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Executives

Jeffrey Kang – CEO and Chairman

Frank Zheng – CFO

Will Davis – SVP, Business Development and Chief Marketing Officer

Analysts

Amir Rozwadowski – Barclays Capital

Matt Ramsay – Canaccord Genuity

Brian White – Ticonderoga

James Faucette – Pacific Crest

Mark Tobin – Roth Capital Partners

Graham Tanaka – Tanaka Capital

Mike Jolin – Heartland

Cogo Group, Inc. (COGO) Preliminary Q4 2010 Earnings Call Transcript February 1, 2011 4:30 PM ET

Operator

(Operator instructions)

Wanyee Ho

Thank you very much 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 Fourth Quarter Earnings Conference Call.

After the market closed today, Cogo issued a press release reporting preliminary unaudited financial results for the quarter ended December 31, 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 at present 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 excellent execution continued in the fourth quarter of 2010, as we posted unaudited revenues of $113.5 million, up over 13% sequentially and 29% from the prior year period. This represents the highest sequential growth for a Cogo fourth quarter since 2007 and the highest year-over-year growth rate for any quarter in 2010. We easily exceeded our guidance of $107-108 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 Grid/Meters. Our 2010 revenue was up nearly 26% from 2009 and, in our view, it leaves no doubt that we have returned to high-growth mode.

Our Non-GAAP EPS Diluted in the fourth quarter was 24 cents, surpassing our guidance of 22-23 cents and clearly showing we are well on our way to showing one dollar in annual earnings power in the near future. Cogo posted a gross margin of 14.2%, up about 30 basis points sequentially.

Note that our gross margins are determined almost entirely by revenue mix and are not tied to elements 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% through 2011. The growth of our Industrials and SME revenue are two of the key positive drivers of our gross margins.

In the fourth quarter, Cogo posted operating margins of 8.7%, which was flat sequentially. As we have indicated previously, while we could post 10% Non-GAAP operating margins in any given quarter by slashing investments in new growth areas, this would starve growth in future years in some very high growth end-markets. Since the first quarter of 2009, our operating margins have grown over 140 basis points. Additionally, we believe that operating margins can improve sequentially in the first quarter 2011 and rise slightly each quarter through 2011 due to continued efficiencies and increased ARPU per customer. We are maintaining our 10% operating margin target and expect to make clear progress towards that goal as we progress through 2011.

In the fourth quarter of 2010, our Industrials revenue grew 46% year-over-year to $20.3 million, representing about 18% of total sales. Our telecom business grew 28% year-over-year to $27.8 million, representing about 25% of sales. Finally, our digital media business grew about 24% year-over-year to $63.8 million, representing about 56% of total sales. Our services revenue grew 37% year-over-year to $1.7 million. I am rather pleased with the results of all of these business units.

I’d like to take a minute to discuss what we view as the fundamental value that Cogo brings to the marketplace. We are the leading gateway for global semiconductor companies like Broadcom, Freescale, Atmel and Intel to access the fast growth Industrials and Technology sectors in China. We offer a unique business-to-business services platform to design specific embedded solutions for our list of over 1,600 customers, of which about 90 are blue-chip and over 1,500 are SMEs. We are very proud of our component partner relationships and strongly believe that we offer clear symbiotic benefits. Essentially, Cogo offers a cost effective way for our component partners to reach these fast growth end-markets in China and we decrease time to market for our customers. In China, time to market is king because life-cycles continue to shrink and industry fragmentation leads to a tremendous amount of competition. The very nature of high levels of industry fragmentation in China is a natural advantage for us and allows us to capture operating leverage by servicing an increasingly large customer base.

Cogo has undergone some fairly significant changes in the last few years with regards to our revenue and profit generation. When Cogo first listed on Nasdaq, almost all of our revenue and profit was generated from handset and telecom businesses. However, by the fourth quarter of 2010, our Industrials business is expected generate roughly the same gross profit dollars as our handset and telecom businesses combined- and our Industrials business was not even a reportable segment until the first quarter of 2008. This is truly a staggering shift in our business toward a more profitable and faster growing set of end markets, and demonstrates our ability to quickly change course. Unfortunately, the perception remains that Cogo is a China telecom and handset play, which is clearly not the case anymore.

Cogo is a manufacture-less business model. We can quickly target new markets with limited upfront costs. This past summer, for example, we started discussing the upcoming boom for Tablet products with some of our customers. We quickly produced integrated, embedded solutions using products from several of our leading partners and enabled dozens of our customers to attack this marketplace with an array of Tablet product. By the end of October, we were recording our first Tablet revenue.

