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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for your patience, and welcome to the Hon Hai 2020 First Quarter Investor Conference Call. The presenters for today's conference are the Chairman Yang-Wei; the CFO, David Huang; and IR Director, Alex Yang. [Operator Instructions]
I will now hand the conference over to Mr. Alex Yang, the IR Director. And Mr. Yang, please go ahead.
Good morning and good afternoon, ladies and gentlemen. Welcome to the Hon Hai Precision Industry 2020 First Quarter Financial Results Conference Call. This is Alex Yang, Hon Hai IR Director. We have posted the presentation file of today's call on the Hon Hai corporate website, www.foxconn.com. Please download them as your reference. Before we start the call, I would like to remind you of the safe harbor notice on the second page. Hon Hai Chairman, Yang Liu; and the CFO, David Huang, will present on today's call. On the third page, there will be 4 sections of the presentation today, including first quarter financial results, second quarter business outlook and a recap of recent major statements. After that, we will open up for questions.
Now I will pass this to the CFO, David Huang.
Good morning and afternoon, everyone. I'm David Huang, Chief Financial Officer of Hon Hai. I would like to first direct you to Page 5 of today's briefing. According to past conventions, we will first introduce several important company valued subsidiaries of Hon Hai Precision group as a percentage of Hon Hai's overall consolidated revenue. Please see next page.
In the income statement, revenue for the first quarter was TWD 929.1 billion. After the outbreak in late January of this year, a lot of the total working hours of the group fell by more than 20% compared with the same period last year. With the concerted efforts of all employees, final revenue declined by only 12% compared with the same period last year.
Secondly, due to the decrease in revenue, the increase in the proportion of fixed cost amortization, changes in product mix and increase in pandemic protection and prevention cost, gross profit decreased by TWD 16.5 billion, a 28% decline from the same period last year and the gross profit margin was 4.5%. Third, EBITDA and prevention cost was estimated over TWD 10 billion due to COVID-19. As Chairman Yang Liu mentioned on March 3 in the last investor conference, our company has requested our clients and the local governments to share the costs together, thus, most of which will take effect afterwards. Therefore without taking the epidemic into consideration, our operating profit would have been better than the same period last year.
The operating profit for the first quarter was TWD 4.5 billion, which decreased by TWD 11.6 billion compared to the same period last year. In this severe time, despite the increase in epidemic prevention costs, Hon Hai is committed to controlling operating expenses. Therefore, operating expenses in the first quarter has decreased by TWD 4.9 billion compared with last year for an operating profit margin of 0.49%. As for nonoperating income and expenses, due to high volatility in the financial markets during Q1 and TWD 7.4 billion decrease on valuation of investment securities, a TWD 3.1 billion decrease on investment income recognized under equity method compared with the same period last year. In addition, net currency exchange loss in the first quarter has a little impact compared with the same period last year. Based on above, Q1 net profit margin was 0.22% and the EPS was TWD 0.15.
Turning to the balance sheet on Page 7. The most obvious change in Hon Hai's balance sheet in the fourth quarter was a year-on-year increase in cash by 14% and the net cash increased by 37%. At the same time, due to proper inventory control, the cash cycle was reduced by 2 days compared with the same period last year. With a high degree of uncertainty in the overall environment, Hon Hai is able to maintain strategic responsibility by retaining a sufficient cash.
Please continue to the cash flow statement on the next page. Our cash inflow from operating activities continued to increase and the capital expenditures continued to decrease. Free cash flow in the first quarter reached TWD 117.4 billion from TWD 108.5 billion, a TWD 8.9 billion increase compared with the same period last year. Please continue to the next page. After review of Hon Hai first quarter financial statements, let's review the performance of the 3 major consolidated subsidiaries in the first quarter. FI Q1 revenue was flat year-on-year. Profit declined by 35% year-on-year. FIH Q1 revenues declined by 41% year-on-year. The loss continued to converge year-on-year. FIT Q1 revenue declined by 7% year-on-year. Profit declined by 94% year-on-year. Looking back on revenue guidance we provided during the March 3 investor conference, at the same time, we predict that managed mainline production would resume at the end of March, but in fact, we achieved this goal ahead of expectations. Therefore, the outlook for the 4 product categories missed expectations quarter-on-quarter. As for the year-to-year comparison, we are better than originally expected.
