Mr. Seiji Enami
Finance & Accounting Department
Good afternoon. Thank you for taking the time and coming out in the cold to attend today's meeting. Your support for TDK is greatly appreciated.
I will now present TDK's consolidated operating results for the third quarter of fiscal 2005, the three-month period ended December 31, 2004. My presentation will follow the earnings release.
As the upper part of page 1 of the earnings release shows, both sales and earnings fell year on year. Net sales were down approximately ¥7.2 billion, or 4.0%, to ¥174,657 million. Operating income declined roughly ¥1.4 billion, or 7.8%, to ¥16,722 million. Income before income taxes declined 10.7% to ¥16,718 million and net income was down 13.6% to ¥12,209 million.
I'd now like to give you results for the first three quarters of fiscal 2005, the period from April 1 to December 31, 2004. These are shown on page 2 of the earnings release. For the nine-month period, net sales declined approximately ¥4.7 billion, or 0.9%, compared with the same period in fiscal 2004 to ¥493,427 million. Operating income, however, increased about ¥1.5 billion, or 3.4%, to ¥43,611 million. Income before income taxes rose 4.1% to ¥45,522 million, but net income declined 3.9% to ¥32,078 million. So, while operating income and income before income taxes increased, our bottom line fell. This was the result of an increase in tax payments due to higher dividends from overseas in the first half and third quarter of fiscal 2005. Basic net income per common share was ¥92.35 in the third quarter and ¥242.44 for the nine-month period.
From here, for the most part, I will report on consolidated results for the third quarter of fiscal 2005, the three months from October 1 to December 31, 2004.
Average third-quarter yen exchange rates for the U.S. dollar and euro were ¥105.92 and ¥137.19, respectively. The yen appreciated 2.8% versus the dollar and depreciated 6.0% against the euro year on year. This had the effect of lowering net sales by approximately ¥2.2 billion and operating income by approximately ¥0.9 billion.
There were three main reasons for the lower sales and earnings in the third quarter. One was the loss of a major customer in the fourth quarter of fiscal 2004 because this customer started producing heads internally. This compares with the third quarter of fiscal 2004 when earnings were extremely strong due to strong sales volumes and prices. There was a considerable recovery in the third quarter of fiscal 2005 in terms of volume due to our sales efforts following the loss of this customer's account, but this was negated by falling sales prices, the result of the prolonged lifespan of 80GB/P products. This meant that we were unable to achieve the same profits in HDD heads in the recording devices sector as in the previous fiscal year's third quarter. However, this decline was in line with our expectations. The second reason concerns the recording media business. Here, there was a sharp drop in DVD prices, which negated efforts to improve earnings by selling the loss-making software business in the previous year. Even now the recording media & systems segment remains unprofitable. We did not expect this to happen. The third main feature of our third-quarter performance concerns electronic components. In this area, we were able to increase profits more than sales, in part because of the benefits of ongoing structural reforms. This enabled us to absorb sales price discounts and the effect of the yen's appreciation against the U.S. dollar. Thanks to this increase in earnings in electronic components, we were able to limit the decline in our earnings as a whole.
Let's now look at a breakdown of sales, which is shown on the lower half of page 1. The breakdown shows our operating results for each segment, the share of sales for each segment and sector and the percentage change from the same period in fiscal 2004.
First, in the electronic materials and components segment, net sales rose 1.4% to ¥144.2 billion and accounted for 82.6% of total net sales. In electronic materials and electronic devices, year-end growth in demand was lackluster in respect of our components for digital home appliances, including LCD TVs, plasma displays and DVD recorders, mobile phones and PCs. We suspect that this was due to excess inventories of finished goods caused by a one-time surge in demand related to the Summer Olympic Games in Athens in the first half of fiscal 2005. Regarding recording devices, HDD sales volume continues to rebound. Because of severe price discounting pressure in each sector of the segment and the higher yen, the increase in sales was only slight.
