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Case 1:04-cv-01338-JJF

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EXHIBIT K

Case 1:04-cv-01338-JJF
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Case 1:04-cv-01338-JJF

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One stealthy Taiwanese cornp to the top of the EMS sector

Hon Hai Precision Industry, well, that's just fine with the company. Founder and Chairman Terry Gau doesn't do industry conference keynotes and r to the press. Hon Hai has a corporate site, but the latest What's New item is nearly two years old. Financial information is released mainly through the Taiwan ge Web site, where Hon Hai makes the minimum disclosures required by law.
F YOIJ'VF. NEVER HEARD OF
And yet this once-obscure Taiwanese coni. pany has bccome a major player in the eieccronic manufacturing services (EMS] industry. Using its only slightly more recognized trade name, Fowmm, it manufactures motherboards for Intel, PCs for Hcwlett-Packard, PlayStation crmstilec for Sony and mobile phone componcnts for iivlororola. R u t rhese coiitpanies don't likc t o Jdinit ir. And H u n Hai doesn`t like to brag. (The company declined ro ralk to ELKBur rhocc ~ 4 i o the trouble to peek behind take rhts veil of secreq w e e! e-popping numbers. Since 2000 much of the rest of the EMS sector has seen rtagnanr wles 2nd hottom-line red ink. Rut l - h i HJI'\ sales grew troni $2.9 billion in 2000 to 44.6 I~illronin 2001 to $7.7 billion i i i 2002. Analysts cmrnatc` rhat
anies aren't looki
does most of its manufacturing in niainlan is nctw pushing beyond the desktop PCs a game cotisoles that got it this far. Last fall i t went on an acquisition spree that has positioned the company to make cell phones, sewers and networking gear. One of its acquisitions gave Hon Hai product design capabilities, potentially filling a gap in its offerings that has kept the company from breaking into more-lucrative notebocrks and other original design manufacturing (8D.M) work. But as Won Hai has grown larger, its footsteps have become heavier. And some say new chal-

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lenges may trip up the srealrhy conipany It has n o experience in folding successful companies into the Hon Ilai nitrid. I t has Faled in previous attempts t o build up design capabilities. And companies crrnsigning ODM work may shy away Frim a partner that keeps so many secrets, inilucling any succession plan icrr the inscrutahle Gou. "We recognix it as a strong competitor," admits hficliael hlarks, CEO of Floxtronics. \*ithas done an cuceltcnt job of manufacturing in China, and it is now tupai.lditig as a global player. if it can do thar successfully, which is iior yet proven, it will bc recognized JS one of thc major phycrs in our industry." hlosr analysts alrcady consider Hon Hai `3 niajor player. "We have already seen thar in PCs Hun Hai can cornprce with rhe major contract manufacturers," says Sharon So, 311 malyst with UAS Securities in Taipei. "`how it is moving into new conipetitive spaces."
Hon Hai who? Hon Hat'$ unusual approach tu business IS a reflection of i t s unusual foundel: Unlike the legions of engineers who biulr up Taiwan`s semiconductor and computer indusrries after gaining adyanccd degrees and work experience i n rhe IJnitet! States, Cou graduated from `3 nierchanr m,irine college. insread of going r o w:~, he m r t e d Hon l-hiin 1974 in a garage wirh I O employees making pldsric parts fur hlack-andwhite TVs. In a prescienr m o w , he hegan making conriecrors in 198 I for contpurers.

Among the producrs that gave Hon * Hai early S L I C C ~ S Sand a famili with the biisiness were [he soc rhar allowed add-on memory mod co be snapped into 1'Cs. "The c pany captured a major

HON MAf REVENUES BY PRODUCT CATEGORY 111millions of S 12.000 r

""i l.GLJ
G.OW
'BIlnm WC W mwFs RE A N

low-cost leader for building

relationship," says Jeff Bloch, vice president of EMS services at i supply chain eonsultancy. B1 c o know rhe company and Gou when he was a purchasing manager for Intel, which used Hon flai connectors on its IC motherboards. ' Ilon Hai's sales grew along with tfie PC hoom. And froni connectors, the company worked irs way up the tomponeiit chain, Bloch says, to modules, circuit boards and evenrnilly into coniputer enclosures. To continue expanding its growing list of products, Won Hai became part of the vanguard of Taiwanese businesses moving production ro China. It opened its first production fasi there in 1993 and now has five i

