Annual Reports

 
Quarterly Reports

  • 10-Q (Nov 4, 2011)
  • 10-Q (Aug 10, 2011)
  • 10-Q (May 10, 2011)
  • 10-Q (Nov 5, 2010)
  • 10-Q (Aug 6, 2010)
  • 10-Q (May 7, 2010)

 
8-K

 
Other

Viewtran Group, Inc. 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Unassociated Document


SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
FORM 10-Q
 
þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended June 30, 2011.
 
or
 
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from                   to                   .
 
Commission File Number 000-02642
 
COGO GROUP, INC.
(Exact name of registrant as specified in its charter)

Maryland
 
52-0466460
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
Room 1001, Tower C, Skyworth Building
High-Tech Industrial Park
Nanshan, Shenzhen 518057, PRC
(Address of Principal Executive Offices including zip code)
 
011-86-755-267-43210
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every, Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
 
Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company
Large Accelerated Filer  ¨
Accelerated Filer  þ
Non-Accelerated Filer ¨
(Do not check if a smaller reporting company)
Smaller reporting company  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).  Yes ¨  No þ
 
On August 4, 2011, the Registrant merged with and into Cogo Group, Inc., a Cayman Islands company. As of the close of business on August 3, 2011, the Registrant had 41,309,285 shares of Common Stock issued and 34,246,050 shares of Common Stock issued and outstanding.>
 
 
 
 

 
 
Cogo Group, Inc.
Index to Form 10-Q

PART I - FINANCIAL INFORMATION
    1
       
Item 1.   UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
    1
       
Unaudited Condensed Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010
    1
       
Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for the three months ended June 30, 2011 and 2010
    2
       
Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for the six months ended June 30, 2011 and 2010
    4
       
Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010
    6
       
Unaudited Condensed Consolidated Statements of Changes in Equity for the six months ended June 30, 2011
    7
       
Notes to Unaudited Condensed Consolidated Financial Statements
    8
       
Item 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    18
       
Item 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    28
       
Item 4.   CONTROLS AND PROCEDURES
    29
       
PART II — OTHER INFORMATION
    29
       
Item 1.   LEGAL PROCEEDINGS
    29
       
Item 1A.  RISK FACTORS
    30
       
Item 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    30
       
Item 3.   DEFAULTS UPON SENIOR SECURITIES
    30
       
Item 4.   (REMOVED AND RESERVED)
    30
       
Item 5.   OTHER INFORMATION
    30
       
Item 6.   EXHIBITS
    30
       
SIGNATURES
    31

 
i

 
 
PART I- FINANCIAL INFORMATION
 
Item 1.   UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
COGO GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010

   
June 30, 2011
   
December 31, 2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Assets
                 
Current assets:
                 
Cash
    84,587       546,725       699,650  
Pledged bank deposits
    59,451       384,260       332,050  
Accounts receivable, net
    120,786       780,702       681,911  
Bills receivable
    6,046       39,080       31,001  
Inventories
    61,836       399,678       250,573  
Income taxes receivable
    168       1,085       2,478  
Prepaid expenses and other receivables
    4,644       30,023       49,338  
Total current assets
    337,518       2,181,553       2,047,001  
Property and equipment, net
    2,462       15,912       14,613  
Goodwill and intangible assets, less accumulated amortization, RMB139,551 thousand (USD21,591 thousand) in 2011 and RMB122,637 thousand in 2010
    62,197       402,010       258,935  
Other assets
    460       2,970       1,468  
Total Assets
    402,637       2,602,445       2,322,017  
Liabilities and equity
                       
Current liabilities:
                       
Accounts payable
    23,260       150,343       63,283  
Bank borrowings
    87,883       568,034       505,888  
Income taxes payable
    1,633       10,556       16,153  
Accrued expenses and other liabilities
    11,904       76,937       15,581  
Total current liabilities
    124,680       805,870       600,905  
Deferred tax liabilities
    4,207       27,195       13,777  
Total liabilities
    128,887       833,065       614,682  
Equity
                       
Common stock:
                       
Par value: USD0.01
                       
Authorized: 200,000,000 Shares
                       
Issued:  41,309,285 shares in 2011
                       
41,181,529 shares in 2010
                       
Outstanding:  35,110,950 shares in 2011
                       
 35,848,764 shares in 2010
    517       3,340       3,332  
Additional paid in capital
    209,342       1,353,084       1,315,806  
Retained earnings
    119,262       770,850       716,839  
Accumulated other comprehensive loss
    (18,707 )     (120,913 )     (117,479 )
      310,414       2,006,361       1,918,498  
Less cost of common stock in treasury, 6,198,335 shares in 2011 and 5,332,765 shares in 2010.
    (39,910 )     (257,961 )     (226,495 )
Total Cogo Group, Inc. equity
    270,504       1,748,400       1,692,003  
Noncontrolling interests
    3,246       20,980       15,332  
Total equity
    273,750       1,769,380       1,707,335  
Total liabilities and equity
    402,637       2,602,445       2,322,017  
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
1

 
 
COGO GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for the three months ended June 30, 2011 and 2010
 
   
Three Months ended June 30,
 
   
2011
   
2011
   
2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Net Revenue
                 
Product sales
    134,584       869,881       608,485  
Service revenue
    -       -       8,496  
      134,584       869,881       616,981  
Cost of sales
                       
Cost of goods sold
    (118,028 )     (762,873 )     (522,818 )
Cost of service
    -       -       (6,882 )
      (118,028 )     (762,873 )     (529,700 )
Gross profit
    16,556       107,008       87,281  
Selling, general and administrative expenses
    (7,532 )     (48,682 )     (39,796 )
Research and development expenses
    (3,772 )     (24,381 )     (18,991 )
Other operating income
    1       4       9  
Income from operations
    5,253       33,949       28,503  
Interest expense
    (582 )     (3,759 )     (1,666 )
Interest income
    555       3,589       3,493  
Earnings before income taxes
    5,226       33,779       30,330  
Income tax expense
    (548 )     (3,540 )     (3,040 )
Net income
    4,678       30,239       27,290  
Less net income attributable to noncontrolling interests
    (508 )     (3,284 )     (132 )
                         
Net income attributable to Cogo Group, Inc.
    4,170       26,955       27,158  
 
 
2

 
 
   
USD
   
RMB
   
RMB
 
Earnings per share attributable to Cogo Group, Inc.
                 
