Symbol List Views
FlashQuotes InfoQuotes
Stock Details
Summary Quote Real-Time Quote After Hours Quote Pre-market Quote Historical Quote Option Chain
CHARTS
Basic Chart Interactive Chart
COMPANY NEWS
Company Headlines Press Releases Market Stream
STOCK ANALYSIS
Analyst Research Guru Analysis Stock Report Competitors Stock Consultant Stock Comparison
FUNDAMENTALS
Call Transcripts Annual Report Income Statement Revenue/EPS SEC Filings Short Interest Dividend History
HOLDINGS
Ownership Summary Institutional Holdings Insiders
(SEC Form 4)
 Save stocks for next time

Cogo Group, Inc. (COGO)

Q2 2010 Earnings Call Transcript

August 5, 2010 4:50 pm ET

Executives

Wanyee Ho – IR

Jeffrey Kang – Chairman and CEO

Will Davis – SVP, Business Development and Chief Marketing Officer

Frank Zheng – CFO

Analysts

Amir Rozwadowski – Barclays Capital

Brian White – Ticonderoga

Nathan Johnson – Pacific Crest Securities

Quinn Bolton – Needham & Company

Eric Stephens – RENN Capital

Scott Searle – Merriman

Bill Choi – Jefferies & Company

Presentation

Operator

(Operator instructions)

Waynee Ho

Thank you Luke 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 Second Quarter Earnings Conference Call.

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

Before we begin, I'd like to remind everyone that the call today may contain forward-looking statements regarding future events and the financial performance of the Company. We wish to caution you that such statements are just predictions, and actual results may differ materially as a result of the risks and uncertainties inherent in the Company's business. We refer you to documents that the Company files periodically with the SEC, specifically the most recently filed Form 10-K, as well as the Safe Harbor statement made in today’s press release. These documents contain important risk factors that could cause actual results to differ materially from those contained in the Company's current projections. Cogo assumes no obligation to revise the forward-looking information contained in today's call.

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

Jeffrey Kang

Thank you, Wanyee, and thanks to everyone for joining our earnings call. I remain very pleased with our company’s execution as we followed a strong first quarter result with another great quarter in Q2. In the second quarter, Cogo posted revenues of $91 million US dollars, up 24% year-over-year and up over 12% sequentially. We easily surpassed our guidance of $85-87 million as we saw improved bookings in industrials, telecom and HDTV in particular.

Our Non-GAAP EPS diluted in the second quarter was 19 cents, up about 29% year-over-year and ahead of our guidance of 17-18 cents. Cogo posted a gross margin of 14.2%, up slightly quarter-over-quarter. This was due to strong growth from the Industrial Applications business, which typically carries a gross margin higher than the Cogo average, and offset slightly by a continued better-than-expected telecom revenue, which carries a gross margin below the corporate average Note that our gross margins are almost entirely dependent on revenue mix, and the specific gross margins for each business segment were basically flat sequentially. We are maintaining our target for 15% gross margins, but as we have indicated many times previously, most of our margin expansion has and will continue to come from the operating side.

In the second quarter, Cogo posted operating margins of 8.4% up from 8.3% sequentially and up from 7.7% in the same period last year. While we continue to see the need for increased investment in certain areas --- for instance in the second quarter we ramped up spending within our newly announced Intel relationship and within our auto business - we expect our operating margins to improve sequentially for the rest of 2010. While we could have reached our 10% operating margin target in the current quarter by slashing investments in new growth areas, this would prevent us from effectively pursuing all of the tremendous opportunities for growth that we see in various market segments. My goal is to grow this company to be a $1 billion revenue company and we must continue to invest to reach this target. However, the investments have to be prudent and we will avoid “science projects” that don’t have a reasonable ROI. My mission has always been and will continue to gain “profitable growth.”

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

  • Industrial business represented 17.4% of total sales, growing 84% year-over-year and 17% sequentially.
  • Digital media made up about 57% of total revenue, representing a sales increase of 15% year-over-year and 11% sequentially.
  • Telecom represented 24% of total revenue, showing a sales increase of 17% year–over-year.
  • Service business represented about 1.3% of total revenue, with revenue increased about 18% year-over-year.

In the second quarter of 2010, Cogo’s Blue-chip customer base grew from 80 to 84 sequentially and was up 13.5% on a year-on-year basis. The total number of SME customers increased by 36 sequentially to a total of 1,386, a year-on-year increase of 14.6%. Many of our new SME customers focus in the digital media and Industrial segments. Total number of Cogo customers is now just short of 1,500 and more than 90% are repeat customers. Our total revenue is split about [68%] and 32% between Blue Chip and SME respectively, and we expect that this will move gradually to a 50/50 ratio over the next few years.

