Cogo Group 1Q10 Earnings Call Transcript (Prepared Comments)

| About: Viewtran Group, (VIEW)

Cogo Group, Inc. (COGO) 1Q10 Earnings Call May 6, 2010 4:30 PM ET


Jeffrey Kang - CEO & Chairman

Frank Zheng - CFO

Will Davis - CMO

Wanyee Ho - Investor Relations Director

Wanyee Ho

Thank you Craig and good afternoon to everyone. I'm Wanyee Ho, Cogo’s Investor Relations Director, and I'd like to thank you all for joining us today to participate in Cogo's 2010 First Quarter Earnings Conference Call.

After the market closed today, Cogo issued a press release reporting final financial results for the quarter ended March 31, 2010. This release can be accessed in the investor relations section of Cogo's website at 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; Will Davis, our Senior Vice President of Business Development and Chief Marketing Officer, who will discuss guidance; and Frank Zheng, our CFO, who will report the Company’s financials.

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

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

Jeffrey Kang

Thank you, Wanyee, and thanks to everyone for joining our earnings call. I am very pleased with our results in the first quarter of 2010, and I would like to extend congratulations to the whole Cogo team for such a great performance. In the quarter, Cogo posted revenue of $81 million dollars US, up 28% year-over-year and down only 8% sequentially. This is versus our guidance of $70-72 million, as our order booked improved continually through the quarter in all business segments.

Our Non-GAAP EPS diluted in the first quarter was 17 cents, up about 40% year-over-year and versus our guidance of 14-15 cents. Clearly we succeeded in flowing the better than expected revenue down to the bottom line. Cogo posted a gross margin of 14.1%, down slightly quarter-over-quarter due to better than expected telecom and handset revenue. Note that our gross margins are almost entirely dependent on revenue mix, and the specific gross margin for each business segment was flat sequentially. We are maintaining our target for 15% gross margins, but as we have indicated many times previously, most of our margin expansion has and will come from the operating side.

In the first quarter, Cogo posted operating margins of 8.3%. While we do see incremental opportunities for opex investments based on our improved visibility, we expect our operating margins to improve sequentially for the rest of the fiscal year. We continue to target an operating margin of 10%.

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

* Industrial business represented nearly 17% of total business. This segment grew 96% year-over-year. Our Industrial business continues to excel, and we expect it to contribute nearly 20% of sales by the end of 2010.

* Digital media made up about [58%] of total revenue, representing a sales increase of 19% year-over-year.

* Telecom represented 24% of total revenue, showing a sales increase of 21% year–over-year.

* Service revenue represented about 1.1% of total revenue, with revenue increasing about 24% year-over-year.

In the first quarter of 2010, Cogo’s Blue-chip customer base stayed flat at 80, a 16% increase on a year-on-year basis. The total number of Small & Medium Enterprise customers increased by 10 to a total of 1,350, a year-on-year increase of 14.5%. More than 90% of these customers are long-term, repeating customers. Average Revenue per User (“ARPU”) from Blue-chip customers in the first quarter was $691 thousand, down 8% sequentially and up 5% from the prior year period. ARPU from SME customers in the first quarter was $19 thousand, down 10% sequentially and up 24.4% year-over-year.

We are seeing continued opportunities to increase our SME customer base, particularly in our Industrials and Digital Media segments, and we expect to show continued progress throughout 2010 and 2011.

Overall, we are very pleased with Cogo’s business results in the first quarter. We are well on our way to return to the company’s high-growth mode. We see great opportunities across a variety of business segments, including Auto Electronics, 3G handsets, HDTV, Smart Grid and Smart Meter. Our confidence in China’s economy continues to grow as the fundamentals improve in both the consumer and industrial verticals. Large government projects in the Industrials space are typically multi-year plans.

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

The results for our Industrials business speak for themselves. This segment was up 96% year-over-year and is now almost 17% of total sales. This should be our fastest growing segment for the foreseeable future, given the positive trends in the Auto Electronics, Smart Meter, Smart Grid and Railway sectors. In 2010, we expect our Industrials revenue to be split into three areas with approximately 60-70% of revenue coming from Smart Meter and Smart Grid; 15-20% to railways and 15% toward Auto Electronics.

I’d like to highlight our Auto Electronics business, which recorded its first revenue of around $2 million in the first quarter. Given our strong relationship with BYD and the continued strong growth in the Chinese automotive sector, which reached 1.64 million units in March, up 56% year-over-year, we expect our Auto Electronics business to ramp well in 2010 and 2011. In the second quarter, we expect that both our Auto Electronics business and our overall Industrials business will grow faster sequentially than our overall sales. Over time, we will pursue opportunities in other verticals such as medical and security.

Demand trends within the handset industry in China are improving, and we expect our handset revenue to increase slightly sequentially in the second quarter after a much stronger than expected first quarter. Within our overall digital media segment, the two key drivers for Cogo revenue for the remainder of 2010 include the ramp of HDTV roll-out and the increase in Smartphone sales. The ramp of Mobile Internet Devices (“MiD”) and HDTV will help to drive sequential growth in the range of 5-8% for the overall Digital Media segment in the second quarter. Additionally, we believe that the Apple iPad will help drive growth within the MiD space, for example, ebooks, just as the iPhone helped stimulate demand for Smartphones.

