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Executives

Wanyee Ho – IR

Jeffrey Kang – Chairman and CEO

Frank Zheng – CFO

Will Davis – SVP, Business Development and Chief Marketing Officer

Analysts

Brian White – Ticonderoga

Mike Walkley – Canaccord Genuity

Amir Rozwadowski – Barclays Capital

James Faucette – Pacific Crest

Mike Driller – Heartland Capital

Wayne Brown – Private Investor

Presentation

Cogo Group, Inc. (COGO) Q3 2010 Earnings Conference Call November 4, 2010 4:30 PM ET

Operator

[Operator comments]

Wanyee Ho

Thank you Craig, and good afternoon to everyone. I'm Wanyee Ho, Cogo’s Investor Relations Director, and I'd like to thank you all for joining us today to participate in Cogo's 2010 Third Quarter Earnings Conference Call.

After the market closed today, Cogo issued a press release reporting final financial results for the quarter ended September 30, 2010. 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; Will Davis, our Senior Vice President of Business Development and Chief Marketing Officer, who will discuss guidance, and Frank Zheng, our CFO, who will report on the Company’s financials.

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. Our strong execution continued in the third quarter of 2010, as we broke the $100 million revenue barrier in a single quarter for the first time. Specifically, our revenue was $100.2 million, up 22% from the prior year and up 10% sequentially. We easily exceeded our guidance of $94-96 million due to continued solid bookings across all of our business segments with specific end market strength in 3G Smartphones, HDTV, fiber roll-outs, and Industrial areas such as High-Speed Railways, Automotive and Smart Meters. Our revenue in the first nine months of 2010 was up over 24% versus the same period of 2009.

I would like to extend my sincere appreciation to the employees of Cogo, who continue to drive excellent performance, as the Company grows its customer base, expands into new industries, and signs new supplier partnerships. In fact, our revenue per employee has grown 40% since the beginning of 2009. We are continually streamlining our organization to focus our efforts on the areas with the best chance of profitable growth, and our manufacture-less business model allows for a very efficient allocation of capital to respond quickly to changing market conditions.

Our Non-GAAP EPS Diluted in the third quarter was 21 cents, surpassing our guidance of 19-20 cents. Cogo posted a gross margin of 14.2%, up from the 14.1% posted last quarter, which is particularly impressive given our telecom business, which carries a gross margin below the corporate average, was our fastest growing segment sequentially.

Our gross margins are determined almost entirely by revenue mix and are not tied to indicator such as capacity utilization. Over time, we expect that our gross margins will trend upward, and we maintain our 15% gross margin target, although we would expect it to stay in the range of 14.2-14.4% over the next few quarters. The growth of our Industrials and SME revenues are two of the key drivers of our gross margins. We have seen and will continue to see more leverage on operating margins than gross margins.

Cogo continues to demonstrate solid improvement operating leverage. In the third quarter, Cogo posted Non-GAAP operating margins of 8.7%, up from 8.4% sequentially, and we expect sequential operating margins improvement in the fourth quarter. We are maintaining our 10% operating margin target and expect to make progress towards that goal as we progress through 2011.

Our goal is to achieve the delicate balance between investing in new revenue opportunities and showing operating leverage. We still focus on Cogo becoming a billion dollar-revenue business, but our growth must be within the framework of our 10% operating margin target. Make no mistake, my number one priority is to show revenue and earnings growth at Cogo, and I firmly believe we are well-positioned to do just that over the next few years. I have never been more confident than I am right now that I have the right team in place to successfully execute our strategy.

To help underscore my confidence in our execution abilities, let’s look at some of the milestones we have reached over the last six months.

1) We announced a ground-breaking deal with Intel in May;

2) In June, we added Geely, a leading domestic China player, as a key auto customer;

3) In September, we signed an agreement with Xilinx, another leading global semiconductor player;

4) Several weeks ago, we announced design wins in a new revenue segment, the tablet market, which falls within our digital media space; and

5) In the last two quarters, we increased our total customer count by 90 and we increased our ARPU within our SME customer base by 16%.