Next, Hon Hai Chairman, Yang Liu, will present our outlook for the second quarter.
Thank you, David. Good morning and afternoon, everyone. I'm Yang Liu, Chairman of Hon Hai. I'll now present to you our outlook for the second quarter of this year.
We estimate that the Q2 revenue should grow by over 15% compared with the first quarter. Compared with the same period last year, it is estimated that there will be a single-digit decline. Overall, due to the rapid spread of the epidemic, many countries have implemented restrictions, coupled with high unemployment rates which has impacted consumer demand significantly. However, remote working, online entertainment and new lifestyles have given us some new growth drivers. From the perspective of the 4 major product categories, consumer products will have a single-digit Q-o-Q decline or an over 15% decline Y-o-Y. But as for the rest of the 3 product categories, we show growth trend for both Q-o-Q and Y-o-Y.
Since the onset of the epidemic, both enterprises and governments have implemented policies such as work-from-home and learn-from-home, further driving the demand for home office and online education. Therefore, enterprise products will grow more than 15% Q-o-Q and more than 10% Y-o-Y. Computing products will also benefit from the increase in demand for home office and online entertainment. Q2 Q-o-Q and Y-o-Y growth will exceed 15%.
Finally, in the Components & Other Product category, due to the increase in shipments of optical lens modules, there will be more than 15% growth on quarter-to-quarter in Q2 and more than 10% growth Y-o-Y.
Next, I would like to review with you the progress of several important investments from our last investor conference today. First of all, our strategy of new products is not affected by COVID-19 pandemic. Hon Hai, with Yulong and HAITEC, officially signed a joint venture agreement on March 6. Subsequent preparations for the new joint venture company as well as the R&D projects will proceed as planned. Secondly, we mentioned our responsibility as a green energy supplier at our investment conference last June. Therefore, we invested in Shandong Chengshang Energy in April to strengthen our efforts on clean energy. At present, our solar power has accumulated a total of 253 megawatts. In the next 2 years, we expect to generate an additional 210 megawatts. This is all a part of our commitment on environmental sustainability efforts.
Third, following Hon Hai Group's Foxconn 3.0 strategy. Each subsidiary also has its own plan in their respective areas of expertise. FIH announced the capital increase in its subsidiary, Mobile Drive Technology Co. on April 29, for the extension of its in-circuit infotainment and connected system, including hardware, software and service platform. Please see the following page. Finally, I further update the impact of the epidemic. At the end of January, upon the outbreak of COVID-19, I issued the highest principle at our internal epidemic prevention meeting. That is, first, the employee safety is the highest priority. Second, the operation of the plant must be legal and compliant with all regulations. As for each individual factories, all major factories in Mainland China have resumed normal operations. For India, the Indian government announced restriction will be gradually lifted beginning May 17, and company will apply for resumption of operations in accordance with local government regulations. Production in most of our Mexico factories are classified as essential goods for people's livelihood, thus remain in operation. The Vietnam factory is still operating as normal. Northeast Asia, Southeast Asia, Europe and North America are all under normal operations. A small number of offices are working from home in response to government regulations. Above is all my presentation for today. Thank you for listening.
Operator, now we start to taking questions.
[Operator Instructions] And our first question is coming from Gokul Hariharan of JPMorgan.
My first question is regarding supply chain changes and relocation. Are we seeing more activity from your customers in terms of looking to diversify the supply chain a little bit more away from China? Obviously, last year, we talked about trade war being a risk and being -- prepare for that. But now I think some of the companies are even talking about diversification because of resiliency reasons. Are we seeing an accelerated move?
And added question to that is, if we are seeing that kind of a move during this period, do we think that Hon Hai CapEx is likely to be higher? Or are we still going to be able to manage with a similar kind of CapEx?
And lastly, given this year, revenue outlook seems to be less certain, do we think that the 2020 CapEx could be lower than 2019 CapEx?
