2013 Q2 Earnings Conference Call

August 15, 2013 8:00pm ET

Jeffrey Kang – CEO & Chairman
Wanyee Ho – Investor Relations Director

Analysts/ Shareholders
J.D. Abouchar – SED
Brian Alger – Wedbush Equity Management
Nick Caputo – Kingdom Ridge Capital

Operator: (Operator Instructions)

This conference is being recorded, today at August 15, 2013. I would now like to turn the conference to our host Wanyee Ho, Investor Relations Director. Please go ahead, ma’am.

Wanyee: Thank you Liz, 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 2013 Second Quarter Earnings Conference Call.

After the market closed today, Cogo issued a press release reporting unaudited financial results for the quarter ended June 30, 2013. 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.

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 the call. I will keep my prepared comments brief to allow time for Q&A. Most of the key financial data is in the press release.

We continue to demonstrate solid top line growth across all business segments and reported the second quarter revenue of approximately $184.9 million. Taking into account that approximately 30% of Q2 2012 revenue was generated by the subsidiaries disposed in November 2012, the top line growth for the quarter would have been almost 37% year over year. We continue to demonstrate ability to produce sustainable profit and continuous revenue growth in these uncertain economic times but the condition of China is still very uncertain this year.

In the face of these difficult macro conditions, we continue to drive operating profit and grow our tangible book value each and every quarter. The Company had cash and pledged bank deposits totaling approximately $140.8 million at the end of the second quarter, down slightly from $141.5 million at the end of 2012. Bank borrowings stood at $90.1 million as of June 30, 2013, down from $98.6 million at the end of 2012. We had net cash of $50.7 million at the end of the second quarter.

Since the authorization of the 10-million-share-repurchase program in September 2012, we have to date repurchased more than 6.4 million shares. The Company used more than $4.3 million to repurchase approximately 2.2 million shares in the second quarter. From the close of the sales on Jan 2, 2013, to-date, we have bought back more than 2.8 million shares. With the funds injected by the sales of the subsidiaries, we will continue the swift execution of the buyback program.

While the Company has demonstrated its ability to sustain business growth and profitability in an adverse market environment, our current stock performance has been disappointing, trading far below net asset value. It remains management’s top priority to recover the recognition of asset value and improve shareholder value.

A month ago, I submitted my proposal to the Board of Directors for the purchase of approximately 30.5% of Cogo’s net assets through a company I wholly own. Management has considered the end-market reality: that growing gross profit pressure and rising working capital demand will likely intensify if the company continues to operate its component business. Although I still believe it’s good for Cogo to continue to expand business scale and market share in the component business, even though margin would be low, management also recognizes that this direction has not been supported by our shareholders.

My proposal aims at increasing Cogo’s cash position while letting go of low margin business to allow the company to focus on developing its higher margin services and technical solutions business, thus creating greater value for shareholders. If the transaction is approved, it is expected that Cogo would dispose most of the component businesses, while all remaining services and technical solutions business would become the core business.

The majority of Cogo’s accounts receivable, inventories, debts and bank loans would transfer to buyer under the proposal. Cogo and the departing companies would operate independently. Cogo would retain a lean structure to continue [to] develop technical services and solutions with approximately 50 staff, including the most senior management of technical services and solutions business.

Upon completion of the proposed transaction, the cash position of the company is expected to increase; in addition to the approximately 69.5% of the Company’s net assets represented by the remaining subsidiaries running services and technical solutions business.

Currently, the Company has no plan to go private. Management believes that retaining the Company’s listing provides a greater return for our shareholders than privatization. While the proceeds of the asset sales could also fund the Company’s buyback program for investors who wish to sell their shares to the Company, it allows the Company to continue to leverage its publicly listed position to develop higher margin business and even venture into new businesses to generate greater value to shareholders.

This concludes my remarks. Thank you everyone for joining this call. And now let’s turn the call to the operator to open up the floor for questions. We will look to end the call at around 9pm. Operator?



Operator:And our first question comes from the line of J.D. Abouchar with SED. Please go ahead.

J.D. Abouchar – SED: Couple questions for you, first the accounts receivable went up quite a bit this quarter, can you tell us what that was due to?

Jeffrey Kang: I think that our account receivables is quite a normal and comparing with our normal second stance, so we are not saying any abnormal account receivables. I think – in general we see the revenue increasing and in this remaining business as I said, if we use apples-to-apples comparison, we have like 37%, the revenue increasing year-over-year. So that’s when our revenue increased normal in the AR amount will increase, but in terms of AR general to AR base which is the main metrics for us to manage or to measure our business. We still think, it’s within our normal range.

J.D. Abouchar – SED: Okay, because in your press release compared to December, it went up quite a bit.

Jeffrey Kang: Yes, I think that’s it’s just a normal business natures and we don’t see any abnormal patterns in terms of our business.