My target for Cogo to have a billion dollars in revenue assumes 5% market share of what we view to be our Addressable Market, which is the $20 billion annual market in China for customized solutions that we provide. This is out of a total imported China semi IC market of around $100 billion. Another way to look at this target is our under-representation in the massive SME market. We currently have about 1% market share of the estimated 160 thousand SME customers that we view to be our Addressable Market, i.e., technology and innovation based companies, as defined by the government. Over time, we would like to increase our market share to 3-6%, implying an SME customer base of 5 to 10 thousand.

I would also like to take a minute to touch on the value creation of the unique Cogo business model. I believe that the recent tablet wins we announced are a great example of what we bring to the table. The tablet market is an off-shoot of the laptop market bringing in a wave of new innovation and new players and will ultimately lead to a variety of price points with dozens of competitors offering different formats, different user interfaces and different levels of quality We have traditionally avoided the PC market because most of the technology has been standardized and there isn’t much need for the type of customization that we provide. Now the tablet market is a different story, where we are providing solutions utilizing a handful of leading global semiconductor companies in an efficient manner that speeds their time to market. Product life cycles are likely to be very short in the tablet market in China and this will play into our strengths. We thrive in fragmented markets with lots of players who need our help in bringing quality product to market with cutting edge technology.

Cogo’s revenue breakdown in the third quarter is as follows:

Industrial business was 17.5% of total sales, growing 59% year-over-year and 11% sequentially.

Digital media was 56% of total revenue, representing a sales increase of 14% year-over-year and 8% sequentially.

Telecom represented 25% of total revenue, showing a sales increase of 22% year–over-year and up 14% sequentially.

Service business represented about 1.3% of total revenue, with revenue growing about 2% year over year.

In the third quarter of 2010, Cogo’s blue-chip customer base grew from 84 to 87 over the previous quarter and was up 13% on a year-on-year basis. The total number of SME customers increased by 47 sequentially to a total of 1,433 and showed a year-on-year increase of 9%. Most of our new SME customers focus on the Digital media and Industrial segments.

The total number of Cogo customers surpassed 1,500 during the quarter, reaching 1,520, up almost 50% since the beginning of 2008. Our total revenue is split about 68% and 32% between Blue Chip and SME respectively, and we expect this to move gradually to a 50/50 ratio over the next few years. In general, the increase of SME revenue as a percentage of total revenue should, on an-apples-to apples basis, improve our gross margins and reduce our working capital requirements.

Average Revenue per User (“ARPU”) from Blue-chip customers in the third quarter was $785 thousand, up 7% sequentially and up 3% from the prior year period. ARPU from SME customers in the third quarter was $22 thousand, up 6% sequentially and 25% year-over-year. Our SME efforts are clearly paying off -- our SME ARPU is up 45% since the beginning of 2009.

To bolster our efforts, we are in the early stages of evolving our strategy to become an Integrated Platform Service Provider to our SME customers -- meaning, quite simply, expanding our offerings beyond our traditional customized design solutions to include other high value-add services like logistics and supply chain management. In effect, we can become a one-stop shop for SME customers by offering more of a soup to nuts set of solutions. Currently, we are trialing some of these services with about 10 customers and the results are encouraging. One thing is clear: these customers need our help. We can offer the services at a cheaper cost due to our scale and experience and this allows them to focus on their core competencies. Not only do we expect this to become a more significant revenue driver over the next 2-3 years, but it should also have a positive gross margin effect on our business.

Now let me discuss a few highlights from our business sectors, starting with the Industrial segment.

Once again, our Industrial segment experienced a great quarter with revenue up 59% year-over-year and representing 17.5% of total sales. This business should continue to grow faster than our overall revenue for the foreseeable future. In 2010, we expect our Industrials revenue to be split into three areas with approximately 60-65% of revenue coming from Smart Meter and Smart Grid; 15-20% from railways; and 20% from Auto Electronics. In the fourth quarter, we expect our Industrials business will grow over 10% sequentially.