Average Revenue per Customer (“ARPU”) from Blue-chip customers in the [second] quarter was [$736] thousand, up 7% sequentially and up 4% from the prior year period. ARPU from SME customers in the second quarter was $21 thousand, up 10% sequentially and up 21% year-over-year. Our SME efforts are clearly paying off: our SME ARPU went up 37% in the last six quarters. At Cogo, we believe that growing our sales per customers is just as important as acquiring new customers.

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

Once again, our Industrial segment produced a great quarter with revenue up 84% year-over-year and representing 17.4% of total sales. This should be our fastest growing segment for the foreseeable future, given the positive trends in the Auto Electronics, Smart Meter, Smart Grid and Railway sectors. In 2010, we expect our Industrials revenue to be split into three areas with approximately 60-70% of revenue coming from Smart Meter and Smart Grid; 15-20% to railways and 15% toward Auto Electronics.

While overall auto sales growth in China has slowed in recent months, it is still the largest auto market in the world and we see tremendous growth potential for us given that we have only announced two contract wins to date: BYD and Geely, out of a total auto market of 75 manufacturers. Our second quarter auto related business amounted to about $3 million in revenue, up from about $2 million sequentially

Demand trends within the handset industry in China played out as we expected, with flattish revenue in the second quarter versus the first quarter. The effects of the “white box” crackdown are waning and we expect digital media trends to improve in the third quarter. We expect 3G handset trends to continue to improve for both TD-SCDMA at China Mobile and WCDMA at China Unicom and most of this growth will be related to Smartphone sales, which are typically higher ASP for Cogo. Additionally, we see continued strength in HDTV, which recently hit 2 million subscribers.

On our last earnings call, we announced our landmark relationship with Intel and I am pleased to say that we recorded a small amount of Intel revenue in the second quarter, which was ahead of my expectations. This relationship is still in the beginning stages, but I am confident that Intel will become a major revenue contributor for Cogo over the next couple of years across a wide range of both Industrials and Consumer verticals.

In the second quarter, our telecom business continued to perform better than expectations due to the continued roll-out of China Mobile’s PTN network and fiber builds (like EPON). Over time, we expect the other two mobile operators to announce similar plans for their own PTN networks, which will replace their existing backhaul systems with a more efficient IP-network and we expect other fiber builds to be announced. In the third quarter we expect our telecom business to grow 3-5% sequentially.

I would like to comment briefly on the ban of Chinese telecom equipment in India. We have taken revenue from India out of our internal estimates and have no plans to change that at this point. Most of the strength of our telecom business has come from domestic China sources, like PTN, fiber and continued 3G coverage and capacity builds. We continue to see good international strength outside of India. Relationships with Huawei, HP/H3C (Huawei-3Com), ZTE and Alcatel Lucent continue to benefit Cogo as these companies are likely to gain share in the Chinese telecom market.

I’d like to briefly discuss our M&A strategy. We are very pleased with the integration of Mega Smart, which contributed about $8.4 million in the second quarter and surpassed our guidance of $15-20 million in the first four quarters since closing. We remain committed to pursuing a successful acquisition strategy that is focused on companies that are instantly accretive and offer a good cultural fit within our existing corporate structure. In this area, we continue to maintain very strict parameters and would most likely include companies in the Industrials space.

I’d also like to say a few words about our outlook on the China economic situation. First, although China GDP growth has slowed down as compared to the beginning of the year, we believe the growth is and will remain very strong, and that the government is taking active steps to achieve a balance between strong growth and low inflation. We see plenty of opportunities for great growth in China in a large number of end markets and frankly speaking, there is no other place where I would rather do business.

Second, onto the topic of wage inflation- we focus on R&D design and sales, and do not manufacture. Unlike the unskilled labor pool in China, the labor market for the skilled R&D and sales teams from which we hire is not very tight, so we are not under any pressure to increase wages. Right now, individual wages are only increasing due to better than expected revenues creating higher commissions.

Third, I’ll touch on currency appreciation. In general, appreciation of the RMB is positive for us because it increases the value of our large cash position. We typically buy in US dollars and sell in RMB, but the currency moves have been very small and we think future moves will most likely be modest in order to not negatively affect exports. So overall, currency appreciation is a mild positive, not a game changer.

