Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  
TRANSCRIPT SPONSOR
ChinaDirect Logo

Comtech Group, Inc. (COGO)

Q1 2007 Earnings Call

May 10, 2007 4:30 pm ET

Executives

Jeffrey Kang - Chairman, President & CEO

Hope Ni - CFO

Analysts

Brian White - Jefferies & Co.

Charles Golvin - Piper Jaffray

Ramesh Misra - C.E. Unterberg

Wren Barnet - Lehman Brother

Quinn Bolton - Needham & Co.

Adele Mao - Susquehanna Financial Group

Amir Daniel - W.R. Hambrecht

Edward Hemmelgarn - Shaker Investments

Marc Tobin - Roth Capital Partners

Julie Chen - Brean Murphy

Presentation

Operator

Good afternoon. My name is Barbara, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Comtech Group First Quarter 2007 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period (Operator Instructions).

Thank you. It’s now my pleasure to turn the floor over to your host Mr. Jeffrey Kang, CEO. Sir, you may begin the conference.

Jeffrey Kang

Hope?

Hope Ni

Yes. Thank you Barbara and good afternoon to everyone. My name is Hope Ni; I am the Chief Financial Officer of Comtech Group. And on behalf of the company, I would like to thank you for joining us today for this earning conference call. After the bell today, the company issued a press release reporting financial results for the three months period ending March 31, 2007.

This release can be accessed in Investor Relations section of Comtech's website at www.comtech.com.cn or at most other financial websites. Your call today will be hosted by Jeffrey Kang, Chairman, President and CEO of Comtech Group, as well as myself the Company’s Chief Financial Officer.

Before we begin, I would like to take a few moments to discuss our forward-looking statements. The call today will contain several predictions regarding future events and the future 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 that pertain to the Company business.

We refer you to documents that Comtech's files periodically with SEC. Specifically, our Company's S-1 and S-3 Forms, recent 10-Qs and 10-K Forms and in the Safe Harbor statement including 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 projections and the Company assumes no obligation to revise any forward-looking information contained in today's call.

At this time, I would like to turn the call over to Jeffrey Kang, Chairman, President and CEO of Comtech Group. Jeffrey, the floor is yours.

TRANSCRIPT SPONSOR

China Direct Logo

China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

To sponsor a Seeking Alpha transcript click here.

Jeffrey Kang

Thank you, Hope. Thank you to everyone for joining us on this earnings call. I am happy to report that we’ve had a very strong first quarter and posted better than expected quarterly financial results. Even though the stress of fourth quarter has transitionally or relatively weaker season for our market.

First quarter revenue grew 32% over the same period last year and a non-GAAP earnings per share was $0.15 representing growth of the 36%. Later on Hope will provide a more detailed update on our Company’s financial performance and she will review earlier guidance for ’07.

But first, let me provide an overall update on our business drivers, recent contract wins, partnership announcement and a growth alternate for the rest of the '07. Our Q1 revenue continues to increase at a strong pace year-over-year, as a result of continued growth across all of our end markets.

Broaden products offerings and our ability to identify and target high growth market opportunities. All of our major business segments show the minutes for year-over-year growth. First let me talk about our work in the digital media end market. This is the fastest growing end market for Comtech.

During the first quarter our digital media end market grew 82% over the prior year, contributing almost the 25% of our total revenue. This increase was primarily driven by the strong growth in demand for the modules used in the digital and IPTV set-top box as well as the home gateway devices.

We expect 2007 to be an important year as the digital media trends are federating in anticipation of the 2008 paging our impacts. As of end of the '06 only about 10 millions of the Chinas 116 million cable renovation subscribers had a digital cable.

This number is expected to rise to over 60 million by the end of the '08. We are seeing a federating implementation of the digital TV in China and we are confident, that we will continue to capture more of this market throughout this year and in the years to come.

We announced a $15 million contract win with a leading set-top box customer in Q1 and expect some more new contract wins in the near future. Our partnership with Microsoft has already started to help us generate the revenue in the new business parameters. For example, we’ve started to supply GPS solutions to several customers this quarter, which as you know is an industry that permitting years to Microsoft the windows embedded OS.

Our partnership with Microsoft is not administrative to acknowledge collaboration it also own opportunity to work together with Microsoft sales and a marketing team to pick other than a job as new high growth opportunity. We expect to see our revenue strong ramp-up in the second half of this year from this new developed businesses.

We are equally encouraged as we look across our traditional market, mobile handset and telecom equipment. And the market which has delivered a strong growth during the traditionally week sales period. Our telecom equipment related to revenue increased to 20% over Q1 last year as we’ve benefited from our major telecom customers including Broadway and MediaNews both of which are been global past this year.

Although, we are not coming on it as a part of our business growth in this year, I would also like to take these opportunity to give you an update on the current status of the 3G market in China. As you probably know China Mobile plans to invest over $3 billion to build a 3G CDMA networks in 8 to 10 selected cities in China. Our customers including ZTE, Huawei, Tata have already announced the some winning bids with China Mobile.

We believe COGO is well positioned for this upcoming market opportunity. Our strong relationship with all of our major telecom OEMs and our broad library of their functional module offering should allow to us grow alongside with these companies. This data at a latest stage, so it is still too early to predict the actual impact of the 3G of this year.

We will only include already confirmed 3G revenue in our guidance. But certainly we'll give our at investor at topside industry view which are scheduled later this year.

Irrespective of this significant potential of the 3G market we are still expecting our telecom equipment and sale to experience a stable growth in 2007. We have continued with sequential wins as evidenced by our recent announcement of a payment on our optical contract from ZTE.