Our auto business recorded revenue of $4 million in the third quarter, up from about $3 million sequentially. So far in 2010, our auto business has produced about $9 million in revenue, and we have named only 2 customers: BYD and Geely. Over time, we expect to add new customers, some of which we should be able to announce shortly. Please stay tuned on that front. Order trends for smart meter and high speed railway roll-outs remain strong.

Handset trends improved in the third quarter, as the industry snapped back after the “whitebox” crackdown, and 3G Smartphone trends, particularly TD-SCDMA, continued to improve. Increasing 3G Smartphone sales drive higher content per device for Cogo and these positive Smartphone trends should drive our traditional handset revenue to some slight growth sequentially in the fourth quarter. Within our digital media division, we expect to continue to benefit from the aggressive roll-out of HDTV, and we have very high expectations for the tablet strategy we announced a few weeks ago. In the fourth quarter, we expect our digital media business to grow in the 5-10% range sequentially.

During the third quarter, we announced a strategic partnership with Xilinx, and we are excited about the potential to work with the Company across a number of industrial and consumer verticals. Our design activity with both Xilinx and Intel is quite strong and over the longer term, we believe each of these partners could contribute 5% of the total Cogo revenue. Both act as strong validation for the Cogo business model and hats off to our team for sealing both relationships.

In the third quarter, our telecom business continued to perform better than expected due to the continued roll-out of China Mobile’s PTN network and fiber builds (like EPON). We had solid order strength across all of our key telecom customers. Over time, we expect the other two mobile operators to announce similar plans for their own PTN networks, which will replace existing backhaul systems with a more efficient IP-network. We also anticipate other fiber builds to be announced. In the fourth quarter, we expect our telecom business will grow in the range of 5% sequentially.

Now, on to our M&A strategy, I view our Mega Smart acquisition that closed in June of 2009 to be a “home run”. It produced about $6.4 million in revenue in the third quarter and since closing, has well exceeded even our aggressive internal estimates.

We are currently planning to announce our next M&A deal before the end of this year with a planned closing in the first quarter of 2011. It would most likely involve a new vertical in the industrial space. We remain committed to pursuing an acquisition strategy focused on companies that are instantly accretive, are in a fast growing end markets and ones that offer a good cultural fit within our existing corporate structure.

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

Will Davis

Thank you Jeffrey. Good afternoon everyone, and thank you for joining our call. In the fourth quarter of 2010, we expect our revenue to be in the range of $107-108 million US dollars, and Non-GAAP EPS Diluted to be 22-23 cents. At the midpoint of this range, our projected revenue growth in the fourth quarter would be around 22% and would deliver nearly 24% annual revenue growth in 2010 versus 2009.

We expect gross margin to remain roughly stable sequentially in the fourth quarter with the gross margin bias and operating margins to be up slightly. As a reminder, our gross margins are very dependent on product mix.

As usual, we are not providing full year revenue guidance. However, given our strong third quarter results and good visibility into the fourth quarter, we remain comfortable that we are returning to high growth mode as we head into 2011. Given the continued strong macro trends in China and our ability to drive revenue growth across an increasing number of end markets, we are confident in growth prospects and ability to drive some operating margin leverage in 2011.

Here is the specific guidance in a number of areas to help with your modeling for the fourth quarter of 2010:

· Non-GAAP Operating expenses for R&D and SG&A in the fourth quarter are expected to be approximately $6 million, with the split staying consistent at about 30% for R&D and 70% for SG&A. As indicated, we maintain our longer term gross and operating margin targets of 15% and 10%, respectively.

· Interest income in the fourth quarter is estimated to be around $80 thousand, flat compared to third quarter. For modeling purposes, assume the same for 2011.

· We continue to estimate our Non-GAAP effective tax rate to be around 8.5% in the fourth quarter 2010 and in the range of 8.5-9% through 2011. In the fourth quarter, stock compensation should be approximately $2.6 million, which will likely be split evenly between R&D and SG&A.

· Acquisition-related costs, including amortization and impairment of intangible assets, will be approximately $1.5 million. Total diluted share count will probably be around 38.5 million shares.

