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Executives

Jeffrey Kang - Chief Executive Officer

Frank Zheng - Chief Financial Officer

Will Davis - Chief Marketing Officer

Wanyee Ho - Investor Relations

Analysts

Amir Rozwadowski - Barclays Capital

Mike Walkley - Piper Jaffray

Brian White - Ticonderoga

Quinn Bolton - Needham & Co.

James Faucette - Pacific Crest

Scott Dale - Unidentified Company

David Wiseman - Jefferies & Co.

Cogo Group, Inc. (COGO) Q4 2009 Earnings Call February 4, 2010 4:30 PM ET

Operator

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Cogo Group Inc. fourth quarter 2009 results conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions)

I would now like to turn the conference over to Wanyee Ho, Investor Relations Director; please go ahead ma’am.

Wanyee Ho

Thank you Lisa, and good afternoon to everyone. I’m Wanyee Ho, Cogo’s Investor Relations, Director and I'd want to thank you all for joining us today to participate in Cogo's unaudited preliminary 2009 fourth quarter earnings conference call.

After the market closed today, Cogo issued a press release reporting final unaudited financial results for the quarter ended December 31, 2009. This release can be accessed in the Investor Relations section of Cogo’s website at www.cogo.com.cn and on most other financial websites.

The discussion today will be hosted by Jeffrey Kang, Chairman and CEO, who will discuss the company’s business operations; Frank Zheng, our CFO, who will report the company’s financials; and Will Davis, our Senior Vice President of Business Development and Chief Marketing Officer who will discuss guidance.

Before we begin, I'd like to remind everyone that the call today may contain forward-looking statements regarding future events and the financial performance of the company. We wish to caution you that such statements are just predictions, and actual results may differ materially as a result of the risks and uncertainties inherent in the company's business.

We refer you to documents that the company files periodically with the SEC, specifically the most recently filed Form 10-K, as well as the Safe Harbor statement made in today’s press release. These documents contain important risk factors that could cause actual results to differ materially from those contained in the company's current projections. Cogo assumes no obligation to revise the forward-looking information contained in today's call.

At this time, I'd like to turn the call over to Jeffrey. Jeffrey, the floor is yours.

Jeffrey Kang

Thank you Wanyee, and thanks to everyone for joining our earnings call. I’d like to start off with a few key points to highlight on this call. Number one, we plan to make sure we generate our revenue growth rate in 2010 versus 2009. We are able to grow 7% in a very challenged 2009 Q4, to extend the high growth this year.

Second, we expect to expand our operating margin nicely in 2010 versus 2009. Third remain very confident in the growth prospects of our industrial business, particularly in the small grade and smaller meter areas. Our railways and auto electronics business are also poised to grow in growth in 2010. Despite concerns about the changes in many parts in China, the industrial programs are part of the three to five years plan that are affected by wage and the partnership.

Four, after the slow start, the 3G handset market in China is starting to show signs of life, and we are to benefit from this growth in 2010. Fifth, we believe that our telecom business will face better than expected in 2010, not only driven by the continuous 3G spending, the new fiber-to-premises building and the rollout of the new PC and networks.

Six, we continue to see strong opportunities in our SME business, and the SME business in China typically don’t restate large amounts of credit, so that any slowdown in mending typically has an effect on SME annually.

Seventh, we expect a progress in establishing new supply partnerships with the leading global semiconductor players in 2010. Finally, we believe that our authorization of another five million share buyback is strong indication of our place in the current business trend.

Now, onto some financial data; during the fourth quarter of 2009, Cogo posted revenue of $88.1 million in U.S., up 7% year-over-year and up 7.4% sequentially. Our non-GAAP EPS diluted was $0.19, which is at its higher end of our guidance, $0.18 to $0.19. Our gross margin, 14.5% was up slightly sequentially, and our non-GAAP operating margin up 8.4% was down slightly sequentially due to the higher operating expenses associated with some year end bonuses and a one-time impairment charge with the fixed asset.

For the year 2009, we expect to post a revenue of approximately $306 million in U.S. Our three year non-GAAP EPS diluted is expected to be around $0.54 and our gross margins is around 14.4%. Cash balance is expected to be approximately USD 115 million, which including $17 million in pledged bank deposits. Our operating margin should be slightly seasonally weaker across the quarter and then begin to move higher as we go through 2010. We should end 2010 very close to our target of 10% operating margin.

In the fourth quarter, our industrial business represented nearly 16% of total business. This segment grew roughly 100% year-over-year and increased about 25% quarter-over-quarter. Digital media made up about 28% of our total revenue, representing a sales increase of 1% year-over-year, and an increase of 4% quarter-over-quarter.

Telecom represented 25% of total revenue, showing a sales decrease of 9% year-over-year, and increased 7% quarter-over-quarter. Service business represented about 1.4% of total revenue, with revenue increase of about 35% year-over-year, and about 7% quarter-over-quarter.