Basic
    0.11       0.71       0.73  
Diluted
    0.11       0.70       0.71  
                         
Weighted average number of common shares outstanding
                       
Basic
            38,078,756       37,133,304  
Diluted
            38,719,290       38,045,705  

   
Three Months ended June 30,
 
   
2011
   
2011
   
2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Comprehensive income:
                 
                   
Net income
    4,678       30,239       27,290  
Other comprehensive income
                       
Foreign currency translation adjustments
    (378 )     (2,442 )     (2,235 )
Comprehensive income
                       
Less:comprehensive income attributable to noncontrolling interests
    (503 )     (3,254 )     (46 )
                         
Comprehensive income attributable to Cogo Group, Inc.
    3,797       24,543       25,009  
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
3

 
 
COGO GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for the six months ended June 30, 2011 and 2010
 
   
Six Months ended June 30,
 
   
2011
   
2011
   
2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Net Revenue
                 
Product sales
    240,372       1,553,643       1,155,331  
Service revenue
    -       -       14,449  
      240,372       1,553,643       1,169,780  
Cost of sales
                       
Cost of goods sold
    (208,787 )     (1,349,497 )     (992,766 )
Cost of service
    -       -       (11,655 )
      (208,787 )     (1,349,497 )     (1,004,421 )
Gross profit
    31,585       204,146       165,359  
Selling, general and administrative expenses
    (14,081 )     (91,013 )     (77,356 )
Research and development expenses
    (7,136 )     (46,126 )     (35,022 )
Other operating income (expense)
    (1 )     (6 )     36  
Income from operations
    10,367       67,001       53,017  
Interest expense
    (1,062 )     (6,862 )     (2,781 )
Interest income
    1,039       6,719       6,787  
Earnings before income taxes
    10,344       66,858       57,023  
Income tax expense
    (1,101 )     (7,113 )     (5,699 )
Net income
    9,243       59,745       51,324  
Less net income attributable to noncontrolling interests
    (887 )     (5,734 )     (405 )
                         
Net income attributable to Cogo Group, Inc.
    8,356       54,011       50,919  
 
 
4

 
 
   
USD
   
RMB
   
RMB
 
Earnings per share attributable to Cogo Group, Inc.
                 
Basic
    0.22       1.42       1.37  
Diluted
    0.21       1.39       1.34  
                         
Weighted average number of common shares outstanding
                       
Basic
            38,036,997       37,088,817  
Diluted
            38,958,170       38,070,100  

   
Six Months ended June 30,
 
   
2011
   
2011
   
2010
 
 
 
USD’000
   
RMB’000
   
RMB’000
 
Comprehensive income:
                 
                   
Net income
    9,243       59,745       51,324  
Other comprehensive income
                       
Foreign currency translation adjustments
    (545 )     (3,520 )     (2,096 )
Comprehensive income
                       
Less: comprehensive income attributable to noncontrolling interests
                       
      (874 )     (5,648 )     (264 )
Comprehensive income attributable to Cogo Group, Inc.
    7,824       50,577       48,964  
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
5

 
 
COGO GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010
 
   
Six Months ended June 30,
 
   
2011
   
2011
   
2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Cash flows from operating activities:
                 
Net income
    9,243       59,745       51,324  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation expense
    470       3,029       3,031  
Amortization of intangible assets
    2,617       16,914       10,902  
Deferred income taxes
    (340 )     (2,198 )     (1,799 )
Allowance for doubtful accounts
    (102 )     (657 )     2  
Loss on disposal of property and equipment
    -       -       353  
Share-based compensation
    5,769       37,286       33,691  
Change in current assets and liabilities:
                       
Accounts receivable, net
    (16,213 )     (104,791 )     (7,856 )
Bills receivable
    (1,250 )     (8,079 )     (26,649 )
Inventories
    (23,732 )     (153,391 )     (94,594 )
Prepaid expenses and other receivables
    2,732       17,659       (999 )
Accounts payable
    13,797       89,179       (8,734 )
Income taxes receivable
    210       1,357       -  
Income taxes payable
    (855 )     (5,526 )     (778 )
Accrued expenses and other liabilities
    (1,636 )     (10,578 )     (7,712 )
Net cash used in operating activities
    (9,290 )     (60,051 )     (49,818 )
Cash flows from investing activities:
                       
Increase in pledged bank deposits
    (8,598 )     (55,572 )     -  
Payment for acquisitions of subsidiaries
    (11,072 )     (71,565 )     (51,578 )
Purchases of property and equipment
    (679 )     (4,389 )     (4,688 )
Net cash used in investing activities
    (20,349 )     (131,526 )     (56,266 )
Cash flows from financing activities:
                       
Purchase of treasury stock
    (4,868 )     (31,466 )     (40,309 )
Proceeds from bank borrowings
    11,363       73,444       357,630  
Net cash provided by financing activities
    6,495       41,978       317,321  
Effect of exchange rate changes on cash
    (515 )     (3,326 )     (806 )
Net increase (decrease) in cash
    (23,659 )     (152,925 )     210,431  
Cash at beginning of the period
    108,246       699,650       667,320  
Cash at end of the period
    84,587       546,725       877,751  
Supplementary cash flow information:
                       
Interest paid
    1,062       6,862       2,781  
Income tax paid
    2,083       13,463       6,502  
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
6

 
 
COGO GROUP, INC. and SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Changes in Equity for the six months ended June 30, 2011

    
Cogo Group, Inc. Stockholders
 
   
Common Stock
   
Additional
paid in
capital
   
Retained
earnings
   
Accumulated
other
comprehensive
loss
   
Treasury
stock
   
Noncontrolling
interest
   
Total
equity
 
   
No. of Shares
outstanding
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Balance as of January 1, 2011
    35,848,764       3,332       1,315,806       716,839       (117,479 )     (226,495 )     15,332       1,707,335  
Net income
    -       -       -       54,011       -       -       5,734       59,745  
Foreign currency translation adjustments
    -       -       -       -       (3,434 )     -       (86 )     (3,520 )
Issuance of common stock pursuant to share-based compensation plan
    127,756       8       (8 )     -       -       -       -       -  
Share-based compensation
    -       -       37,286       -       -       -       -       37,286  
Purchase of treasury stock
    (865,570 )     -       -       -       -       (31,466 )     -       (31,466 )
Balance as of June 30, 2011
    35,110,950       3,340       1,353,084       770,850       (120,913 )     (257,961 )     20,980       1,769,380  
Balance as of June 30, 2011 (in USD)
            517       209,342       119,262       (18,707 )     (39,910 )     3,246       273,750  
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
7

 
 
COGO GROUP, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
 
Note 1 – Basis Of Presentation

The unaudited condensed consolidated financial statements of Cogo Group, Inc., (the “Company”) and its subsidiaries (the “Group”), include, in the opinion of management, all adjustments (consisting of normal recurring adjustments and reclassifications) necessary to present fairly the Group’s consolidated financial position, results of operations and cash flows for all periods presented.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2010.