Next, lets move into mobile handset in market, which grew 19% in the first quarter. The handset market has been beating expectations with a strong growth despite the fact that the first quarter is seasonally week.

In the Chinese markets alone between 120 and 140 million handsets were sold in 2006. We estimated that handset market demand in China will continue to experience the double-digit growth in 2007, selling between 140 to 160 million units and it didn’t stay there doesn’t even Comtech cell phone manufactured in China and exported aboard.

We think there are two drivers at a pace here. One is the high annual cell phone retention rate of around 22% to 25% among China's over a 400 million wireless subscribers.

The second is the strong growth in the new subscribers, which is around 60 million per year. We continually benefit from the broader products offering, higher market penetration and overall industry trend of shift in design and manufacturing work into China.

Although, we factored in the potential market slow down in Q1 due to the seasonal fluctuations, we are pleased to be able to announce better than expected results. More importantly we are seeing a very strong re-bounce since April.

Overall we are optimistic about 2007 most opportunity in this sector. Driven by end of market growth and an increase in ASP from our existing customers. The cell phones market is a rapidly changing market in China that offers to create opportunities and challenges as well.

We are seeing to convince of the communication, internal applications and computing on to a single form, resulting in an endless integration of new features, such has TCS, Video recording, playing and more. This will increase demand for customers to module from our customers and well therefore positively impact our business. The COGO business model has proven to be very effective, as topping this dynamic industry.

Turning to our service duration, in the first quarter of this year we’ve generated service revenue up to $1.4 million, which represented a 40% increase over the same period of last year. We continued to be confident that this will be a high growth, high margin proportion for COGO.

We will continue to stay close to our key customer by way to offer Telecom Engineering Service as they move to significantly increase their marketing shares, both domestically and internationally.

We believe there is a significant potential for this settlement of our business as we are seeing slow demand from our Chinese customers who request the total solutions that only include technological products but also request implementation, maintenance and the related service.

This is occurring none on in the telecom sector, but in other industry as well, such as surveillance and security. We are currently working on to expand our service business to meet demand in these growth areas.

Finally, I would like to briefly discuss our recent public offering. The offering raised approximately $84 million in funds, strengthening our financial capabilities to pursue acquisition opportunities. The addition to organic growth we are actively seeking out position opportunities that will enhance our company’s development.

I would like to take this opportunity to express our internal guidelines and the strategy regarding acquisition. First, we are looking for candidates who has been profitable and who is already Asian will see accretive deal to COGO.

Every deal we make should favor our investors and impact positive earnings per share. For instance, if we came here 5 to 10 times molecular to acquire the company, we invest $3 million to $5 million in profit we were accelerate our EPS growth.

Second, and as more importantly in our view the targeted company needs to have good synergy with COGO, which we believe we will generate additional value and drive our long-term growth. The companies we are currently targeting such as the designer solution companies, share the same customer base and offer complementary solutions and a surveillance that we can easily offer to our customers using our existing well-established platform.

Third, we look at acquisition as the midst of the supplementing or organic expansion into new high growth market that will remain highly fragmented. As you know, we have already started moving into the many new industries including the auto electronics, medical equipment, surveillance and security industries.

Acquisitions offers a promising and rapid mix for achieving this goal. And of course we will give our investor update as soon as we enter into any future agreement.

With that I will like to turn the call over to Ms. Hope Ni our Chief Financial Officer in order to discuss in detail just the result for the first quarter. Hope?

Hope Ni

Thank you, Jeffrey. Good afternoon everyone. For clarity all the figures I am discussing here unless, otherwise, noted, will be in U.S. dollars. Revenue for the quarter was $44.6 million an increase of 31.5% compare to $33.9 million reported for the first quarter of last year. We have experienced solid growth in all our end market.

In particular Digital Media had the strongest growth. The compensation of revenue was mobile, $17.9 million or 40% of total sale, which would presented 19% increase, Telecom $14.2 million, 32% of our total sale representing a 20% increase and at Digital Media $11.1 million or 25% total sales representing 82% increase.

The company service recommend with introduce in ’06 and it contributed $1.4 million in revenue for the quarter of 2007 compared to $1 million in first quarter of ’06 representing 14% increase. It also kind a approximate 3% of the total sales.

Cost of revenues, which includes the aggregate purchase of component from suppliers and the direct cost of services, was $36 million compare to the $27 million into ’06 and increase of 31.5%. Gross profits for the quarter was $8.5 million up 31% compared to $6.5 million for ’06. Gross margin were 19.12%, which is close similar to the 19.15% reported during the same period of last year.

It increase slightly from 18.8% reported during the fourth quarter of ’06. Also for people who are new to our company just wanted added points on gross margin, because our revenue recognition is the selling price of the component on cost of good sold, that we divide the gross margin, our gross margin have duration typically is different from a typical designed house.

Usually we recognize the revenue as the service revenue, therefore, our gross margin is a little bit lower than typical design house for our operating margin is reasonable. So we normally look at our operating margin as one of other metrics.

Now lets look at operating expenses. Operating expenses for the quarter was $4.5 million, which included $1.2 million in stock-based compensation expenses up 96% from the first quarter of ’06. Selling, general and R&D expenses totaled $3.4 million up 440% compared to $1.4 million reported in first quarter of last year.

The increase was attributable to increase in sock cost due to higher employee headcount, notably related to the engineering service, which was launched in Q1 ’06, as well as growth in stock-based compensation expenses, other sales related expenses to support our ongoing business, and a cost associated with Sarbanes-Oxley 404 compliance et cetera.