J.D. Abouchar – SED: Okay, great and so if your transaction goes through, you said that the receivables inventory payables basically all that goes. So the company would essentially be getting about $70 million in cash then it’s in lieu of that those assets and liabilities.

Jeffrey Kang: Yes, as we stated in our press release. So along with the assets, all those in AR entry and payables, loans all related to this portion of the business will [go] to the buyer, so that’s why we are going to see the cash position will be significantly increasing for the remaining companies.

J.D. Abouchar – SED: Any idea sort of what the business model will look like in terms of revenues and margins of these 50 senior people, who are going to be staying and what exactly will they be doing just helping with design services or how does that build out to a degree you can’t flush out for sure, what the new business will be.

Jeffrey Kang: What we explained in our press release, in terms of Cogo to overall business, we have the components business, at the same time we also have some small volume, but its high margin services business and technology solutions business. So for that portion of the business, the gross margin actually is very high and comparing with our existing components business.

So for example for components business, our gross margin is normally around lower than 10% and both for the services or the technology solution business, that portion of business gross margin normally is like 30% to 60% or above. We are not building everything new. We actually had a lot of business in the past. It’s just that from absolutely revenue dollar amount is relatively small, but after we disposing that components business as we said in our press release, once we start focusing on that business and in the future, that’s the long-term direction we want to go. That’s our new strategy we map out and for this, how-to-transition this Cogo from components focus business to new service oriented business.

J.D. Abouchar – SED: All right, thank you. Jeffrey. Keep up the good work.

Jeffrey Kang: Thanks, J.D.

Operator And our next question is from the line of Brian Alger with Wedbush Equity Management. Please go ahead.

Brian Alger – Wedbush Equity Management: Good evening or good morning, Jeffrey. Thanks for having the call. I want to follow-up on J.D’s question a little bit. As a shareholder of Cogo, trying to understand what we would have on the assumption that your proposal goes through. As a shareholder, if I understand correctly, we’d be converting basically all the working capital and the cash for the remaining entity and the new operations would be the services business. What is the starting point in terms of revenues, can you give us a baseline in terms of – for instance in the March quarter, how much of the revenues reported was tied to what will continue to remain at Cogo under your proposal?

Jeffrey Kang: To follow-up your questions, I think that’s the starting point internally, we have a plan. I think that’s if my proposal get approved [the] independent directors and the shareholder vote, I think what could happened in the end of this year and so we disposing this components business, I think our services business, we are starting from anywhere from like $10 million to $50 million as of starting base a year.

So our plan is try to leverage our strong financial background, which after we sell the old assets and we probably have the cash. As we’ve stated in our press release in the past, we at least will have over $140 million net cash. We’re all set to run at that starting point to earn $10 million, $50 million revenue plus and we can grow the business from there. That’s our plan, how we should grow that business step-by-step and in the future to transit the company from existing model to a new service oriented business model.

Brian Alger – Wedbush Equity Management: Okay and Jeffrey, if we’re starting from $10 million to $15 million on an annual basis then we have roughly 50 professionals associated with that business, will that business be cash flow positive or breakeven or slightly negative, where would it be from an operating profit level starting now?

Jeffrey Kang: We think every line of our business is profitable and that’s how we are very quite confident. So from operating level I think that every business will be profitable after this transition. It’s definitely one we’re starting from what expected no bar, in terms of the revenues and step-by-step growth that in revenue size.

Brian Alger – Wedbush Equity Management: So if I understand correctly or if your proposal goes through and if we as shareholders support it, what we – as shareholders would ultimately be betting on and would be holding, would be a balance sheet that is supported by above $140 million in cash, virtually no liabilities and a cash flow breakeven to cash flow positive business starting right out of the gate, is that correct?

Jeffrey Kang: Yes, correct. So we are talking about all those. Before we are talking about our new direction and strategy, internally we have kind of what’s the internal plan for next three years. So I think that’s we have the long discussion internally in terms of this new direction and we are quite confident and we gonna grow this business and step-by-step from as I earlier said, relatively no bar, but we’re going still going well run a profitable business on every quarter.

Brian Alger – Wedbush Equity Management: Excellent and excellent and then I guess, as I pertain to returning capital to shareholders that maybe don’t have the patience of others. What is the plan, is the plan to just continue the slow buyback as we’re seeing right now in the marketplace or is there a plan to accelerate the buyback and perhaps clean up any worthy sellers?

Jeffrey Kang: Well in terms of the buyback program, we do everything we could do under the SEC Regulation, so normally– we give this buyback decision power to – for the party to give them our this kind of – I think within the full scale, we’re capable. So right now, we are executing our buyback programs.

Again, as you know SEC has quite a lot of restrictions about the buyback program of the company. So we have all 100% follow up that regulation, but other than that, we will right now and I think it’s company –the policy to try to execute the maximum amount of the buyback program.