Other than the items noted above, there are no significant differences between GAAP and Non-GAAP results. With that, I would like to turn the call over to Mr. Frank Zheng, our Chief Financial Officer. Thanks Frank.

Frank Zheng

Thank you, Will. Good afternoon everyone. For clarity, all figures I’m discussing here, unless otherwise noted, are in US dollars.

We ended the quarter with about $80 million in net cash or about $2 per share. During the third quarter, our operating cash flow was $5.4 million and we used $2.1 million for M&A and $365 thousand for buybacks. The M&A payout was the last Mega Smart payment.

We continue to see a strong order book as we approach 2011 and we have the flexibility to increase working capital requirements as needed. We have indicated in the past that we plan to use our strong balance sheet to drive growth, and this is exactly what we are doing, particularly as we continue to add new customers, suppliers, and lines of business. I am working diligently with our finance team to maximize our cash flow, but our business model requires working capital to drive growth, plain and simple. Our balance sheet is helping us win new customers, cultivate new supplier relationships and drive increased ARPU at existing customers. Consequently, our operating cash flow will vary from quarter to quarter, but looking out over the long term, we expect to be able to generate solid operating cash flow. As we have stated, revenue and earnings growth are our main priorities at this time.

It is also important to keep in mind that our capital expenditure requirements are very low, under $1 million per year. So we feel confident that we are efficiently using our total capital structure. As an example, we measure our Return on Working Capital to be around 16-17%.

In the third quarter, our inventory turnover increased from 41 days to 47 days, our Accounts Receivable Days fell from 91 to 82 and our Accounts Payable Days were up slightly at 13 from 12.

In the third quarter, we purchased 58,571 shares at an average cost of about $6.23, and we have repurchased 916,420 shares at an average price of $6.82 in the first nine months of 2010. We continue to view the strategic repurchase of our shares as an important use of our cash.

This concludes my remarks. Thank you everyone for joining the call to discuss our 2010 second quarter unaudited results. At this time, let’s turn the call to the operator to open up the floor for questions. We will look to end this call around 5:30. Operator?

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time, we will begin the question-and-answer session. (Operator Instructions). And our first question does come from the line of Brian White from Ticonderoga, please go ahead.

Brian White – Ticonderoga

Hi Jeffrey. Wondering if you could talk a little bit about the tablet market on terms of the margin profile we should think about this, the ASP to COGO, and also what type of operation systems are you seeing in this market?

Jeffrey Kang

Thanks Brian. We announced our tablet contract with our customers and design wins with our customers in aftermath. We actually work through with like over 20 customers. They have – they develop a couple of type of the tablet products. In general, some people are using Android, some people are using like a Windows platform, still some customers are using very link their own operating system.

So we are – we’ve already seeing these products already finished and is starting to ship to the market. So we expect that this market has a very strong growth since next year. Our average ASP actually is quite high, I think anywhere from $5 to $20 even more depends on how much solution our customer has adopted from what we provide.

Brian White – Ticonderoga

And Jeffrey, in the margin profile, how did they compare to COGO’s average?

Jeffrey Kang

I think it should be, because it’s a new market, and we are like a first mover – the early stage solution provider. So I think – I believe the margin structure shouldn’t be above in a normal corporate average.

Brian White – Ticonderoga

Okay. And just finally Jeffrey you said – obviously there are a lot of operating systems out there. What operating system is most prevalent with these customers that you’re talking to, is it Android or is it Microsoft?

Jeffrey Kang

Actually it’s hard to tell at this moment. In my experience, I think both should have market in China, because given the size of the market. We’ve heard a lot of people taking about Android a lot. But if we look – if we look at the results – the shipping to the market still we’re seeing Windows still have a certain market there. So that’s why we are – what we’re seeing is that both operating systems should have like decent market share in China.

Brian White – Ticonderoga

Great, thank you.

Operator

And our next question does come from the line of Mike Walkley with Canaccord Genuity. Please go ahead.

Mike Walkley – Canaccord Genuity

Great, thank you.

Jeffrey Kang

Hi Mike.

Mike Walkley – Canaccord Genuity

Hi, congratulations on your first $100 million quarter, it’s a nice milestone for the company.