Research and development expenses increased 25% to $1.1 million compared to 0.9% million in the first quarter ’06. R&D expenses formally related to investment and developing new and higher margin product.

Income from operation was $4 million, which decreased slightly 3.9% as compared to $4.2 million for the first quarter ’06. Again one of the reason is due to the higher stock-based compensation cost, related to employee headcount.

If we exclude stock-based compensation cost, our income from operation certainly will be higher than last year. The operating margin for the first quarter was 9% versus 12.4% for the previous year excluding the effect of stock-based compensation and amortization purchase intangible asset, the operating margin would have been 12.2%.

The effective tax rate for the first quarter of ’07 was 9.3% compared to 10.3% for the same period in ’06. Minority interest income share was $70,000 as compared last year income of $677,000 over the same period last year as a result Comtech's increased holdings in subsidiaries including Shanghai E&T, Huameng and Comloca.

Net income for the first quarter was $3.7 million, representing Diluted EPS 11 on a U.S. GAAP basis compared to a net income $3.3 million or Diluted EPS $0.10 in the first quarter ’06. Non-GAAP net income excludes share-based compensation expenses, acquisition related costs including amortization of purchase intangible assets.

Included in the first quarter ’07 net income was an amount of $1.2 million for stock-based compensation expenses to reflect adoption SFAS 123R as well as amount of $230,000 for amortization of purchase intangible asset mainly related to our earlier acquisition of Viewtran. The weighted average number of shares used in the calculation of diluted EPS was $34.3 million compared to $33.3 million in the first quarter of '06.

For your information, the estimated numbers for diluted share going forward since we did a offering as Jeffery mentioned recently, the number of diluted share will increase. For Q2 the estimated number would be 38 million, for Q3 it would be approximately 40 million shares. And for Q4 it would also be approximately 40 million shares.

Now let’s look at our balance sheet. Turning to the balance sheet, our financial figures for this quarter again looked quite strong. The company completes a quarter with a cash of $43.2 million, slightly down from $48.1 million at December 31, '06.

We maintained a low bank borrowing of $4.3 million, which is all what the capital were brought down. The company continues to be in a strong financial position with a current ratio, 3.9 to 1.1, shareholder equity increased by $5.5 million to $19.6 million from December 31, '06.

Again with the recent offering our balance sheet is further strengthened and that will reflect in Q2 and then the number I just reported doesn’t include the offering number yet.

Accounts receivables was $40.9 million as compared to $37.3 million in Q1 '06, days of sales outstanding shortened to 83 days for the first quarter as compared to 99 days for the same period last year.

As some people may know the telecom industry in China with standard payment day is about 90 days to 180 days, we have always stayed on the lower side of industry standards.

It is also important to note that in our in entire 10-year operating history we never had a major receivable problem.

Finally lets discuss our future outlook. In terms of our guidance for the year '07 based on the current guidance management is increasing '07 full year guidance to between $215 and $218 million in revenue, up from the previous guidance to $210 million to $215 million and a non-GAAP EPS $0.68 for the full year of '07 from the previous guidance of $0.67 non-GAAP earnings per share providing in March.

Recently we completed a secondary offering as we issued as told 5.06 million primary shares raising proceeds of $84 million, which we will be using only for acquisition. The management puts a lot of emphasis on increasing shareholder value. And if we do not anticipate that this offering will dilute our existing shareholders value.

As evidenced we are actually increasing our annual EPS guidance. We are very confident about company's strong performance in '07.

This concludes my remarks and I will turn the call back to Jeffrey.

Jeffrey Kang

Thank Hope. As you can see Comtech always deliverers or even delivers when it comes to our guidance figures. We have been a public company for 11 quarters and we have delivered significant growth and consistent strong performance throughout. Our management team is a truly committed to achieving and maintaining the sustainable growth.

We believe that we persist a strong prospects in 2007 and anticipated that each of our markets were contributed to this growth. Although, we continue to focus on the new business development to address new industry opportunities and to explore other future growth opportunities.

We believe Comtech remained a pioneer in identifying and capitalizing our strategic prospects. In addition to organic growth we also are actively seeking merge acquisition opportunities to support our growth.

Now, I would like to turn the floor over to questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. Our first question is coming from Brian White, Jefferies & Co.

Brian White - Jefferies & Co.

Hi, good morning, Hope. Good morning, Jeffery.

Hope Ni

Good morning.

Jeffrey Kang

Good morning.

Brian White - Jefferies & Co.

When we look at the set-top box it looks like it actually rose sequentially in the March quarter which is highly unusual compared to other companies I follow, can you maybe speak to that Jeffery were you surprised by the strength of the set-top box business and do you expect that to continue throughout the year?

Jeffrey Kang

Well, as we have mentioned before and this year and because may be Olympics is closing and so we are seeing the kind of accelerating of the adoption of the set-top box in many Maniacilius (ph) in China. So, that’s why in this Q1 we’re still seeing a very quite a strong demand from many of our customers.

So, that’s why but I think in that moving for the next couple of quarters we probably are going to stay and this kind of adoption is accelerating. So, that’s why COGO still expect the rise in your increasing and from this business in the rest of the quarters in this year. And I think that one thing is for sure this next year and the next year that will be a very good business and at least in the next two years.

Brian White - Jefferies & Co.

Okay. And could you talk a little bit Jeffery may be about some of these next generation market like a automotive, Stivala’s medical. What are some of the dynamics, that make these interesting whatever the margin profiles and really what is the opportunity, how big is the market in these areas for you guys?