I would now like to comment briefly on what I view to be a very important milestone in the history of Cogo, and that’s our announcement yesterday of our customized embedded module supplier relationship with Intel. We expect that revenue will start in the third quarter and ramp through 2011. We expect to work with them on a variety of solutions for both Industrial and Consumer solutions and anticipate that this partnership will open up a range of new end markets for Cogo. The fact that a global leader and innovator like Intel has signed [an agreement with Cogo is a clear validation of our value in the marketplace. I would like to congratulate our team in securing this partnership.

Our telecom business performed quite a bit better than our own aggressive internal estimates predicted. Strength in the market is coming from the roll-out of China Mobile’s PTN network, which we highlighted as an opportunity in the March 22nd press release. Over time, we expect the other two mobile operators to announce similar plans for their own PTN networks, which will replace their existing backhaul systems with a more efficient IP-network. Fiber builds (like EPON) also continue.

There has been a lot of discussion about the planned capex cuts for the three wireless operators. We believe that many of the cuts relate to installation and construction costs rather than Cogo’s Addressable Market. Other larger OEMs like Ericsson have spoken of the expected “de-coupling” of spending. We anticipate that the Company’s telecom revenue will grow slightly, on a quarter-over-quarter basis.

I would like to comment briefly on the stories about a rumored ban of Chinese telecom equipment in India. First, I think that the exact specifics surrounding this issue are unclear. Secondly, we have been aware of this possibility for some time and have removed shipments of India out of our forecasts. Most of the strength of our telecom business has come from domestic China sources, like PTN, fiber and continued 3G coverage and capacity builds. We continue to see good international strength outside of India.

Relationships with Huawei, HP/H3C (Huawei-3 Com), ZTE and Alcatel Lucent should continue to benefit Cogo as these companies are likely to gain shares in the Chinese telecom market. Additionally, Cogo benefits from the continued rapid international growth of Huawei and ZTE in the telecom sector.

I’d like to briefly discuss our M&A strategy. We are pleased with the integration of Megasmart, which contributed about $6.6 million in the first quarter. We remain committed to pursuing a successful acquisition strategy that is focused on companies that are instantly accretive and offer a good cultural fit within our existing corporate structure. In this area, we continue to maintain very strict parameters.

With that, I would like to turn the call over to Will to discuss our guidance. Will, over to you.

Will Davis

Thank you Jeffrey. Good afternoon everyone, and thank you for joining our call. In the second quarter of 2010, we expect our revenue to be in the range of 85-87 million US dollars and Non-GAAP EPS Diluted to be 17-18 cents. We expect gross margin to remain roughly stable to slightly up in the second quarter versus the first quarter, and we expect operating margins to be flat to up slightly quarter-over-quarter. As a reminder, our gross margins are very dependent on product mix.

As usual, we are not providing full year revenue guidance. However, given our strong first quarter results and visibility into second quarter, we are confident that Cogo will return to its previous high growth mode in 2010. Assuming the midpoint of our guidance for the second quarter of 2010, our revenue growth in the first half of 2010 will be about 22% versus the first half of 2009.

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

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

* Non-GAAP Operating expenses for SG&A and R&D in the second quarter should be approximately $5 million, split approximately 25% for R&D and 75% for SG&A. As indicated, we maintain our longer term gross and operating margin targets of 10% and 15%, respectively.

* Interest income in the second quarter is estimated to be around $300 thousand. We would expect this to remain roughly constant over the next several quarters. We continue to estimate our Non-GAAP effective tax rate to be around 8% in the second quarter 2010 and the same through 2011. In the second quarter, stock compensation is estimated to be around $2.6 million US, which will likely be split evenly between R&D and SG&A.

* Acquisition related costs, including amortization and impairment of intangible assets, will be approximately $1 million. Total diluted share count will probably be around 38.5-39 million shares.

Other than those items noted above, there are no significant differences between GAAP and Non-GAAP results.

With that, I’d like to turn the call over to Mr. Frank Zheng, our Chief Financial Officer.

Frank Zheng

Thank you, Will. Good afternoon everyone. For clarity, all figures I’m discussing here, unless otherwise noted, are in US dollars.

During the first quarter, our [operating] cash flow was a positive $800 thousand. In the first quarter, we spent approximately $2.6 million on our stock buyback program, where we re-purchased approximately 364 thousand shares at an average cost of [$7.05] per share. On last quarter’s conference call, we announced that we had received authorization from the Board to purchase up to 5 million additional shares. We continue to view strategic repurchase of our shares as an important use of our cash. In the second quarter, we expect our working capital metrics will stay roughly flat, sequentially.

This concludes my remarks. Thank you everyone for joining the call to discuss our 2010 first quarter unaudited results. At this time, let’s turn the call to the operator to open the floor up for questions. We will look to end this call around 5:30. Operator?

Question-and-Answer Session

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