In terms of the relocation, I think before the epidemic starts, we actually started the -- some of the relocation, okay, based on the customers' demand. So after the break -- outbreak of the epidemic, we don't see any specific requests of our customers for us to expedite the relocation. But no matter how the political situation changes, Hon Hai will always focus on customers' needs first, okay? Well, that will be the answer for your first question.
Okay, so the second question is about the CapEx. The CapEx, we don't see too big a change because the relocation doesn't really happen after the epidemic, okay?
Okay, okay. Understood. Second question on margins. How should we think about margins in Q2 as well as how should we think about second half once we are largely over this issue? Do we get back to that 1% gross margin expansion sales target in second half of this year or do we have to wait for next year for that to start kicking in?
Yes, we believe that Q2 gross margin, operating margin will return back to the previous levels of the same period last year. Now due to the fourth quarter, we have some special situation, as our CFO mentioned. Only about -- we have lost about 20% of our manpower -- manhours, okay? So margin-wise, we would think Q2 will return to its previous level. But in terms of Q3 and Q4, so far, it's still unclear for us what is going to happen.
Okay. Do you feel that -- do you feel more pricing power -- or pricing pressure from customers, given that demand is a little bit weaker now compared to previously? Should we expect then that could push back some of this margin expansion that we were expecting previously?
Yes, we don't see any pricing pressure at the moment. I think the pressure is on how we deliver the product on time, so far.
Next, we'll have Rob Cheng of Bank of America Securities for questions.
Okay. Chairman Liu, this is Rob. Yes, All I'm asking is a question that is probably more on the virus impact. I think the whole world is changed as the virus [indiscernible]. I guess from your point of view, because you guys are probably biggest EMS company, and at the same time, you probably see how the consumer, their behavior is almost change, even in the political environment or even in the business environment. I don't know, from your point of view, like, will you start doing some kind of strategy change on your business plan or some adjustment after the virus? I mean, this is probably more long-term strategy kind of question.
I think if you are familiar with our Foxconn 1.0, 2.0 and 3.0 strategy. Our long-term plan has always been to diversify our business into a new industry. So that has not changed. And will the consumer behavior change after the epidemic? We believe so, okay, it will change. But to what degree and to what scale is yet to be seen. Okay?
Okay, okay. Understand. Probably another one and a follow up is on probably on the CapEx side. Because of -- I mean we know Hon Hai has production facility globally. But right now, especially the biggest [indiscernible] or the biggest production and the final assembly place in Wuxi is in China. I mean, have you started thinking about, like, for example, building the assembly side, for example, in U.S.? I mean -- because I know you guys already had some facility before in India, even in Vietnam or in Europe. But probably not really -- I know in U.S., you guys have some R&D center and the stuff over there, but mostly it's on small side. I mean, so how is your view on this?
I think in terms of assembly sites in the U.S. area, in the North American area, we have 3 big production sites in Mexico. And to do production inside of the U.S., we had to pick the right products to do, okay? And we already have some products being made over there. It's mostly maybe server-related products. Due to the situation, the cost consideration in the U.S., only limited number of products can be made in the U.S. Okay?
Okay. So yes, so can we say that the possibility is to have, for example, like a smartphone or the other consumer products made in the U.S. going forward, can we say -- probably in the coming 2 to 3 years, can we say here, I mean, very unlikely?
My personal opinion is that it's going to be difficult for the mobile devices to be produced in the U.S. because it requires a lot of labor.
Yes. Understand. Probably my follow-up question is on margin side. Based on David, the CFO, mentioned something like a lot of the cost coming out is in first quarter. Can we say it's more like a one-off costs? And basically, a lot of this kind of additional costs, I mean, going forward, either with government or clients, some of them that were coming back will pay back. So can we have, for example, looking at not only normal, probably a sign in upside opportunity for second half? And even for next 2 years -- because I know company has been talking about -- like you mentioned 1.0, 2.0 is kind of long-term plan. And one of big, I would say, important indicator for us is probably in the operating margin or gross margins, you guys talking about 10% is kind of a target. I mean I don't know I haven't heard this kind of hierarchy. Have you see and maintained the same kind of target?