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 third quarter of 2010, we expect our revenue to be in the range of $94-96 million US dollars and Non-GAAP EPS Diluted to be 19-20 cents. We expect gross margin to remain roughly stable in the third quarter versus the second quarter with the bias to be up slightly, and we expect operating margins to tick up sequentially also. As a reminder, our gross margins are very dependent on product mix.

As usual, we are not providing full year revenue guidance. However, given our strong second quarter results and visibility into the back half, we are confident that Cogo has and will stay in a high growth mode in 2010.

Going forward, we plan to continue to broaden our customer base, add new supplier relationships (to go along with the recently announced Intel partnership), and benefit from expanding opportunities across a variety of verticals, including Industrials, 3G Smartphones and HDTV. We also expect to continue to utilize our capital structure strategically, extending our stock buyback program, using working capital to finance growth, and continuing to seek growth opportunities with M&A.

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

· Non-GAAP Operating expenses for R&D and SG&A in the third quarter should be approximately $5.4 million, with the split staying consistent sequentially at 20-25% 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.

· Interest income in the third quarter is estimated to be around $200 thousand. We would expect this to remain roughly constant over the next several quarters. We continue to estimate our Non-GAAP effective tax rate to be around 8% in the third quarter 2010 through 2011. In the third quarter, stock compensation should be approximately $2.6 million, which will likely be split about evenly between R&D and SG&A.

· Acquisition related costs, including amortization and impairment of intangible assets, will be approximately $1.3 million. Total diluted share count will probably be around 38.5 million shares.

Other than those 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.

We ended the quarter with about $76 million in net cash or about $2 per share. During the second quarter, we used approximately $15 million in cash, with $8 million used in working capital (mostly inventory), $3.7 million for M&A and $3.3 million for buybacks. We see increased strength in our business in the back half of 2010, so we are preparing for this with incremental inventory. In the third quarter, we expect that our A/R days plus our Inventory days will stay roughly flat sequentially. We have indicated many times that we plan to use our strong balance sheet to drive growth and this is exactly what we are doing. In the second quarter, we purchased 493,000 shares at an average cost of $6.73. We continue to view the strategic repurchase of our shares as an important use of our cash.

This concludes my remarks. Thank you everyone for joining the call to discuss our 2010 second quarter unaudited results. At this time, let’s turn the call to the operator.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from the line of Amir Rozwadowski with Barclays Capital. Please go ahead.

Amir RozwadowskiBarclays Capital

Thank you very much and good afternoon, Jeffrey, Will and Frank.

Jeffrey Kang

Hi, Amir.

Frank Zheng

Hi, Amir.

Amir RozwadowskiBarclays Capital

I was wondering if you can give us a bit more color in terms of the strength in the digital media business. It seems as though we are seeing a healthy amount of growth within that business. Is that particularly attributed to – in the HD side of the business or the handset side of the business, could you give us more color there that would be helpful?

Jeffrey Kang

Great. Actually our strong second quarter results actually mostly coming from our strong industrial business as well as the better than expected optical broadband and networking business. So, in terms of digital media business we still have right now very strong growth in that area too but mostly coming from our HD TV and high definition TV segment, which we had a press release in a few weeks that to tell the investor in China HD subscriber in China just two million and we feel a tremendous growth upcoming in the next quarters because that will – the high definition set top box will become more and more popular in China. So, I think that answer your question specifically our strong growth in digital media in the second quarter is – comes from the high definition TV segment.

Cell phone segment is relatively flat versus the first quarter. I think the major issue – in addition to the normal seasonality, I think the major issue is that there is a crackdown of the white box cell phone business in China happened in the second quarter and I think that (inaudible) a little bit of headwind to the – our cell phone business. But I think that campaign is almost over. So, we expect a strong growth in cell phone sector and digital media sector as well in the third quarter.

Amir RozwadowskiBarclays Capital

Great. Thank you very much, Jeffrey. Then if I may on the industrial side, as you mentioned, it continues to be a very strong area of growth for you. How shall we think about other potential automotive wins? You know, obviously you guys have been gaining some traction there and in terms of the spending on the smart meter side, from an initial perspective, should we expect to see sort of accelerating investment in those areas? Thank you.

Jeffrey Kang

Yes, I think we – as we just said, industrial business that space in terms of the total market size is much bigger and much bigger than in the telecom sector in China. So we're just starting to grab a little bit of this big market. So, that’s why I believe from my perspective I will – I am going to say our industrial business still going to grow very strong in the next – quarters and years and it will become one of our faster growing area of Cogo.

Amir RozwadowskiBarclays Capital

Great. Thank you very much for the amount of color. Thanks.

Jeffrey Kang

Thanks, Amir.