Sales in the electronic materials sector were ¥43.0 billion, on a par with the previous year, and accounted for 24.7% of total net sales.
(Capacitors) Sales of capacitors were slightly down on the previous year. Sales of capacitors for use in automobiles were healthy, but an improvement in the sales mix alone was insufficient to allow TDK to absorb sales price discounts and the effect of the yen's appreciation in other market categories.
(Ferrite cores and magnets) Demand for metal magnets for HDDs surged.
As a result, capacitors accounted for 69% of sector sales, and sales were down 1% year on year. Ferrite cores and magnets accounted for the remaining 31%, and sales were up 3% year on year.
In the electronic devices sector, sales were ¥30.6 billion, up 5.6% year on year, and accounted for 17.5% of total net sales.
(Inductive devices) Sales of inductive devices increased on the back of higher demand for devices used in the expanding digital home appliances market, automobiles, which are being equipped with more electronics, and increasingly sophisticated mobile phones.
(High-frequency components) Sales of high-frequency components were up year on year due to higher volumes, particularly for mobile phone applications, and an improved product mix. These factors allowed us to overcome strong discounting pressure from customers, which stems from the continuing supply glut of components.
(Other products) Sales of other products rose year on year on extremely strong sales of DC-AC inverters for the industrial equipment market. Sales of sensors and actuators were largely unchanged.
In the third quarter of fiscal 2005, inductive devices accounted for 45% of total sector sales, up 3%. High-frequency components accounted for 11%, up 10%, and other products accounted for the remaining 44%, up 7%.
In the recording devices sector, sales were ¥65.3 billion, basically unchanged with a 0.1% decline year on year, and accounted for 37.4% of total net sales.
(HDD heads) HDD head sales were up on both a volume and monetary basis, the result of expansion in the HDD market. This was despite a decline in orders due to the in-house production of heads at a major customer, as well as strong discounting pressure from customers due to a longer lifespan for products.
(Other heads) Sales of other heads declined as a result of sluggish sales of optical pickups for DVD drives.
Overall, HDD heads accounted for 94% of total sector sales, up 4%, and other heads accounted for the remaining 6%, down 36%.
In the semiconductors & others sector, sales were ¥5.3 billion, up 10.7%, and accounted for 3% of total net sales.
(Semiconductors) Sales of semiconductors continued to decline due to softer markets.
(Others) Sales increased due to brisk external sales of manufacturing equipment.
In the recording media & systems segment, sales were ¥30.5 billion, 23.3% down year on year, and accounted for 17.4% of total net sales.
(Audiotapes and videotapes) Sales of audiotapes and videotapes were lower amid generally declining demand, although TDK retained its market share.
(Optical media) Optical media sales edged down year on year due to falling CD-R sales prices and sales volume. DVD sales rose as expanding demand in the DVD market sparked a precipitous drop in prices but a sharp increase in sales volume.
(Other products) Sales of other products were down year on year as a whole. Sales of LTO-standard* (Linear Tape-Open) tape-based data storage media for computers continued to rise steadily. However, lower sales due to the sale of a U.S. software development subsidiary in the previous fiscal year and sluggish sales of recording equipment as well as the downsizing and realignment of these operations brought overall sector sales down.
In the recording media & systems segment, audiotapes sales declined 32% and represented 6% of segment sales. Videotape sales were down 25% and accounted for 27% of sales. Sales of optical media products declined 2% and accounted for 44% of sales. Other products sales dropped 43% and accounted for 23% of segment sales.
Please turn to the third-quarter consolidated income statements on page 9. Operating income decreased ¥1.4 billion year on year. The main positive factors were higher sales, including improvements in the capacity utilization rate and product mix, which contributed ¥8.3 billion; lower materials costs contributed ¥3.9 billion; and rationalization and cost-cutting contributed ¥9.0 billion. Positive factors lifted earnings by a total of ¥21.2 billion.