In the fourth quarter of 2009, Cogo added a three blue chip and 22 SME customers. At the end of 2009, Cogo had 80 blue chip customers and 1,340 SME customers, up 4% and 2% from the previous quarter, and up 16% and 13% from the previous year respectively. More than 90% of these customers are long term repeating customers.

Average revenue per user ARPU from the blue chip customer in the fourth quarter was USD 748,000, down 2% sequentially and down 5% from previous year period. ARPU from SME customers in the fourth quarter was USD 21,000, up 19% sequentially and down 12% year-over-year. Currently our revenue is approximately 70% from blue chip customer and 30% from SME.

Over time, we continue to expect this ratio will move to 50/50. Currently our penetration to the [RSME] addressable market is less than 1%, assuming 160,000 innovation based SME in China. We expect our SME strategy will be an important contributor to our extensive high growth in 2010, as well as our operating margin expansion.

Overall we are very pleased with Cogo’s business results in the fourth quarter, and we are excited to turn page from the 2009 and look ahead to 2010. We expect to return the higher growth value in 2010, and we are excited about a variety of growing revenue streams, particularly in our industrial and smaller and medium enterprise segment. The increasing opportunities within the automobile sectors, combined with the HDTV roll-out continues telecom build-up, and improves demand for our 3G handset.

I do like to make a few brief comments about our Chinese economic situation. There has been a lot of discussion about the moderation of the long growth within china in within a weak. I would like to make a few key points here; number one, the large industrial projects within China are part of the three to five year projects that in our view will not be affected by the changes in [monetary producing]. Instead changes in the monitory product are more focused on the asset classes like the real space. I feel that the growth of our industrial business speaks for itself and we expect strong growth to continue. Our pipeline is vast and we continue to add new customers.

Second, since SME typically doesn’t relay on credit, any short term changes in monetary products won’t affect their business. We remain optimistic about the Chinese government monitory and physical policies and our visibility into spending for the non governmental projects, like the SmartWave, [SmartLeaver] where we continue to increase. We continue to remain confident about the inflation that is under control and we have modest and relevant wage inflation. In fact the job market has been relatively soft allowing us to hire great tenants at a reasonable cost.

Let me discuss a few highlights from our business segments, starting with our Industrial segment. As we have highlighted in our recent press release, Cogo is an active participant in rapid growth of modernization of China’s electrical grid, and the nationwide upgrade of electrical meters to a Smart Meter. The annual capital expenditure on China’s Smart Grid is estimated to reach 280 billion Yuan by 2011, from 180 billion Yuan in 2010. For the years 2009 to 2011, the capital expenditure on the Smart Meter is expected to be at around 50 billion Yuan.

We believe that the electric network could be more than 1,000 times larger than this internet. While China’s internet penetration rate is low at just over 22%, it’s already the world’s largest internet population. Electricity access will eventually be available to everyone in China and we see tremendous opportunities in this area.

Additionally, we are currently benefiting from the high speed railway infrastructure build out in China. We’re beginning to record a revenue in the calendar quarter with BYD Auto Electronics. We’re expected to be able to add more automobile customers in 2010 in this launch of revenue growing end market. Our major components in the industrial segment are leading global semiconductor players like [Inaudible].

In the longer term, we see the potential in the cleantech security and the medical sector. While some of our end market customers has acknowledged and utilized our industrial segment as different from the core segments, the business model is exactly the same. Cogo is the gateway for the component suppliers wanting to do business in China, and that will accelerate the go-to-market for our customer.

Our industrial business continued to carry a gross margin higher than our profit average and we expect this to remain the case for the foreseeable future. In many trends, the handset industry in China are improving. We expect the domestic China handset market to grow approximately 10% in terms of the units in 2010, compared a roughly flat growth rate in 2009. We expect to benefit as domestic handset vendors gain shares through export.

Overall, mobile has a demand that’s roughly flat sequentially for Cogo in the fourth quarter and we believe that the handset supply chain is roughly equilibrium and the handset entrance into China appear normal. In 2010, we expect to benefit from a number of growth drivers in the digital media segment. We believe China handset vendors will work to aggressively drive down the cost of Smartphones to the $100 level, and this should help to drive incremental Smartphone demand for both domestic consumption and export.

We have announced design wins on both Android and Windows Mobile platforms, and we don’t expect that the issues surrounding Google will affect our business, and the majority of the Android products work well for the export, and the group of the Smartphone market is bigger than one platform. We expect handset vendors within the SME segment of our business will pursue the Smartphone market, including WCDMA, and we expect to benefit from these trends.

We expect the 3G handset trend will improve in 2010, and we’re seeing increased numbers of the 3G handset in the market. Additionally we’re seeing the new 3G handset products ramping with the significantly higher content of Google. We review this trend as intelligent. From our condition of these two media business, we expect to benefit from the roll-out of HD in China to the news paper boxes and a variety of the converter devices and mobile internet devices, including the e-book devices.