Jeffrey Kang

Well, I think each of this market today in China still that’s a very small comparing with FCOM cell phone market, but you know just like any new industry in China, everybody is starting from the small business but eventually while we believe in the three to five years down to a road. So, in those industries itself in the telecom and the cell phone market today. So surveillance as an example to -- it’s given your head an explanation how big the market could have be.

So after 9/11, I think the public security is one of the major concern of each government. So that’s why in China this kind of -- there is a program called Pisco China which almost is the prime tool in every city, every street corner, they want it in store, the video camera. So this is the more like -- and then you just think about it, it’s actually a creating a new industry.

So in every corner they have the camera and we need fiber nano-works to connect orders, thousands or ten thousands of cameras across the city and then in the backhand we need a storage, we need a management software. This is a kind of create a new industry in next couple of the years. So figure them in those provinces are now in the city that sends in.

So in this year they are talking about invest kind of 200,000 pieces of the IP camera across the city. So that mix that the mix that investment is closed to 2 billion RMB try governing. So this is just a once city and china has another on the 100 to 500 similar cities that is sizable investment. So that’s why we are very excited about this new opportunity.

By this like any other new business in the very beginning in China is relatively in a small and are fragmented. So that’s the industry COGO -- we are very interested in because when DDM did this high growth and faster changing dynamic industry, our business model has proven to be very effective. So we offer -- IP solution, licensing protection module as we as the service to surveillance new industry and there is new opportunities.

Even though currently our revenue is relatively small and starting to generating revenue and since we know this year. By we can have the two drivers to growth. Two ways to grow our business in this segment, one is just organic growth. We already have some of the revenue, already have some customer in this segment.

On our hand we can think about using acquisition strategy to co-acquire a CEU and other companies that enable COGO will become of the pioneer in this industry. So that’s one example to show or invest to how we are going to grow our business investment in new industry and a new area.

Brian White - Jefferies & Co.

Very good, thank you.

Operator

Thank you. Our next question coming is from Mike Walkley from Piper Jaffray.

Charles Golvin - Piper Jaffray

Good morning, Hope and Jeffery this actually Charles heading in for Mike Walkley.

Hope Ni

Hi Charles.

Charles Golvin - Piper Jaffray

Hi. First a quick clarification on the comment Hope made about gross margin, some of the calculations that would be helpful. Question number TBS, CDMA contract pretty significant dollar amount and given primarily to local Chinese players, trying to get a sense of the timing of how these are going to impact to revenue?

Looks like near guidance to you opted by about $4 million or $5 million, trying of get a sense of the timing into ’07 and may be if you have a perspective into 2008?

Hope Ni

Okay let me answer your first question and Jeffery can address the second question. Your first question is that people, some people are familiar but some people may be less familiar with our business model. Our business model is, we do design solutions for our customer and however, we do not collect a design fee but we are selling specific component, customized component incorporating our design.

So our revenue is not a relative to our design fee. Instead our revenue is the selling price of those customized component and then we have the cost of good sold from which is a purchase price of a those customized components then we get the gross profit. And now we divide with gross margin obviously.

And then the point I was making is if we have collected designs fee instead of selling the customized component then our gross margin would have been much, much higher than obviously our revenue will be smaller as well.

So we are using a different revenue recognition from a typical design house. Therefore, our gross margin, our status looks like lower than some of the design house. If we look at our operating margin, usually its in line with the most of tech companies or maybe better than some of the tech companies.

Jeffrey Kang

So, let me address this on TD/SCDMA status in China. So as you know China Mobile announced, roughly over $3 billion investment for the planning through invest in the TD/SCDMA to build a nano works in aid to penetrating us to which including the Olympic stadium, I think Beijing.

So in terms of lot of $3 billion in their investment, roughly in product infrastructure equipment at the base-station and a core nano works is roughly 30% is over $1 billion, say investment. Another $1 billion investment including work spend in construction. You know that the installation of the spacing building, the box to most likely the construction related

And accessory like the power supply transmission and all type of the and our management software is roughly $400 million investment and at the terminal is roughly a $0.5 billion investment. So this is how becomes to the rough $3 billion investment and planning and for the TD/SCDMA in this year.

In terms the timing and China, many of our customer updating here in far away already announced they are winning the bidding from China Mobile and ATE probably one of the biggest winner they claim roughly 45% of the total the bidding win from this TD prime.

But currently the extra situation, even though they winning the bidding it still, that takes for a while to get the real contract. So that’s a lot, we believe it’s around end of the May. So where each, many of our customer will announce they can handle contract to win, winning from the China Mobile.

Because China Mobile using the way, using each of -- they are ready to sign the contract to separate where each of our customer, even though the bidding usually arrange the better headquarter of the China Mobile. So, from our view, we’ve already listed to some that TD orders from our customers.

We think above in terms of the big order even though and probably is coming into in the Q3 and so that’s why in terms of the revenue impacted to us or too many of our customers, I think we probably are going to see this impact in Q4 and most of the award goes to the '08.

So that’s why we are, by now we don’t want to be very aggressively project our TD 3Q revenue in this year. So, certainly I know we are seeing this service is rolling out and I guess there will give offset to our investors.

But as of today, we don’t want to give it up too much of details or precise, quantifying what the number should be this year but certainly I think it will -- certainly it will be good as good up sight to us in the end of this year, October in the next year.

Charles Golvin - Piper Jaffray

Okay. Got it. One quick follow-up question, in terms of projections for the size of the TD-SCDMA your handset forecast for 2007 and 2008. Do you think like what is the size for that forecast and how well are customers like VT, eProvision for getting that share?