Jeffrey Kang

Thank you.

Mike Walkley – Canaccord Genuity

Yes, just still on those questions on the tablets, demonstrating the success of your diversifying business model, can you share with us difference I guess between maybe a $5 design win and then $20 plus if it’s different content that some of your customers might be taking? And then also do you see other opportunities in digital media group to grow into new market segments?

Jeffrey Kang

Yes, I think that’s the – this market actually is a very good case study to lead us to show investors how COGO helps our SME customers especially in China, which to address those are faster growing and faster changing market. And as a matter of fact, most of the customers who is designing and producing the tablet business are those customers previously in the PC market or in the laptop market.

As you know, because the PC market has relatively standardized the market, so which is normally not within our coverage. But when these customers are starting to shifting from the PC business to the tablet business, and then suddenly they need a company like COGO to give them the solution, to help them to design the new futures products, and then ship to the market quickly.

For example, I’ll give you an example, if some customer wants embedded the Wi-Fi – Wi-Fi module into their tablets, so there are a lot of porting in the software works – we needed to be ready there. So that’s why we’re working with our customer and based on their software, based on their platform, we embedded the Wi-Fi module into the tablet. So that’s – and then if they then later then do the design work by themselves, maybe takes a half a year to get everything done. But for us we have experience in this whole area. So for us it’s just like a work of a one week.

So that’s how we try to leverage COGO as a platform to offer the customized design solution to the tablet market. So for example, the reason why the cost [ph] varies from the $5 to anywhere higher to the $20, $25 depends on how advanced the tablet product or customer to define their products. For example, some customers use a Wi-Fi function, some customers wants to even embedded a digital [inaudible] module into their tablet products. So depends on how much of features they want to integrate into that tablet product. So that’s why to do our ASP ranges from anywhere from $5 to $20, $25

Mike Walkley – Canaccord Genuity

Great, that’s very helpful.

Will Davis

Mike, one thing I would add to is that, depending on how much memory is within any of these devices, obviously the memory is a big cost capital. So depending on this little memory very high that can also add quite a bit of variability in what our ASP is.

Mike Walkley – Canaccord Genuity

Okay, great. Thanks Will. And just building into the digital media division, just on the 3G mix in China and the Smartphone mix and potential for higher content for your business in that area in terms of higher content for 3G phone versus 2G phones.

Jeffrey Kang

Well, actually we see a very good trend in this market. So 3G, especially 3D cell phone has become – we’re seeing more and more 3D users in China. Addressing this quarter, the China mobile will have another 3D for the 3D cell phone. So we’re seeing 3D users actually increasing and also the 3D Smartphone has actually grown dramatically since the second half of this year. So – because at COGO we offer much higher components in a Smartphone – within a Smartphone.

For example like a mobile QV module, Wi-Fi, Bluetooth, we’ll have the multimedia sensor, and all kinds of stuff putting together. So we have a much higher content in one single Smartphone than our business in a normal middle end or low end normal MTK cell phone or MTK baseband cell phone. So from that perspective, so we’re seeing more leverage, a more – a significant revenue increase [inaudible] China the 3G cell phone is moving in an uptrend.

Mike Walkley – Canaccord Genuity

Thank you. So I guess the reason the gross margins maybe aren’t expanding on shorter term is your highest revenue division is just growing so fast with the tablets and the 3G mix. Is that a fair way to imply your guidance kind of lower 14% gross margins even though industrial is growing fast this piece of business that’s larger and lower gross margin is growing almost the fast over the next several quarters?

Jeffrey Kang

There is one – if you look at this third quarter, our telecom business is actually beyond our own expectation so we see a different growth. Our telecom revenue actually is I would think have a far growth faster than what we expected. So telecom is normally is our low gross margin business, so that’s why we are – even though our industrial revenue growth 59%, so we’re only able to grow certain gross margin, mostly because of the strong telecom revenue growth.