Frank Zheng

Thank you.

Operator

We have a question from the line of Brian White with Ticonderoga. Please go ahead.

Brian WhiteTiconderoga

Jeffrey, just on the industrial business, it sounds like it’s still strong. What type of growth are you expecting sequentially in the September quarter in industrial?

Jeffrey Kang

Will, can you answer this question?

Will Davis

Yes, Brian, sequentially, in the third quarter, I would say, it will still be the fastest growing segment. I would say sub 10% but close to10% probably is reasonable.

Brian WhiteTiconderoga

Okay. And then how should we think, I guess DYD [ph] lowered their forecast for automobiles this week from 800,000 to 60,000. China’s auto market has been a little slower. It sounds like you’ve got a lot of new customers potentially to ramp over the next year. Jeffrey, may be just explain what’s happening there in the auto market, why is this slowing down and how should we think about this business in terms of opportunity for Cogo over the next 12, 24 months?

Jeffrey Kang

I think if you are looking back, what – how many units be like the (inaudible) no matter it’s 600,000 or 800,000, that becomes (inaudible). So, as I sad DYD is just one of the many players in the U.S. We have like 75 auto makers in China. DYD is a newcomer; it’s one of them and one of the 75. So I think even looking at the overall auto market, China today definitely is the number one in not just the market in the world. At the same time, we also expect the growth should be picking up in the second half because normally in the second quarter and in the summer it is for the spending for the auto sales, it’s little bit seasonal flow. So, that’s why we believe based on our order book our customers’ demand information we are expecting a strong growth in the second half of this. That’s why we are very, very confident our automobile business will become one of the supporter of our growth driver. Probability wise a lot of upside in the near future.

Brian WhiteTiconderoga

But Jeffrey, when you look at 12 to 24 months, how many customers do you think you can be working with? Sounds like you have two today.

Jeffrey Kang

Ten. I think that’s the number in mind. We are actively working on more than that numbers, but in terms of converting them into the revenue customer, I think my sales margin like (inaudible) 10 customers.

Brian WhiteTiconderoga

Great. Thank you.

Will Davis

Thanks, Brian.

Operator

We have a question from the line of James Faucette with Pacific Crest Securities. Please go ahead.

Nathan JohnsonPacific Crest Securities

Yes, hi, this is Nathan Johnson calling in for James. I appreciate you taking the question. Just wondering if you could turn back to the discussion on the white box crackdown. You mentioned the effects of that are starting to may be come to an end. In looking at Q3 are you anticipating the growth that you talked about to be in line with typical seasonality or kind of typical of what we’ve seen in the past or is there actually going to be a bit of a bounce back as the crackdown on white box manufacturers comes to an end?

Jeffrey Kang

Well, yes, basically the Q2, the second quarter is the low season of the cell phone market in China and the third quarter is the one – is the high season especially up normally from the end of August to beginning of – end of August, beginning of October is the high season for the cell phone business. So, we are seeing, in addition to the normal seasonality because of the campaign or crackdown, the white box campaign in China in the second quarter some of our white box customers they significantly lowered their production shipment in the second quarter. And – but at least our existing demand from all our customers because for Cogo we pretty much cover everybody. We have all the Tier 1 guys like ZTE, Huawei, and Lava [ph]. We also cover all the other white box vendors in China. So, we see a very – pretty much strong demand in the third quarter. So, that’s why we are very confident that the whole mobile business should be picking up in the – since the middle of the third quarter.

Nathan JohnsonPacific Crest Securities

Do you think that Q3 could see sequential growth in the high single digits?

Jeffrey Kang

Yes. Yes, that’s what we believe.

Nathan JohnsonPacific Crest Securities

Great.

Will Davis

Nathan, I would just add that in addition to the overall demand picking up I think specifically within the 3G market we are starting to see some improvements. I mean going through the year I think there have been some ups and downs, but China Mobile recently announced a slew of plans with discounted tariffs. And I think we are seeing an increased amount of models for both Unicom and Mobile. So, that should help also and that depending on the model that typically carries a higher ASP for us. So, I think it’s a function of better units and some better ASP models for us helping out.

Nathan JohnsonPacific Crest Securities

Great. That’s very helpful. And one other question from me. Just – the (inaudible) reports flat panel TVs in China were slowing down. Is that something you guys are seeing, is that something that you guys expect to impact year-end in Q3 and beyond?

Jeffrey Kang

We actually don’t have too much in the traditional like TV segment. So we – in terms of our business, we are pretty much focusing on like a high definition TV segment. So, that’s why we don’t have like too much corner [ph] about it. But in general, we don’t think this TV market is going to – slowing down in the near future. I wish you can anticipate a very – quite a strong demand for both domestic consumption and as well as in export business for the TV manufacturers.