And he keeps his lie
mizes outsiders' access co in formation about the company. "Other members of the n i a n ~ ~ e m eream don't show up in nr public much,'? says %ai. "We are really not familiar with them.'" "I think rhis secrecy i s parrly due to Chinese culrurerYsays William Fong,

ative about disc

he adds, in wliat most analysts consider an understatement. The stingy disclosure is partly to keep information out of the hands of competitors, says Fong. Hon Hai has further obscured itself by using Fosconn as a trade name and as the naine of most of its overseas subsidiaries. The secrecy helped keep Hon Hai o u r of the liiiielighr until it just got ton big to miss. Since 1998 Hon Ilai has posted sales growth of more than 35 percent each quarter, except die second quarter of 2003, when the SARS crisis disrupted demand for electronics in Asia. That growth made it Taiwan's largest manufacturing company (in terms of sales) in 2001 when it passed
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Taiwan Semiconductor Manufacturing Corp. (TSMC),rhe island`s quinressential high-tech powerhouse. Won Hili became Chiria's largest exporter in 2002, shipping $4.38 billion wonh of goods out of rhe coun according to the nwinland's Ministry of Conmterce. Even rhar understates I-Ioti l-iai's true strength in the hliddle Kingdom, Imxtse sales within China account for about 20 percent of revenues, according to a Lehman Bratliers report. And because Hon Hai was focused primarily on PCs and game co~isoles,it had niininisl exposure to the overcapacity i n relecotnmunications that has socked other EMS companies since 2000.
Shy giant

Having g~-own big so quickly?rhe retso icent giant now finds itself the subject of increasing scrutiny. "Suddenly at industry ccxifereiices, people wanted me to tell them inore about Won h i , " consulrant Rloch says. One thing analysts know is that Hon Hai has the lowesr cost srrucmre in the indusrr): It% adsantages start with i s exrensive ncnmrk o f factories in China, where the company has akour 80 percent o f irs production capacity, according to marker restarch firm Taiwan Ratings. By comparison, Flexaonics has about 40 percent and Solectron 27 percent of their capacities in Asia, according to the Lehman report, How much o f a cmt advanrage does this give Hiin Hai? h 2002 report from the 1J.N. Conference on Trade and Development concluded that China's wage5 are as low as 2 perccix o f those of rhe U.S. (though China's lower productivity narrows the gap in unit nimufacturing coan). 1 - h I-Iai's conrroi oi ctr\ts ts as fanattcnl as its control of information, somcrhing I.C?h113al1 ,3nalysr Endy <:hang realized o n a visit to E?& facilttics in China I;ist year. The "nice howing and officec" of Fleurroiiics' expars contrasted sh.irply with the accomniodations of Nctn Hat's manqers. "Even the I r m l chairman? offices had hare zoncrcrc fiocw;' rhe cays. "`This coinpmy i really rhrtfry." s O n rctp ot char, Hon Hat can rely o n the 3 0 percent and higher margins of it$
48
April 2004

TSMC and United

R b D spending dt $115 about 1 3 percent of sales.

trots means that

others. Hsn HaiS pa

HON HA1 REVENUES BY PRODUCT SECTOR

trace manufactu

Total revenue fiscal year 2003 estimated at $10.7 billion
SraRCE L E W

mom

lawwit brought in the U.S. by F a , a French connector maker. Damages were expecred ro run EO millions of doflars but had nor been decided pet. Hon f-lai also has become one of the industty'q fascesr manufacturers in terms of time to marker, which provides .xiorher opportunity to sneak up on rivals. I-ion H3i surprised Acer last year by taking just rwo inoiirhs to go from

Of course, the conipetition is nor going to roll over. Orher EMS mmpanics are now moving tn copy Won H s $ model. Current industry leader Flexrronics starred out with a diamerrically opposite EMS approach, buying all cnrnponenrs and just doing assembly, according tu Louis hlisrioscia, senior vice president for EMS and computer research at Lehman Brothers in New J`ork. But now "Flestronics has expanded to include plastics and enclowres," he says. As a result, Hun Hai
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cCHt~n Hai% customers h

more information, and the
--Pamela Gordan, preside
and Fleutronics "now locrk suhsrmtially Grnila-," he adds. Fleutrtmics also is ramping up new hcilitics i n China to take advanrage of rhe low wages. Bur it will t ~ k e time to march Hon Hai'.; China manufacturing infrastructure. The real challenge to I-lnii H a i on the low end w i l l come from mainland Chinese rivals, which have hecome more aggressive in hargaining for outsourcing wrtrk, s q s Noniura's Lee. For novice coI1ti-m mnriufacrurers, he says, one of the easiest targets is desktop PCs. This will keep pressure on n~irsins,no niatter how efficient Hon Hai hccome~. maintain profitability, To Hon 1-lai riccris to extend into other prtrduits, Lee ~ i y s .
Moving up the value chain f3on Hai has already wen the writing o n
its

handset. operations and publicly list-

badly wanted to. So to strengthen its hand in communications, Hon Hai w7enr on a n acquisition spree lasr fall that surprised observers (see chart, page 48).

companies in the past, but

rhnse hare Chinew walls. it has k e n building up business in rtrher sectors, making switches for Cisco Systems;
YEAR-ON-YEAR GROWTH as of third quarter 2003 [wrcent)
FuxConn