Will Davis

Michael, I would also add just in terms of basic modeling of this. The industrial business on a longer term basis is growing faster, but that those gross margins are in the 20% range, so it’s not like we’re modeling in 50% growth margin with that business. So in general it’s a positive trend, but a lot of it depends on the revenue split with the other segments. So I mean if you model that out, it just doesn’t change a whole lot within one quarter, because that gross margin was kind of in the 20% range.

Mike Walkley – Canaccord Genuity

Thanks, that’s helpful Will. And one last question and I’ll pass it on. Thanks for breaking out the different revenue split within industrial. As you look into next year, would you expect a similar mix or would think like auto has become a kind of larger piece of the mix and within industrial how do those three segments margins look among themselves between smart grid, railway and the auto business? Thank you.

Jeffrey Kang

Thanks very much. And we actually expect that industrial will continue to grow. We’re thinking about it next year industrial will – and it could be like a 25% even to 30% of the total revenue. So our – we also expect that we may have the new sector – revenue from the new sector starting to kick out since next year. So I think we expect the revenue is relatively – sorry the gross margin is relatively stable at every segment in the next year, but our industrial revenue grow faster than the rest of the business. We expect to say that gross margin improving smoothly in the next few quarters.

Mike Walkley – Canaccord Genuity

All right. Thanks Jeffrey, and congratulations again on the milestone.

Jeffrey Kang

Thanks Mike.

Will Davis

Thanks Mike.

Operator

And our next question has come from the line of Amir Rozwadowski with Barclays Capital. Please go ahead.

Amir Rozwadowski – Barclays Capital

Thank you very much, and good afternoon, folks.

Jeffrey Kang

Hi Amir.

Amir Rozwadowski – Barclays Capital

Jeffrey I was wondering if we could talk in particular about the strength in the telecom equipment market. You had mentioned that it was outperforming even your own expectations. And if I recall in speaking in the beginning part of the year, sort of the outlook for some of the spending for various telecom related projects was not as robust as it ended up being. I was wondering if you could talk to us about what’s driving that particular growth, and if possible, how we should think about that going forward?

Jeffrey Kang

Well, I think our telecom growth this year is mostly driven by the optical – by the broadband optical business. And I think one of the co-driver here is the PTN adoption by the China Mobile, which is – the fundamental driver in China – every increase in China Mobile, Internet traffic has increased dramatically in the quarter-over-quarter, year-over-year, so that forced the operators in China has to operate at their platform system in order to carry this ever increasing mobile 3G Internet traffic.

So this – the big macro picture works in the demand of well the fiber business, and the broadband business increased dramatically from our customers [inaudible] fiber-to-the-home, Huawei, all those guys in China. So that business no matter what the 3G overall spending increasing or decreasing, we haven’t seen any slowing down signal since the beginning of this year. So I believe recently China Mobile have another new run of the beading prepared for next year. So I’m very confident about this trend will continue at least to next two years. So that’s how – I’m not going to worry about slowing down from this segment.

And if – on top of that, they’re still increasing the 3G investment, so that will give us additional revenue and a growth from the Telco sector next year.

Will Davis

And I would just add to that Amir, if you think about some of the moving parts, the strength has happened and we’ve basically taken India out of our whole set of numbers for the last two quarters and then we’ll see what happens this quarter, but that’s – that was some decent revenue that’s been pulled away and we’re still waiting on some guidance’s to the PTN networks being built at Unicom and telecom. So there are some other moving parts there that could keep some of the strength going. I noticed ZTE had kind of a lower than expected revenue number, I think some of that was based on India, but I think if that comes back, that will help, and I also think those that ZTE has won some international business recently.

They’ve got that WiMAX contract in India, I think they got something with Telenor recently, so they’ve got some international, should help keep some decent growth for us.

Amir Rozwadowski – Barclays Capital

So do you believe that sort of growth rates from how we’ve seen in the last couple of quarters, be – call it the high teens or 20% on a year-over-year basis is sustainable.

Jeffrey Kang

Yes, I think – from the – to the telecom sector alone we may – we think about it double-digit growth business, but if you think about overall October business, telecom become less and less important to us, because we have the digital media where it’s growing strongly, and then more importantly we have those industrial business, and we have the new sector we’re starting next year. So considering all this a new revenue stream, so we are very confident about our long-term sustainable growth rate.