Our telecom business grew 7% sequentially and we’re expecting our telecom business will grow in 2010, although it will for public grow more slowing than the digital media business. 3G spending is a cost saving, as well what we have expected and we’ll know the new phases of the 3G bill beginning in the first quarter. The full national 3G coverage is still not completed yet and is not close to matching the 3G coverage.

Additionally, we participated in optical wire-line and connectivity businesses. So our business is connected much more than the rollout of 3G. The broadband demand is increasing and we are seeing strong order patterns for fiber-to-Home and G-PON. Finally we are starting to see strong opportunities as China mobile begins to rollout the TTN, which is where we place the conditional SG&A networks and well increased capacity to prevent FMX in the network.

Relationship with Huawei, Huawei-3 Com, ZTE, Alcatel Lucent should continue to benefit Cogo as we are all likely to be share gainers in the Chinese wireless market. Additionally, Cogo benefits from the continued rapid international growth of Huawei and ZT in the telecom sector.

I would like to briefly discuss our M&A strategy. We are very pleased with the integration of the Mega Smart, which contributed about $4.4 million in the fourth quarter. We maintained our guidance for Mega Smart to contribute $15 million to $20 million in the first year after closing. We remain committed to pursuing a successful acquisition strategy that is instantly accretive and a good cultural fit within our existing corporate structure.

With that, I would like to turn the call to Will to discuss our guidance. Will, over to you.

Will Davis

Thank you Jeffrey and good afternoon everyone, and thank you for joining our call. In the first quarter of 2010, we expect that our revenue will be in the range of USD 70 million to USD 72 million, with non-GAAP EPS diluted of $0.13 to $0.15. The entire growth rate of about 11% at the low end of this revenue range will be the fastest year-over-year growth we’ve seen in many quarters.

We expect gross margin to remain roughly stable for the fourth quarter, in the range of 14% to 15%, and we anticipate continued good OpEx discipline that allows us to pursue profitable new opportunities, particularly within the industrial and SME segments. We are not providing full year annual guidance for 2010; however, given our increased confidence in the Chinese economy, our growth prospects within the industrial business and the SME space, coupled with increasing visibility within our digital, media and telecom segments, we expect to clearly accelerate our growth rate in 2010 versus 2009.

We expect to continue to broaden our customer base and see opportunities to gain share against some weakened competitors, particularly given our strong capital structure. Additionally, we expect to continue to add new component suppliers in 2010, while also enhancing our status with current key suppliers like Broadcom, Freescale and Atmel. We anticipate to further broaden our industrial business to include even more verticals in 2010, after adding recently the automotive electronic sector.

Here are some specific guidance items to help you model in for the first quarter of 2010. Non-GAAP operating expenses for R&D and SG&A in the first quarter should be approximately $4.5 million, split approximately 25% for R&D and 75% for SG&A. As indicated, we maintain our longer gross and operating margin targets of 15% and 10% respectively.

Interest income in the first quarter should be around USD 400,000 and we would expect that to remain roughly constant over the next few quarters. We continue to estimate our non-GAAP effective tax rate to be around 8% in the first quarter of 2010, keeping that through 2010 and 2011. For the first quarter of 2010, stock compensation is estimated to be around USD 2.3 million, which will likely be split evenly between R&D and SG&A.

Acquisition related cost including amortization and then impairment of intangible assets will be approximately USD 1.2 million. Total diluted share count will probably be around 38.5 million to 39 million shares. Other than those items noted above there are no significant differences between GAAP and non-GAAP results.

With that, I’d like to turn the call over to Frank Zheng, our Chief Financial Officer.

Frank Zheng

Thank you, Will. Good afternoon everyone. For the clarity, all the figures I’m discussing here, unless otherwise noted are in US dollars. Typically now in our fourth quarter results, we do not have a fully audited balance sheet and cash flow available, but we remain very comfortable with our capital structure and our ability to pursue opportunities within the three key potential use of our cash, including buyback, use of a working capital to fund growth and MA.

During the fourth quarter, we bought back approximately 365,000 shares at an average cost of about $6.25. At this time we announced that we received authority from the board, to purchase up to additional five million shares. We continue to view strategically equation of our share as an important element of use of our cash.

This concludes my remarks. Thank you everyone for joining the call to discuss our 2009 fourth quarter unaudited results. At this time, let’s turn the call to the operator to open the floor for questions. We will look to end this call around 5:30 pm. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Amir Rozwadowski - Barclays Capital.

Amir Rozwadowski - Barclays Capital

I was wondering if we could dig a bit into sort of some of the trends that we’re seeing in the cost for your key end market Jeffrey. It seems as though in thinking about progression, the handset market seems to be recovering for you folks. Digital media seems to also be progressing very well; you’re gaining further exposure in the industrial arena.