It’s my goal for Cogo to reach one billion dollars in annual sales in the next few years. How do we get there? At first glance, this might seem like too aggressive a target. However, let’s think about our total addressable market. Currently, the market for imported semiconductor content into China is about $100 billion annually, with about 80% of this being commoditized products where we can add no value. We view the remaining $20 billion (and growing) as our addressable market; and we are shooting for a less-than-5% share of that market. Given our customer base and expanding supplier relationships, and our continuous march into new high growth markets, I am increasingly confident that we can reach this target.

At the end of 2010, Cogo’s blue-chip customer base was 92, up 15% year over year. Our blue-chip ARPU was $828,000 in the fourth quarter, up 11% year-over-year. Our SME customer base passed 1,500 for the first time- and is now nearly 1,510, up 13% year over year. Perhaps more significantly, the ARPU in our SME customer base was about $25,000 in the fourth quarter, up about 17% from the prior year period. Incredibly, our SME ARPU is up almost 62% since the first quarter of 2009.

Our SME strategy is clearly starting to pay dividends. Given the nature of the fragmented China economy and the importance of SMEs in China, success in this strategy is critical in order to reach one billion dollars in revenue, and it clearly demonstrates the value of our customer footprint. How could a component supplier possibly reach 1,500 SME customers in an effective and timely manner and service the hundreds of thousands of products and R&D track records across that base? It’s impossible. And why would they? We are offering a ready-made business-to-business services platform that does the work for them in a very cost effective manner.

In the fourth quarter, SMEs constituted 33% of total sales (with blue-chip customers making up the remaining 67%), SMEs up about 28.5% from the first quarter of 2009. Over time, we expect that this figure will reach 50/50, perhaps around the time that we reach one billion dollars in revenue. Bear in mind that there are over 160,000 SMEs in China that are “technology or innovation based”. Therefore, our market share is under one percent. We are just getting started. At current levels of ARPU for SME customers, if we could double our market share to 2%, or 3,000 SMEs, we would add $150 million in annual revenue. When we reach one billion dollars in total sales, we estimate that we will have about 5,000 SME customers, which still implies a market share of 3-4%.

Now I will discuss some segment highlights, starting with Industrials.

In the fourth quarter, our Industrials business grew 46% year-over-year and now constitutes about 18% of total Cogo sales. We saw continued traction across a variety of end-markets, including the Smart Meter/ Smart Grid, Autos and High Speed railways. For 2011, we expect that our Industrials revenue will be split as follows: approximately 60% for Smart Meter and Smart Grid, 15-20% for Autos, 15-20% for High Speed Railways and 10% for Healthcare. I am pleased to announce that our MDC Tech acquisition was closed in January and is expected to contribute in the range of $1-2 million in revenue in the first quarter. We continue to believe that this highly strategic acquisition will contribute in the range of $15-20 million dollars revenue in the first four quarters after closing. I am very excited about the prospects for MDC as it increases our foothold in the Smart Grid industry and places us squarely in the sweet spot of the rapidly growing Healthcare sector in China. Government estimates that total Smart Grid spending at $300 billion and Healthcare at $125 billion in the next few years.

Our auto business continues to drive increased content per car and we anticipate being able to announce new customers to go along with Geely, BYD and Chery. Our auto revenue was about $4 million in the fourth quarter. The recent Smart Meter bid announcement for 17 million lines continues to drive good revenue strength for us on that side of the business. Additionally, we continue to see strong opportunities in the roll-out of high-speed railways in China.

Our telecom business continues to surprise on the upside, largely driven by continued fiber builds. While we expect 3G spending to be lumpy, we still see clear revenue growth for our telecom business in 2011. But, over time, our telecom business will probably have the slowest growth of our three business segment.

We entered the fourth quarter of this year assuming that our handset revenue would be generally flat sequentially and this turned out to be roughly accurate. We continue to benefit from higher ASPs as 3G Smartphones increase as a percentage of total handset units. Within the channel, inventory appears normal and we are expecting strong 3G handset growth as vendors push lower-cost 3G Smartphones into the marketplace.

Within our digital media segment, the key drivers will be Tablets, the roll-out of HDTV and 3G Smartphones. Revenue from our Tablet business is faster than expected and we now have close to 50 Tablet customers. Product reception at CES was positive and we are seeing strong month-over-month improvements in our Tablet revenue.