Jeffrey Kang

In terms of the terminal side, because terminal that the bidding hasn’t released yet. So, I think that TD we are talking of, even though China Mobile talking about over $10 million, the first runner will have the $10 million cell phone users, but we’ve don’t think that’s, it’s the realistic number in the near future.

So, that’s why we think this year probably $1 million to $2 million the TD and a cell phone will up be ready purchased to buy the China mobile. And the next year the number could have been ranged from anywhere from $10 million to $30 million. So that is still to earning to give that precisely projection.

But this year we actually don’t put in too much of the estimation from the TD business. And I think in terms of the, who is going to be the major players in this TD, I think its still the major telecom vendors like ZT of Broadway, and (inaudible), they will become one of the major TD-SCDMA cell phone suppliers because the TD cell phone sold in China which is totally different with the GSM cell phone most likely will be subsidized by that China Mobile.

So that’s why China Mobile, if this isn’t cell phone business its more like a penetrate equipment its carrier related business, that’s why current time both our customer which have a very strong business with our existing carrier operators, we’ll have advantage to be more business there.

Charles Golvin - Piper Jaffray

Thanks a lot. And good luck guys.

Operator

Thank you. Our next question is coming from Ramesh Misra from CE Unterberg.

Ramesh Misra - C.E. Unterberg

Good morning guys, can you hear me?

Hope Ni

Yes, hi Ramesh.

Ramesh Misra - C.E. Unterberg

Hi. So my first question was in regards to the OpEx this quarter, it declined fairly significantly sequentially from Q4 levels. Can you tell us what where the drivers over there and what should we model going forward?

Hope Ni

OpEx is very much linked with the revenue, and then as we compared to Q4 number one as the revenue is more than Q4 according operating expenses will be lower as well.

And second, I believe that actually the main reason what are the main reasons, I think it linked with the revenue. And then for going forward if you look at Q2, Q3, or Q4 the percentage of each line item, which is a selling, general administrative expenses and then the second line item that research.

I think percentage will be remain quite similar so, selling general administrative income will be around 6% of revenue and then research again will be between 1% to 2% of revenue. So, I think the percentage if we look through is all quite similar.

Ramesh Misra - C.E. Unterberg

Okay, great. In terms of your engineering services revenue that also decline quite sharply sequentially, any reasons for that? And can you kind of give us your overall kind of perspective over there?

Hope Ni

Our engineering services is usually a long-term it’s a contrast basis. So, we look nice revenue while we have to finish our work and then our customer has to accept our work before we can book revenue. So, therefore, if we look at beginning of the year Q1 compared to last year Q1 our service revenue they increased about 40%, but if we compared to Q4 it declined because a lot of revenue recognition have been in the later of the year.

Ramesh Misra - C.E. Unterberg

I see. So revenues over there will tend to be lumpy just as you close any particular contract of…

Hope Ni

Usually, you know, our revenue recognition for service business that we have to deliver or our services then our customer is satisfy with our services and now we can book our revenue. So we’re looking at quite conservatively to booking the revenue.

Ramesh Misra - C.E. Unterberg

Okay. And your full year breakdown or forecast for these segment has a proportion of revenues is still around 5% to 10%?

Hope Ni

Yeah, we still stay with that range.

Ramesh Misra - C.E. Unterberg

Okay. My final questions was in regards to inventory that was up sequentially is that because of anticipated business ramp in the Q2 period or are there any other drivers for that?

Hope Ni

In the inventory?

Ramesh Misra - C.E. Unterberg

Yeah.

Hope Ni

Days of inventory is 32 days and then our inventory level actually is still quite low, Q4 was particularly low, but I think our Q1 inventory is quite normal.

Ramesh Misra - C.E. Unterberg

So those are the case of Q4 being especially low rather than…

Hope Ni

Right, right again it’s kind of big year, you know, time-to-time if end of the year and then obvious from our side if we want to sell as much as we can and then inventory level may fluctuate quarters-from-quarter, but I think overall due to our business model we don’t have much inventory risk.

We occasionally sell its usually back to back order and now we’re keeping our entry only if we put the fair in a product maybe have a short days in future or if we think know in different transportation times delivered to multiple sites, so we have inventory levels but normally its also healthy so even for the this quarter I will consider it's quite healthy level.

Ramesh Misra - C.E. Unterberg

Okay, thanks very much.

Operator

Thank you. Our next question is coming from Wenn Him (ph) from Lehman Brother.

Wren Barnet - Lehman Brother

I am Wren Barnet (ph). My questions have been answered.

Operator

Okay, thank you. Our next question is coming from Quinn Bolton from Needham & Company.

Quinn Bolton - Needham & Co.

Hi. Good morning to Jeffrey. Good morning to Hope. I was wanting first a quick question for Hope. Can you give us a split for the stock comp between R&D and SG&A?

Hope Ni

The split is pretty much half and half. The SG&A is about $0.58 million and then R&D is about $0.63 million.

Quinn Bolton - Needham & Co.

Great, okay thanks. The second question was just on the tax rate. It looks like it was over 9% this year, we’re still wondering if sort of a 7% to 8% is the right rate as you look at over the entire year 2007?

Jeffrey Kang

Yeah. I think that’s the raising we have the 9, I think over the year I would still believe the 7 to 8% is what is our average the tax rate. I think in this quarter particularly we have this on the tax provision and so that’s why it makes our tax looks a little bit higher and but it’s not because in some country like in Hong Kong we pay tax annually so the quarterly we get to put a sum that we reserve there. So that’s why we still believe the whole year the tax rate it was same in at to 7% to 8%.

Quinn Bolton - Needham & Co.