If we think about sort of the handset arena specifically though, we’ve seen some tempered trends in 3G adoption, particularly on the TD-SCDMA side, which we believe that you folks have exposure on TMMB. I was wondering if you can address that a bit and sort of how you see that pick up rate over the course of the next year.

Jeffrey Kang

Great, I would guess that we are seeing that 3G trend is improving and we’re seeing especially in the sense of the fourth quarter of last year, we are seeing that China mobile is really starting to ramp up the 3G handset business. They’re planning to have less backend. China mobile is planning to adopt around $30 million of TD-SCDMA 3G cell phones in 2010 and many of our customers like Huawei, ZT, they’re already increasing their order to us in this quarter and the next quarters.

We usually have the higher compound or higher ASP for the sales to the TD 3G cell phone, because in China typically almost every 3G phone is a computer with a SCMMB mobile standard format there. So we have the higher ASPs on the TD cell phone. So we are seeing this trend is very encouraging and I’m very confident it will bring a decent revenue to us in this current quarter.

Amir Rozwadowski - Barclays Capital

If I may ask, it seems you folks have announced some of the share repurchase program. Historically one of the primary usage of cash was to look and acquire to non-vendors who you can then use and leverage your scale and relationships with. Can you talk a bit more in terms of your acquisition strategy? Are you focused on additional opportunities to bolster some of your end markets or for the time being are you sort of stepping back from your acquisition strategy?

Jeffrey Kang

We feel we are quite aggressively looking for the acquisition target. As you know we have a lot of cash, and Cogo, we always run a very profitable business every quarter. So right now, I plan to get the express. Right now we believe we have enough cash to do both the buyback, and acquisition and also financing our internal organic growth.

So basically we are this year looking for some deals, particularly in two segments; one is in the industrial segment like the mega smart deal which looks very successful to us, and others which we are trying to dig up some of the opportunities in the digital media side, especially for the mobile internet device and kind of the factors. So we are very confident we are able to find more deals, more accreditive deals and to help Cogo grow faster in 2010.

Operator

Your next question comes from Mike Walkley - Piper Jaffray.

Mike Walkley - Piper Jaffray

Just a quick housekeeping question for Frank; is 8% the proforma tax rate that we’re using for the fourth quarter; and there’s a question maybe for Jeffery; certainly pointing out to a much stronger growth from the 7% growth in 2009, can you touch on any potential other catalyst such as maybe 3G outside of TD. Are you seeing any pick up in WCDMA and EVDO, and if so would Cogo benefit in those things like Portability, Siemens, a better driver than what you have given us today. Thank you.

Frank Zheng

I’ll answer the tax questions first. The tax rate will be constant for the next two years; around 8% to 9%.

Mike Walkley - Piper Jaffray

8% in the quarter?

Will Davis

It was right about 8 Mike for the fourth quarter.

Frank Zheng

In terms of the business trend, yes in the 3G segment that we just emphasized on HDTV and LAN part in China since the fourth quarter and we are very confident about the TD business in 2010, and especially for Q1 we are seeing increasing order from our customers like Huawei, ZT, ChinaWards, many of the Chinese, the major TD telecom provider and they increased their order to us in the first quarter.

In addition to the TD 3G, the TD mostly it focuses on China’s domestic market. We’re also seeing that WCDMA trend is very encouraging. So we believe this year WCDMA adoption in China will also increase. I think that it does increase and probably what started is in the end of Q1, and that the driver actually, one thing is from the China’s domestic market.

Secondly, I think more importantly, the driver is coming from our cell phone customers who are at least able to export the WCDMA and our 3G cell phones to international markets, to compete and again shares from the conventional and the global leaders in a global market.

So that’s another catalyst allowing the goods to trend to us, to increase our 3G cell phone of related revenue in this year. So we think this year, in addition to the TD business, we’re still going to save us some demand from WCDMA, kind of unique deal business in 2010.

Mike Walkley - Piper Jaffray

It’s certainly encouraging to see the stronger growth trend; do I have a right in understanding that industrials practice growth, and kind of the digital media would be second and then telecom is still going to grow based on a little bit of visibility from export trends. Also just question on automotive; is that included in industrial, or is that going to be a new business segment as that grows longer term?

Frank Zheng

Currently the automobile is part of the industrial business. We just started to record our revenue since the first quarter of this year. That’s the part of the growth driver of the industrial segment since this year, but you’re right, we still believe that industrial will be fastest growth driver among our sectors. So our Smart Grid, Smart Meter business is very good this year, and we add the railway and the auto electronics business this year.

So once each segment becomes much bigger than what we are having today, we might divide them sector by sector, but at this moment, we just try to put all of them in the bucket of the industrial segment, because that’s what is our fastest growing growth driver in the next few quarters.