Will Davis

And it looks like our semiconductor partner for HD looks to gain some material share in HD versus digital set top boxes. So, that’s been a big help.

Nathan JohnsonPacific Crest Securities

Great. That’s very helpful. Thanks so much.

Will Davis

Sure. Thanks, Nathan

Operator

Thank you. We have a question from the line of Quinn Bolton with Needham & Company. Please go ahead.

Quinn BoltonNeedham & Company

Hi Jeffrey, Frank and Will, quick question, just wanted to follow-up on your commentary about the handset market, you know up high single digits. You guys done a good job now, you did digital media. So is digital media expected to be up sort of similar high single digits or are you seeing perhaps a little bit less growth in the other part of digital media?

Jeffrey Kang

I would say, Quinn, if our telecom grows low single, I think the other two segments will grow high singles is probably—

Will Davis

I mean it’s still a little too early to get that granular, but I think those – digital media and the industrials will be reasonably close in terms of sequential growth and then telecom not its best.

Quinn BoltonNeedham & Company

Got you. Just sort of follow-up, I know it sounds like the China build-outs in – I am sorry the fiber build-outs in China have been pretty strong. I have heard from some other suppliers that there seems to be some seasonality in that business in Q4. Do you guys see sort of lower seasonality as you get into the end of the year in kind of that telecom or particularly the optical or fiber part of the telecom business or do you think it tends not be as seasonal for you?

Jeffrey Kang

Well, we don’t think it’s that seasonal business yet and we are – because we are – based on our existing visibility, we still see a very reasonable third quarter and the fourth quarter and we have also heard about it. We might have another new bidding on the (inaudible) in the like in Q3 and Q4 from the three carriers. If that happens that will certainly give us upside in terms of our optical business.

Quinn BoltonNeedham & Company

Would those bids be for deliveries beginning in the second half or those would be sort of more the 2011 bids?

Jeffrey Kang

I think that will be – easily go to the fourth quarter and the first half.

Quinn BoltonNeedham & Company

Great.

Will Davis

Quinn, and I would just add that there is definitely increased interest by the government and the operators to ramp broadband penetration.

Quinn BoltonNeedham & Company

Okay.

Will Davis

That seems pretty clear and I think it’s – you could argue that the wireless build-out is more middle to late stages. The fiber stuff is pretty early.

Jeffrey Kang

Yes. I think mostly that’s why the fiber channel has to invest more and more on the fiber network is because of the – more and more popular [ph] usage of the Mobile Internet. So, that will drive the demand for that. We have – the carrier have to – in order their – the fiber network to carry that every increasing mobile Internet usage.

Quinn BoltonNeedham & Company

Great. Just a couple of additionals. You had mentioned that you agreed to some initial revenue from the Intel relationship. I know you are looking at both consumer as well as industrial applications. Can you say which side of that business do you expect they contribute first or was it – did you see incremental or initial revenues on both the consumer and the industrial business in Q1 – Q2?

Jeffrey Kang

It’s the industrial.

Quinn BoltonNeedham & Company

Industrial, okay. And then lastly, if I heard Frank right, it sounds like you had $3 million spend in M&A. Was that a new small M&A transaction or was that a earn-out provision from one of the earlier transaction?

Jeffrey Kang

It’s an old deal. It’s not a new deal.

Quinn BoltonNeedham & Company

Okay. Is there anything – I know M&A is part of your strategy, Jeffrey, anything active, anything you are pursuing right now that could lead to an announcement over the next quarter or two or is it – most of the discussion is earlier stage at this point?

Jeffrey Kang

We have a few deals in our pipeline and probably going to close or launched in the next one or two quarter.

Quinn BoltonNeedham & Company

Okay, great. Okay, thank you.

Will Davis

Quinn, that was just – it was 3.7 on M&A in the quarter.

Quinn BoltonNeedham & Company

3.7, okay. Thanks, Will.

Will Davis

Sure.

Operator

Thank you. We have a question from the line of Eric Stephens with RENN Capital. Please go ahead.

Eric StephensRENN Capital

Hi Jeffrey, Will, and Frank.

Jeffrey Kang

Hi.

Will Davis

Hi.

Eric StephensRENN Capital

Will, you mentioned that your tax rate is expected to be about 8% through 2011. Can you explain a little bit why is it so low and do you think it’s going to be substantial beyond 2011?