The Group has experienced, and expects to continue to experience, seasonal fluctuations in net revenue, which have historically been lowest in the first quarter of the year due to the Chinese New Year holiday season period and are typically highest in the fourth quarter of the year due to the desire by original equipment manufacturers (“OEMs”) and other customers to spend the remaining allocated annual budgets. Consequently, the Group’s financial position, operating results, cash flows and trends in these unaudited condensed consolidated financial statements are not necessarily indicative of future results that may be expected for any other interim period or for the full year.

The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

The accompanying unaudited condensed consolidated financial statements are expressed in Renminbi (“RMB”), the national currency of the People’s Republic of China (the “PRC”). For the convenience of the reader, the June 30, 2011 RMB amounts, included in the accompanying unaudited condensed consolidated financial statements have been translated into United States dollars (“USD”) at the rate of USD1.0000 = RMB6.4635. No representation is made that the RMB could have been, or could be, converted into USD at that rate or at any particular rate or at all.
 
Note 2 – Summary Of Significant Accounting Policies
 
The Company has evaluated that the recently issued accounting pronouncements have no significant impacts to the unaudited condensed consolidated financial statements.
 
Note 3 – Accounts Receivable, Net
 
   
June 30,
   
December 31,
 
   
2011
   
2011
   
2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Accounts receivable
    132,024       853,337       755,203  
Less:  allowance for doubtful accounts
    (11,238 )     (72,635 )     (73,292 )
Accounts receivable, net
    120,786       780,702       681,911  
 
 
8

 
 
An analysis of the allowance for doubtful accounts is as follows:
 
   
Three Months ended June 30,
   
Six Months ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Beginning Balance
    72,892       73,306       73,292       73,306  
Addition charged to allowance for doubtful accounts
    18       324       18       324  
Write back on allowance for doubtful accounts
    (275 )     (322 )     (675 )     (322 )
Ending Balance
    72,635       73,308       72,635       73,308  

The Group has a credit policy in place and the exposure to credit risk is monitored on an ongoing basis. Credit evaluations are performed on all customers requiring credit over a certain amount.

The Group records the transfers of accounts receivable pursuant to the factoring agreement as sales when it is considered to have surrendered control of such receivables under the provisions of ASC 860, Transfers and Servicing. For the three months and six months ended June 30, 2011, the Group received proceeds from the sale of accounts receivable amounting to RMB306,370 thousand (USD47,400 thousand) and RMB367,773 thousand (USD56,900 thousand), respectively. For the three months and six months ended June 30, 2010, the Group received proceeds from the sale of accounts receivable amounting to RMB148,944 thousand. In addition, the Group recorded interest expense amounting to RMB1,514 thousand (USD234 thousand) and RMB1,759 thousand (USD272 thousand), respectively, in respect of the factored accounts receivable for the three months and six months ended June 30, 2011. The Group recorded interest expense amounting to RMB195 thousand in respect of the factored accounts receivable for the three months and six months ended June 30, 2010. As of June 30, 2011 and December 31, 2010, the Group has derecognized factored accounts receivable amounting to RMB311,545 thousand (USD48,201 thousand) and RMB188,042 thousand, respectively, in accordance with ASC 860. As of June 30, 2011 and December 31, 2010, the Group has not accrued a recourse liability since the estimated fair value of the recourse obligation was immaterial.
 
Note 4 – Bills Receivable

The Group has arranged to transfer with recourse certain of its bills receivable to banks. The Group received proceeds, net of discount, from the sale of bills receivable amounting to RMB22,443 thousand (USD3,472 thousand) and recorded a discount of RMB383 thousand (USD59 thousand) in interest expense accordingly for the three months ended June 30, 2011. The Group has not discounted any bills receivable during the three months ended June 30, 2010.  For the six months ended June 30, 2011 and 2010, the Group received proceeds, net of discount, from the sale of bills receivable amounting to RMB28,695 thousand (USD4,440 thousand) and RMB18,733 thousand, respectively. In addition, the Group recorded discounts amounting to RMB486 thousand (USD75 thousand) and RMB145 thousand, respectively, in respect of the bills receivable sold for the six months ended June 30, 2011 and 2010. The annualized discount rate ranges from 6.40% to 7.65% of the balance transferred, which is recorded as “interest expense”.

For bills receivable sold to banks that the Group has surrendered control, the Group derecognized the discounted bills receivable pursuant to the provisions of ASC 860. As of June 30, 2011 and December 31, 2010, gross amount of RMB17,349 thousand (USD2,684 thousand) and RMB2,158 thousand, of discounted bills receivable were derecognized by the Group respectively, in accordance with ASC 860. As of June 30, 2011 and December 31, 2010, the Group has not accrued a recourse liability since the estimated fair value of the recourse obligation was immaterial.
 
Note 5 – Inventories
 
Inventories are stated at the lower of cost or market.  Cost is determined by the first-in, first-out method.  Cost of inventories comprises direct materials.  Inventories by major categories are as follows:
 
   
June 30,
   
December 31,
 
   
2011
   
2011
   
2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Raw materials
    27       172       162  
Finished goods
    61,809       399,506       250,411  
Total inventories
    61,836       399,678       250,573  
 
 
9

 
 
Inventories amounting to RMB63 thousand (USD10 thousand) were written off during the three months and six months ended June 30, 2011. No inventories were written off during the three months and six months ended June 30 2010.
 
Note 6 - Property And Equipment, Net
 
Property and equipment is stated at cost less depreciation and if applicable, impairment.  Property and equipment consists of the following:

   
June 30,
   
December 31,
 
   
2011
   
2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Property and equipment, at cost
    7,267       46,969       42,685  
Less:  accumulated depreciation
    (4,805 )     (31,057 )     (28,072 )
Property and equipment, net
    2,462       15,912       14,613  
 
Note 7 – Goodwill And Intangible Assets
 
The changes in the carrying amount of goodwill and intangible assets for the period ended June 30, 2011 is as follows:
   
Goodwill
   
Intangible Assets
   
Total
 
   
RMB’000
   
RMB’000
   
RMB’000
 
Balance as of January 1, 2011
    175,436       83,499       258,935  
Acquisition of MDC Tech International Holdings Limited (note 15(a))
    61,756       98,233       159,989  
Amortization of intangible assets
    -       (16,914 )     (16,914 )
Balance as of June 30, 2011
    237,192       164,818       402,010  
Balance as of June 30, 2011 (in USD)
    36,697       25,500       62,197  
 
Note 8 – Bank Borrowings And Banking Facilities

The Group entered into several banking facilities with Standard Chartered Bank (Hong Kong) Limited, Bank of China (Hong Kong) Limited (“BOC”), Guangdong Development Bank Holdings Company Limited (“GDB”) and China Merchants Bank Company Limited. As of June 30, 2011 and December 31, 2010, the aggregate credit limit of these facilities amounted to RMB1,008,306 thousand (USD156,000 thousand) and RMB886,233, respectively. These facilities include letters of guarantee, bank loans and irrevocable letters of credit. The banking facility with BOC also included an accounts receivable factoring agreement as disclosed in note 3. The credit limit and the respective secured deposits for the accounts receivable factoring agreement share the same credit limit with the banking facility with BOC.