Okay. For the margin for this year, the first quarter is very special due to the virus, coronavirus. And as we mentioned in the past that we're getting some help from the local government and our customers, but the help will not be realized, okay, in Q1. Most of them will be realized in Q2 and Q3, and some of them will be realized in Q4. So because of that, we think, overall, the margin for the whole year will be about the same. Okay? So in terms of the 10% margin goal, we still think that's still in our plan, okay? And we are not changing it.
[Operator Instructions] The next question is coming from Kylie Huang of Daiwa.
Chairman Liu and David, this is Kylie from Daiwa. I have a couple of question. The first question I want to follow up. I just heard about you mentioned about the margin for this year is about 10%. I just want to clarify, you mean the whole year gross margin is similar to last year?
That's correct. That's correct.
Okay. The second question, actually, I want to check about your progress in Wisconsin. I know -- I just want to know because COVID-19, do you have any new plan for this site? Or could you give us some update about when we see the panel will be ramped up later this year? And what kind of product are you aiming for that site?
Our investment in Wisconsin is currently proceeding according to the plan, okay? The mix of planned locally manufactured products continue to grow. Now that includes networking equipment and network security products and some server products. And in terms of the panel products, that plan has changed.
Okay. So I just want to follow up. So it means in the future, Wisconsin site won't focus on the display product anymore, but more of like networking enterprise, these kind of products?
We're in the process of negotiating with the local government. So we will let you know once it is confirmed. Okay, because the product we are producing at the moment, they are networking-related and server-related products.
Okay. Understood. And from the news I see you guys actually already missed some requirement. So potentially, we will get a subsidy from the U.S. government is that something potentially will factor in, in like the second half this year?
Well, as I mentioned, that we are working with the local government. Okay. And I think due to the epidemic impact, I think the plan -- the flexibility of the plan is understood by the local government, but it takes time for us to communicate with the government officials.
Okay. Understood. My last question actually is about your cash dividend. I think a lot of long-term investors really care about that part. We see last year, our cash dividend actually increased to $4.2. For this year, I understand the situation may be quite challenging because of the overall economy uncertainty. But I was wondering, this company have some intention of -- in the future, what's your policy in terms of cash dividend? Will we maintain a certain amount of cash dividend or we want to maintain a certain percentage of a cash payout ratio?
As far as now, we're going to stick with our percentage commitment. It's still at least 40% of the net profit.
Okay. So no one speaks percentage rather than absolute dollar payout?
Yes.
[Operator Instructions] And the next question is coming from Gokul Hariharan of JPMorgan.
Yes, Chairman Liu. A couple of -- one follow-up to Robert's question. Post the virus outbreak and the feedback from the customers, et cetera, given the challenges that we have had in terms of the staffing of the factories initially and then kind of bringing it back on, are you thinking about potential long-term changes in terms of how assembly as well as other parts of the process is likely to work? Is there any meaningful changes that you think that could happen in the industry that you could bring about? And are there any implications from a cost or a customer perspective to that? My second question is, obviously, there's been a lot of focus on health care-related products, and Hon Hai group has also pitched in with some of expeditating some of these kind of products. I think you've talked about digital health among one of the 3 key growth areas. Could we talk about anything that's changing? I mean you've talked about some of the progress that you've made previously in some of the medical instruments, et cetera. Are we seeing that accelerate as a result of a bigger focus on some of these areas? And could we talk about what is the kind of 2- to 3-year plan for that vertical?
And my last question would be, I think there's a lot of press reports about competition and one of your customers talking about bringing in China competition, et cetera. I think I just wanted to understand what is Hon Hai's view on the core business? I think, obviously, competition has always been there, but is this kind of a competition going to be different from the Taiwanese peers you've faced? Or you feel that it's going to be fairly similar kind of dynamics compared to what you've seen over the last several years?
Gokul, you're testing my memory.
Okay. Sorry, I'll ask one by one then.
To answer it as I can recall, the first question was about the...
Any change in the assembly plan or any -- like, long term, do you see that there is going to be change in how you do things because of this...