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 first quarter of 2011, we expect our revenue to be in the range of $95-100 million US dollars, and Non-GAAP EPS Diluted to be 19 cents. Our first quarter guidance includes about $1-2 million in revenue from the MDC acquisition. At the midpoint of this range, our projected revenue growth in the first quarter would be around 20% from the prior year period.

We expect gross margin to remain roughly stable sequentially in the first quarter, in the range of 14.2%. We would also expect operating margins to improve sequentially. As a reminder, our gross margins are very dependent on product mix and you should continue to expect more operating margin leverage than gross margin leverage.

We are not providing annual guidance for 2011, but given our order backlog, we believe that we can remain in high growth mode in 2011 and should soon begin to show clear visibility to one dollar in earnings power. Our view of the China economic backdrop remains favorable and we see great opportunities across a wide range of markets. We also expect to be able to expand operating margins in 2011 over 2010.

Here are some specifics to help you with your modeling in the first quarter of 2011:

· Non-GAAP Operating expenses for R&D and SG&A in the first quarter are expected to be a combined $5.1-5.3 million US [approximately], with the split staying consistent at about 25-30% for R&D and 70-75% for SG&A. As indicated, we maintain our longer term gross and operating margin targets of 15% and 10%, respectively. We expect operating margins to be in the range of 9% in the first quarter of 2011

· Due to prior contractual obligations related to past acquisitions, our minority interests will total in the range of approximately $5.5 million in 2011, with about $1.25 million occurring in the first quarter and with that figure scaling up through 2011. We view this as a critical measure in order to retain key talent and keep their interests aligned with the overall interests of Cogo.

· Interest income in the fourth quarter is estimated to be around US$80,000, flat sequentially. For modeling purposes, assume the same for 2011.

We continue to estimate our Non-GAAP effective tax rate to be around 8.5-9% in the first quarter and in that same range through 2011. In the fourth quarter, stock compensation should be approximately $2.7-2.8 million US, with the split slightly higher for R&D than 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.

Frank Zheng

Thank you, Will. Good afternoon everyone. For clarity, all figures I’m discussing here, unless otherwise noted, are in US dollars. As typical, we are not in a position to offer a full compilation of balance sheet items at this point, but we continue to maintain a strong capital structure and we expect to generate some operational cash flow in 2011. Keep in mind, that when we grow as rapidly as we have, our business model requires working capital. Our focus remains to deliver high quality revenue and earnings growth. We expect to pay out the $22 million for MDC over the next year and Megasmart has been fully paid. Our business model requires very low capex of around US$1 million per year and generates a solid return on invested capital. I would also like to point out that we are quickly approaching our fifth year anniversary with KPMG (Hong Kong) as our auditor. We are pleased to have the consistency of this relationship and feel that it helps us to [distinguish] ourselves.

Buybacks continue to remain an important use of cash. In the fourth quarter of 2010, we re-purchased about 107 thousand shares at an average price of $7.61 and in the full-year 2010, we re-purchased about [1.23 million] shares at an average price of $6.91.

This concludes my remarks. Thank you everyone for joining the call to discuss our 2010 fourth 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 at around 5:30. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And our first question is from the line of Amir Rozwadowski with Barclays Capital. Please go ahead.

Amir Rozwadowski – Barclays Capital

Thank you very much, and good evening, gentlemen.

Jeffrey Kang

Hi, Amir.

Frank Zheng

Hi, Amir.

Amir Rozwadowski – Barclays Capital

I was wondering if you could talk a bit about the growth trends here, if I may, Jeffrey. If we look at your revenue growth on a year-over-year basis, I mean, it certainly continues to be at a very healthy growth rate at this $119 million this quarter. And taking up pretty substantially over the course of this year, I’m trying to assess, I realize that you folks aren’t giving guidance on forward growth rate, but I was wondering if you could give us a little bit in terms of the puts and takes and sort of what you define as sort of that high growth mode? In the past, we’ve considered it around the 30% range, and I was wondering if sort of 20% to 30% is the new borrower, how we should think about that.

Jeffrey Kang

Well, thanks. As we always explain to our investors, we believe Cogo – if you look at our historic number after we’re listed on NASDAQ since 2005, our average growth rate is around – our annual growth rate is around 30%. The only year we even reached that growth rate was in 2008. (inaudible) we still grow, but only grew like 9% in that year. But back to 2010, we shipped over 25% growth rate. So we believe we are – there is no doubt about it, we’re back to our high growth mode. So, from that point, and even though we didn’t give the full year guidance and we are very confident that we are back to this 20%, 30% of growth – along some growth rate. But that’s our internal target as to how we can keep this – keep Cogo consistently grow at that rate in the next few years, to reach up $1 billion in revenue target in the next few years.