As of June 30, 2011 and December 31, 2010, the total outstanding bank borrowings amounted to RMB568,034 thousand (USD87,883 thousand) and RMB505,888 thousand, respectively. The weighted average interest rate on outstanding bank borrowings as of June 30, 2011 was 1.9% (December 31, 2010: 2.1%). The aggregate amount of funds secured as pledged deposits with the respective banks at June 30, 2011 and December 31, 2010 amounted to RMB384,260 thousand (USD59,451 thousand) and RMB332,050 thousand, respectively.
 
 
10

 
 
Note 9 – Accrued Expenses and Other Liabilities, and Other Non-Current Liabilities
 
Accrued expenses and other liabilities, and other non-current liabilities consist of the following:

   
June 30,
   
December 31,
 
   
2011
   
2011
   
2010
 
   
USD’000
   
RMB’000
   
RMB’000
 
Legal and professional fees
    355       2,296       2,749  
Accrued staff related costs
    117       756       7,750  
Payables for acquisitions (Note 15 (a))
    11,000       71,099       -  
Other accruals
    432       2,786       5,082  
Accrued expenses and other liabilities
    11,904       76,937       15,581  
 
Note 10 – Share-Based Compensation
 
During the three months ended June 30, 2011 and 2010, the Company recognized share-based compensation expense for awards issued under the 2006 Incentive Plan and the 2009 Omnibus Securities and Incentive Plan (the “2009 Incentive Plan”) of RMB18,367 thousand (USD2,842 thousand) and RMB17,636 thousand, respectively. During the six months ended June 30, 2011 and 2010, the Company recognized share-based compensation expense for awards issued under the 2006 Incentive Plan and the 2009 Incentive Plan of RMB37,286 thousand (USD5,769 thousand) and RMB33,691 thousand, respectively. A detailed description of the Company’s share-based compensation awards is included in the Company’s Form 10-K for the year ended December 31, 2010.
 
(a)       Options under the 2004 Incentive Plan
 
Under the Company’s 2004 Incentive Plan, the Company issued options to purchase shares of the Company’s common stock. The options granted under the 2004 Incentive Plan had a weighted average exercise price per option of USD4.08 and weighted average remaining contractual term of approximately 4 years as of June 30, 2011.  During the three months and six months ended June 30, 2011, no share options under the 2004 Incentive Plan were exercised.  During the three months and six months ended June 30, 2010, nil and 7,500 options were exercised, respectively. As of June 30, 2011, 1,184,769 options were outstanding under the 2004 Incentive Plan.
 
(b)       Non-vested share units
 
A summary of non-vested share units activity is as follows:
 
   
2006 Incentive Plan
   
2009 Incentive Plan
 
   
Shares
   
Weighted average
grant-date fair value
   
Shares
   
Weighted average
grant-date fair value
 
         
USD
         
USD
 
Balance as of January 1, 2011
    786,465       6.74       1,615,952       6.26  
Granted on January 1, 2011 (note i)
    -       -       210,000       8.85  
Granted on March 21, 2011 (note i)
    -       -       1,000,000       7.80  
Granted on April 1, 2011 (note i)
    -       -       150,000       8.85  
Granted on June 24, 2011(note ii)
    -       -       50,000       5.27  
Vested
    (242,352 )     7.58       (513,629 )     6.67  
Balance as of June 30, 2011
    544,113       6.36       2,512,323       7.14  
  

Note i
The stock awards vest in equal quarterly installments over a period of three years from the date of grant.
 
Note ii
The stock awards were fully vested on the date of grant.
 
 
11

 

(c) Performance shares
 
A summary of performance share units activity is as follows:
   
2009 Incentive Plan
 
   
Shares
   
Weighted average
grant-date fair value
 
         
USD
 
Balance as of January 1, 2011
    -       -  
Granted on January 1, 2011 (note i)
    330,000       8.85  
Granted on January 1, 2011 (note ii)
    270,000       8.85  
Granted on April 1, 2011 (note i)
    30,000       8.85  
Granted on April 1, 2011 (note ii)
    30,000       8.85  
Vested
    -       -  
                 
Balance as of June 30, 2011
    660,000       8.85  
 

Note i
The performance awards which were granted on January 1, 2011 and April 1, 2011 vest in equal annual installments over a period of three years from January 1, 2011 to December 31, 2013 and April 1, 2011 to March 31, 2014, respectively, and are subject to meeting certain earnings or other performance measures in 2011, 2012 and 2013. Management assessed that the earnings or other performance measures for these performance awards were improbable of achievement during the three months ended June 30, 2011, and a reversal of the share-based compensation of these performance awards recognized during the three months ended March 31, 2011 of RMB2,360 thousand (USD365 thousand) was recognized.
 
Note ii
During the three months and six months ended June 30, 2011, the Company has granted performance share awards that contain service and market conditions. For performance share awards with market conditions, the market conditions are considered in the grant date fair value using a lattice model and will be recognized over the requisite service period regardless of whether the market condition is satisfied, provided that the requisite service period has been completed. The share awards which were granted on January 1, 2011 and April 1, 2011 vest in equal annual installments over a period of three years from January 1, 2011 to December 31, 2013 and April 1, 2011 to March 31, 2014, respectively, and are subject to meeting the specified market condition in 2011, 2012 and 2013.
 
 
12

 
 
Note 11 – Earnings Per Share
 
The following table sets forth the computation of basic and diluted earnings per share:
   
Three Months ended
June 30,
   
Six Months ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Numerator for basic and diluted earnings per share:
                       
Net income attributable to Cogo Group, Inc.
    26,955       27,158       54,011       50,919  
Denominator:
                               
Basic weighted average shares
    38,078,756       37,133,304       38,036,997       37,088,817  
Effect of dilutive non-vested equity share units, performance shares, options and warrants
    640,534       912,401       921,173       981,283  
Diluted weighted average shares
    38,719,290       38,045,705       38,958,170       38,070,100  
                                 
   
RMB
   
RMB
   
RMB
   
RMB
 
Basic earnings per share:
    0.71       0.73       1.42       1.37  
Diluted earnings per share:
    0.70       0.71       1.39       1.34  
 
Non-vested equity share units, performance shares and options amounting to approximately 2,035 thousand and 322 thousand are excluded from the Company’s dilutive computation as their effect would be anti-dilutive for the three months ended June 30, 2011 and 2010, respectively.  For the six months ended June 30, 2011 and 2010, approximately 1,481 thousand and 370 thousand of such non-vested equity share units, respectively are excluded from the Company’s dilutive computation as their effect would be anti-dilutive.
 