Turning to factors that negatively affected earnings, sales price discounts had a ¥21.7 billion detrimental effect and exchange rate fluctuations had a ¥0.9 billion negative effect. These and other factors resulted in a combined negative effect on earnings of ¥22.6 billion, outweighing the positive factors and thus bringing operating income down ¥1.4 billion.
In the third quarter, price discounting was severe, particularly in respect of HDD heads in recording devices and DVDs in the recording media & systems segment, as well as in electronic components.
With respect to the other-net component of other income (deductions), a gain of ¥0.8 billion on the sale of a U.S. videogame software company was included in this account last year, but there was no such gain this year. Furthermore, while we recorded a foreign exchange loss due to the high yen, this was fortunately offset by an increase in equity in earnings of affiliates. As a result of these factors, other income (deductions) were more or less zero in the third quarter, meaning that operating income and income before income taxes were essentially the same.
Please look at the balance sheet on page 10 of the earnings release. I would like to discuss our financial position with reference also to the cash flow statements on page 11.
Total assets stood at ¥806.2 billion, a decrease of ¥1.8 billion, compared with September 30, 2004. The yen appreciated by ¥6.84 against the U.S. dollar, from ¥111.05 at September 30, 2004 to ¥104.21 at December 31, 2004. During the same period, the yen depreciated ¥4.57 against the euro, falling from ¥137.04 to ¥141.61. These changes had the effect of reducing yen translations of overseas assets by ¥16.0 billion and was a reason for the decrease in total assets.
Cash and cash equivalents at ¥235.3 billion were about the same as at September 30, 2004, decreasing only slightly by ¥0.7 billion. The main positive factors were net income and a decrease in inventories. On the other hand, in addition to the demand for cash in the third quarter, such as for paying year-end bonuses and interim dividends, trade receivables increased by about ¥5.9 billion. However, the trade receivables turnover was 2.6 months, compared with 2.7 months for the first half of the year, so this figure is not worsening.
Capital expenditures in the third quarter were ¥13.0 billion and depreciation and amortization was ¥13.6 billion. For the nine months to December 31, 2004, depreciation and amortization was ¥39.0 billion, compared with capital expenditures of ¥42.9 billion. So, capital expenditures are roughly within the bounds of depreciation.
In the third quarter, operating activities provided net cash of ¥20.6 billion, investing activities used net cash of ¥12.2 billion and financing activities used net cash of ¥3.9 billion. The effect of exchange rate changes was to reduce cash and cash equivalents by ¥5.2 billion. The net result was a decrease in cash and cash equivalents during the third quarter of ¥0.7 billion.
Accumulated other comprehensive loss, which is a component of stockholders' equity, increased ¥14.5 billion. Details of this account are provided in Note 3 on page 15 of the earnings release. In short though, foreign currency translation adjustments worsened by ¥12.3 billion due to the yen's appreciation versus the U.S. dollar. Minimum pension liability adjustments worsened ¥2.1 billion due to a ¥4.8 billion decrease in pension assets resulting from recent stock market sluggishness. Together, these factors raised the accumulated other comprehensive loss.
Please turn to the segment information on the top half of page 13.
First, operating income in the electronic materials and components segment edged up ¥0.1 billion, or 0.6%, to ¥19.0 billion, while the operating loss in the recording media & systems segment widened by ¥1.5 billion to ¥2.3 billion.
The electronic materials and components segment avoided a decline in earnings, with higher profits in electronic materials, electronic devices and semiconductors & others offsetting the large year-on-year decline in the recording devices sector.
Regarding the recording media & systems segment, lower earnings from optical media, especially DVDs, was one reason for the poorer performance. This was due to three factors. First, the fall in sales prices was greater even than the considerable fall we were expecting. Second, we were unable to lower the cost of internally produced products enough to respond to the rapid price drop. Third, we ran into difficulties in the initial stages of initiatives that were taken to reduce costs. In fact, these difficulties led to higher costs. Sluggish sales of recording equipment and actions to downsize and realign this business also contributed to lower earnings. For these reasons, the segment operating loss widened ¥1.5 billion to ¥2.3 billion.