Hai solved by replacing managenienr. Ambit, already s u ~ e

Flextroniu

And here, its track record is prerty disc seen in Mon Wai's he notebook computer ese ODM companies
ily Nokia. Then in October, Hon Hai bought Motorulo's mobile handxt manufacturing plant in Chihualiua, Mexico, for $18 million. Under rhe agreement, Hon Elai will be supplying handsets made at the factmy to Motsrola. But those were penny-anre deals compared to what came next. In November, Hon Hai agreed to acquire AriilGt illicrosysterns, a Taiwanese maker of muters, modems and networking equipmenr, in a stock swap vattied at about $1.1 billion. Ambit, a spin-off of Acer, had L(IO2 s l s of $74.5 ae million and net income of $60 million. Analysts supeuc the Motorola and Eimo deals t o allow Hori I-Sai to move Further inro the mabile phone handset business, shz~rpeningits campetirion wirh Flextronics and Czlestica. Eion Hai is even studying the idea of spinning off
EMS MARKET SHARES as o third qoartar 2GO3 f

solccfrml
Sanrnina

Celest1ca
Jrlbl

industry

mohilc phone m t d u i e ~for Motorola ~ n d Nokia; and mobile handsets for UTStarcom, a mobile phone company hsadqoanered in California that is a marker leader in some regions of China. 1 rhman'c ~ h n g emmates that I-hn Hnri rrventie trtrm handsets ;end networking cqi~ipnienr tncreasetf from 12 pcrsent of coral s.11~. 2C)OZ r o ahout in 20 permit last !car. But i i n r i l lare last \ v x * Mon Mai hadn't I w n .~bler o w i t i ftrw,ticJ-puJuct rn~niifamring orders for hnndsen trom ani' c rmipany ctrlier rhan U1'Starwm. And, m n l y s t c say, it
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April 2004 * Electronic Business

12.24
sM&ccRli

14.4%

such as Quanta Cornpurer and Compal Electronics dominate the notebook secror, because they offer OEM customers complete packages, iricluding snazzy designs. Hon Hai wants to expand into design for several reasons, say analysts. Margins are better rhan the 10 percent or less that deskrops earn. `S;iell-designed
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nurehonks \imply cc)nmianci more respecr i n rhe industry. An norel3ooks \VOiild give Hun up on Flcsrronics, whicti has a h been hullding up irs 0I)M work l w r doesn? have any customers f o r notebooks, according to Lehman 13rorhers' Miscioscia. I-lon H a i nukes notehook housings and supplies connectors and compononts to the major norebook makers, And in 2002 1-2 Firm Flai and Gnu, using his own money, helped finance a srartup to make TFT-LCD panels not only for notebooks h u t also for desktop displays and LCD Tvs. But so f:ir Hnn E-lai has Imn mahle r o win orders for coniplere Iiorehook prodiicrs, hecaiise of i a weak design skills. <:hang cays. And its attempts to dewlop those skills h a w so f x failed. To hclp ir break into rhe marker, I-Ion Hai recruited Bing Feng, a d w g n wiz Fcrrmrriy with Tiitvan's Elite-

group Computer Systems, in early 2

rleac

notebook maker, according to Nomura's Lee. "The company denies it," he says,

bled. Meanwltile, lnnolux Display, w

"excruciating Icveis of

ON HM PRECEION INDUSTRY`S arrival in the top ranks of took the i n d u m y by surprisis because the company is so suc ing its secrets. Its public antirelations efforts start wirh its own invesrors. Asianznr zine has tapped Hon Hai as having "the leasr impressive invest0 among Taiwanese companies for rhree years running. The com

changing. News of Hon f-LZi's recent acquisirions all came from its targets. Eimo, Mororola and .hibit all issued prcss releases, and Eimo and Ambit followed up with management leners ro shareholders, explaining the dtwils and benefits ai &e deal. None of the disclmsed infomadon originated fro

sales hy region or praduct category. One analysr who did not want to be idenrifi mnrion available makes it "almost impo crack and project the company's performance.
nvo interviews a year, and no Q pan?, says Conrad Huang, a Hon Hai spokesman. Hon Wai never direaly refused to make a exccurive available for an inreniew with E L E ~ R I O ~B C % I ~ ~but , i ?L ~S Wuang very policely-and repeatedly over the course of nvo niontfis-explained that rhe request was pending \vith higher-ups. I-hang insists d m the company is not deliherarely trying to keep out of the news, but most business publicarions hesi t a c to run a story about a company wirhour any managemenr interviews. `Ilie smie goes tor Industry surwys. For the last several yetars, I3on Hai has refused to cooperare wirh Reed Business Research for EB's annual list of top contract manufacturers. As a result, RBR does nor include Non Hai on the Usr.-D,N.

msnt team, of Han Hai`s managers in hiding, analysts, investors and porential customers righrfully wonder what would happen withoiir the indusrrious yet taciturn founder. "We can't see anyone in management who could take ovcr if Terry G o u suddenly died in a plane crxh,* Lehman's C:Iiang says.
Do you think tougher disclosure rules should be adopted in Taiwan? Why or why not? Send ywr comments to: [email protected].

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