Jeffrey Kang

Well, we actually explained this things to our big investor. We expect our tax rate – because among a few of our subsidiaries based in China which has been ranked as high technology company, which the government well granted some tax free holiday for the first few years, so that’s why our – and in making our average tax rate is around 8% or 10% per year. But it’s quite persistent in few years. So we also expect our tax rate will be stable in the next two years around similar level as we are having today. (inaudible) because we can – we – unless the Chinese government will release other tax benefits, otherwise we are going to say our tax rate is going to be moving up step by step to like average 15% – 15% in average in next five years. But, at the end, it’s too early to predict the Chinese government, the tax, honestly. In my hearings, the government in China always try to initial and the new tax benefit to those high technology companies, which will be a benefit to us.

Eric StephensRENN Capital

Thank you. The – on a different subject, on M&A, what – how would you characterize the ideal acquisition target for you?

Jeffrey Kang

We are – as we just mentioned, we are currently, we are pretty much focusing on the industrial segment in which we needed to increase our customer base in like auto, in electronics, the smart grid and smart meter and high speed railway. So we are – the way we are – definitely access the mega smart deal. That’s a different deal we are looking forward to acquiring. Those types have a similar – like at a customer, but a customer base but they have the proven technology and it’s a few customer base and after acquiring by Cogo, we are able to enable them in (inaudible) dealing with a much broader customer base using our platform and using our strong balance sheet to grow the business. And also from that angle it’s easier for me to integrate the people into our platform. So, that’s the ideal case for me the deal to look at it in our position.

So, in China, so we – today we still have a few deals working on at a similar deal. So, basically I am not looking for a big deal. So we are typically for the deal like say, like anywhere from $15 million-$20 million deal which can generate let’s say for a company like (inaudible) like $15 million, $20 million revenue a year after acquired by Cogo. So that’s kind of the deal I am looking for.

Eric StephensRENN Capital

Alright. Thank you.

Will Davis

Thank you.

Operator

Thank you. (Operator instructions) We have a question from the line of Scott Searle with Merriman. Please go ahead.

Scott SearleMerriman

Hey, good afternoon.

Jeffrey Kang

Hi, Scott.

Scott SearleMerriman

Just in terms of visibility into the quarter, what are you guys currently booked for the quarter?

Jeffrey Kang

We actually have a very strong – very good visibility and so basically our customer I think for the Q3 we pretty much have a very strong book from our customers. And so I think the most – our – the risk to us is our customer may immediately increase their order in the end of the Q3. So that’s how we expect, how we to – we have to well prepare for the high season even starting from the middle, or end of the forecast for the beginning of October. So, that’s why we think we pretty much have the order demand information, demand from our customer. So, right now I think most of our job is to do more allocation and to help our customer to get enough part when the high season comes.

Scott SearleMerriman

Hey, Jeffrey, maybe to follow-up on that point, there have been component availability issues that have been cited kind of throughout the communications food chain. How are you guys positioning on this front? Obviously, you’ve built some inventory there it looks like to make sure you are prepared to be able to deliver on the September results. But is that giving you real competitive advantage now? Does that give you the ability to raise pricing a little bit, may be increase you gross margins? Could you take us kind of through how you are positioned and how you see component availability impacting it?

Jeffrey Kang

Yes, I think in general I think you are right. Because we foresee that some – it could have some of the shortage come in the next one or two months. So, that’s what we are foreseeing I think one or two months ago. That’s why we intentionally build more inventory end of the Q2 and then – so that’s why – yes, you are right. If the – if the revenue is – if the demand is very high, so certainly we possibly increase some of the same price. But as I said generally we don’t do that that is the saturation.. Because we always announce – like announce relationship with all – -each of our customer. I think our main job to do that is to ensure our customers get better served even in the tight environment. So – and that is a more – we are not looking for the one quarter being higher gross margin or a little bit higher margin. But we prefer is non confirmed [ph] relationship with each of our customer like Cogo is the ideal trust to work honor to each of our customer.

Scott SearleMerriman

And Jeffrey, a couple of questions on the handset side of the equation, in particular on the dollar content front. Certainly with TV and your attach rates for CMMB you’ve been able to grow some dollar content there, but it sounded like CMMB was may be expanding beyond just TV phones and wireless LANs and Bluetooth were finding more homes and devices as just smart phones were building kind of across the spectrum of the various OEMs and the operator. So, what are you seeing from a dollar content standpoint in general? Is it taking a step function. Obviously you guys is it very gradual in terms of what you are seeing. And then may be on the lower end of the equation, low end 3G handsets particularly for exports into places like India, what are you seeing on that front. It seems like there is a lot of design activity going on through the first half of this year. Are we going to start to see some of the benefits of that going forward?