Brian Alger – Wedbush Equity Management: Okay and then finally because the filings are sometimes difficult, my understanding is that none of the management is actually selling their shares right now, so the buyback that’s going on is effectively reducing the flow available is that correct?

Jeffrey Kang: Yes, basically I’m not stating anything. I think that right now, all this buyback mostly it’s from we just buy from the open market like I just explained to you, so the buyback program has been executed by a professional firm, which is we have no control from the management. So they have to buy it from the public market not from the individual. So even though our internal employee want to sell some of their options or employee granted stocks, they have to come through the market, we have no control over that. So we don’t have any like the management team, leave the buyback program to their professional agents.

Brian Alger – Wedbush Equity Management: Okay, correct. All right, well the proposal is certainly intriguing and the new company sounded will be extremely well capitalized and position well for some good [ph] down the road. I appreciate you updating us and communicating with us through the time, Jeffrey. Thank you.

Jeffrey Kang: Thanks.

Operator Thank you. (Operator Instructions). Our next questions comes from the line of Nick Caputo with Kingdom Ridge Capital. Please go ahead.

Nick Caputo – Kingdom Ridge Capital: Hi Jeffrey, good evening. Thanks for taking the time and as always. Quick question on the transaction as well. Which we welcome seeing this, but just curios can you give us a sense of how much debt will be remaining with your new company post to transaction?

Jeffrey Kang: As I said after this transaction, all those bank loans or debt, everything associated with our components business will [go] to the buyer. So in my understanding, I don’t think in Cogo would have this kind of debt, so that’s my model in terms of after this deal.

So after this deal, I think that Cogo will remaining, as I said, cash which is we higher than the existing cash, invest in market cap and on the same time. Company we don’t think we have like the bank loan. In terms of all the bank loan and other things will [go] to the buyer. That’s the financial positioning after the deal. That’s the kind of the starting point for the new Cogo.

Nick Caputo – Kingdom Ridge Capital: Okay and then on the services business that today is running about $10 to $15 million and that’s the piece that will be remaining with the company. You talked about having a long-term plan, can you just give us sense of your vision of maybe a target on where you think you can grow the revenues over the next two or three years in the services business or what’s a healthy growth rate to same for that business?

Jeffrey Kang: Frankly, I think it’s better because we don’t want to give the guidance straight in terms of our long-term planning in terms of the number, but what I can say is we internally and that’s what we bet and we want to just significantly increase in the service revenue and the technology solution revenue, which relatively is a high margin business. So that’s what we are trying to do. But at this moment, I think it’s too early to just give you a number on what [will happen] three years later. But what I can say that’s the direction the company wants to go in the long run.

Nick Caputo – Kingdom Ridge Capital: Okay and then assuming the transaction does go through to some of the earlier caller points you have, with the flush of cash almost $4 per share of cash or more. I’m just curios, it seems relative to the revenue levels, you’d be overcapitalized. So can you talk a little bit about how M&A fits in to your growth plans in the services business. I mean should we expect you to be increasingly active and putting that cash to work, that’s just in the buyback, but also acquire companies to grow the services business.

Jeffrey Kang: Frankly speaking we don’t have that near-term M&A strategy at this moment. So I think once the company, I still think we need to give a little bit of time for the new company in terms of the transition and so that’s why I think in the very beginning we still gonna to be very conservative in terms of the ramp up our services and the new business. I think it’s still in a very beginning, we are going to be very focused on the organic growth in rather than, the merger-acquisition. But of course after taking some time or make the after we think the transaction has been completely smoothly finished and that the new management team or if the new team is pretty much in the place and then we can thinking about, we are using more aggressive way to expand and ramp up the business.

Nick Caputo – Kingdom Ridge Capital: Okay, great. The last question I would just ask is, in terms of relative to the stock price. It’s then we’ll go back a year and half almost now that you announced. Your first proposed transaction, which was seemed like a smart idea and certainly brought welcome change to the profile of the P&L and the balance sheet. This is now the second transaction in which seems like you’re working very hard to unlock value, to some extent as you know we are big shareholders in Cogo with but the equity is severely undervalued.

I’m just curious to see to your thoughts, is there a frustration on your part that the stock does not seem to be reacting to some of these positive moves that you’re making and if so, are you doing anything and do you have any plans on the investor side to help raise the profiles for the moves you’re making?

Jeffrey Kang: Well as I said in our press release, the management team is quite [disappointed] about our stock performance which is far below our net asset value- which is basically the fundamental reason we are thinking about this transition. So what we’re trying to do or what we will do, if still I think we keep this penny investor all this plan, we try to adopt it. The new direction once we target, at the same time, want to keep this transparency to all the investors, to show people what we will do and what’s the financial status. I think one of the reasons, a lot of the investors are quite skeptical about our AR, inventory or staff, but I think after everything becomes cash, I expect that will make more clear evidence to show people what our asset value is. That’s why the management team wants to do this deal. I think it want to give the investor much better and clear message and what our financial asset look like. After people seeing the real cash on our balance sheet, I think it will help our stock performance.

