbers. Could you just update me on your progress in the Dubai, on the Metro? And at the west conference, you did talk about bidding on additional contracts for $80 million. How is that going along?

Haris Tajyar

As far as the Dubai Metro project, Ken, as far as the Dubai Metro project, we made an announcement when we announced that we were awarded that initial project early this year. And we expect additional projects from that primary project. And I think it’s safe to say that some of that could be or will be in the back half or the second half of 2008.

Ken Hartman

Very good, very good. And everything is on time and no delays on that project, correct?

John Anderson

That is correct.

Haris Tajyar

That is –

Ken Hartman

I’m sorry. You broke up. I didn’t hear it.

John Anderson

Yes. That is correct. The project –

Ken Hartman

Okay. Thank you very much then. Good luck, guys.

John Anderson

Thank you.

Haris Tajyar

Thank you.

Operator

There are no further questions. I would like to turn the call back over to Mr. Anderson for closing comments.

John Anderson

We’d like to thank everyone for their interest in calling in today. We hope to report back with a good third quarter (inaudible).

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

Ken Yi Luo

Thank you.

John Anderson

Thank you.

Haris Tajyar

Thank you.

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