Amir Rozwadowski – Barclays Capital

That’s very helpful, Jeffrey. And then if I may, I mean, obviously a lot of your efforts in the Industrial arena has proven quite helpful in terms of driving your industrial opportunities. And it seems as though that’s going to be the continued driver of the overall growth of the company, at least the fastest growing business. Where do you expect the Industrial business to be in terms of percentage of revenues if we think out a couple of quarters from now?

Jeffrey Kang

In the last fourth quarter, Q4 last year, Industrial reached from 18% of our total sales, scratch from zero in that. It took only one or two years to it from zero to 18% of our total revenue. I think this business will continue to be our largest growing segment in the next few years. So I think, for example, in fourth quarters from now, in the end of this year, I’m pretty much confident this business could be anywhere from 25% to 30% of our total revenue.

Amir Rozwadowski – Barclays Capital

Great. And then lastly, if I may, you did discuss that really the key in terms of driving leverage shares on the operating line. Clearly, you folks are sort of within that sort of the 9% operating margin on an adjusted basis right now and that’s sort what you are seeing in the near term. In terms of your 10% operating model, I mean, it seems as though that could be reached fairly within the near future. How should we think about sort of the trajectory to the 10% operating margin? Is that – do you need to be at that sort of 15% gross margin number to reach that level or could that be achieved better in terms of your revenue growth so far?

Will Davis

Amir, I could help you with that what I think. The short answer is we do not need the gross margins to be at 15% to hit the 10%. I think it would certainly be helpful, but I think that we’re planning that we can get that without 15% gross margin, and we’ve talked about having more leverage on the operating side and the gross side. If you play around with our model, it doesn’t take a lot of OpEx-cutting to get us to 10% from where we are right now. And we can do it right now if we wanted to, but I think you have to balance being able to show leverage and go after new opportunities. I think it would be – we'd be starving the growth for the out-years I think if we cut OpEx for that point.

So first, 2011, I think we’ll show progress towards it, not dramatic in any given quarter, but I think steady progress towards that. At this point, we’re probably not going to be at that 10% range in any given quarter this year. But if you look out towards next year, I think that’s definitely possible. But we are definitely going to make some pretty good progress towards it on a year-over-year basis this year versus last. But we did not have to have 15% gross margin to reach 10% operating.

Amir Rozwadowski – Barclays Capital

Great. Thank you very much for giving [ph] the color.

Will Davis

Sure. Thanks, Amir.

Operator

The next question is from the line of Mike Walkley with Canaccord Genuity. Please go ahead.

Matt Ramsay – Canaccord Genuity

Hello. Thanks very much. This is Matt Ramsay on for Mike.

Jeffrey Kang

Hi, Matt.

Matt Ramsay – Canaccord Genuity

Hi. To expand a little bit on Amir’s first question, looking for specifically for Q1, could you talk about the seasonal growth trends you expect in each of your divisions off of Q4?

Frank Zheng

Well, in Q1, the first quarter is normally – because of based on the normal seasonality for Q1, we’re going to say that the revenue is going to be down sequentially by every segment because of the Chinese New Year actually almost from now – anywhere from now to the next two or three weeks in China is holiday season. So we’re going to say most of our customers don’t produce anything in this one month. So that’s why we are going to see the revenues sequentially down in this first quarter. But in general, in addition to the normal seasonality, we do not see anything abnormal there. We still find the demand is very strong up till now. And we also believe, after the holiday season is over, the demand will be very strong. So that’s giving me a very good confidence that in our first quarter, it should be slightly better than the normal seasonality.

Will Davis

And just to follow on that, Matt, I think if you look in the last few years, we’ve had some pretty distinct differences in the first quarter fall-off. And I think in the worst of times, it was down maybe 23%, best of times down closer to 7% off of that weaker ’09. In general, I think that probably equals, if you look out over a longer period, maybe a mid-teens sequential decline in terms of revenue growth of fall-off from 4Q to 1Q. I think you’ll probably see more seasonality in telecom and digital media. And based on some of this industrial strength, I think that can’t help us maybe be a little better than normal seasonally. But if you look at the midpoint of our guidance, I think it’s down about 14% sequentially, with better strength on industrials I’d say.

