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Executives

Jeffrey Kang – Chairman and CEO

Wanyee Ho – IR Director

Analysts

Brian Alger - Wedbush Equity Management

Chris Zepf - Kingdom Ridge Capital

Cogo Group, Inc. (COGO) Q3 2012 Earnings Call November 15, 2012 4:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Cogo Group Incorporated third quarter 2012 earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions)

This conference is being recorded November 15, 2012. And I would now like to turn the conference over to Wanyee Ho, investor relations director. Please go ahead.

Wanyee Ho

Thank you and good afternoon to everyone. I am Wanyee Ho, Cogo’s investor relations director. And I would like to thank all of you for joining us today to participate in Cogo's 2012 third quarter earnings conference call.

After the market closed today, Cogo issued a press release reporting unaudited financial results for the quarter ended September 30, 2012. This release can be accessed in the investor relations section of Cogo's website at www.cogo.com.cn and on most other financial websites.

The discussion today will be hosted by Jeffrey Kang, Chairman and CEO, who will discuss the company’s business operations and update you on the status of the proposal to purchase certain Cogo subsidiaries.

Before we begin, I'd like to remind everyone that the call today may contain forward-looking statements regarding future events and the financial performance of the company. We wish to caution you that such statements are at present just predictions, and actual results may differ materially as a result of the risks and uncertainties inherent in the company's business. We refer you to documents that the company files periodically with the SEC, specifically the most recently filed Forms 20-F and 6-K, as well as the Safe Harbor statement made in today’s press release. These documents contain important risk factors that could cause actual results to differ materially from those contained in the company's current projections. Cogo assumes no obligation to revise the forward-looking information contained in today's call.

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

Jeffrey Kang

Thank you, Wanyee, and thanks to everyone for joining this call. I will give my prepared comments (inaudible) enough time for Q&A. Most the key balance sheet data is in the press release.

Cogo continues to demonstrate solid top line growth across all business segments and I am pleased with our ability to continually grow our revenue in this uncertain economic times. As we have indicated many times previously, the credit situation for our SME customers in China are still tight. That continues to negatively affect our gross margins. It’s impossible to predict when that situation will materially improve.

Additionally, we are facing some higher operating costs in the back half of 2012 as we pursued the new customers and product launch and this will temporarily hurt our operating margin. However even in the face of the difficult macro headwinds, we continue to drive operating profit adding a significant numbers of the new customers and grow our tangible book value in each and every quarter.

In the third quarter of 2012, we added 200 customers while our operating cash flow was a negative $8.7 million in the quarter, it’s largely related to the changes in the working capital that are made in order to position our sales for continued growth. As I have said many times, cash flow will shift from quarter to quarter based on the business conditions. As you are aware, Cogo generated positive operating cash flows in the previous two quarters.

I am pleased to announce that I have presently completed the transfer of the $278 million required to close my proposed acquisition of certain subsidiaries of Cogo. This fund will help to fund already approved the 10 million shares buyback and as the Audit committee consisting of three independent board members recently approved the terms of the deal, I continue to strongly believe that the closing of this deal will help to legitimize the overall financial assets of Cogo. After the closing of the deal, we believe that our overall gross margin will improve because assets I intend to purchasing has a lower gross margin than Cogo’s overall gross margin. And as stated in the press release Cogo’s financial payment will be updated to show the sales during our next earnings call in February. Please remember that after the close I will still own over 30% of Cogo, I will be far and away its largest shareholder and my number one goal remains enhancing the shareholders that’s for Cogo.

I began to really expand (inaudible) our 10b5 buyback program towards the end of the third quarter (ph). Approximately over 39,000 shares were bought back in the third quarter out of the 300,000 shares that we really bought back in September 24, 2010. We continue to view the share buybacks as a strategic use of cash given where the stock is trading at around 40% of the tangible book value. This concludes my remarks. Thanks for your everyone for joining this call. Let’s turn the call over to operator to open up the floor for the questioners. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Brian Alger from Wedbush Equity Market.

Brian Alger - Wedbush Equity Management

Jeffrey, thank you for hosting the call, it’s nice to hear your voice. If I can, can I ask you to clarify what I think is probably the most important line in terms of you said you’d completed the transaction as of today for the $78 million. My understanding from reading prior documents and prior releases was that there was going to be kind of a two phase approach. Has the entire transaction been completed and all $78 million are now on the balance sheet for Cogo or where are we in that process?

Jeffrey Kang

Yeah from the legal and technical perspective, this is like a two transaction – two wires, one is -- the first payment is a $10 million, the second payment is a fixed $8 million and all these two wires have been found in this week. So technically the deal is already closed.

Brian Alger - Wedbush Equity Management

And so the deal is closed at this point and we have the 10 million share buyback that’s been approved. Do we need to approve another buyback to utilize the cash from this transaction or what’s the intention here?

Jeffrey Kang

As we stated publicly, we are – this 10 million shares and buyback has been approved months ago in the past. So I think our first priority is to utilize and complete all those approved buyback program and then after that we will – if we have any group buyback program, the management – because right now the management have right to do within our power – we don’t need the shareholder vote to approve additional buyback. So that’s why for technically it’s very convenient and use it for Cogo to make the decision.

Brian Alger - Wedbush Equity Management

And then finally, you mentioned the credit constraints affecting your SME customers. Is there any sign of that, that is going to change any time soon or should we expect the split between your blue chip customers and SME customers to remain the same through the foreseeable future?

Jeffrey Kang

I think at this moment, because this is little bit in a something about the macro economy. So far we have seen the overall situation is quite similar and overall situation is little bit tight comparing for towards those on the SME and the overall market. So this trend is actually kind of favours the blue chip customers business. So I wouldn’t say the situation will be changed significantly in the near future. If you ask me two or three quarters down the road, I wouldn’t expect there is significant change in terms of the overall macro situation. So we are still – that’s something kind of out of our control but we will continue to grow in our both lines of the business for the blue chips and the SME customers. But I think in the near future overall trend is still favour the blue chip customer group.