Okay great. And then a question for Jeffries. Jeffrey you mentioned I think in your prepared comments that you’ve seen a pretty good uptick in orders in your mobile handset segment here in April. Wondering if you think that’s really just a typical seasonality headed in the going the week holiday in May or what do you think that this is just a longer term kind of strength for the Chinese market?

Jeffrey Kang

I think you know, overall in the market in China and the harbors still have a various strong end demand and a year-over-year growth and I just mentioned that in last year in China, within the Chinese domestic market it’s a sold around roughly under 40 million cell phone units into China alone and this year we still estimate and the market will be demand.

The demand is still going to increase here. So we estimate around 160 million units cell phone will be sold within the Chinese market alone. So amount is 160 million new phones sold in China roughly 60 million are the new subscribers demand and another one main area is the refurbishment margin. So, the first I am seeing end market is quite healthy on a year-over-year.

So, we’re seeing very strong revolve, thanks to April and one of the reason, yes its Golden Gate and in May and that’s typically is that in the short-term momentum and in the month of April.

But we’ve also -- after the Golden Gate, what you’re seeing, our customers demand is very strong. So, that’s why making we belief you know Q2 for the cell phones business, which would have been very strong and not only just for COGO, I think for many players in this market.

And then after heading into the Q3 and maybe come through another $1 million saving usually in the June, in the July and August, it’s a summer season that’s in our cell phones market will coming down a little bit and then will coming to the stop of season which is just starting from the October to December.

Quinn Bolton - Needham & Co.

Okay. Great and then just a last question probably and up on the sort of questions on the inventory. I assume that for most of you supply partners that they recognize sales on a selling basis to you sort of once you bring inventory under your book you own it.

I’m wondering -- just want to confirm that in Q2 you know if that’s the case how do is your sort of -- what are you guys see just cross your end markets in terms of price.

I mean it seem like we’re kind of coming out of the inventory bottom my guess is the component pricing -- price decline may start the slowest not start to increase in the second half of year.

But I’m wondering if you give us your thoughts on just sort of semiconductor component pricing into they seasonally stronger second half of the year? Thanks

Jeffrey Kang

Basically, even though we carryover sale from the customized of specific components to our customer to carry our design value but usually we don’t try to sell any commodity products lot of this sale is typically in a specific or customize.

So, that’s why our pricing is actually fixed. But once we’re winning the design from our customer. So, we don’t have that kind of price pressure in the once its offered. I’m not saying you set demand price and so that the price is so different this week within last week.

But the most of products that we’re seeing is, we have the very fixed stable price. And we also, after we getting the order from our customer we have given order to our supplier. So, that’s why we don’t have this trend of price pressure for running our business.

And going back to your first question, so we typically don’t take too much inventory for our suppliers in order to help them meet their numbers in the quarter end because this kind of delivery may basically not just a once a month and more likely is once a week from our suppliers.

So, this is kind of repeating revenue and the repeating delivery process. So, that’s why I think the thirty days of the inventory is kind of the normal and healthy situation for us.

And we’re also seeing the semiconductor and orders our customers of demand for the most of the component, since April is very strong and then actually many of the semiconductor and many other passive components is kind of more shortage. So, that’s why we estimate in overall market demand should be a very strong and the for the rest of the ’07

Hope Ni

Just to add a point, I think your first question, yes it understanding it’s correct. And the second I think Jeffery had already answer.

Quinn Bolton - Needham & Co.

Okay. Thanks very much.

Operator

Thank you. Our next question is coming from Adele Mao from Susquehanna.

Adele Mao - Susquehanna Financial Group

Hi, I have a couple of questions. Number one, Jeffery you mentioned that you initiative with Microsoft will accelerate revenue growth into the second half of ’07 with this ramp up factor into your guidance?

Jeffrey Kang

What I can say is, orders for new business we for the visible parts, we have already included in our guidance. But it’s still possible we can do better and to deliver the off side on top of our guidance.

Adele Mao - Susquehanna Financial Group

Will this go to mobile phone or digital media? What kind of gross margin you are looking at?

Jeffrey Kang

I think it’s mostly digital media, it’s like GPS, like portable video players, like multimedia devices.

Adele Mao - Susquehanna Financial Group

Okay. Also my other questions, is related to engineering services, it’s 3% of total revenue in 1Q and you mentioned earlier that you expect full year continue to be 5% to 10%. And you also mentioned you are getting into surveillance and security and engineering services, are you implying that in traditional telecom engineering services is kind of declining?

Jeffrey Kang

No, I think the one of the reason and I know for the Q1 because currently our revenue from engineering service that’s on the service recommended still the telecom engineering service, which as you know telecom in Q1 is typically the weak season.

So that’s why we are not able to -- and then also as you know in China there is almost one month of high in the Q1, so among is the three months of the working period. So that’s why we are typically all the telecom related revenue including the infrastructure sales as well as the service will be in $1 million in this quarter.

Hope Ni

Also for full year, the surveillance service revenues well, just I mentioned that is our seasonal growth strategy. We believe this is the new area we have capacity into and a very actively and during our prepared remark but for to become a meaningful revenue stream halfway is not what this year, it’s for more intermediate longer-term.

So this year we’re still thinking our listing business will be our main driver. So the main service revenue next year we don't think that’s going to be mainly from telecom area.

Adele Mao - Susquehanna Financial Group

Okay. That’s fair. When you do ramp up your services and services security, surveillance security engineering service business, what kind of gross margin are you looking at?

Jeffrey Kang

We are still thinking about our gross margin in service sector we feel a project around over 40%.