Matt Ramsay – Canaccord Genuity

All right. Thanks very much for that. And a couple of questions about the MDC Tech acquisition, you just reiterated your $15 million to $20 million revenue target for the year from the acquisition. I think you had mentioned in the past $2.0 million to $2.5 million operating income target. Are you guys sticking by those numbers or do you have any further comments?

Jeffrey Kang

Well, we still believe that this deal will contribute our $15 million to $20 million in revenue and $2.0 million to $2.5 million in operating profit. That’s I think the minimum target we are targeting at this moment.

Will Davis

Yes. Matt, that’s going to be – we're trying to be as precise as possible. Obviously, there are a lot of moving parts here. We’ve got to integrate the deal we have. Some contracts are going to be longer than some others. But I think when you look out over a three to four-quarter period, we’re pretty comfortable with that type of operating profit, yes.

Matt Ramsay – Canaccord Genuity

Okay. And one – I guess a couple more little things about MDC. Could you talk a little bit about the split between smart grid and medical devices for MDC and also the split of blue chip versus SME customers?

Jeffrey Kang

We are actually – I think at this moment, based on our $15 million to $20 million revenue target, we think about a smart grid portion, we’ll have – mostly have like 60% of the business goes to the smart grid and 40% – and roughly 30% to 40% goes to the healthcare in the 2011 time period. And so most of the customers in this deal at this point in the first four quarters are the blue chip customers. And so most of them are the new blue chip customers. So I think that that’s why every contract for this business is even every contract is over $1 million. So if you do a simple modeling, almost like 10, 15 contracts and cover whole $15 million, $20 million business. So we believe that the first year would pretty much rely on the new customer base – the customer base that MDC brings to us. And for the next year, we are going to see more leverage by – leverage a much broader customer base to generate incremental revenue.

Matt Ramsay – Canaccord Genuity

Great. Thank you very much.

Jeffrey Kang

Thanks, Mike.

Operator

The next question is from the line of Brian White with Ticonderoga. Please go ahead.

Brian White – Ticonderoga

Yes. Hi, Jeffrey.

Jeffrey Kang

Hi, Brian.

Brian White – Ticonderoga

When we think about the cloud initiatives in China, we already have some of your customers come again with cloud solutions. One of your customers said they would double that business. In 2011, carriers are aggressively rolling out cloud services. I’m curious we don’t hear that much about how Cogo fits into the cloud. Could you talk a little bit about what you are seeing, some of the discussions on opportunities potentially in cloud solutions for Cogo?

Jeffrey Kang

We actually – Brian, as you know, we’re actually involved in many new projects. So the thing we talk about usually is a business that we generate rare revenue. Without a material revenue contribution, even with a lot of the new research and new business there, we might not able to talk about it. In terms of the cloud computing, yes, it’s actually a very – and has a good business trend. And demand is very strong. And we are actually involved in quite a few of that project. For example, by working with Intel, we are actually dealing with a few – quite a few very important customers in that segment. But at this moment, frankly, and we haven’t generated so much revenue. We’ll also not expect a material revenue contribution in the next few months or few quarters. So that’s the reason why we haven’t used the cloud computing as a new growth driver for us to talk about. But – if we look at on a two or three years, a middle-term target, yes, you are right. Cloud computing certainly will be another segment that we are focusing on the new development at this moment.

Brian White – Ticonderoga

Okay. And Jeffrey, just on the tablet market, it sounds like you’ve got 50 customers, I think last time on the last call it was something like over 20. I’m just curious what was the revenue contribution. We know it was small in the fourth quarter, but what was the revenue contribution, and what do you think it will be for 2011 from tablets?

Jeffrey Kang

Well, this could be – tablet is one of the most important growth drivers for us in this year. And from the customer number increasing, you will know how quickly we’ve helped our customer ramp up their – all kinds of things – tablet products. So we are – at this moment, we do not have a breakdown in detail, but I can give you a rough number. Let’s assume the digital media business in this year could have run like 50% of our total business, for example, 50% for the year. So I think tablets, it could be around 5% to 10% of the total revenue of our whole business.

Brian White – Ticonderoga

Okay, great. Thank you.

Operator

Your next question is from the line of James Faucette with Pacific Crest. Please go ahead.

James Faucette – Pacific Crest

Thanks very much. I have a couple of questions. First, obviously you just closed one acquisition. If you look at your growth forecast and targets for the next few years, Jeffrey and Will, how should we think about that being split between organic growth and what you still see on the horizon for potential contribution from acquisitions?