Operator

And your next question comes from the line of Chris Zepf from Kingdom Ridge Capital.

Chris Zepf - Kingdom Ridge Capital

Jeffrey, could you remind us with the transaction now behind us, what the gross margin, operating margin profile of the base Cogo will be going forward?

Jeffrey Kang

I think as we stated in our public filing, so after this deal, two company, and the two group companies will be split, and run the business independently. So I think in this perspective as we stated in previous filing, the business remaining in Cogo roughly have two-third of the overall business in terms of the revenue. And roughly have the one third of the total revenue. And in terms of the gross margin structure and two-thirds of the remaining business is slightly higher than all business. I accepted that and I think the rest is relatively similar. So I think in the future on the two companies will be run independently because the business – the management of this inner company they will run the business independently. All of the group management, all of the people still have the business goal, including myself. So I think in the future on the two business will run independently and also we will continue to grow the business and by themselves. So that’s kind of the overall arrangement after this deal.

Chris Zepf - Kingdom Ridge Capital

And so if we look at this quarter your gross margin was 6.2% because of the mix of customers. If the deal had been done going in this quarter, the whole Cogo Group where the gross margin has been roughly?

Jeffrey Kang

Well, actually because our gross margin as you know is the from the mix of the customer and the business. So I think overall the gross margin and remaining in Cogo I think is still around 6% to 7% range. We’ve seen that kind of a range. So I don’t expect too much of the downside, risk for the gross margin continues to going down. But at the same time, I wouldn’t expect too much of the upside in the near term because you can see the overall strategy for me is still to target scale, the business to reach in this uncertainty of the environment situation. So that’s why I wouldn’t expect too much of the gross margin decrease or increase in the near future. I think we will – the gross margin will still apply the overall product mix and mostly customer mix and we are seeing that in the coming fourth quarter or next – another while for profitable growth, I think our gross margin is probably around 6% to 7% range.

Operator

And at this time I am showing no further questions in my queue. You may continue.

Jeffrey Kang

So then if there is no further questions, then you have just like – it’s final comments.

Operator

And we just received a follow-up question from the line of Brian Alger from Wedbush Equity Management.

Brian Alger - Wedbush Equity Management

Just Jeffrey, if you can give us some detail in terms of what businesses are part of the spin-off group and what is remaining within Cogo? I understand that what is going in the spin-off is lower gross margin but is there difference in terms of the markets that are going to be serviced, is one more focused on say the communications market versus handsets or is there any way we should think about these two businesses as a separate?

Jeffrey Kang

Yes, we actually have really two year task. So the business, we actually – Cogo as a group company and we put every operating business into the each (inaudible) of our Cogo Group. So technically we are cut off, roughly one-third of the operating companies and they are under my act together and the spin-off that portion of the business. So in terms of – so we haven’t breakdown this. It’s nice at the business by segment. So that means one is sold in that one third of the business, including both the business segment and – both business segments, both the telecom, wireless and industrial. And so technically it’s relatively easy for us to separate them the costs. In our daily operation, each of the business line and the solutions have been in the subsidiary.

So that’s why if we decided to sell that separate as a subsidiary out, so all of the business and their customer and under my asset, AR, inventory, all this – and the people working for that subsidiary will be sold to another company. So that’s the arrangement for this deal. So mostly we sell is the asset. So that’s why the remaining part of the business in Cogo, so we still have the three segments covering both the telecom, wireless and industrial business. So I wouldn’t say the significant percentage change in terms of the mix, probably we’re going to say more telecom and industrial business in the remaining Cogo’s business and less of wireless business. But still both companies have the – we still have the three sectors available.

Brian Alger - Wedbush Equity Management

And then just one other final clarification, with regards to the buyback and I think it’s fantastic that we already – were able to acquire 300,000 shares, down here this prices is kind of silly. Are we limited in terms of how many shares we can buyback on a daily basis? I know originally 144 rules were restricting things but after this earnings announcement, does that restriction continue to be in place or is there a different rule in terms of how fast the buyback can occur?

Jeffrey Kang

I think I am not an legal expert but I think – as far as I know whether we can do the buyback after as in the restriction, well less after like today after the signing. So after that we are able to because we don’t own any material information. So we can do the buyback based on trading volume. There is kind of the restriction, if the trading volume picks up, and based on that we have like a limit -- daily buyback limit. But I think the management as I said, at this moment we are accepting to the 25 (ph) which have certain restrictions. Management couldn’t make any involvement, we actually needed this buyback through the authorized bank to do it. But after this earnings call, after our signing I think we have more flexibility to try our bet, to try our largest limit in terms of the daily buyback limit.

Brian Alger - Wedbush Equity Management

And the firm has received that first wire already right?

Jeffrey Kang

Yes.

Operator

Thank you. I am showing no further questions in my queue sir. Did you have any closing comments?

Jeffrey Kang

Yes. Thank you for the continued commitment to Cogo. The final closing, my purchasing of the Cogo business with roughly $78 million which values all of the Cogo at $8 per share. It’s a strong indication of the – the credibility of the Cogo’s financial asset. This appraisal is now more than three times Cogo’s current market cap. I believe strongly that at the closing of this deal and the subject to plan to repurchasing of Cogo shares, we have ultimately demonstrated the true value of Cogo’s financial and operating asset. So I hope – and this is my summary this call. I hope to see you in the next earnings call. Thank you.

Operator

Ladies and gentlemen, this does conclude our conference for today. We thank you all for your participation and at this time you may now disconnect.

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