The digital media have the second growth and our fastest growth among our sectors. I think the major growth driver comes from our HDA in China. That will be in the near term and a very visible comment and a growth driver in China. Growth kind of actually is our major partner in this segment, so we’re going to grow with our partners into Chinese market and we’re going to be dominant in this market in the next few quarters.

With that yes, the telecom business, even though the growth rate it is the most among all our sectors, but at last we are going to see that the growth is here and growth driver, not only by our 3G rollout; we’re still seeing a very different demand from the broadband related to area like the ADS sale, the G-PON and also most registering in the PTM networking to replace the traditional SDH for China Mobile.

All of this trend combined together give us a very good indication that this year we’re going to accelerate our growth across every segment of the business we’re doing right now in China.

Operator

Your next question comes from Brian White - Ticonderoga.

Brian White - Ticonderoga

Jeffrey, on the industrial business, it’s going to be the fastest grower, what type of growth should we think about this year?

Jeffrey Kang

I think Will, can you answer this question?

Will Davis

Yes Brian, we don’t give 2010 guidance. I mean I would say that we basically doubled at this quarter year-on-year. Obviously that growth in probably not going to hold, but when we start looking out to next year, clearly it’s going to be growing at multiples of our overall growth target. So I assume some slowdown from the 100% year-on-year growth that you saw this quarter, but it going to still be very, very strong.

Jeffrey Kang

The estimate is that the industrial sector could have over 20% of our total revenue, to 25% of our total revenue and that’s our external target to grow this business. So that will translate it into like a strong and high growth to us in 2010.

Brian White - Ticonderoga

Jeffrey, what is your general feeling about shipment into the Chinese New Year on the overall phone we’re approaching soon? Maybe just commentary on Chinese New Year?

Jeffrey Kang

I think it’s very strong and if you ask me now, I will tell you it’s very strong; and if you ask me one month later, I can tell you it’s stronger than what I expected, but basically I think that if you look at the driver of our business, the first thing was the infrastructure investment. In the pipeline it’s still very visible and very strong and continues to have a very stronger growth in the segment.

The second, which is you know surprisingly the Chinese consumer spending. It’s very strong, the market is stronger than anybody expected in the beginning of last few year, so that’ll give us all surprisingly good results in the past few quarters and in this trend also I believe the consumer spending will continue grow dramatically in this year.

The third one is divesting and picking up of the exporting business of the most high end electronics business. So combining all the three sectors, what we say is only one thing; it’s good; it’s better than what we expected. So that’s what we feel at this moment.

The Chinese New Year this year will be a very good year. So we’re going to see inventory in our pipeline. So the only thing, we are not going to worry about is demand in the near term, but the only thing we need to worry about is if we can allocate it that good to meet our customers demand.

Brian White - Ticonderoga

Just really quickly Jeffery, you talked about China Mobile looking for 30 million 3G handset this year. What is the overall 3G market handset projections in China for 2010?

Jeffrey Kang

That could be a wide number and when you’re talking about 3G number, I think it includes the 3G cell phone design made in China and it will be sold into the international market. So I think that number could easily go over anywhere from 100 million to 200 million unit. So for Chinese domestic market, we see conservatively anything above; if you add the 3G, WCDMA; I think anywhere from seven million to 50 million unit

Operator

Your next question comes from Quinn Bolton - Needham & Co.

Quinn Bolton - Needham & Co.

Jeffrey, the first is just a follow-up on that 3G activity that you are seeing now. Is there any concern that you are seeing a pretty strong build in promotions by China Mobile ahead of the New Year and it could slow after the holiday?

Jeffrey Kang

Actually, we are using the customer demand, and the first thing, the demand in the near term is very strong and so we’re working very hard to meet our customers demand within kind of a week.

So that gives us a very good indication to say at least the Tier 1 TD business is very strong, but based on our existing order pattern, we’re seeing this trend kind of over the second quarter. So from our existing visibility, we’re not going to see any slowing down in Q2 based on our existing order we get. So from that angle we are not going to see any significant slowing down of the Chinese New Year.

Last thing, I want to emphasize, the strong TD trend at this moment is not driven by the Chinese New Year. It’s actually driven by the whole year trend from China Mobile. From that angle we are very confident. Anyway 30 million units that 3G cell phone through the TD itself is a big number, but through the total Chinese number it’s just a single digit in demand. So from that angle, we’re not advising or surprising to stay in TD. We’ll have a very good year in 2010.

Will Davis

I would just follow-up to that, just to kind of give some more perspective on the 3G trend. If you look at total TD subs at the beginning of the year, I think it was about 3.5 million for China Mobile and they’ve got 600 million total subs right. So it’s still a drop in the bucket.

One of things we wanted to point out is that, three or four months ago I was getting investor calls everyday; people asking me, “is China even going to proceed with 3G?” I mean the sentiment had gotten so negative; people thought that the whole network was going to get scrapped. So I think our point is saying that we’re off the bottom, we’ve got new models coming all the time at a lower cost. A lot of those models are much higher ASP for us, so it’s a great trend.