Note 12 – Operating Segment Information
 
Segment information is as follows:
   
Three Months ended
June 30,
   
Six Months ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Net revenue
                       
Product sales
                       
Segment revenue from external customers
                       
Digital media
    374,233       354,036       749,016       675,227  
Telecommunications equipment
    323,996       147,234       476,766       280,798  
Industrial business
    171,652       107,215       327,861       199,306  
      869,881       608,485       1,553,643       1,155,331  

 
13

 

   
Three Months ended
June 30,
   
Six Months ended 
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Service revenue
                       
Segment revenue from external customers
    -       8,496       -       14,449  
Inter-segment revenue
    6,093       3,511       6,093       7,520  
      6,093       12,007       6,093       21,969  
Inter-company elimination
    (6,093 )     (3,511 )     (6,093 )     (7,520 )
Total net revenue
    869,881       616,981       1,553,643       1,169,780  
Income from operations
                               
Product sales
    66,711       33,571       111,981       67,133  
Service revenue
    -       5,984       -       6,876  
Unallocated (note i)
    (32,762 )     (11,052 )     (44,980 )     (20,992 )
Total income from operations
    33,949       28,503       67,001       53,017  
Interest expense
    (3,759 )     (1,666 )     (6,862 )     (2,781 )
Interest income
    3,589       3,493       6,719       6,787  
Earnings before income taxes
    33,779       30,330       66,858       57,023  
                                 
                   
June 30,
2011
   
December 31,
2010
 
                   
RMB’000
   
RMB’000
 
Total assets
                               
Product sales
                    2,577,946       2,298,459  
Service revenue
                    22,587       21,995  
Unallocated (note ii)
                    1,912       1,563  
                      2,602,445       2,322,017  
 

Note i:  Unallocated income from operations includes items such as corporate staff and overheads.
 
Note ii:  Unallocated assets mainly include cash for corporate use.
 
Note 13 – Comprehensive Income
 
The following table reconciles equity attributable to noncontrolling interest:
   
Three Months ended
June 30,
   
Six Months ended 
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
RMB’000
   
RMB’000
   
RMB’000
   
RMB’000
 
Beginning balance
    17,726       8,673       15,332       8,455  
Net income attributable to noncontrolling interest
    3,284       132       5,734       405  
Foreign currency translation adjustments
    (30 )     (86 )     (86 )     (141 )
Ending balance
    20,980       8,719       20,980       8,719  
 
 
14

 
 
Note 14 – Fair Value Measurement
 
The fair values of pledged bank deposits, accounts receivable, accounts payable, bank borrowings and accrued expenses and other liabilities approximated the respective carrying amounts because of the short maturity of these instruments. The Group adopted ASC 820-10, for the nonfinancial assets and liabilities that are remeasured at fair value on a nonrecurring basis. The nonfinancial assets and liabilities that are remeasured at fair value on a nonrecurring basis did not impact our financial position or results of operations; however, it could have an impact in future periods.  In addition, the Group may have additional disclosure requirements in the event it incurs impairment of the Group’s assets in future periods.
 
Note 15 – Acquisitions
 
(a) MDC Tech International Holdings Limited (“MDC”)
 
On January 31, 2011, the acquisition date, the Group acquired 100% of the outstanding shares of MDC and thereby obtained control of MDC and its subsidiary for a consideration of USD22,000 thousand (equivalent to RMB145,237 thousand as of the acquisition date). The purchase consideration will be funded with existing cash balances. The purchase consideration would be paid over twelve months in four equal installments on or before the last business day of each of the four fiscal quarters. The first two installments were USD5,500 thousand each (equivalent to RMB35,549 thousand) and were paid during the three months ended March 31, 2011 and June 30, 2011, respectively. The remaining consideration payable of USD11,000 thousand (equivalent to RMB71,099 thousand) for the acquisition is due to be settled within the year ending December 31, 2011 and is non-interest bearing. In light of the installment schedule, the Group has recorded the purchase consideration on a discounted basis, which amounted to USD21,869 thousand (equivalent to RMB144,372 thousand as of the acquisition date).
 
The principal activities of MDC and its subsidiary are the distribution of medical and healthcare equipment in the PRC, and the development of industrial applications on energy saving modules in the PRC.
 
The acquisition of MDC was accounted for by the Group as a purchase business combination in accordance with ASC 805, Business Combinations. On a provisional basis, the acquisition of MDC resulted in the recognition of goodwill of RMB61,755 thousand and the recording of net identifiable assets of RMB82,617 thousand at the date of acquisition. Recognized intangible assets relate to order backlog, customer relationships, non-compete agreements and proprietary technology which have a total weighted-average useful life of 6.0 years from the date of acquisition. Goodwill and the amortization of these intangible assets are not deductible for tax purposes.
 
The acquisition is expected to support the expansion of the Company’s industrial business in the PRC and the medical equipment and system sales in the PRC. Goodwill is attributed by (1) synergy to expand MDC’s operation and business on the established platform, industry knowledge and experience of the Group and the current experience of the Group in providing module reference design and solutions to customers; (2) assembled workforce including engineers and management which is capable of achieving ready integration with the Group; and (3) the expected outlook in the PRC medical and healthcare equipment and industrial application market with the PRC government stimulus package. The combination of these factors is the drivers behind the excess of purchase price paid over the value of assets and liabilities acquired.
 
Management has revised the estimate of the fair value of the acquired customer relationships by RMB18,779 thousand and recognized order backlog of RMB3,595 thousand as a result of the refinement of the valuation during the three months ended June 30, 2011. The revisions in valuation have resulted in addition of goodwill by RMB12,085 thousand and reduction of deferred tax liabilities by RMB3,099 thousand. The Group is still in the process of its assessment of the allocation of the purchase price to the identifiable net assets acquired, including identification of any other intangible assets arising from the acquisition, valuation of each of the intangible assets identified and determination of the useful lives of the intangible assets identified. Thus, the allocation of the purchase price is subject to further adjustments.
 
 
15

 
 
The purchase price allocation is as follows:
   
USD’000
   
RMB’000
 
Intangible assets
           
– order backlog
    545       3,595  
– customer relationships
    455       3,006  
– non-compete agreements
    13,700       90,443  
– proprietary technology
    180       1,188  
Goodwill
    9,354       61,755  
Deferred tax liabilities
    (2,365 )     (15,615 )
                 
Net asset acquired
    21,869       144,372  
 
The amount of revenue for MDC since the acquisition date included in the consolidated income statement from January 31, 2011 to June 30, 2011 is RMB46,855 thousand (USD7,249 thousand).
 
