Mr. Hajime Sawabe
President & CEO
Thank you for taking the time to attend today's presentation on our operating results for the first half of the fiscal year. Your support and guidance is greatly appreciated.
Let's begin with a discussion of some highlights of our first-half consolidated results.
During the first half of the year, net sales increased 0.8% year on year to ¥318.8 billion and operating income rose 11.9% to ¥26.9 billion. Income before income taxes climbed 15.2% to ¥28.8 billion and net income was up 3.2% to ¥19.9 billion. Basic net income per common share was ¥150.11 and equity per share was ¥4,615.44.
Our first-half performance was largely in line with our initial projections of net sales of ¥317.7 billion and operating income of ¥24.5 billion.
In terms of segment sales, in the electronic materials and components segment, sales increased 3.1% year on year to ¥262.4 billion. Looking back at the past six months, as you know, the electronics market in the first quarter of fiscal 2005 saw extremely strong demand for digital home appliances. Mobile phone demand also remained strong from the fourth quarter of fiscal 2004. However, the second quarter was characterized by a slight slowdown in the mobile phone and PC markets. Furthermore, the digital home appliances market lost momentum after the end of the Summer Olympic Games, putting downward pressure on prices.
Despite these market conditions, sales in the electronic materials and electronic devices sectors-that is, sales of electronic components-rose year on year.
Indeed, in the electronic materials sector, sales increased 11% year on year to ¥91.0 billion.
Capacitor sales increased 13% year on year. Higher sales due to growth in demand for use in digital home appliances and to the increasing sophistication of mobile phones, which are being equipped with features such as color displays and cameras, absorbed the effect of downward pressure on sales prices and the higher yen.
Sales of ferrite cores and magnets rose 6% year on year. This reflected growth in sales of transformers and power supplies for digital home appliances and cores for communications equipment in the ferrite core sector as well as higher sales of magnets for car electronics and PC and peripheral applications.
In the electronic devices sector, sales rose 10% to ¥57.5 billion.
Sales of inductive devices increased 11% year on year, reflecting higher sales fueled by growth in the digital audio-visual market and the increasing sophistication of mobile phones, as well as increasing demand for use in car electronics, including CAN-BUS.
Sales of high-frequency components edged down year on year. Growth in sales for wireless LAN products failed to offset the effect of inventory reductions by mobile phone manufacturers in China.
Sales of power supplies and other products rose 12% year on year, the result of strong sales of DC-DC converters and DC-AC inverters for the IT home electronics appliances and industrial machinery markets. Furthermore, sales of sensors and actuators increased for use in PCs and peripherals.
In recording devices, sales decreased 7% to ¥103.3 billion.
HDD head sales declined 6% year on year due to the in-house production of heads by TDK customer Western Digital and inventory reductions at HDD manufacturers. TDK's market share declined from 33% in the previous year to 29%. More details will be given about HDD heads later on in a separate presentation. In other heads, optical pickups recorded a 16% drop in sales year on year due to production cutbacks at some customers.
Semiconductors & others sales climbed 28% year on year to ¥10.5 billion. While semiconductor sales declined due mainly to lower sales to the communications equipment market, sector sales were boosted by higher sales of industrial machinery and other products.
By market field in the electronic materials and components segment, sales to the IT home electronics field decreased 2% and accounted for 63% of segment sales. The decrease was largely due to lower sales of HDD heads, as previously mentioned. Sales to the car electronics field rose 5% on higher sales of components for automotive electronic devices and accounted for 9% of segment sales. Sales to the high-speed, large-capacity networks field rose 16% due to higher sales of components for mobile phones and accounted for 10% of segment sales. And sales to other fields rose 16% due to higher sales of components for industrial machinery and accounted for 18% of segment sales.
In the recording media & systems segment, sales declined 9% to ¥56.4 billion. Sales of DVDs and other optical media were insufficient to offset lower sales of analog products such as audiotapes and videotapes and the negative effect of the sale of a software development subsidiary.