3G is still going to be in limited volumes, but things are up into the right, both in terms of subs, our ASP in minutes. So still small in the overall as Jeffrey pointed out, but relative to it our sentiment have gotten some negative, and I think it’s important to point that things are progressing, we are seeing new face build outs at China Mobile that will start around the New Year, so we’re seeing improvements.

Quinn Bolton - Needham & Co.

So I think you’d mentioned CMMB, but any sense of your tax rate right now on the TD phones?

Frank Zheng

I think the CMMB into the TD phones it roughly anywhere from 30% to 50% tax rate.

Quinn Bolton - Needham & Co.

I know you talked about the industrial business being the growth driver or the fastest growth part of the business in 2010. Any sense how that business behaves seasonally in the first quarter? Does it tend to see similar seasonality to the digital media and the telecom business or could it be more muted than the other two product launch?

Frank Zheng

Basically, they have the normal seasonality, because the Chinese New Year actually is in February this year, so roughly most of our customers have like only two weeks of holiday. So roughly the working hours in the first quarter is much less than the other three quarters. In addition to that and the normal seasonality, I think that industrial demand is relatively good to the normal consumer than you have it. So it is relative stable, because they even have a number order to support the investor business.

Quinn Bolton - Needham & Co.

Lastly, you talked about accelerating growth in 2010 versus 2008. I mean should we be thinking something in the low sort of double-digits, somewhere between 10% and 15%?

Will Davis

Well Quinn, I mean if we ended up the year doing north of 7% growth for the year and then you are putting the low end of our guidance like the 70 million that was a little bit above where the street was, that probably gives you a almost double-digit growth roughly for 2010 if you fill that through. So that’s kind of what we’re looking at, it’s the low end of that.

But like I said, we’re not giving on full year guidance, but we’re trying to make the point that we definitely see growth accelerating nicely this year versus last based on a variety of factors. I think the fact that’s broad based in terms of the strength across a lot of new revenue streams across all of the business segments gives us increased confidence.

Jeffrey Kang

Let me add a few points about our growth perspective in this year. As you know Cogo has been a very high growth company in the past five years. Our average growth rate is around 30% every year, and [Inaudible] this financial crisis. So right now, even last year during the financial crisis, we actually managed our business to grow in the last year, but right now from the market perspectives I think they know we are in one of the faster here in the past year 10 year.

So the end of the market is going to given us a lot of opportunity to grow our business. So then our company adjusted our strategy to refocusing our growth since the end of last year. So we are very confident we are able to extend our growth and return to our normal high growth pattern for this year. So that’s our view of our growth rate, about how we are able to grow our business in the next few years, starting from now.

Operator

Your next question comes from James Faucette - Pacific Crest.

James Faucette - Pacific Crest

First, when we look at 2010 and looking at your growth prospects for each of the different group, are you contemplating doing any acquisitions. I know Jeff you said you were still looking for acquisitions, but does your growth outlook for 2010 right now have any expectation of closing acquisition during the year.

Jeffrey Kang

Not as yet. As well explained, so basically the growth we are talking about is based on the business that we have clear visibility. So basically we’ve got a clear visibility, we will either include it into the guidance or the growth is what we’re talking about. So basically right now the growth potential we are looking at is from our existing business. So the acquisition will bring additional growth rate to us if we are able to close a few deals in this year. That will certainly accelerate our growth rate and even come to a higher growth with the master deal.

James Faucette - Pacific Crest

Great, and then just on share count, in the context of the share buyback that was announced. During 2009 we bought back a fair number of shares, not quite the five million, but the board has approved for 2010, but your share count was going to be about the same if not slightly higher into 2010. Can you talk about what your expectation is for 2010 in terms of exercising the buyback, and how that could impact share count or what kinds of things could cause us to buy down, the acquisitions or what other?

Will Davis

James, it’s an interesting question; thanks for raising that. I think that a couple of things to keep in mind, is that we are going to be strategic about the buyback. So obviously depending on where the share price goes, that’s going to dictate how we act with that, but I think that it’s pretty clear that’s going to be an important use of cash.

There is some impact in terms of share grants from time to time that we do to key employees, which is fairly typical, and we’ve done since the inception of the company. I think that the shares, our diluted shares peak at about $40 million mid-way through 2008, and now we’re above $38 million. That should stay I would say between $38 million and $39.5 million over the next four quarters. That’s depending on how aggressive they get on the buyback obviously. That share count is probably not assuming a super aggressive buyback.

So when I’m modeling this outlook, let’s think maybe “okay, we’re at $38 million now, going to $38.5 million, and then trending up north of $39 million by the end of the year,” so creeping up a little bit, and that’s probably assuming modest buybacks, but that’s not what I would an aggressive buyback mode.