Unaudited proforma financial information
 
The following unaudited proforma financial information represents the combined results of operations of the Group as if the acquisition of MDC had occurred as of January 1, 2010. The unaudited proforma information is not necessarily indicative of what the Company’s consolidated results of operations actually would have been had it completed the acquisition as of January 1, 2010. In addition, the unaudited proforma financial information does not attempt to project the future results of operations of the Group.
 
   
Three Months ended June 30,
   
Six Months ended June 30,
 
   
2011
   
2011
   
2010
   
2011
   
2011
   
2010
 
   
USD’000
(unaudited)
   
RMB’000
(unaudited)
   
RMB’000
(unaudited)
   
USD’000
(unaudited)
   
RMB’000
(unaudited)
   
RMB’000
(unaudited)
 
Net revenue
    134,584       869,881       638,904       240,372       1,553,643       1,213,769  
Income from operations
    5,831       37,688       27,679       10,658       68,888       50,604  
Net Income attributable to Cogo Group, Inc.
    4,745       30,670       26,469       8,672       56,179       48,901  
Earnings per share
                                               
Basic
    0.13       0.81       0.71       0.23       1.48       1.32  
Diluted
    0.12       0.79       0.70       0.22       1.44       1.28  
 
(b) Goldshare Holdings Limited (“Goldshare”)
 
On April 1, 2011, the Group entered into a note subscription and share purchase agreement to acquire 3,142,857 shares (representing 44% of the outstanding shares) of Goldshare for a cash consideration of RMB22,000 thousand (equivalent to USD3,404 thousand); and to subscribe to a convertible note to be issued by Goldshare for RMB20,000 thousand (equivalent to USD3,094 thousand). The note will be convertible into 2,857,143 new shares of Goldshare at the option of the Group. The Group will be entitled to a total of 60% of the outstanding shares of Goldshare and Goldshare will become a subsidiary of the Group, if the Group exercises the conversion options.
 
Goldshare engages in the business of distribution of passive components with most of its operations in the PRC. The purchase consideration is contingently payable at various dates upon achieving certain agreed earnings levels of Goldshare and will be funded with existing cash balances. The schedule of payment of the purchase consideration will be separately agreed upon by the Group and the seller of Goldshare.
 
The note subscription and share purchase agreement has not been consummated. Therefore, the results of Goldshare have not been included in the unaudited condensed consolidated financial statements of the Company for the period ended June 30, 2011.
 
 
16

 

Note 16 – Redomestication Merger
 
On May 2, 2011, Cogo Cayman Group Inc., a wholly owned subsidiary of the Company, filed a Form F-4 that relates to the Company’s redomestication from Maryland to the Cayman Islands. The redomestication was approved by a shareholder vote on July 25, 2011. The redomestication became effective and changed the Company’s domicile from Maryland to the Cayman Islands effective August 4, 2011.

Note 17 – Subsequent Events
 
On July 4, 2011, the Group entered into an amendment agreement (the “Amendment”), effective as of July 15, 2011, to the general banking facility with BOC. Pursuant to the Amendment, BOC extended to the Group a general banking facility up to USD95,500 thousand (equivalent to RMB617,264 thousand). The overdraft facility included therein bears an interest rate at 2% per annum above the HIBOR or USD LIBOR depending on the currency of the overdraft. The Amendment requires the Group to deliver to BOC an irrevocable standby letter of credit of USD20,000 thousand (equivalent to RMB129,270 thousand) and a USD15,000 thousand (equivalent to RMB96,953 thousand) charge of deposit to secure the general banking facilities. In addition, the Amendment contains other requirements including the Company remaining as the ultimate holding company of the Group, Mr. Jeffrey Kang remaining as the single largest beneficial owner of the Company’s shares, the Company maintaining its NASDAQ listing status and meeting certain other financial ratios.
 
On July 14, 2011, the Group entered into credit facility agreements with the Shenzhen branch of GDB (“GDB Shenzhen”). The credit facility agreements carry a maximum aggregate loan amount of RMB50,000 thousand (USD7,736 thousand) for which the Group can draw upon for credit. Such RMB-drawn loans are subject to a variable interest rate as a 20% increase on the base interest rate set by the People’s Bank of China. Any loans drawn in a foreign currency will be subject to terms of interest pursuant to a separate agreement. The credit facilities available under such facility agreements may in certain circumstances require a security deposit of up to 20% of the amount of funds to be received.
 
 
17

 
 
Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This commentary should be read in conjunction with Cogo Group, Inc. (the “Company”) and its subsidiaries’ (together, “we,” “us,” “our” or the “Group”) unaudited condensed consolidated financial statements for the period ended June 30, 2011 and 2010 as well as the Group’s consolidated financial statements and related notes thereto and management’s discussion and analysis of financial condition and results of operations in the Company’s Form 10-K for the year ended December 31, 2010.
 
Portions of the discussion and analysis below contain certain statements that are not descriptions of historical facts, but are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. These forward-looking statements may include statements about our plans and objectives for future expansion, including our new digital consumer electronic and storage solution products; expectations for the domestic wireless handset, telecommunications equipment, consumer electronic and storage solution end-markets in the People’s Republic of China (the “PRC”); anticipated margins for our solutions; general and cyclical economic and business conditions, and, in particular, those in the PRC’s wireless handset, telecommunications equipment and consumer electronics industries; our ability to enter into and renew key corporate and strategic relationships with our customers and suppliers; changes in the favorable tax incentives enjoyed by our PRC operating companies; and other statements containing forward looking terminology such as “may,” “expects,” “believes,” “anticipates,” “intends,” “projects,” “looking forward” or similar terms, variations of such terms or the negative of such terms. Such information is based upon various assumptions made by, and expectations of, our management that were reasonable when made but may prove to be incorrect. All of such assumptions are inherently subject to uncertainties and contingencies beyond our control and upon assumptions with respect to future business decisions which are subject to change. Accordingly, there can be no assurance that actual results will meet expectations and actual results may vary (perhaps materially) from certain of the results anticipated herein. For a further description of these and other risks and uncertainties, see our most recent Annual Report filed with the Securities and Exchange Commission (“SEC”) on Form 10-K, and our subsequent SEC filings.
 
Overview

We provide customized module design solutions for a diverse set of applications and end-markets, serving as a gateway for our technology component suppliers to access leading electronics manufacturers in the PRC. Our customized module design solutions allow our customers to take advantage of technology components from reputable suppliers in an efficient and cost-effective manner, effectively reducing their time-to-market and lowering their overall costs. Our close collaboration with our customers’ product development teams provides us with a unique understanding of their needs, enabling us to customize our suppliers’ technology components with module designs that meet our customers’ needs. In addition, in 2006, we began offering technology and engineering services in the PRC and in 2007, we began offering software design services in the PRC.