At the very bottom of the page you will see a breakdown of sales by region.
In Japan, sales rose 6.6% to ¥49.3 billion, with higher sales in recording devices offsetting decreases in electronic materials, electronic devices and the recording media & systems segment.
In the Americas, sales decreased 19.4% to ¥19.8 billion. Sales of electronic devices increased, but sales in the electronic materials and recording devices sectors and recording media & systems segment decreased due in part to the appreciation of the yen versus the U.S. dollar.
Sales in Europe decreased 16% year on year to ¥18.7 billion. Sales of electronic devices increased. However, sales in the electronic materials sector and recording media & systems segment decreased, despite expectations that the weaker yen versus the euro would boost sales.
Sales in Asia and others declined 2% to ¥86.8 billion. Sales increased in the electronic materials and electronic devices sectors, but decreased in the recording devices sector and recording media & systems segment.
The overall result was a 7.6% decrease in overseas sales year on year to ¥125.4 billion. Overseas sales accounted for 71.8% of consolidated net sales, a 2.8 percentage point decrease from 74.6%. Naturally, Japan sales accounted for a higher share of consolidated net sales as a result.
In the middle of the page, you will find geographic segment information. Most significant are the dramatic recovery in earnings in Japan, before the elimination of inter-segment transactions, and the sharp fall in earnings in Asia and others, partly because of recording devices.
Finally, I would like to cover TDK's consolidated projections for fiscal 2005, ending March 31, 2005. These are shown on page 7.
Previously, we stated that we were projecting net sales of ¥680.0 billion, operating income of ¥60.0 billion, income before income taxes of ¥62.0 billion and net income of ¥46.5 billion. We are now projecting net sales of ¥660.0 billion, operating income of ¥60.0 billion, income before income taxes of ¥62.0 billion and net income of ¥44.5 billion. We are assuming an average yen-U.S. dollar exchange rate of ¥105 for the fourth quarter.
In respect of the core electronic materials and electronic devices sectors, growth in demand in the second half of fiscal 2005 is weaker than in the first half, when the Summer Olympic Games spurred demand. Demand over the year-end period was lower than expected. A rapid recovery in demand for components in the fourth quarter is not expected. Equally, however, a sudden drop is not expected either. Consequently, sales are forecast to fall slightly below our previous projection. In HDD heads, orders are recovering along with an upswing in demand for HDDs. Our revised projection includes a forecast for higher sales in recording devices than previously expected. In the recording media & systems segment, sales are expected to decline in the face of a greater-than-expected drop in prices for DVDs. As a consequence of the above assumptions, we have lowered our sales projection by ¥20.0 billion. Operating income and income before income taxes are the same as previously forecast, while we have lowered our projection for net income. This is due to the higher taxes on dividends I mentioned earlier.
Today, we also filed revised non-consolidated earnings forecasts with the Tokyo Stock Exchange. We revised our profit forecasts due to the booking of a ¥30.2 billion gain on the transfer of the substitutional portion of the Employees' Pension Fund liabilities following determination of the amount of transfer. To avoid any misunderstanding, I'd like to elaborate on this. TDK adopted pension accounting standards for its consolidated financial statements earlier than for its non-consolidated statements. Furthermore, the shortfall in pension assets was supplemented when we adopted the standards on a non-consolidated basis. Moreover, the unrecognized actuarial difference accompanying the change in system is booked as a one-time gain on a non-consolidated basis, but under SEC standards it must be booked over the remaining service period of 16 years. So the timing difference in the accounting treatment of this amount means a gain won't all be booked at once. We expect to book almost no gains on transfer on a consolidated basis for these reasons.
This completes my remarks concerning third-quarter operating results and our outlook for the fiscal year.