Jeffrey Kang

Well, if you look at our historical history, Cogo fundamentally is an organic growth company. So most of our growth actually is coming from our organic growth from our operating leverage, from our customer base increase. That is our fundamental growth driver. Even in the next five years, I still believe Cogo is fundamentally an organic grower in the next five years. Having seen that, just very quickly, if you want to – let's assume we can see the 25% of the growth rate in the next five years, probably 20% is coming from our organic growth and acquisition maybe at a few percentage every year. So that’s if we have to quantify as how much of growth coming from organic and how much from the acquisition.

James Faucette – Pacific Crest

So should we assume that there is very good chance that we’ll continue to see small acquisitions on a year-in year-out basis, just as you see opportunities and not – or should we think about that that we’re basically done with acquisitions for the near-term?

Jeffrey Kang

Yes. I believe we probably will be more aggressive this year in terms of pursuing the acquisition opportunities, given the end market opportunities as well as our strong financial performance, and more importantly, the end market demand is very strong. So I believe we are going to pursue more aggressively for the new opportunities of acquisition, and the investors are going to get more acquisition announcements. But again, at this moment, our focus is still relatively small deal rather than we pursue. We are not pursuing to make a deal. But at this moment, our focus is acquiring relatively small companies to put them in front of our product line and in front of our broad customer base to generate the incremental growth and revenues.

Will Davis

James, I will just add that when we look at the Mega Smart deal and then what we are seeing kind of out of the gate on MDC is that the business was – the way we have it set up is that we can quickly integrate these new assets and really get us up to speed so much faster than we would have been able to do on an organic basis. And I think when you look at what we’ve done with Mega Smart in the first six or seven quarters, if we can replicate that with MDC, it will – both of those will be homeruns. So we’re seeing it as a great way to quickly put us as a viable player in these new growth areas.

James Faucette – Pacific Crest

Yes. But I mean, it seems like you guys are putting pretty good track record with your acquisition. Then, separately, how should we think about – I know that there has been some effort over the past couple of years to establish better relationship with key component suppliers like Broadcom et cetera, how should we think about those types of relationships on a go-forward basis and their contribution to your growth rate?

Jeffrey Kang

Well, if you look at our business last year, we totally had roughly the semiconductor partners – roughly 40 to 50 in semiconductor partners, and which we, let’s say, we are closing to $400 million revenue next – last year. So if we target $1 billion revenue target in the next few years, I believe we need to increase our supply partners from the current level like 40, 50 at the far level. It just doubles at the far level in the next few years to 100 – to flat 100. So that’s why last year you had our announcements of working with a few tier one partners like Intel and Zynix [ph]. So I’m going to say we’ll have more announcements in terms of the new tier one strategic partnership with the tier one guys. At the same time, we’re actually adding a new supplier almost every month. Most of them are second tier semiconductor partners. So combining all of them together, we are very confident, in the next few years, when we reach the $1 billion revenue, we can reach – at the same time, we can reach over 100 supply partners from currently 40 to 50 suppliers level.

James Faucette – Pacific Crest

That’s great. Thanks very much.

Will Davis

Thanks, James.

Operator

The next question is from the line of Mark Tobin with Roth Capital Partners. Please go ahead.

Mark Tobin – Roth Capital Partners

Hi. Thanks for taking my questions. On the breakout for the Industrial segment, you talked about smart meters and smart grid remaining a large portion of it. Can you give us a sense of what’s driving that growth? Are you looking to add additional customers within that sector, or is this mainly just growing with the existing customers?

Jeffrey Kang

Well, yes, you’ve actually asking a very important question. In terms of Cogo, our revenue is simple, only like three components matters; how many customers we are having, what’s the revenue per account, and what’s the gross profit per transaction. So those three components can describe our whole business. So in terms of our revenue growth driver in Industrial segment, I believe in the next few years we will have – most of the growth will be coming from new customers increasing. And so that means in the Industrial segment that we have more new customers than that’s increasing. But for the existing and conditional business, I think the sales planning in the telecom business, we have pretty much covered everybody. So revenue growth is mostly coming from that increasing per account. So specifically for your question, in the Industrial business, most of the growth were coming from the customer number increasing in the next few years.

Mark Tobin – Roth Capital Partners

Okay. What are you seeing with the 12 five-year plan due to come out within the next month or so? Are you seeing a lot on the smart grid side, or how much insight do you have into the policies there?

