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, 2009 and 2008 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 Group's Form 10-K for the year ended December 31, 2008.

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 into 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 China. Our customized module design solutions allow our customers to take advantage of technology components from reputable suppliers in an efficient and cost-effective manner, thus 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 to earn income through the provision of engineering service to existing and new customers.

We are focused on the mobile handset, telecommunications equipment, industrial business and digital media end-markets in China. In the mobile handset end-market, we provide module solutions for functionalities such as LCD, camera, power supply and Bluetooth; in the telecom equipment end-market, we provide solutions for PSTN switching, optical transmitters, electrical signal processing and optical signal amplification; in the industrial business end-markets, which commenced since the beginning of 2008 and further expanded in 2009 with the acquisition of Mega Smart Group Limited ("Mega Smart"), we provide industrial solutions for the green energy and auto-electronics sectors; and in the digital media end-market, we provide solutions for digital set-top boxes and GPS applications. Over the course of our operating history, we have worked with over 1,200 customers, including a majority of the most established manufacturers in the mobile handset, telecom equipment and digital media end-markets in China such as ZTE, Huawei and Lenovo. In addition to these original equipment manufacturers, or OEMs, our other customers include industry participants that support these OEMs, such as subsystem designers and contract manufacturers. 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, JDS Uniphase and Matsushita. In addition, in October 2006, we became one of the first China-based companies to license software technology and have access to selected source codes directly from Microsoft.

We have two reportable operating segments: product sales consisting of revenues generated by providing customized module design solutions focusing primarily in the mobile handset, telecommunications equipment, digital media and industrial business end-markets, and services revenue, generated by providing technology and 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. Over the last year, digital media related sales, which have generally higher profit margins than our mobile handset module related sales and our telecom equipment module related sales, have constituted a significantly greater portion of our total net revenue as compared to previous years.

Growth in end-market industries. The rapid growth of the domestic mobile handset, telecom equipment, industrial business and digital media end-markets have been important growth drivers for China'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 telecom 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 mobile handset, telecom 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 China's domestic mobile handset, telecom equipment and digital consumer electronics manufacturers to be competitive in the global marketplace. As an example, ZTE, a major manufacturer of mobile handset and telecom equipment in China, as well as other telecom equipment and mobile handset manufacturers, have 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 mobile handset and digital media clients.

Growth by entering new end-markets, strengthening in-house capabilities and leveraging our customer base. In 2005, we began targeting the digital media end-market and, over time, we intend to develop integrated circuit and application software design capabilities and provide solutions based on our own proprietary technology. In the first quarter of 2005, we began generating sales from customized module design solutions for digital home entertainment products, primarily for digital set-top boxes, through sales to our existing end-customers Haier, Konka, Lenovo and TCL. We have since then grown our revenues generated from this market from constituting 10.8% of our 2005 revenue to 28.9% of our first half of 2009 revenue. We anticipate that sales related to the digital media end-markets will generally have higher profit margins than our mobile handset 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.

Our success in the digital media 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 digital media end-market.

General economic and market conditions. Due to the tough 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 declined because we strategically lowered our pricing in order to grow the business in a slowing economic environment. Our other businesses, such as telecommunications and digital medial products, continue to show solid growth, driven by stable infrastructure investments in the PRC.

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. Our net revenue is net of a 17% value-added tax, or VAT.

Our broad and diversified customer base includes many of the major mobile handset, telecom equipment, industrial business and digital consumer electronics manufacturers in China. In addition, our customers include industry participants supporting these OEMs, such as subsystem designers and contract manufacturers in China, as well as international manufacturers who have begun to manufacture end-products in China for the domestic and international market.

Our net revenues are 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 the desire by OEMs to spend remaining budgets allocated for a given period, usually on an annual basis. Net revenues have 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.

Services Revenue

We provide software design 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.

Cost of Sales

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

Cost of Goods Sold

Cost of goods sold primarily consists of the purchase of components 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), Maxim (integrated circuits), Matsushita (switches), and Freescale (microcontrollers). We typically issue purchase orders to our suppliers only after we receive 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.

Cost of Services

Cost of services 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.

General and administrative expenses include compensation and benefits for our general and administrative staff, professional fees, amortization of intangible assets, including intangible assets identified resulted from the acquisition of Mega Smart, foreign exchange gain/loss, 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("R&D") Expenses

R&D 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 R&D expenses as they are incurred. As of June 30, 2009, we had approximately 252 engineers and other technical employees engaged in R&D-related activities to develop new customized module design solutions targeted at the mobile handset, telecommunications equipment, industrial business and digital media industries. As a result of additional costs incurred in developing new customized module design solutions, and an increasing headcount in our R&D department, we expect that our R&D expenses, including those relating to the planned hiring of additional R&D personnel, will increase in the future as we seek to expand our business by developing new customized module design solutions and penetrating new end-markets, and as we seek to grow our engineering services business.