Adele Mao - Susquehanna Financial Group

I see. And this new area will that be new customers or the existing customers expanding into our new product?

Jeffrey Kang

I think of the both and we certainly have well acquired new customers. And also we are seeing our some of our existing customer also moving to the new industry. So, that will bring us into the new industry as well.

Adele Mao - Susquehanna Financial Group

Okay. We do more looking at the surveillance security on the organic growth basis or if you are thinking about an acquisition as well?

Jeffrey Kang

Both. And we are of course, we already had some of the organic business from this new segment that we are in, if we can find a right target and we work on it so certainly we can -- we are able to use the acquisition strategy to grow our business in that area. So, we keep the option open we will use the two hands to grow our business in this new segment.

Adele Mao - Susquehanna Financial Group

Okay. Great. Thank you very much.

Operator

Thank you. Our next call is coming from Daniel Amir from W.R. Hambrecht.

Amir Daniel - W.R. Hambrecht

Thanks a lot. A couple questions here. First of all last year you had a very strong June quarter that was seasonally up about 23% Q-over-Q. I mean, how do you think this year plays out from in terms of the seasonal from quarterly growth in Q2, Q3, Q4, do you think it will more equally distributed with September being the big quarter or do you expect more of a strong June quarter and then a little lesser September and December?

Jeffrey Kang

I think in our view of course Q2 estimate will be much better than the Q1 and Q3 its should be slightly an better of than the Q2 and the Q4 will still be the strong quarter of the whole year. So, I think last year I think that's from our existing we still estimates and our Q2 and Q3 were at a strong and Q4 will be the mix of quarter of the whole year.

Amir Daniel - W.R. Hambrecht

Yeah, but from a quarterly growth rate not from an absolute dollar?

Jeffrey Kang

I think that the in terms of the quarterly growth rate the Q2 versus Q1 certainly will higher than Q3 versus the Q2 and Q4 versus the Q3 will have the biggest growth rate.

Hope Ni

And looking onto quarterly growth, Q2 compared to Q1 or compared to last year?

Amir Daniel - W.R. Hambrecht

Compared to Q1?

Hope Ni

Okay. Yeah, yes Jeff already addressed the question.

Amir Daniel - W.R. Hambrecht

Okay. And then my other question is what type of interest income should we be looking out for the year now, that with the additional cash from the offering and what’s kind of the number you want to give us?

Hope Ni

The interest rate would be around 5%.

Amir Daniel - W.R. Hambrecht

Okay. And then final question is on the MNA, I think you commented a little bit about the areas that you’re looking into. I mean is this a short term event, long term event with regard to the acquisition, is it something that the Board has basically decided that this year is an year of acquisition, where do you stand kind of on the prospect business?

Jeffrey Kang

From -- we actually we don’t have the rush to do any deal. And I think the deal we will based on we have a well -- very discipline to think about and to execute our acquisition strategy. So frankly we don’t have the better line, we have do a deal before what that might, but we have to firstly identified the working base and internally we will be very comfortable with there financials, with their business growth.

So, that’s why we don’t have a very, well we’ve going to set a better line for us, so we have to do a deal before any specific time.

Amir Daniel - W.R. Hambrecht

Okay. Thanks a lot.

Operator

Thank you. Our next question is coming from Edward Hemmelgarn from Shaker Investments.

Edward Hemmelgarn - Shaker Investments

Yeah, just a couple of things, questions about the engineering services, just so I understand essentially what you’re saying is that you were, you’re timing of revenue recognitions is going to be just a function of when you complete the projects or when the customer chucks the project.

So, I’m looking at your numbers, I am assuming is that you’re actually busier in Q1 it looks like than you have been in the past, but that as you, as the work has being done the non-build work as a non-work has been recognized for revenue would go into inventory?

Jeffrey Kang

I think, I Hope already mentioned that part is actually two things. The one is that typically the Q1 is not a good quarter for any account related to business. The second thing is, even though we’ve already delivered some service, but and maybe our customer needed to in good acceptance in the Q2, so if that’s the case, so our revenue will be booked in the Q2 rather than in Q1.

So that’s the case and Hope just to mention. So we certainly would going to see some service revenue facing in the next couple quarters and after the telecom second main year starting to in the grow quarter over quarter.

Edward Hemmelgarn - Shaker Investments

Yes, I guess what I am just trying to get at, Jeffrey…

Hope Ni

You trying to know, I understand your question, there is actually product that we deliver in this Internet service. Its just a man power it engineering work. The cost we incurred is the salary and then on these people, on those engineers.

Let say have performance in our work and then only upon certain stage then we can feel a lesser the contract revenue when that becomes zero, maybe 80% of $1 million upon first stage when the customer accept. And then there is 20% now they have to wait another maybe month, so we can sell this revenue. And before compare the service it doesn’t really go in inventory because there is really no physical product.

Edward Hemmelgarn - Shaker Investments

I understand Hope. But I mean when you’re, its like any construction or service product. If you are paying people you’ve got a in your, you haven’t billed for yet or you haven’t recognize the revenue yet, put the amounts into your, the work that there been done and put it somewhere, is that going into inventory or I realize its not a product but it’s a service you haven’t yet build for.

I mean it’s not, as if you people were setting around or not doing any work.

Jeffrey Kang

So, you know for the people, if for the case I think you mentioned is we will put that in our SG&A line so rather than in the inventory, so that why for us we don’t have that as Hope mentioned. So we actually, you know, the first thing our purchase order of the service contract is kind of, even though we sign a $1 million contract. So that contract can be breakdown by another very small pieces of the purchase order, which come into every week.