Of course, the lighthouse manufacturing will be the way to go. Okay. We put a lot of efforts in lighthouse manufacturing, okay, or smart manufacturing, okay? We think that will be the way to go, okay? And the lighthouse manufacturing will be based on that to build-up our digital transformation for the whole company. So that's what we are going to do. Okay. And your second question, the new products that we're going to do?
Yes. Is on digital health, I think what are the new engagements you have? And how should we think about it, given there is a lot of focus on the digital health side, obviously, recently?
Okay. Yes. On a digital health front, we have partnered with a global consulting company on several projects, such as medical imaging, AI-related products, the DNA sequencing products and some advanced x-ray equipment. Those are the 3 areas that we are looking -- we're looking into. And we already have some collaboration with some company in Israel on the new generation of x-ray machines. We also are working on some MBI equipments for imaging of the breast cancers, okay? Those are the areas that we have been working on in the digital health area.
Okay. And my last question was about competition.
About competition, we always face a lot of potential competitor in the past. And we think these challenges are always there. We'll leverage our best talents and resources in our existing industry to provide global manufacturing services to our customers in order to fulfill their needs. But in the long run, we are into 3 new future industries, as we mentioned in our Foxconn 3.0. That includes EV, digital health and robotics. That's how we're going to outrun our competitors.
And the next question is coming from Jordan Pong of Franklin Templeton.
Dear Chairman, just a follow-up question on relocation. And actually, recently, there's an article talking about your big customer, who asked to shift around 20% of the capacity to India from China. So I just wonder that would be the -- actually the further request on your group? And what would be the CapEx yearly incurred going forward? And would that change your pipeline? I understand that you already have the capacity in India, but I mean under such a new development, would this speed up such relocation and incur extra cost on the CapEx?
First of all, I think that's a rumor. I don't know what's going on with that, where the information comes from. That's my first answer. But in terms of the plan for our specific customers and with their specific products, I'm not the right person to comment on this -- on other specific customers and products. So sorry.
[Operator Instructions] And next we'll have Kylie Huang of Daiwa for questions.
Chairman Liu, this is Kylie, again. I have a question regarding your progress on the company transformation for Foxconn 1.0, 2.0 to 3.0. I'm just wondering, because this year, I think a lot of delivery on margin maybe deteriorate because of virus. But if we take a look about your internal efforts to fall under Foxconn 1.0 and 2.0, can we expect to see some margin improvement from, let's say, next year, maybe some, like, 1% to 2% digit point you're talking about?
We're quite optimistic about the progress of our Foxconn 1.0 and 1.2 projects. In terms of the margin improvement for this year and next year, we'll do our best. So far, we're not able to predict how big the impact will be because it's quite complicated due to the virus situation. But we think the progress of these 2, Foxconn 1.0 and 2.0, we're quite happy about it. And we think it will have some impact, but in terms of how big, just can't tell at the moment.
Okay. May I follow on next part, could I say, because I think originally, we are talking about 10% gross margin within the 5 years view. I say because this year, we might be impacted by the COVID-19, so it's more like delay for 1 year. Of course, let's assume the impact from the virus is over next year, so it's more like a delay in the process. But actually, a lot of effort we're already making, but the overall progress is actually on track to our original plan.
Yes, we don't see any change in terms of our 2025 target, okay. Even with the -- with the coronavirus situation, the progress towards the 2025 is quite promising. That's what we see. The impact of the pandemic is mostly on our current business. And if you look at the whole year performance, if nothing goes too wrong in the next second half, our estimate is the margins will go back to what it was a year ago.
And the next question is coming from Henry Kuai of Orient Securities.
Just now you mentioned about the lighthouse is the direction you're going to be. And can you maybe elaborate more about the program of the lighthouse and digital transformation? And maybe, what is the impact of the digital transformation or maybe we call the industrial Internet to the top line of the company?
Okay in terms of lighthouse project. Our goal was to transform about 10 of our factories into lighthouse factories this year, we're still working on it, and the progress were still made according to the plan. That will be the foundation, as I mentioned, for the digital transformation because we are a manufacturing company, our -- the digital transformation will help to improve our factories. Unlike a lot of different kind of industries, companies in different type of industries, when they do digital transformation, they mean something else. But for us, as a manufacturing company, factories will be the foundation of the company. So the majority of the efforts for our digital transformation will be to transform our factories to a digital -- digitized factory. That is, from our point of view, lighthouse factories will be the target for us. And with the lighthouse production, lighthouse factories, the intention of that is to increase of -- increase our efficiency, the OEE. So with that, we think it will increase our bottom line, not the top line, okay? The top line increase will be for the new business and the new industry. Okay? That's how we look at it.