Jeffrey Kang

Yes, CMMB just one of the feature embedded into the – most of the 3G cell phones. But you are right, we are seeing more contents get into that 3G or smart phone business, smart phone access. For example, you already mentioned Bluetooth, figure them, but we have the Bluetooth, WiFi and also the FM combined together. The better solution can be to fund customers’ demand. Also in addition to CMMB with new offers analog TV, mobile TV solution which has been used in many countries outside of China like South America, like in India, in the Middle East, so the analog mobile TV function is very useful there. So a lot of our customer needed analog TV module solutions there. So that’s also one of the factor to increase our ASP among each cell phone. So, you are right, what we are seeing the trend is we are offering more contents. More – higher ASP to this (inaudible) 3G cell phone as well as the high end smart phones as well.

Scott SearleMerriman

Jeffrey, is there a number you can put on that, is it growing your dollar content on a sequential by a couple of percent, by 5%, by 10% or just – ?

Jeffrey Kang

I – you know, I don’t have that number nearby but I certainly I can say for that – if we are looking for that, the average cell phone is the ones (inaudible) but for the smartphone for the higher – for the 3G cell phone we are certainly looking for like $1.5 and $2 certainly level for that kind of ASP per phone.

Scott SearleMerriman

And may be on the low end or lower end Wideband CDMA, 3G phones, how is the outlook for that, is that starting to pick up as well?

Jeffrey Kang

Yes, that’s what we believe. You know, basically I think most of our customer right now is able to produce design and produce low end 3G cell phones by their own capabilities. So, that’s why after I think the cracking down happening in the second quarter is over, you know it’s pretty much over now, so that’s why – what we are expecting there, their order is starting to picking up since the second quarter of this year.

Scott SearleMerriman

And one other question if I might. On the Intel front, when the relationship was announced, it sounded like it was a very large potential opportunity. It sounds like your tone on that front is becoming incrementally more positive in terms of that your are progressing along on the design front with OEM partners, and that relationship in general. Could you – is that a correct interpretation, are you getting a lot better visibility on that front, and does Intel have the potential to be a 10% customer in calendar 2011?

Jeffrey Kang

You know, it’s hard to say if Intel has 10% revenue in 2011, but it certainly be – will be the 10% partner plus in the next few year. The reason why we are – Intel is so strong in the (inaudible) and server and that sector. But what we are focusing on is the embedded solution, which is (inaudible) say a settlement. So, we pretty much – we were going to help the Intel to dig out the new territories like in auto electronics, in the industrial applications, in the consumer mobile Internet device. So in that area – it also is relatively new to the Intel themselves. So we need to work with them to find opportunities. So, that’s why I – so I don’t think that this business is not very easily like what we do in a PC related business. Because you can (inaudible) from Intel related business but we are focusing on the territory which impacted the solution for Intel.

Scott SearleMerriman

Okay, great. Thanks so much.

Jeffrey Kang

Thanks.

Will Davis

Thanks, Scott.

Operator

Thank you. We have a question from the line of Bill Choi with Jefferies & Company. Please go ahead.

Jeffrey Kang

Hi, Bill.

Bill ChoiJefferies & Company

Hi, guys. Most of my questions are answered, but just curious how you are looking at your balance sheet, your bank borrowings have been growing fairly consistently keeping still a lot of cash around. What are you looking to do here and what’s kind of the interest rates?

Jeffrey Kang

Will, can you address that?

Will Davis

Yes. Bill, hey, basically what we have been doing is borrowing in U.S. dollars at a very, very low interest rate to fund the working capital and then we’ve been start piling all of the Chinese currency. We’ve been expecting some appreciation of the Chinese currency and that’s happened a little bit, but it’s been pretty gradual as we expected. We didn’t think this was going to be a very rapid rise. So I think that’s consistent with what the government would like to do there. As far as uses of cash, we’ve got a little bit left on the M&A front to pay for Mega Smart, not much, most of it has been paid for. And we’ll strategically buy back stock within the SEC windows we are allowed to.