Taxation

The Company and the subsidiaries file separate income tax returns.

USA

The Company is a holding company incorporated in the State of Maryland, and is subject to United States federal and state income taxes. The Company did not generate taxable income in the United States in the six months ended June 30, 2009 and 2008.

Cayman Islands and British Virgin Islands

Under the current laws of the Cayman Islands and British Virgin Islands, our subsidiaries that are incorporated in the Cayman Islands and the British Virgin Islands are not subject to tax on income or capital gains. In addition, upon payments of dividends by these companies, no Cayman Islands and British Virgin Islands withholding tax will be imposed.

PRC

On March 16, 2007, the National People's Congress passed the new Corporate Income Tax law (the "new CIT law") which sets the income tax rate to 25% for all companies. The new CIT law was effective as of January 1, 2008. The new CIT law provides a five-year transition period from its effective date for those companies which were established before March 16, 2007 and which were entitled to a preferential lower tax rate under the then effective tax laws or regulations, as well as grandfathering tax holidays. The transitional tax rates are 18%, 20%, 22%, 24% and 25% for 2008, 2009, 2010, 2011 and 2012 onwards, respectively. For the Shenzhen Subsidiaries that were entitled to a tax holiday such as the two-year tax exemption followed by a three-year 50% tax reduction shall be entitled to the tax holiday.

Based on the above, the Shenzhen Subsidiaries are subject to the following tax rates:

• Shenzhen Comtech International Limited and Comtech Communications Technology (Shenzhen) Limited was subject to a tax rate of 18% in 2008, and a tax rate of 20% in 2009

• Comtech Software Technology (Shenzhen) Company Limited was subject to a tax rates of 9% for 2008, and a tax rate of 20% in 2009

• Comloca Technology (Shenzhen) Company Limited and Shenzhen Huameng Software Company Limited was under a tax holiday in 2008 and is under a tax holiday in 2009

• Viewtran Technology (Shenzhen) Co., Limited ("Viewtran") and Epcot Multimedia Technology (SZ) Co., Limited were under tax holidays in 2008, and are subject to a tax rate of 10% in 2009

In addition, beginning on January 1, 2008, Shanghai E&T System Company Limited, Shanghai Comtech Electronic Technology Ltd. and Keen Awards Beijing Limited are subject to the corporate income tax rate of 25% under the new CIT law.

Hong Kong

Our subsidiaries incorporated in Hong Kong are subject to Hong Kong Profits Tax. The profits tax rate for these companies for 2008 and 2009 was 16.5%.

As a result of the PRC tax incentives above, our operations have been subject to relatively low tax liabilities. Our effective tax rate was 10.7% and 6.3% in the six months ended June 30, 2009 and 2008, respectively. The increase in our effective tax rate was mostly due to the expiry of tax holiday for certain subsidiaries in Shenzhen, as compared to the corresponding period in 2008.

Noncontrolling Interest

Noncontrolling interest (previously referred to as minority interest) consists of an interest of 30% of the outstanding equity interest in Long Rise Holdings Limited ("Long Rise") that is held by a third party. For the quarter ended June 30, 2009, approximately 10.8% of our total net revenue was generated through this subsidiary.

Three months ended June 30, 2009 compared to three months ended June 30, 2008

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,
                                              2009             2008
                                             RMB'000          RMB'000
           Net revenue
           Product sales
           Mobile handset                       160,920          160,961
           Telecommunications equipment         126,863          136,795
           Industrial business                   58,604           17,231
           Digital media and others             148,979          148,910
           Services revenue                       7,263            4,020

           Total net revenue                    502,629          467,917

Net Revenue. Total net revenue increased RMB34,712 thousand (USD5,082 thousand), or 7.4% in the three months ended June 30, 2009 when compared to the corresponding period in 2008. The increase was mainly due to the continued expansion in the industrial business end-market.