Jeffrey Kang

Well, basically China, over the next five years development plan, which we’re seeing the spending in the smart grid, smart meter and many other new investor segments will continue. This trend has just started. So we’ll continue to (inaudible) spending increase in China in those segments. So that’s why we are – we have – frankly, so we’ll only scratch a little bit of the surface of this much broader market. So that’s why we believe we have a huge growth potential in terms of increasing our customer numbers. So frankly speaking, our existing revenue customers, probably only 10% of our existing and targeted customers in our CRM [ph]. So that’s why I’m very confident we’re going to significantly increase our revenue by converting our target customer into the new revenue customer and by offering them something useful to them in their products and then we can get more customers and more revenue from them.

Mark Tobin – Roth Capital Partners

Okay. And then finally, how do you expect the MDC revenue will ramp through 2011? You’ve mentioned the Q1 guidance and full year. Is that – do you view this kind of linear?

Jeffrey Kang

Well, we feel very confident for the MDC deal. The first year, we explain to the investors we expect the $15 million to $20 million revenue and $2.5 million of EBIT for the first fourth quarter after closing. And most of them should be in this year. And this business will continue to grow at least 20%, 25% per year in the next five years. So that’s how we view that we are able to leverage that this deal to expand our business in the Industrial segment.

Will Davis

Mark, it’s Will. I would say reasonably linear. I mean, I think it’s hard to get too granular on a quarter-to-quarter basis because some of these contracts will be multiple quarters in length. But for the purposes for this, linear is probably reasonable.

Mark Tobin – Roth Capital Partners

Okay. That’s helpful. Thank you.

Will Davis

Sure.

Operator

The next question is from the line of Graham Tanaka with Tanaka Capital. Please go ahead.

Graham Tanaka – Tanaka Capital

Yes. Hi, Jeff and Will.

Will Davis

Hi, Graham.

Graham Tanaka – Tanaka Capital

Yes. I just want to ask about the ability to understand a little bit more about your ability to finance – to self finance your growth rate. And wondering what kind of growth rate you can grow at, and will that having to access additional outside capital.

Jeffrey Kang

Well, that’s actually a very important question. So we actually look at our Cogo financial and business model. So we don’t have too much of CapEx. Our capital expenditure is roughly like $1 million per year, which is not –

Graham Tanaka – Tanaka Capital

Right, right. If the working capital, your cost of capital –

Jeffrey Kang

Capital. So we are – working capital (inaudible) corner. So our average (inaudible) around 90 days. And our average inventory is around 30 days, and our average payable days at around 20 to 25 days. So in general, there is a – so that’s roughly we need like 60 to 90 days of the days of revenue at the working capital. So if the revenue should grow 20%, 30% a year, that means we need to increase the working capital. So the way we address our working capital is – there are two trends. The one trend is, in the longer term, we are going to see the working days increasing because as the company given more leverage, we can’t ask more in payable days increasing, that will decrease our working capital days demand. That’s the first trend. Another trend is, actually we don’t need to use the financial market and use the capital market to try to finance our growth.

So we can easily use the bank credit line to which the existing commercial bank in China and in Hong Kong, which has been a mass credit line fast to grow. So that’s why, to answer your question specifically, I promise them [ph] that we needed to accept the equity market to risk money to finance our growth. So exist currently, we can use – or the profit that we’re generating every year plus the bank credit line to finance our high growth in the next few years. The cash we generate and the cash we are having so far for acquisition, buyback and other use of proceeds.

Graham Tanaka – Tanaka Capital

But your acquisitions that you’re trying to be doing would be cash – all cash deals or could it be equity also?

Jeffrey Kang

We internally – it could be both. But given the evaluation we are having today, I prefer cash instead of stock. When the stock moving up, I mean, and I can state or use a combination of cash and stock as a way of acquisition. At this moment, only one (inaudible) cash.

Graham Tanaka – Tanaka Capital

And what was the cash at the end of the year? And what do you think are you projecting for the end of this year if you did not do any deal?

Jeffrey Kang

Well, that will be very simple. And I don’t have that – your answer is without any additional deal. Basically, if you look at our – we are generating the cash flow – positive operating cash flow every year. So if we have like roughly net of cash in the last year, so let’s assume we don’t – and we’re going to pay like $22 million for the MDC deal in this year. But in this year, we’re going to generate those addition cash. So we can assume – the cash that we’re generating this year pretty much pays out for the MDC deal. So that’s one – if we know further an acquisition is coming, we probably will have the seminar cash level end of this year if we don’t do anything, like a buyback or other things.

Graham Tanaka – Tanaka Capital

Great. Okay. Thank you.