Will Davis

It’s no secret Amir that our telecom business has the lower gross margin and there are some factors going into that, we’ve got had less customers. Longer term the market obviously less kind of month-to-month innovation. So it should shrink both in terms of revenue and profit as a percentage of our total is – if you look out one to two years.

Amir Rozwadowski – Barclays Capital

Okay, thank you very much for the incremental color.

Operator

And our next question does come from the line of James Faucette with Pacific Crest. Please go ahead.

James Faucette – Pacific Crest

Great, thank you. One just housekeeping item, I missed what Jeffrey you had indicated in terms of the growth that you expect the industrial segment sequentially in the December quarter?

Jeffrey Kang

We expect 10% quarter-over-quarter growth in the fourth quarter.

James Faucette – Pacific Crest

Okay, great. And then looking forward on the industrial segment, I know in response I think to Mike’s question, you had said that you expect your gross margins on industrials to maintain themselves as you go into 2011. I guess, did I heard that correctly and secondly, as that business grows, where might you see margin pressure eventually in that business. Should we expect that eventually to materialize, or do you think that even in the long-term that you can maintain the margin structure for industrial portion of your business?

Jeffrey Kang

We are confident that we are able to keep that margin relatively stable for the industrial business in the next three to five years. The reason is that the total addressable market of this industrial business is a much bigger than, in a digital media segment or our telecom segment. More importantly more and more our SME customers are actually from those industrial segments.

So we are usually be able to have a much better margins when getting with our broad SME customer base. So that has given the confidence that we believe we are able to maintain our industrial margin structure for the segment, our industrial segment in the next three to five years.

James Faucette – Pacific Crest

And then finally, reference to the acquisition that you’re hoping to undertake during the fourth quarter. How should we think about the potential impact on your cash balance from that acquisition?

Jeffrey Kang

We actually – we today as Frank just mentioned that we have been net of cash around $80 million US. We are confident we are having enough cash for both our organic growth acquisition and the stock buyback. So normally and as we – as investor in which our preserve total for couple of years. We normally don’t pursue on like a big size of target. We usually target the middle sized company which, so almost every deal we’re targeting is around $20 million range. So that’s why so you go for any single deal, I think we should be in that range.

James Faucette – Pacific Crest

And just on, if I heard you correctly just to make sure I heard you correctly, you would expect that deal if it does in fact closed to be accretive immediately?

Jeffrey Kang

Yes.

James Faucette – Pacific Crest

All right, great.

Will Davis

James, if I could just add a couple of things just to kind of be clear on what we’re looking for in an M&A target, I think that the – what happened on the Mega Smart thing is that sets, that’s the ideal scenario for us. We take in some people carved out from another company who have some design wins but whack scale, and like our customer base and like the capital structure, but they have good relationships and solid (inaudible) so you’re able to move those two together, have it be instantly accretive and doesn’t require a lot of integration issues.

So that’s the type of deal that we’d like to see again. Just to give you an idea that it’s not going to be large deal. It’s not going to require laying up 3,000 peoples to have the synergies to make it work. That’s not our daily work. It’s got to be something like this Mega Smart thing.

James Faucette – Pacific Crest

Yes, well we’d all like deals like that. So yes, congratulations on that and hopefully this one will work out as well.

Will Davis

Well and I think it’s important, I mean when we think M&A strategy, which I think sometimes people can get the wrong idea and obviously they have been plenty of M&A deals and technology that haven’t worked out, but the Mega Smart thing for us has been a real dream. It’s exceeded margin targets, its exceeded revenue targets, the integration has been easy and it’s in a fast growing market that has great margins, I mean that’s really what you’re looking for.

James Faucette – Pacific Crest

Good, thank you very much gentlemen.

Will Davis

Thanks James.

Jeffrey Kang

Thanks James.

Operator

And our next question does come from the line of Mike Driller [ph] with Heartland. Please go ahead.

Mike Driller – Heartland Capital

Yes, hi congratulations on the quarter.