Turning to sales by region, sales were up 8% in Japan. Sales were down 7% in the Americas due mainly to unfavorable currency movements, and down 2% in Europe, reflecting sluggish recording media sales. Sales in Asia were on a par with the same period a year earlier. Sales were flat in Asia and other areas. This was because a ¥11.0 billion, or 17%, rise in sales of electronic components was offset by a ¥10.0 billion decline in recording devices. Overseas sales decreased 1.5% to ¥231.1 billion and accounted for 72.5% of consolidated net sales, down 1.5 percentage point.
Consolidated operating income rose ¥2.9 billion, or 12%, from ¥24.0 billion to ¥26.9 billion. This improvement was driven by an increase in sales and an improved product mix, which raised operating income by ¥25.0 billion; ¥16.6 billion from improved yields, materials discounts and streamlining efforts including cost-cutting; and ¥1.4 billion from other areas. These items outweighed negative factors such as discounts in sales prices of 9.7%, equating to a decline of ¥34.2 billion in operating income, and a ¥5.9 billion negative impact from exchange rate fluctuations as the yen strengthened from ¥118 versus the U.S. dollar to ¥110.
By segment, the electronic materials and components segment posted operating income of ¥29.9 billion, ¥4.1 billion up year on year, as lower sales and profits from recording devices were countered by higher sales and improved profitability in electronic materials and electronic devices. In the recording media & systems segment, the operating loss increased ¥1.2 billion to ¥3.0 billion. In addition to lower sales from profitable magnetic tapes, this loss reflected a sudden drop in sales prices of optical media products despite higher sales of these products, and expenses for clearing excess optical media inventories in the first quarter.
The segment thus fell short of its initial plan, with the main factor being the sharp drop in DVD sales prices.
When we formulated our plan, we assumed a 20% fall in sales prices in the first half of the fiscal year. The drop was in fact 40%, double what we'd forecast. In monetary terms, we forecast a negative effect of ¥3.4 billion from sales price discounts. This ended up being ¥6.5 billion. In the second half of fiscal 2005 we intend to move quickly to improve earnings in recording media products. We will implement various strategies such as reforming our sales system, bolstering productivity, improving SCM and normalizing inventories.
Turning now to cash flows, free cash flows were ¥9.3 billion, falling ¥24.2 billion from ¥33.5 billion in the same period of the previous fiscal year. Capital expenditures, such as for HDD heads and capacitors, increased ¥5.8 billion. Trade receivables increased ¥5.2 billion, but ¥4.9 billion was attributable to foreign exchange movements. Therefore, there was no deterioration in the trade receivables recovery rate, which was 2.7 months. Inventories increased ¥10.1 billion, of which ¥2.6 billion was due to foreign exchange movements. Furthermore, we intentionally increased inventories by about ¥4.0 billion to ensure sufficient inventories at the start of the third quarter, which coincided with China's National Day holiday. Excluding these abnormal factors amounting to ¥6.6 billion, inventories only increased ¥3.5 billion, representing ¥2.0 billion in HDD heads and ¥1.5 billion in electronic components. The increase of ¥3.5 billion equates to a tenth of one month's sales. Because this increase will allow us to cope with higher sales in October, inventories should return to normal levels by the end of October 2004.
Excluding the effect of foreign exchange, inventory turnover in the recording media & systems segment was 2.2 months, thus returning to the March 31, 2004 level.
Moving on to non-consolidated results, net sales increased 10% to ¥167.7 billion. Operating income was ¥5.7 billion, up 436%. Current income was ¥22.2 billion, up 360%. Net income was ¥15.9 billion, up 1,309%. The increase in operating income was due to higher sales of capacitors and inductive devices. The improvement in current income reflects an increase in dividends from subsidiaries of ¥8.6 billion and an improvement in foreign exchange losses of ¥2.3 billion.
The interim dividend has been set at ¥30 per share of common stock, up from ¥25 one year ago.
Next, I would like to look at TDK's projections for the fiscal year ending March 2005. The consolidated projections are the same as our initial projections. That is, on a consolidated basis, we are forecasting net sales of ¥680.0 billion, 3.2% higher year on year. Operating income is forecast at ¥60.0 billion, up 10.5%. Income before income taxes is forecast at ¥62.0 billion, up 11.5%. Net income is forecast at ¥46.5 billion, up 10.4%. First-half results were slightly above plan and we still aim to achieve our initial targets, despite increasing uncertainty in both the macro- and micro-economic environments since the beginning of the fiscal year's second half. We are assuming a rate of ¥105 to the U.S. dollar in the second half, the same as our initial plan. The exchange rate was ¥109.80 versus the U.S. dollar in the first half of fiscal 2005.