Operator

(Operator instructions) The next question is from the line of Mike Jolin with Heartland. Please go ahead.

Mike Jolin – Heartland

Hey, congratulations, guys, on a great quarter.

Will Davis

Hey, Mike. Thank you.

Jeffrey Kang

Hi, Mike.

Mike Jolin – Heartland

Most of my questions have been answered regarding MDC. So I guess I wanted to ask about wages and what you’re seeing on the SG&A front. You talked about more leverage on operating margin, but I’m just curious as to supply labor and what you are seeing on the hiring side.

Jeffrey Kang

Well, that’s – the first thing, the wage, the cost of wage actually have a very low percentage among Cogo’s overall expense. So that’s why – as you know today, China’s inflation is actually one of the most concerns today for everybody. That’s we’re seeing the wage increasing dramatically since the two years as of, starting from two years as of. So, normally we can increase the wage to our employees. And it normally is over 10% year-over-year. So – but having seen that, we are not increasing, we’re (inaudible) about any burden to Cogo because we’re hiring most of the high end people. We pay them far beyond and higher than the market price in order to keep the balance. So for the Cogo-like company, I’m not going to say the wage increasing is an issue to us. But you are right. For the labor-intensive business like EMS or other and ODM business, (inaudible) increasing will strive their (inaudible). But at Cogo, we don’t see it as an issue for us.

Mike Jolin – Heartland

Okay. Great. And what type of integration do you expect for the MDC acquisition at the end of the four quarters – the first four quarters? Do you expect that to be fully?

Jeffrey Kang

Yes. Yes, you are right. Normally, it takes about two to four quarters to integrate a deal. So the first two quarters is most important, most critical in a time to integrate those businesses. But given today the nature of the MDC nature, I think it’s relatively easier for us to integrate because the customer base is relatively limited roughly, let’s say, five to ten key customers. And as they are – the single contract is relatively bigger than our normal business. So our view is actually for this deal is to be much easier to integrate the Mega Smart deal we found almost two years ago. So I’m very confident we’ll be able to quickly integrate the MDC deal and make it and have leverage, and we’ll be able to find and expand the customer base quicker than what we expected.

Mike Jolin – Heartland

And last question real quickly, what’s the biggest risk on the horizon for achieving your $1 billion revenue target and 15% gross and 10% operating margin targets?

Jeffrey Kang

Well, frankly speaking, I’m very confident we are confident we are able to achieve that goal. It gets the speed. Either we could achieve it in one year or we’d achieve it in four or five years. So I think for Cogo, our challenge is not we are able to achieve or not achieve that goal. It’s how quickly we can achieve that goal. So internally we actually have a very aggressive target, aggressive speed to achieve that goal, but I think we just want to run the business more sustainable. We don’t want to be like run a business.

If you look at our history, we’re relatively conservative in terms of manage our business, we want to just grow consistently year-over-year. I don’t want to one year grow 50%, another flat year. But I want to run a quite consistent growth to make the company and integrate it as a team to digest every deal, digest every new business. So I’m very confident giving this end-of-market environment and I’m pretty much sure, and just give me another two or three year or more and we can get there.

Will Davis

Mike, hey, it’s Will. I would just add that we’ve been pretty consistent in talking about how we’ll see more operating margin leverage than gross margin, and we’ve seen that over the past six quarters and that trend probably continues. And I think it was Amir from Barclays who had asked earlier about – do we have to have 15% gross to hit 10% operating. The answer is now. So just keep that in mind.

Mike Jolin – Heartland

Okay. Super. Thanks, guys.

Jeffrey Kang

Thanks, Mike.

Operator

I’m showing no further questions at this time. I’ll turn it back over to management for any closing remarks.

Jeffrey Kang

Thank you. As we enter the earnings stage of 2011, I feel that Cogo is entering a critical stage. The full value of the Cogo business model is being validated by our investor base, and we are adding customers and strategic supply partners at a rapid pace. Our small and medium enterprise strategy is the bearing fruit in terms of our customer base and increasing our SME apple.

I’m committed to driving Cogo to $1 billion in revenue in next few years, and I am focused to make this growth profitable and within the bound of our 10% operating margin target. We have identified an addressable market of $20 billion and growing. And I am confident that we are well positioned to implement this goal. I would like to thank all of our Cogo employees for their great execution in helping us reach our goals and our shareholders for their strong support on Cogo. Thank you, and hope to you see you soon. Bye.

Operator

Ladies and gentlemen, this concludes the conference call. You may now disconnect. Thank you for your participation.

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