Hon Hai Net Misses Estimates on Higher Costs, Unit Losses

Foxconn Auditor Finds 'Serious' Violations
Workers are seen inside a Foxconn factory in the township of Longhua in the southern Guangdong province May 26, 2010. Employee deaths at global contract electronics manufacturer Foxconn, Apple's main supplier, has cast a spotlight on some of the harsher aspects of blue-collar life on the Chinese factory floor. Photographer: Bobby Yip/Landov

Hon Hai Precision Industry Co., manufacturer of Apple Inc.’s iPad and iPhone, posted profit which missed analyst estimates after raising wages, spending to build factories and losses at its Hong Kong unit.

First-quarter net income climbed 3.6 percent to NT$14.9 billion ($510 million), from NT$14.4 billion a year earlier, the Taipei-based company said in an exchange filing today. The average of 10 analyst estimates compiled by Bloomberg was for profit of NT$21.5 billion.

Foxconn Technology Group, of which Hon Hai is the flagship, raised wages 25 percent in February and is continuing to spend money moving factories to inland China. Hon Hai’s profitability usually moves in the opposite direction to that of Apple, which posted its highest operating margin in over a decade.

“That poor result caught me by surprise,” said Vincent Chen, the top-ranked analyst covering Hon Hai according to data compiled by Bloomberg, who rates the stock “hold” at Yuanta Financial Holding Co. in Taipei. “The wage rises haven’t been passed on to customers yet, which impacted profits.”

Planned Migration

Customers have agreed to cover the cost of higher salaries, Chairman Terry Gou told Bloomberg News today before the earnings announcement. Foxconn’s planned migration of production capacity from Eastern China to the interior of the country is around 60 percent complete, he said.

“There’ll be a shortage of labor if you don’t pay more. We’ve calculated the real cost if we pay more, and in fact when considering overtime, we will actually be saving on costs,” Gou said. “And secondly, if we pay more, then everyone will pay more.”

Gross margins, which measure revenue less the cost of goods sold, will gradually rebound throughout this year, Chief Financial Officer Huang Chiu-lian told Bloomberg News today before the earnings announcement, without providing a target for gross margin.

Unconsolidated sales climbed 43 percent to NT$789.9 billion for the quarter, Hon Hai said. The company will publish consolidated numbers before the end of May.

Gross margin at the unconsolidated level fell to 4 percent during the period from 4.5 percent a year earlier, while the operating margin, which measures sales less all operating costs, dropped to 0.9 percent from 1.1 percent.

Apple Sales

Apple sold 35.1 million iPhones for the March quarter, ahead of the 31.2 million average of analyst estimates and 11.8 million iPads, compared with expectations for 11.9 million. Hon Hai makes both devices at its factories in China, while rival Pegatron Technology Corp. is a secondary supplier of the iPhone.

Apple’s gross margin widened to 47 percent, its highest on record, while operating margin climbed to 39 percent during the March quarter, its highest since 2000. Apple’s margins usually climbed when Hon Hai’s decline, Bloomberg News reported in January.

Production bottlenecks for producing the iPad, including a lower yield rate and a shortage of panels, may have impacted Hon Hai’s profits during the quarter, Arthur Liao, who rates the stock “buy” at Fubon Financial Holding Co., wrote in a note to clients last week. The panel-supply problems will probably be solved this quarter, he wrote.

Apple’s iPhone will account for 23 percent of Hon Hai revenue this year, and iPad around 17 percent, Liao wrote.

Shares and stock options granted to management will also raise costs throughout this year, Yuanta’s Chen said.

Foxconn raised base wages by up to 25 percent in February, doubling the salary of a junior worker in Shenzhen, its main production hub, to 1,800 yuan ($285) a month from 900 yuan three years ago. The company in March agreed to a further unspecified salary hike after the Fair Labor Association said it found cases of employees working longer hours and more days in a row than allowed.

Growth Forecast

Gou, who founded the company, cut his annual sales-growth forecast in September 2009 to 15 percent from a 30 percent target that had been in place for more than a decade as Hon Hai’s size burgeoned. Revenue growth will be at least 15 percent this year, driven by China and Brazil, he said Dec. 1.

Slowing labor supply and increased government incentives prompted Gou to begin expansion in central China, away from Hon Hai’s main production base on the east coast and closer to its workforce, a move that raised costs and cut profit margins.

Foxconn International Holdings Ltd., a Hong Kong-listed phone manufacturing affiliate 72 percent owned by Hon Hai, last week said its first-half loss will widen “significantly” due to weaker demand from customers and higher costs.

The supplier of phones to Nokia Oyj, which posted a loss of $17.7 million for the first half of 2011, fell to its lowest in 3 1/2 years in Hong Kong after the profit warning.

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