James Faucette - Pacific Crest

Finally, you talked about operating margin improvement during the course of 2010, but yet the gross margin in auto remains about the same at around 15% and you’re pretty close to that now. So as we go through 2010, and we see the operating margin improvements, is the leverage going to come simply from the larger size of the company, or is the best growth of industrial providing benefit there, or can you just talk us through a little bit of what that operating margin leverage is coming from, and how much improvement we should expect for 2010?

Will Davis

Yes, I would say a couple of points there. You’re right, our targets going to stay at 14% to 15%, which was 15% being the target and we’re right in the middle of that now at about 14.5%.

For now that looks like the right gross margin for us in terms of optimally driving growth, and the industrial segment certainly helps keep that in that range, given that it’s roughly 20%. So that helps to mitigate any other issues. In fact the fastest grow, certainly that’s a benefit for us, but most of the leverage is going to come on the operating margins side, and that’s also going to be top line driven.

We will probably have to had some sales people overtime as needed, but as we’ve indicated before, we’re not going to go out and hire 50 people and then have them add to business overtime. We’ll add one or two people over time as needed. So it’s going to remain a very tight ship. We’ll add people where we need it, but as we grow the revenue and we get the revenue run rate back-up towards $90 million to $100 million a quarter, that’s when you can start seeing the leverage go through and getting up towards 10% operating margin.

Not to say that we don’t need to invest in the business from time-to-time, obviously we can do, if we’re going to grow as fast as we think we are, but there will still be leverage in the model definitely, but keep in mind that most of it’s going to come on the operating side and most of it’s going to be top line driven.

I think the other thing too is that if you’re able to execute on SME strategy as we’ve liked to, you’ll be in the process of both recruiting new customers, but also over time adding ARPU per customer. So some of the math that we’ve used before; if you have one sales person handling 20 accounts at USD 50,000 per account, that’s a $1 million in revenue, take average gross margin of not much R&D and then you pay the sales person, you’re getting double-digit operating margin, that’s just as a rough math.

Now, if you’re able to increase that USD 50,000 to USD 75,000, that’s where the leverage comes in. So it’s a combination of adding new customers, but also increasing the penetration adding to that kind of the ideal scenario.

Operator

Your next question comes from Scott Dale – Unidentified Company.

Scott Dale – Unidentified Company

First just a quick clarification, Will, did you say that OpEx for the first quarter would be 4.5 million on a pro forma basis.

Will Davis

Yes

Scott Dale – Unidentified Company

And then in terms of the guidance for the first quarter, if you’re obviously looking for some seasonality I think the low end of the range implies about 20% down. If I look back over the past couple of years, you’ve got some growth modes [Audio Dip]. Is particular reason for it, is there a kind of a switch in terms of the mix of your business or is it you guys just being cautious as we are going into the first quarter.

Will Davis

The sequential decline has bounced around, and the angle is down about 15% in the first quarter 2008, and then 23% in the first quarter of 2009. So our guidance kind of implies somewhere in the middle there. So I wouldn’t say that there is anything that unusual going on.

I mean the Chinese New Year, we are expecting strong demand, but the Chinese New Year, you can’t get around the fact that production slows; that’s just a reality so there is going to be seasonality.

However just generically speaking, when you look at our business trends like the improving consumer, all of the new revenues stream that we’re starting to see, weather its auto or HD, we’re starting to see the 3G handset business pick up, I think that the telecom business is probably stronger now than we thought it was going to be; you layer all these things in and I think we are set up for an order book that’s better than what we thought and I think that really is going to play out nicely for us in the first half.

Scott Dale – Unidentified Company

Maybe follow it on that the 3G point, you had indicated earlier about the WiBAN tax rate extending for the CD attach rate for CMMB being at 30% to 50% range. Is CMMB filing its way into WiBAN CDMA phones and EVDO phones right now, and if you could as well, you talked about the WiBAN CD may export opportunity, is the dollar content there increasing as well, and what’s you expectation for how big that can be for you guys in 2010.

Frank Zheng

Because from the technology angle that CMMB is able to attach with any standard of 3G cellphone, but in China because of the political raising, so legally it’s only allowed to about the CMMB standard into the TV cellphone, so that’s why we’re talking about our tax rates with CMMB with TV. Because CMMB is from a standard adopted by the Chinese government for the mobile standard in China, so we are I think the only application, they’re only used for the Chinese domestic market.

Another trend we’re seeing is this year is very interesting. We’re going to see many exports in the cell phone still in variable ways [Inaudible] function available. So from that angle we’re seeing a more content or the ASP increasing opportunity where the existing GSM and WCDMA cell phone are exporting business. The Chinese domestic application is CMMB, the major mobile TV content for that telecom segment.

Scott Dale – Unidentified Company

Jeffery, how big do you think the widening CDMA export market is for you guys?