We focus on the digital media, telecommunications equipment and industrial business end-markets in the PRC. In the digital media end-market, we provide mobile handset and module solutions for functionalities such as CMMB mobile TV, motion sensor, camera, power supply and bluetooth as well as solutions for high definition digital set-top box, GPS and solutions for Tablets. In the telecommunications equipment end-market, we provide solutions for public switched telephone network or PSTN switching, optical transmitters, electrical signal processing and optical signal amplification; in the industrial business end-market, which we entered in the beginning of 2008, we provide industrial solutions for the green energy, smart meter, smart grid, railways, healthcare and auto-electronics sectors. Currently, we have over 1,600 customers, including many of the most established manufacturers in the digital media, telecommunications equipment and industrial business end-markets in the PRC such as ZTE, TCL and BYD. We work with original equipment manufacturers, or OEMs, as well as subsystem designers and contract manufacturers to provide solutions to support industry leaders like Huawei. In developing customized module design solutions for use in our customers’ products, we collaborate closely with over 30 suppliers of technology components, including many large multinational companies such as Broadcom, Sandisk, Freescale and Atmel. Additionally, in October 2006, we became one of the first PRC-based companies to license software technology and have access to selected source codes directly from Microsoft. After our January 2011 acquisition of MDC Tech International Holdings Limited (“MDC”), we began to work with hospitals in the PRC for the sales of medical and healthcare equipment and systems.
 
 
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We have two reportable operating segments: product sales consisting of revenues generated by providing customized module design solutions focusing primarily in the digital media, telecommunications equipment and industrial business end-markets, as well as the distribution of medical and healthcare equipment under the industrial business end-market, and service revenue, generated by providing technology and engineering services, network system integration and related training and maintenance services.
 
Principal Factors Affecting Our Results of Operations

The major factors affecting our results of operations and financial condition include:

Revenue mix. Our net revenue and gross profit are affected by our product mix. In the second quarter of 2011, telecommunications equipment related sales, which have generally lower profit margins than our digital module related sales and our industrial business module related sales, constituted a significantly greater portion of our total net revenue as compared to the previous quarters.

Growth in end-market industries. The rapid growth of the domestic telecommunications equipment, industrial business and digital media end-markets has been important growth drivers for the PRC’s electronics manufacturing industries. Specific markets that we expect to experience continued growth are the data communications market, consisting of asymmetric digital subscriber line (ADSL) modems and Voice over Internet Protocol (VoIP) equipment; the routers and network security equipment markets; the optical transmission systems market; the fixed line telecommunications network market, as well as the digital media market particularly relating to digital TV and GPS applications. Increased domestic consumer spending power has contributed to rapid growth in these markets. This growth in domestic consumer spending power in turn has driven, and we believe will continue to drive, growth in the electronics manufacturing businesses supporting hardware OEMs, including those engaged in the customized design of module solutions such as ourselves. However, these industries and the respective domestic manufacturers that operate in these industries may not continue to grow their sales at historical levels, if at all. The stagnation or reduction in overall demand for telecommunications equipment, industrial business and digital media products could materially affect our results of operations.

Increase in exports. We believe that the development of a highly-skilled, low-cost manufacturing base has also enabled the PRC’s domestic telecommunications equipment and digital consumer electronics manufacturers to be competitive in the global marketplace. As an example, ZTE, a major manufacturer of mobile handset and telecommunications equipment in the PRC, as well as other telecommunications equipment and mobile handset manufacturers, have also begun to expand overseas. We believe that growth in the export market will likely have a positive effect on our results of operations and financial condition, as it should increase the demand for our solutions, particularly among our digital media clients.

Growth by entering new end-markets, strengthening in-house capabilities and leveraging our customer base. In 2008, we began targeting the industrial business end-market by providing industrial solutions for the green energy and auto-electronics sectors. In 2011, after our acquisition of MDC, we began to sell medical and healthcare equipment and systems to PRC hospitals. The revenues generated from the industrial business-end market have grown from 17.4% of our revenue in the second quarter of 2010 to 19.7% of our revenue in the second quarter of 2011.  We anticipate that sales related to the industrial business end-market will generally have higher profit margins than our digital media and telecom equipment modules related sales, though such higher margins may decline over time as this industry matures. We will also look for opportunities to expand into new end-markets that we believe represent significant growth opportunities, including sales of the medical and healthcare equipment and system in the current period.

Our success in the industrial business end-market will depend, in significant part, on our ability to leverage our existing customer base. We expect to continue to incur additional research and development expenses, through hiring additional engineering personnel to develop new solutions and expanding our intellectual property and technological capabilities, to meet the needs of our customers that have expanded into or are expected to expand into the industrial business end-market.

General economic and market conditions. Due to different market conditions, the level of consumer and information technology spending has declined and reduced the demand for our mobile handsets since the third quarter of 2008. Furthermore, our profit margins have been reduced since we strategically lowered our pricing in order to grow the business in a slowing economic environment. Our other businesses, such as industrial business and digital media products, continue to show solid growth, driven by stable infrastructure investments in the PRC.
 
 
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Net Revenue

Product sales

For our product sales segment, we do not charge our customers an independent design fee. Instead, our business model is to generate revenue by reselling a limited number of specific components required in our module reference design. The difference between the purchase price we pay our suppliers for these components and our sales price to the customer for these components compensates us for our design, technical support and distribution services. During the period, we also engaged in the sales of medical and healthcare equipment and system in accordance with the specifications of customers arising from the acquisition of MDC in January 2011. Our net revenue is net of a 17% value-added tax, or VAT. Costs incurred for the design of modules are expensed as incurred and recorded as research and development expense in the Company’s unaudited condensed consolidated statements of income and comprehensive income.

Our broad and diversified customer base includes many of the major telecommunications equipment, industrial business and digital consumer electronics manufacturers in the PRC. In addition, our customers include industry participants supporting these OEMs, such as subsystem designers and contract manufacturers in the PRC, as well as international manufacturers who have begun to manufacture end-products in the PRC for the domestic and international market. Subsequent to the January 2011 acquisition of MDC, our customers also include PRC hospitals.

Our net revenue is subject to seasonal fluctuation and periods of increased demand. All product module sales are typically highest in the fourth quarter of the year due to desire by OEMs and other customers to spend remaining budgets allocated for a given period, usually on an annual basis. Net revenue has historically been lowest in the first quarter of the year due to the Chinese New Year holiday and the general reduction in sales following the holiday season. The digital media industry also experiences cyclical fluctuations, as well as fluctuations in how quickly certain new digital media products and technologies are adopted by the market. These sales patterns may not be indicative of future sales performance.