And then working capital, I think that it was a big jump in inventory sequentially, but it’s a real competitive advantage for us I think versus a lot of our smaller, less well funded competitors. They don’t have the balance sheet to be able to do that and we feel comfortable that the money will come back to us and it’s helping to embed ourselves with a lot of our customers particularly in – right now when supply is pretty tight. So, I think we are going to continue to do what we do – I think we’ve made some good progress in the AR days that from 100 down to 91 and I think sequentially the inventory days plus the AR days should be pretty flat. So, I think we are doing a good job managing in a tight environment and being able to grow and not leave too much on the table. I mean I think – we remember pretty clearly last year when everybody was scared to reach out and go after growth and I think we left some on the table and we are feeling pretty confident now that the consumer is going to improve going into the end of the summer, end of the fall, and that the industrial business is going to stay strong. So we want to be prepared to take advantage of that.

Bill ChoiJefferies & Company

What is the interest that you are paying on the U.S. dollar borrowings?

Jeffrey Kang

It’s around 2% to 2.5% rate for the borrowing cost and our saving cost almost the same in Chinese currency.

Bill ChoiJefferies & Company

And so the strategy here just to borrowing your dollars under working capital investments obviously you talked about working capital increasing, so that borrowing is just going to pay off your lenders?

Jeffrey Kang

Yes.

Bill ChoiJefferies & Company

Very glad.

Will Davis

And then, Bill, I think we are – Jeffrey would like to do an M&A deal if it’s the right deal. I think if you look at something like Mega Smart that was easily integrated, I think it ended up with $23 million or $24 million in the first four quarters after closing. That’s a great deal for us, accretive margins got us established in a (inaudible)

Jeffrey Kang

– in Chinese currency. China’s currency the interest rate is higher than the U.S. dollar.

Bill ChoiJefferies & Company

Yes, it makes sense. Okay, just last question then on gross margins. You did mention each segment had gross margin that was relatively flattish sequentially and I think that makes sense here. Wondering if heading into the second half with some of the seasonality in the digital media business you are anticipating a gradual move upward. I think it’s roughly about 12% digital media in the quarter. We have a lot of room for that in pushing back to 13 %.

Will Davis

I would say in general, Bill, the next couple of quarters we should see modest gross margin improvement, but it’s going to be modest. I think we’ll see more leverage on the operating line. And that’s true that the digital media overall is probably in that 12 to 13 range, but the older handset business is lower than what the old set top box business is so with the handsets improving – that will dim [ph] the gross margin growth a little bit, but it will still pick up sequentially in the next couple of quarters.

Bill ChoiJefferies & Company

Right. So, this quarter you benefited from favorable mix shift within digital media for gross margins and that the mix might not be as good higher volumes, September, December quarter still some uptick in digital media gross margins, you think?

Will Davis

I think that Bill probably most of the sequential – most the individual segment gross margins will probably stay pretty consistent with what they were this quarter. It’s going to be more rather a mix issue. So, I think it’s the – industrial still continue to grow faster. I think that will push them up slightly, but more leverage on the operating side.

Bill ChoiJefferies & Company

Right. But I mean if you have all the gross margins within each of the segment remaining flat and you have high single digit sequential growth in industrial, so which is – stat and services are the highest gross margin businesses. And you are probably going to be somewhere between mid to possibly lower 14% rather than your guidance of 15%, so I am just wondering again the only way to get there is if you see some individual segment gross margins improve like digital media which still remains the largest revenue line for us.

Will Davis

Yes, I think that that’s why we haven’t put a timeframe on getting the 15%. That’s a longer term target.

Bill ChoiJefferies & Company

Okay.

Will Davis

You can probably – I mean you could argue that we could get to the 10% operating margin before we get to the 15 % gross margin. I mean I think that that’s where we will probably see more of the leverage, but, yes, that 15 % is a longer term target.

Bill ChoiJefferies & Company

Okay. And OpEx you mentioned was 5.4 you said in September.

Will Davis

Yes, so I think overall the operating margin should pick up some sequentially. I think you could probably – you can go on 15 or 20 bps something like that.

Bill ChoiJefferies & Company

Right, and I am just clarifying you prepared remarks. You said $5.4 million OpEx, was that correct?

Will Davis

Yes, right.

Bill ChoiJefferies & Company

Okay, alright thanks.

Will Davis

Sure.

Operator

Thank you. And management, there are no further questions in the queue. Please proceed.

Will Davis

Jeffrey?

Jeffrey Kang

I am encouraged by Cogo’s results in the second quarter of 2010 and remain very optimistic about the rest of the year. We are using our balance sheet to help drive growth and buy back stock, and we see tremendous new opportunities across a variety of segments. As we indicated on last quarter’s call, I see a dollar in annual earnings power for Cogo in the not too distant future.

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

Operator

Ladies and gentlemen, this concludes the Cogo Group, Incorporated second quarter2010 conference call. Thank you for you participation. You may now disconnect.

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!