Let's recap the first half of fiscal 2005. Electronic materials and electronic devices delivered sharply higher sales and profits amid strong market conditions, as exemplified by the rising popularity of digital home appliances. This compensated for lower earnings in HDD heads and the recording media & systems segment. The overall result was a 12% increase in operating income.
In electronic materials and components, excluding HDD heads, we succeeded in raising sales from new products, a key goal of ours, from 24% in the previous fiscal year to 30%. Together with further streamlining actions, this is translating into improved profitability.
The HDD head business saw sales drop 6% in the first half of the fiscal year due to the in-house production of heads by Western Digital. Furthermore, due to the extended lifespan of 80GB/P products, sales price discounting was severe. Nevertheless, we still achieved our initial sales and profit goals. Looking ahead, management believes that pressure for further price reductions will grow stronger due to the prolonged lifespan of some products and expansion of non-IT applications. However, we aim to raise earnings by building a profit structure to meet this challenge and developing new products in a timely manner.
The problem in the first half was the underachievement of the recording media & systems segment. There were two main factors. One was that we misread the speed at which prices of DVDs would drop. We assumed prices would fall 20% in six months. In fact, they dropped by around 40%. Second was that we were slow to respond to change, especially the sales and marketing organization, which resulted in an increase in inventories in the first quarter of fiscal 2005, for example. We intend to quickly turn this business around, including reshaping its profit structure.
Pessimistic views abound at this juncture about the macroeconomic environment and electronics industry in the short term. There is alarm about the surge in crude oil prices and the direction of the U.S. and Chinese economies. What concerns me most, however, is whether there will be any change in government policy in the U.S., which has borrowed to expand the economy and held the U.S. dollar strong. If the U.S. departs from its policy of keeping the dollar strong, exchange rate movements could have a major impact on our performance. We intend to keep an eye on this in the second half.
Compared with the second quarter, TDK has seen an increase in orders in the third quarter. While this increase isn't as strong as in a typical third quarter, orders are increasing in the run-up to the year-end selling season, because European and U.S. mobile phone manufacturers have started to go on the offensive, and because Taiwanese PC manufacturers and HDD manufacturers have completed inventory reductions. The problem is how long this will last. We probably have to resign ourselves to a slight correction in the fourth quarter.
I believe the electronics industry will alternate between strength and weakness in the short term but has the strength to grow over the long term. With the broadband and digital convergence finally starting to take shape, TDK is intent on meeting market demands for new products that are compact, deliver high performance, are environmentally conscious, conserve power and can be bought at reasonable prices. We will deliver such products in a timely manner by drawing on our core technologies.
New products targeting the emergence of new markets are starting to contribute to our results. One example is small chip varistors for preventing damage caused by static electricity, a response to the increasingly diverse functions incorporated in mobile phones. Another is noise filters for automotive LAN systems.
With respect to capacitors, we are placing priority on responding to demands for increasingly higher capacity and lower inductance. Furthermore, we expect growth in products such as inverters for LCD multi-lamp backlight systems and DC-DC converters for hybrid cars, products that use TDK's distinctive low-loss ferrite materials. Transformers that use this high-performance material can contribute to energy conservation and thus environmental conservation.
In addition, we are adding products that will be useful in a ubiquitous society, such as products that respond to needs spawned by UWB (Ultra Wideband) communications and providing RFID-related solutions. Key to such products are TDK's core technologies-materials technology, process technologies (including multilayer and thin-film technologies) and evaluation and simulation technologies. By fusing and developing its current technologies, TDK wants to be a supplier of key components in the full-fledged ubiquitous age. And we will actively invest in R&D to this end.
While our operating income has improved somewhat, we have still to reach our goal of double-digit profitability. We will do what we have to, particularly with respect to further improving the profitability of low-margin electronic components, as well as improve profitability in recording media operations, while quickly developing new products demanded by the market to realize our vision of TDK as an Exciting Company.
Thank you for your attendance and I ask for your continued support and encouragement.