So that’s why we are talking about, so for some of the contract, the some of the key or ratio, we are not able to book in the Q1, we probably will book in the Q2. But that’s among in terms of panorama or non of that a peak.

Edward Hemmelgarn - Shaker Investments

All right. Okay we understand. Right.

Operator

Thank you our next question is come from Marc Tobin with Roth Capital Partners.

Marc Tobin - Roth Capital Partners

Good morning Jeffery, Hope.

Hope Ni

Hello, Marc.

Marc Tobin - Roth Capital Partners

On engineering services, I guess overall can you update us on the head account numbers, total company as well as for engineering?

Jeffrey Kang

I think our total head counts in end of Q1 still around 700 engineers so among them we are around, still have there closing to, 300 engineers, service engineers there.

Marc Tobin - Roth Capital Partners

What’s the status of the engineers training, I know they have been added for 9 months or so now or pretty much all of them certified, quality certified?

Jeffrey Kang

No, we think we still have over kind of over 250 qualified engineers and to some, and we actually get as far as further see on quantified engineers in the Q1. And so we also we hired some of the new engineers into, we could put them in a training program. So that thing and among those are 300 engineers so we have the roughly 250 engineers there.

Marc Tobin - Roth Capital Partners

Okay. Do you have the operating margins for the engineering process segment?

Jeffrey Kang

You know, because we are a company, we have a lot the operating expenses has been shared and migrating ultra space like in a lot the, because we share a lot that account from. So internally we don’t have that. We separate each business to operating margin. So we only get to have business at least our model is, we set up them, we have the business.

The revenue breakdown we have the TP calculating and we are, we don’t, but and then we shall, all of them in a common platform staff. So that’s why we don’t give them and then certainly we will do the cost allocation to each our business.

Marc Tobin - Roth Capital Partners

Okay. I thought at one point you use to report operating income by segment maybe…?

Hope Ni

You know, we have reported operating income in the document, in our both the financial statement actually. Really the 10-K and then, so I think that the operating income for the service, operating margin basically should be more than 10% and I remember its around 11%.

Marc Tobin - Roth Capital Partners

Okay.

Hope Ni

And then one of the reason obviously, as Jeffrey mentioned, our revenue is produced only part of our engineers and then some engineers maybe either to under training or hasn’t been fully utilize.

So the operating margins, there is still room to improve as we are fully utilize those people.

Marc Tobin - Roth Capital Partners

Okay, thank you. That’s all I have.

Operator

Thank you, our last final question is coming from Julie Chen from Brean Murphy.

Julie Chen - Brean Murphy

Hi, Jeffrey how are you?

Jeffrey Kang

Hi, Julie.

Julie Chen - Brean Murphy

My question comes in terms of your next generation market, you elaborated on the surveillance and security, did you give some insight in terms of what your plans are for the automobile and the medical markets?

Jeffrey Kang

Oh, yes. We would typically just to talking about this surveillance still -- actually we already have some business from the auto and electronic business. So as you know as the Chinese consumer spending significant increasing in these couple of years, so we are seeing the automobile industry become another a very high growth segment in China.

That might seen what happen in ten years ago but in the telecom segment. So currently and for the -- most of the automobile parts and still you know China just assembling most of the auto vendors in China has adjusted assembling the car, this field by the parts from most of the overseas. But we are seeing this is an opportunity especially for the -- an auto electronic business.

So we already in generating some revenue from the business like in megamix in auto and the payment system like they know auto and make a sensor, auto sensor like the auto ABS system.

So we have a lot of the solution goes to in design win and from our customers in China. So even though I think it is a business still very promising and in next couple of years because we believe in our industry we’re like any other industry.

There will be -- this is the first in this high growth, the second I think is -- or customer needed to some customized solution for their new models of the cars. So that’s why we think about that it should be another high growth area in next three to five years.

Even though today, it is very harder for me to give you or quantify how much revenue we plan to generate from this business. But I think the three to five years down the road is certainly it will be as big as the cell phone and the telecom market has been.

Julie Chen - Brean Murphy

How about in terms of the medical market?

Jeffrey Kang

In terms of the medical market, so we relatively have the small revenue among our new business there and we are in next some of the -- as you know in this medical equipment market in China, still this business has been dominated by the international player like say, GE and Siemens.

Right now what we are focusing on is to serve all those China, Chinese base medical equipment companies. So we are trying to identify who is going to be next Huawei in the medical equipment segment and a provider of solution and modern solution to serve them.

So, we are working with a quite a few medical equipment companies in China, say for example like one of our customer. So, we are starting that business and we believe it’s quite a promising and we are trying to speak each of our key customer and just like what we did kind of borrowing.

Julie Chen - Brean Murphy

Thank you.

Hope Ni

Okay. I want to actually clarify the earlier question about the operating margin, operating income for the services just couple of checks not 11% its actually the 16% but again approximately 16% as I mentioned as the portfolio utilize there should be a room to improve as well.

Julie Chen - Brean Murphy

Okay.

Operator

Thank you. At this time, I would like to turn the floor over to back to management for any closing comments.

Jeffrey Kang

Thanks very much for you attending this call. And I will take this opportunity to thanks all our customers, employees, partners, and investors to help us and so COGO will continue to exclude all growth strategy to give the best return to all investors. Thanks very much for attending today’s call.

Operator

This concludes today Comtech Group Conference Call. You may now disconnect.

Jeffrey Kang

Thank you.

TRANSCRIPT SPONSOR

China Direct Logo

China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

To sponsor a Seeking Alpha transcript click here.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Comtech Group Q1 2007 Earnings Call Transcript
This Transcript
All Transcripts