Service Revenue

We provide technology and engineering services, and related training and maintenance services to our customers. We generate revenue when our services are rendered and acknowledged by our customers. Our service revenue is net of business tax. However, we have not recorded service revenue in the second quarter.

Cost of Sales

Our cost of sales comprises cost of goods sold and cost of service.

Cost of Goods Sold

Cost of goods sold primarily consists of the purchase of components and equipment from suppliers. We develop our customized module design solutions based on specific technology components purchased from suppliers in our target end-markets. Our list of over 30 key suppliers includes Broadcom (integrated circuit and Bluetooth), Sandisk (flash memory), Freescale Semiconductor (automotive solutions), Atmel (industrial solutions), Xilinx (industrial solutions) and Philips (medical and healthcare equipment). We typically issue purchase orders to our suppliers only after we have received customer orders, enabling us to maintain low inventory levels and, in turn, minimize risks typically associated with holding inventory. If we lose a key supplier, or a supplier reduces the quantity of products it sells to us, does not maintain a sufficient inventory level of products required by us or is otherwise unable to meet our demands for its components, we may have to expend significant time, effort and other resources to locate a suitable alternative supplier and secure replacement components. Even if we are able to find a replacement supplier, we may be required to redevelop the customized module design solution to effectively incorporate the replacement components.

 
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Cost of Service

Cost of service consists of direct staff costs and other direct related costs for providing engineering and technology services including training and materials.

Operating Expenses

Selling, General and Administrative Expenses

Our selling expenses include expenditures to promote our new module solutions and gain a larger customer base, personnel expenses and travel and entertainment costs related to sales and marketing activities, and freight charges. We expense all these expenditures as they are incurred. Selling expenses are expected to continue to grow in the future as we diversify by developing and acquiring new design capabilities and expanding into new end-markets. Also included in selling expenses are allowance for doubtful accounts.

General and administrative expenses include compensation and benefits for our general and administrative staff, professional fees, amortization of intangible assets, foreign exchange losses and general travel and entertainment costs. We expense all general and administrative expenses as they are incurred. We expect that general and administrative expenses will continue to increase for the foreseeable future as a result of our expected continued growth and the continuing costs of complying with U.S. rules and regulations necessary to maintain our listing in the United States.

Research and Development Expenses

Research and development expenses consist primarily of salaries and related costs of the employees engaged in research, design and development activities; the costs for design and testing; the cost of parts for prototypes; equipment depreciation; and third party development expenses. We expense research and development expenses as they are incurred. As of June 30, 2011, we had approximately 338 engineers and other technical employees engaged in research and development related activities to develop new customized module design solutions targeted at the telecommunications equipment, industrial business and digital media industries.

Noncontrolling Interest

Noncontrolling interest consisted of 30% and 40% of the outstanding equity interest in Comtech Broadband Corporation Limited (“Comtech Broadband”) and Comtech Digital Technology (Hong Kong) Limited (“Comtech Digital”), respectively. For the quarter ended June 30, 2011, approximately 59.4% of our total net revenue was generated through Comtech Broadband. Approximately 2.7% of our total net revenue was generated through Comtech Digital for the second quarter of 2011. For the quarter ended June 30, 2011, approximately 32.1% and 3.1% of our total net income was generated through Comtech Broadband and Comtech Digital, respectively.

Taxation

Our following PRC subsidiaries are enjoying tax holidays during 2011:
 
 
Comloca Technology (Shenzhen) Company Limited, Shenzhen Huameng Software Company Limited, Viewtran Technology (Shenzhen) Co. Limited and Epcot Multimedia Technology (SZ) Co. Ltd., being production oriented foreign investment enterprises, are entitled to 50% reduction in their corporate income tax rates. They are subject to corporate income tax at 12% for 2011.
 
Mega Sky (Shenzhen) Limited and Mega Smart (Shenzhen) Limited, being software and integrated circuit design enterprises, are each granted full corporate income tax exemption for 2011.

Our effective tax rates were 10.5% and 10.0% for the three months ended June 30, 2011 and 2010, respectively. Our effective tax rates were 10.6% and 10.0% for the six months ended June 30, 2011 and 2010, respectively. The effective income tax rates for the three months and six months ended June 30, 2011 differ from the PRC statutory corporate income tax rate of 25% primarily due to the effect of tax holidays and the effect of non-deductible share-based compensation cost.

 
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Our PRC subsidiaries have cash balances of RMB565,261 thousand (USD87,454 thousand) and RMB738,147 thousand as of June 30, 2011 and December 31, 2010, respectively which are planned to be permanently reinvested in the PRC. The distributions from our PRC subsidiaries are subject to the U.S. federal income tax at 34%, less any applicable foreign tax credits. Due to our policy of indefinitely reinvesting our earnings in our PRC business, we have not provided for deferred tax liabilities on undistributed earnings of our PRC subsidiaries.

As of and for the three months and six months ended June 30, 2011, we did not have any unrecognized tax benefits and thus no interest and penalties related to unrecognized tax benefits were recorded. In addition, we do not expect that the amount of unrecognized tax benefits will change significantly within the next 12 months.
 
Three months ended June 30, 2011 compared to three months ended June 30, 2010
 
Overview
 
The following table sets forth information regarding the breakdown of revenues and income from operations between our product sales segment and service revenue segment:
 
   
Three Months ended
June 30,
 
   
2011
   
2010
 
   
RMB’000
   
RMB’000
 
Net revenue
           
Product sales
           
Digital media
    374,233       354,036  
Telecommunications equipment
    323,996       147,234  
Industrial business
    171,652       107,215  
Service revenue
    -       8,496  
Total net revenue
    869,881       616,981  
 
Net Revenue. Total net revenue increased by RMB252,900 thousand (USD39,127 thousand), or 41.0% in the three months ended June 30, 2011 when compared to the corresponding period in 2010. The increase was mainly due to the continued expansion in all end-markets especially the telecommunications equipment end-market during the period. The acquisition of MDC in January 2011 also generated net revenue of RMB15,330 thousand (USD2,372 thousand) during the three months ended June 30, 2011.
 
Product Sales.
 
Details of product sales by market type are as follows:
   
Three Months ended June 30,
 
   
2011
   
2010
       
   
Amount
   
% of Net
Revenue
   
Amount
   
% of Net
Revenue
   
% Change
 
   
USD’000
   
RMB’000
         
RMB’000
             
Digital media
    57,900       374,233       43.0 %     354,036       57.4 %     5.7 %
Telecommunications equipment
    50,127       323,996       37.3 %     147,234       23.9 %     120.1 %
Industrial business
    26,557       171,652