Okay. Got it. Because some of our factories are very huge and some are relatively small, may we know roughly in terms of revenue or maybe manpower, how big are these 10 factories this year?
Our factory, the physical size of the factory is mostly about 160-meter times 60 meter. So it's about a 10,000 square meters with about 4 stories. That's our typical factories, typical size of the factories. Ten factories that we're going to turn them into the lighthouse will be something in that size. Okay? And it depends on the kind of production that they're doing. It could be, we call, the Level 5, Level 6 or Level 10. With Level 10, you -- in that kind of factories, it will go as much as like 4,000 to 5,000 people at the moment. For Level 6, it's around 1,000 -- 1,000 to 2,000. For Level 5, it's lower than maybe about 1,000. So with lighthouse factories, we will turn that into hundreds for Level 5 and Level 6. For the Level 10 final system assemblies, the reduction of the labor could be less. Less, by that I mean, maybe 30% less of its original labor.
[Operator Instructions] And the next question is coming from Jordan Pong of Franklin Templeton.
Dear Chairman, actually, another question is regarding your major customer. Do you think that there's any chance that the new product would be delayed in terms of the product launch in the second half this year? And when you are saying that if anything will go to normal in the second half of this year, then the margin or everything will go to normal level. Would that assume that this kind of new products would be launched on time?
Jordan, sorry, I cannot comment on any specific customer product or factory stuff related to our specific customers.
And the next question is coming from Robert Cheng of Bank of America Securities.
Chairman, yes. This is Robert Cheng, again. Because of -- I know you talked about big labor decreasing on the lighthouse and -- but I have one of your -- I mean your peers in China been keep talking about SiP, system-in-a-package. Basically, a lot of things become more and more small and -- I mean, need to put a rather small component and into a small package because probably this is also one of the other way to -- in terms of decreasing labor, increasing automation efficiency. I don't know do you -- I mean -- because of -- I think probably from the angle that you're talking about, like, from the Level 5, Level 6, it's probably more from mechanical. But from the SiP point of view, somewhere, I think on more semiconductor and probably also from SMT side, I don't know, because you have experience in both semi and in EMS, so I want to get the U.S. dollar on it.
I think the advanced packaging capabilities definitely will change the way we produce our products, not only SiP package but also advanced 3D or the panel packaging. This -- I think this is the trend, but it will not change the system-level product, okay?
So in terms of the -- for the system-level production, that may be, I would say the function or the way to do the system-level products will be about the same. The impact maybe for the -- is on the Level 6. Okay? The Level 6 may transform into a combination of SiP and the SMT. That's what we see. Okay? Because some of the components will be in a bigger package will be further integrated into the new packaging technology, but that package will still be assembled onto the board with typical SMT process. So SMT will still be there.
Yes. So especially is -- from the SMT and some of the packaging technology, can we say this is actually more in the component, especially in other semi, in other component level to put together. Probably, I also want to know about what is the -- I mean...
Hello, are you there?
Sorry, yes. Sorry, because of phone coming. I also want to know how the Hon Hai's progress in SiP and over advanced packaging in this area.
Yes. We already have the SiP capability right now. We have a company by the name of SST, I think. They are already capable of doing some SiP products. So SiP is not new to Foxconn.
In terms of advanced packaging, we -- if you remember that we have some activity in Qingdao that we are going to build some advanced packaging capability in Qingdao. And we will be targeted to have that kind of packaging products in a couple of years in 2021 -- approximately 2021 -- at the end of 2021 to 2022.
Well, ladies and gentlemen, our time is up. So thank you all today for attending the call, and we will conclude the call now. Thank you.
Yes. Thank you, Chairman Liu. And ladies and gentlemen, this concludes today's conference call. We thank you for your participation. You may now disconnect. Goodbye.