Visit to factory in Taoyuan finds production line shuttered amid rumours it will outsource production as squeeze from Apple and Samsung worsens

Taiwanese smartphone maker HTC has halted at least one of its four main manufacturing lines, accounting for at least a fifth of total capacity, and is outsourcing production as a sales slump puts pressure on its cash flow, according to sources with direct knowledge of the situation.

A Reuters reporter who visited an HTC factory at the company's former headquarters in Taoyuan, about an hour's drive from Taipei, saw loading docks shuttered and a sign on a locked lobby door that read: "Lobby is temporarily closed for use. Thank you for your cooperation."

HTC launched its latest version of the flagship One series handsets this year but has struggled to gain traction in a market dominated by larger rivals Apple and Samsung Electronics.

The company, whose woes have been exacerbated by supply chain constraints and internal turmoil, reported its first quarterly loss in more than a decade this month, of 3.5bn Taiwanese dollars (£73m) and its cash flow from operations dropped to a negative £440m as of the end of June, indicating that it was spending more than it was receiving.

Despite lacklustre sales, HTC devices usually receive rave reviews, and it has in recent months expanded its range to include smaller and larger models of the One phone and hinted at further products, including a tablet and a wearable device.

HTC initially denied it was shutting down any production, in Taiwan or elsewhere, and declined to comment on whether it was in discussions to outsource production.

Update: in a filing to the Taiwanese stock exchange on Wednesday, the company said: "HTC is not shutting down nor does it have plans to sell any of its factory assets. HTC has a strong cash position and financial structure, and will provide the latest financials in our upcoming earnings call to investors and the broader community." That call will be on 5 November.

The statement does not however contradict the sources' suggestion that production at one of the lines has been halted.

'Strong balance sheet'

"HTC is not shutting down nor has plans to sell any of its factory assets," the company said in an emailed response to queries from Reuters. "HTC has a very strong balance sheet and will provide the latest financials in our upcoming earnings call to investors and the broader community."

When asked about what Reuters had seen at the factory in a telephone interview, HTC chief marketing officer Ben Ho declined to give details, but said: "Like any manufacturer, we do volume planning to optimize our lines, our manufacturing and production facilities.

"Whether we are operating those facilities depends on market demand and our own expectations. When you have less demand you work with less facilities to optimize your costs. When you have demand, or bigger growth, you definitely have to activate all these facilities."

According to data from HTC and the research company IDC, HTC's quarterly phone shipments have dropped from a peak of 13.3m units in the third quarter of 2011 to around 6m units in the same period this year.

Two of the four sources who spoke to Reuters said HTC had combined production from two lines at Taoyuan into one, which would reduce its potential capacity by about 1m phones per month, out of a total capacity of around 2.5m at the site and around 4.5m including operations elsewhere.

Manufacturing has been halted since at least August on the line, housed in a facility called Building H, while production continued at a nearby plant known as TY5.

Most of the assembly lines in HTC's Shanghai factory, which can produce 2m phones a month, were also out of production, one of the sources said, with only a small number of phones being produced for sale inside China.

HTC was considering selling the out-of-use production lines in China and Taiwan, two of the sources said.

"HTC's cash flow is not doing well. It has to do something soon to generate cash," said one of the sources with direct knowledge of the manufacturing sale plan.

Temporary handover

HTC' chief executive Peter Chou, the driving force behind its award-winning handsets, has temporarily handed some of his duties to the company's chairwoman in order to focus on innovation and product development, the Financial Times reported on Monday.

Shares of HTC jumped following the report, on hopes that the change of duties among the top management will help it recapture the sparkle that saw it named Device Manufacturer of the Year at the World Mobile Congress in 2011, when its stock was flying high. The company's market value has roughly halved this year.

HTC, which positions itself as a premium brand, will contract out some manufacturing to FIH Mobile Ltd International , a subsidiary of Taiwan's Hon Hai Precision Industry, because contract manufacturers have better component supply management and cost control. It is also in talks with Compal Communications and Wistron Corp, according to four sources.

FIH and Hon Hai declined to comment. Spokesmen for Compal Communications and Wistron could not be reached for comment. HTC also declined to comment.

One of the sources said HTC's top management had agreed to separate the design and manufacturing businesses, which would more closely resemble Apple's model of creating products in-house but then outsourcing to assemblers such as Hon Hai. By contrast Samsung Electronics both designs and manufacturers its smartphones.

However, sources said even if HTC splits the two operations, it would likely hold onto some of its factory capacity initially as the split-up would be a slow process and HTC might explore the possibility of making phones for others.

Chou aims for a doubling

In a Town Hall meeting with staff on Tuesday, CEO Chou said HTC aimed to double its shares of the high-end smartphone market to 15% next year.

When asked about separating out the manufacturing business, he said the company did not rule out the possibility. The comments were reported by local media and confirmed by Ho.

At the end of June, HTC's cash position decreased to NT$48.1bn (£1.02bn) from NT$55.5bn (£1.18bn) a year earlier as cash flow turned negative. Its balance sheet also shows that bill payments increased while less money came in from customers. Receivables - the money owed to the business - increased by NT$7.9bn (£167m), but accounts payable - the money by the business to its suppliers - dropped NT$7.8bn (£165m).

HTC's return on assets (ROA) - an indicator of how effectively a company uses its assets to generate earnings - is expected to turn negative this year at -0.69%, the first time since 1999, according to SmartEstimates. Its ROA last year was 8.1%.

No potential bidders for the manufacturing space have surfaced so far, in part because the global smartphone and tablet PC supply chain is facing overcapacity, the sources said. As a result, HTC is also exploring other options to generate income by using its factories, sources said.

Several analyst and media reports said HTC was in talks with Chinese peer Lenovo Group Ltd and US online retailer Amazon. There is also speculation that Hon Hai will use HTC's plant for its own production.

Hon Hai said there was no plan to use HTC's production lines in Taoyuan now. Lenovo declined to comment and Amazon could not be reached for comment.