Jeffrey Kang

Hi Mike.

Will Davis

Thank you.

Mike Driller – Heartland Capital

Well inventory jumped $9 million over last quarter, I’m just wondering if you could give us some color on what the reason for the jump was?

Jeffrey Kang

For the inventory portion because in the second quarter, in the second half of the year, usually it’s our high season. So our high season, for example in the digital media segment the high season usually starting from the like middle of August continue to the middle of November. So October usually is our high season. So we try to get a more product allocation in this two – couple of months, in order to meet our customer’s that huge demand. So that’s why we intentionally increased our inventory on few products in order to meet the huge demand in the beginning of the fourth quarter.

Will Davis

Mike, also I think when you think about as we’re increasing our lines of business, increasing our customers, adding Intel, adding Xilinx. When you start working with huge companies like that, we’ve had a ton of designing activity then automatically requires some inventory and I would also add this, our net inventory should probably decline slightly in the next couple of quarters. So you may have seen a peak year, that’s kind of what we’re shooting for. So it’s a strategic decision.

Mike Driller – Heartland Capital

Okay, great. Thank you.

Operator

And our final question does come from the line of Wayne Brown [ph] who is a private investor. Please go ahead.

Wayne Brown – Private Investor

Yes good afternoon gentlemen. My question is on the share buyback authorization. Despite what appears having an exceptionally strong balance sheet, pretty has been very conservative in the last quarter as well as its forward guidance on shares that there is not a – is it have been a very conservative approach. Can you reconcile the velocity that you have on share buyback in relation to your M&A cash needs?

Jeffrey Kang

Well as I’ve said currently we have like roughly $80 million cash and roughly net of cash. We are with, and also in our business we are – we need – the way we are using our cash with first priority is the working capital increasing which will, to help us drive our revenue growth. The second is for the acquisition. The third is stock buyback. So we are – usually we are taking the right strategy to using the combining strategy to execute all the three ways to strategically wisely using cash from cash balance.

So in the third quarter we did some stock buyback, but as you said we are actually when we’re doing the buyback, we actually have a lot of the restriction in order to follow the SEC rules. So that’s why we needed to – for example, we needed to calculate that we only have then – within every quarter we only have the four or five weeks who are able to buy and we also before material news announced that we kind of buy anything or sell anything. So if we consider all this restriction there. So actually the windows of ever to buyback is a very, like it’s very narrow. Probably seeing that, we still reviewed the stock buyback is one of the good strategy for us to increase our shareholder value.

The Board authorized our $5 million – 5 million shares, the total buybacks which the management team to choose the rightest timing, right strategy to execute it. So we will continue to choose the right timing to execute our buyback strategy.

Will Davis

Wayne, I would just add a couple of additional thoughts, I think heading into the back half of this year in 2011 we saw the order book growing, we’re adding customers at a very rapid pace. We’re adding at clients [ph] a very rapid pace, (inaudible) so when into high growth mode like that, you need to be able to protect yourself and have (inaudible).

Operator

And with that I would like to turn the call back over to management for any closing comments that they may have.

Jeffrey Kang

Thanks very much for people to attending this earnings call. So we have our Cogo’s results to exceed expectation for both revenue and earnings, and we expect to continue successfully execute in the dynamic China economy in the fourth quarter and into 2011. We continue to deliver – develop new strategic supply relationships, attack new industrial verticals and open up new products like the tablets. I’m prouder to say that where we’ve been (inaudible) $1.00 annual earning power.

I want to take this opportunity to thank all of Cogo’s, employees, customers, partners and the long-term shareholders. You have provided Cogo with the opportunity to deliver robust and a sustainable growth in the past. And we appreciate your support as we re-enter a phase of the high growth and earnings growth. Management is committed to driving sustainable high growth and providing significant return to our shareholders. Thank you again for joining this call. I look forward to talking with you soon. Bye.

Operator

Thank you. Ladies and gentlemen this does conclude the Cogo Group, Incorporated third quarter2010 conference call. Thank you for you participation on today’s call. You may now disconnect your lines at this time.

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