Product Sales

Details of product sales by market type are as follows:



                                                          Three Months ended June 30,
                                                   2009                         2008
                                                           % of Net                % of Net
                                            Amount         Revenue       Amount    Revenue       % change
                                       USD'000   RMB'000                 RMB'000
Mobile handset                          23,560   160,920       32.0 %    160,961       34.4 %        (0.1 )%
Telecommunications equipment            18,574   126,863       25.2 %    136,795       29.2 %        (7.3 )%
Industrial business                      8,580    58,604       11.7 %     17,231        3.7 %       240.1 %
Digital media and other                 21,812   148,979       29.6 %    148,910       31.8 %         0.1 %

Total product sales                     72,526   495,366       98.5 %    463,897       99.1 %         6.8 %

Product sales for the three months ended June 30, 2009 was RMB495,366 thousand (USD72,526 thousand), or RMB31,469 thousand or 6.8% higher than the corresponding period in 2008. Mobile handset related sales decreased by RMB41 thousand (USD6 thousand), or 0.1%; telecommunications equipment related sales decreased by RMB9,932 thousand (USD1,454 thousand), or 7.3%; industrial business related sales increased by RMB41,373 thousand (USD6,057 thousand), or 240.1%; and digital media and other sales increased by RMB69 thousand (USD10 thousand), or 0.1%. The increase in product sales was mainly attributable to the Group's continued effort and strategic focus in the expansion of the digital media and other and the industrial business end-markets, offset by a decrease in telecommunications equipment revenue as a result of a reduction in selling price.

Services Revenue. Services revenue is as follows:

                                         Three Months ended June 30,
                                  2009                         2008
                                          % of Net                % of Net
                           Amount         Revenue       Amount    Revenue       % Change

Services revenue was derived from the provision of technology and engineering services, network system integration and related training and maintenance services. The increase of RMB3,243 thousand (USD475 thousand), or 80.7%, was mainly attributable to more sales generated from software design services for the quarter end June 30, 2009, as compared to same period of 2008 due to the increase in demand resulting from shortages of supply in the market during the first quarter of 2009.

Gross Profit. Gross profit was RMB71,626 thousand (USD10,487 thousand) in the three months ended June 30, 2009, a decrease of RMB12,551 thousand (USD1,838 thousand), or 14.6% when compared to RMB84,177 thousand in the corresponding period in 2008. Gross margin was 14.3% in the three months ended June 30, 2009, compared to 18% in the corresponding period in 2008. The decrease in both gross profit and gross profit margin was primarily attributable to the intense market competition in the mobile handset and digital media end markets resulted in the reduced selling price strategy adopted by the Group since late 2008.

Selling, General and Administrative and R&D Expenses. Selling, general and administrative and R&D expenses were RMB56,134 thousand (USD8,220 thousand) in the three months ended June 30, 2009, or 27.1% higher than the corresponding period in 2008. The expenses for the three months ended June 30, 2009 and 2008 are as follows:

                                                           Three Months ended June 30,
                                                    2009                         2008
                                                            % of Net                % of Net
                                             Amount         Revenue       Amount    Revenue       % Change
                                        USD'000   RMB'000                 RMB'000
Selling expenses                          3,246    22,166        4.4 %     10,794        2.3 %       105.4 %
General and administrative expenses       2,620    17,892        3.6 %     22,570        4.8 %       (20.7 )%
R&D expenses                              2,354    16,076        3.2 %     10,800        2.3 %        48.9 %

Total                                     8,220    56,134       11.2 %     44,164        9.4 %        27.1 %

Selling, General and Administrative Expenses. The increase in selling expenses in the three months ended June 30, 2009 of RMB11,372 thousand (USD1,665 thousand), or 105.4%, was mainly attributable to an additional charge of doubtful account of RMB13,660 thousand (USD2,000 thousand) for the three months ended June 30, 2009 as compared to RMB2,459 thousand for the same period of 2008. The additional charge of doubtful account was due to certain receivable balances being overdue in which the assessment of recoverability is remote.

The decrease in general and administrative expenses of RMB4,678 thousand (USD685 thousand), or 20.7%, was primarily attributable to exchange gain of RMB7,930 thousand (USD1,161 thousand) mainly consisted of RMB8,412 thousand (USD1,232 thousand) unrealized gain resulted by the appreciation of Australian Dollars against RMB during the quarter, offset by an increase in amortization of intangible assets of RMB1,376 thousand (USD201 thousand) and other general administrative expenses such as staff cost and office rental due to an increase in headcount as a result of our acquisition of Long Rise in July 2008 and Mega Smart in May 2009.

R&D Expenses. R&D expenses increased in the three months ended June 30, 2009 by RMB5,276 thousand (USD772 thousand), or 48.9%, as compared to the corresponding period in 2008. The increase was primarily attributable to an increase in share-based compensation cost of RMB6,088 thousand (USD891 thousand) as a result of new stock awards granted to research staff in 2009.

Interest Expense. Interest expense decreased in the three months ended June 30, 2009 by RMB109 thousand (USD16 thousand) or 18.6%, as compared to the corresponding period in 2008. The decrease in interest expense was attributable . . .