Jeffrey Kang

This number is very, very unpredictable at this moment. WCDMA exporting business mostly in the past, mainly from a few big players like Telecom Major, WCDMA sales will export to the global market, but this year we believe many middle sized telephone design companies in China, they are already getting their license from QualiCom. Around 40 of them already get a license from QualiCom.

Also in this year, Broadcom and [NCK] are able to provide those WCDMA base into the Chinese market. It’s of course some more middle size enterprise cell phone customers who produce the WCDMA cell phone. So we’re going to see this market that will have to exclusive growth opportunities, but right now it’s a little harder for us to give out a number about how big it could be.

So we consecutively think about it as a number that’ll increase dramatically. Additionally the incremental number could have been over like 50 to anywhere to 200 million units, depending on how quickly the WCDMA market, the technology becomes mature in the Chinese vendors.

Scott Dale – Unidentified Company

Just two quick follow-up or other questions, 10% customer traditionally has being Broadcom, but you guys have been talking a lot about Freescale and Atmel. Do they get to be 10% type customers this year or someone else who can creep into that category?

On the auto side of the equation, dealing with BYD you are making good progress there. You’ve talked about targeting some other players; I mean, what’s going to constitute success in the auto market in 2010? Is it adding one or two more domestic OEMs, or do you thing there’s an opportunity for one or two falling out as well?

Jeffrey Kang

Broadcom have been our biggest department of buying since many years ago, but our business with Broadcom grew dramatically in the last year and we’re also believing this year our business, we have a very big revenue portion associated with Broadcom that we are going to stay continued in. Our business growth was associated with the Broadcom related business, because Broadcom always is able to provide from the new chipset into the Chinese market, and that we are able to benefit from that trend.

For example; last year we must note that SDG rating [Inaudible] when Broadcom had a very low single chipset solution, we were able to immediately find a customer in China who can advise about the chipset [Inaudible]. So that business alone will grow from a scratch to very big numbers this year, so that’s one of the reason why we’re continuing to see our business with Broadcom increasing dramatically year-over-year.

In addition to that as you said, we will also see other businesses like Freescale, Atmel, Panasonic and with many other semiconductor suppliers that business also continues to grow strongly. For example with BYD, our first automobile customers, and also we have a very big auto plan in the next five years. So BYD is our first customer, we’re continuing to add a few customers in our pipeline this year, which will include [Inaudible].

Currently, China is already the largest open market, but in most parts the major players has been adopted by the GM, Volkswagen, etc. but that’s the trend we’re seeing. This trend is very same like what happened in the telecom segment two years ago.

In the first step, the home market and most of it was dominated by foreign players, and then also had a few domestic good players come up by Huewei. Again we’re going to see the Chinese domestic vendors locating the marketing shares significantly year-over-year, but for Cogo, BYD is our first customer and we’re going to say, we’ll have more in domestic and international customer into our customer list very soon in this year.

Operator

Your final question comes from David Wiseman - Jefferies & Co.

David Wiseman - Jefferies & Co.

I had a quick question and just very quickly on the percentages for SG&A and R&D; is there anyway you can just break that out for the Q4 numbers?

Frank Zheng

SG&A about $3.6 million and R&D about $1.7 million

David Wiseman - Jefferies & Co.

Okay one last question, I know you don’t really provide that much on the balance sheet, is there a way to just get enough cash status there?

Will Davis

Net cash, it’s unaudited, but it looks like its going to about $98 million. Some here is for M&A a little bit, and working capital probably about flat, but then obviously about 2.5 million for the buyback.

Operator

Thank you, and I am showing no further question at this time.

Jeffery Kang

I am encouraged by Cogo’s results in the fourth quarter 2009 and very optimistic about the 2010. We are using our strong balance sheet to help drive growth and buyback stock and we see tremendously opportunities in both industrial and segment and with new small medium enterprise customers.

The 3G handset situation is improving and opportunity or any competitiveness is probably better than popular opinions. I would like to reiterate that we feel that the worst of the Chinese economy is probably behind us and we are ready to move forward into the high growth and the margin expansion in 2010.

I want to take this opportunity to thank all of Cogo’s believers, employees, customers, planners and announcement shareholders. You have provided Cogo with opportunities to deliver robust and steady growth in the past, and we appreciate your support as we enter into a higher growth phase. Management its committed to driving higher growth and providing significant returns to our shareholder.

Thank you again for joining this call, and I am looking forward to talking with you soon. Thank you.

Operator

Ladies and gentlemen, this concludes the Cogo Group Inc. fourth quarter 2009 results conference call. This conference will be available for replay through February 11, 2010. You may access the replay system anytime by dialing 1800-406-7325 or 1303-590-3030 and entering in access code of 4202462.

Thank you for your participation. You may now disconnect.

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Source: Cogo Group Inc. Q4 2009 Earnings Call Transcript
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