Nick Caputo – Kingdom Ridge Capital: Okay, great. Jeffrey thanks so much and continued success.

Jeffrey Kang: Thanks.

Operator Thank you and our next question comes from the line of J.D. Abouchar with SED. Please go ahead.

J.D. Abouchar – SED: Hi Jeffrey, just a follow-up question because I’m little confused. If post transaction we have about $140 million in cash that significantly and that’s all basically it’s left on the balance sheet, which is good thing but it’s all cash, but significantly less than the current liquidation value of the company, which I pencil out to around $250 million. So I’m little confused as to the tangible book value will be less which is more like $4 in change as oppose to currently over $7.

Jeffrey Kang: If you look in our balance sheet, we have like fixed asset, we have like some like goodwill, intangible stuff. So when we are talking about $140 million, it’s also kind of very conservative estimation. So that’s the number we are using but I think actually the cash number should be higher than $140 million. But the number we are using because in public release, we want have to use a very conservative number.

J.D. Abouchar – SED: Yes, well the current asset minus all liabilities is significantly more than a $140 million, so I hope you’re just being conservative. You basically plan on buying the distribution business for essentially its current tangible book value, is that correct?

Jeffrey Kang: I think it’s higher than the existing value.

J.D. Abouchar – SED: Okay, thank you.

Operator Thank you. (Operator Instructions) And our next question comes from the line of Brian Alger with Wedbush Equity Management. Please go ahead. Mr. Alger, your line is open. Please go ahead with your question.

Brian Alger – Wedbush Equity Management: Sorry about that, I’d mute on and I apologize because I’m looking at the balance sheet, but Jeffrey it sounded as though from your answer to J.D’s prior question that some of the fixed assets might remain on the balance sheet of the remaining Cogo and if so, is it less than the full value or would it be the full value of those fixed assets and how should we think about that just in terms of, I think J.D brings up a very good point in terms of, it appears that you’re paying a fair market price for the components business, but as shareholders I’m sure you can appreciate our nervousness about perhaps ending up with less, than what is currently shown on the balance sheet.

Jeffrey Kang: You know because in Cogo we have like non-operating history and internally our business has been breakdown quite a few business units. So in this field, we only bought as I said around 30% of the asset value, so basically in terms of all those value I think, our audit committee were asking for third party, to do the evaluation and have the fairness opinion about that.

Other than that, I think the rest of the things for example like the goodwill and intangible and lot of things will be remaining on Cogo. So I think it’s our job, management team’s responsibility to think about how to utilize that intangible and goodwill stuff. So I think that’s – as of today, as I mentioned to you, our focus right now if you look at our trading prices only around $2 in the very beginning.

So I think our cash level, as J.D. just mentioned is over $4 a share. So that’s why I think our first step is to let the investor fully understand: even the cash value is over like $4, $5. That’s just kind of first thing we want to demonstrate investor and then we still have some bring on like fixed asset, goodwill stuff. So that’s kind of the – I think that’s our plan to to make the investor fully recognize our asset value.

Brian Alger – Wedbush Equity Management: Okay, great. Thank you for clarifying that Jeffrey. Thank you.

Operator: Thank you. (Operator Instructions) and I’m showing no further questions. I’ll turn the call back over to Mr. Kang for any closing remarks.

Jeffrey Kang: Thank you for your continuous commitment to Cogo. I have every confidence in our management team to steer the Company in the right direction and we hope that the new strategy will recover the recognition of asset value. It remains management’s top priority to improve shareholder value. Thank you again and we look forward to talking to you next time.




About Cogo Group, Inc.:
Cogo Group, Inc. (Nasdaq: COGO) is one of the leading gateways for global semiconductor companies to access the rapidly growing Industrial and Technology sectors in China. Through its unique business-to-business services platform, Cogo designs customized embedded solutions using technology from suppliers including Broadcom, Xilinx, Atmel and others for a customer base of over 2,100 Chinese OEMs/ODMs. Cogo’s customer list includes approximately 100 blue-chip companies, including ZTE, BYD and NARI, as well as over 2,000 Small and Medium Enterprises (SMEs). The Company serves a broad list of rapidly growing end-markets in China, including 3G Smart phones, Tablets, Automotives, High-Speed Railway, Smart Meter/Smart Grid, Healthcare and High Definition Television (“HDTV”).

For further information contact:
Investor Relations
H.K.: +852 2730 1518
U.S.: +1 (646) 291 8998
Fax: +86 (755) 2674 3522