Investor Relations | IR Events | Performance Briefing

[ Financial Results for Fiscal 2005 Performance Briefing ]Q&A

Q1. The DVD discs business was extremely challenging in the past fiscal year. Do you see any signs of a recovery now? Some companies say that prices have stopped falling. How does TDK view current price trends?
A1. In the March 2006 fiscal year, we are forecasting another big increase in the DVD market. In fact, the market may almost double in size. There was a sharp drop in prices in the past fiscal year. But this fiscal year, we do not foresee such a steep fall in prices. We expect that the rate of decrease will be about half of what it was in the past fiscal year. Consequently, we do not believe that the decline in market prices has stopped.
Q2. Regarding DVD discs, we have seen the emergence in Taiwan of a cartel-like organization called the Recording Media Industries Association in 2005. It appears that this association is using collaboration among its members to prevent a drop in market prices. Could this type of association be formed in Japan?
A2. No.
Q3. Since PCs account for more than 90% of the demand for HDDs, what is TDK's view regarding the necessity of developing a head that achieves 160GB/P? If we assume that the 80GB/P head offers a sufficient level of performance for today's needs, then the introduction of 160GB/P products would theoretically cut demand in half. I believe we witnessed this same phenomenon four or five years ago. Do you think it could happen again? Is it possible that the number of heads would not decline even if 95% of the market switched to 160GB/P products?
A3. I believe that your question reflects your concern that a take-off in the market for 160GB/P technology would cause a drastic fall in the number of heads per HDD because there would be demand for only one head per HDD. TDK's position is that HDD manufacturers will make HDDs that use two 160GB/P heads. There may be cases where a single head is used. But most HDD makers are expected to introduce models that incorporate two 160GB/P heads.
Q4. You have provided an annual forecast on page 30 of the handout materials. Would you provide figures for the first half and first quarter at the same level?
A4. For the first half, net sales are 325.8 billion yen, operating income is 25.6 billion yen, income before income taxes is 27.4 billion yen, and net income is 19.0 billion yen. So we are forecasting a slight decrease in earnings. This forecast reflects the concentration of recording media business structural reforms in the first half. We cannot disclose first-quarter figures.
Q5. How much in recording media & systems segment restructuring expenses do you plan to record in the first half? Also, please provide a breakdown between first-half and second-half structural reform expenses in the recording media & systems and electronic materials and components segments.
A5. We plan to record restructuring expenses of 4.5 billion yen, approximately 4.0 billion yen in the first half and 0.5 billion yen in the second half. These expenses do not include the electronic materials and components segment because of the considerable progress we have made thus far with structural reforms.
Q6. If your head shipments will be 100 in the first quarter of this fiscal year, what is your forecast for shipments for the entire fiscal year?
A6. I will respond by using head shipments in the last fiscal year's first quarter as 100. At the previous information meeting, we told you that we expected shipments to rise to 142 in the fourth quarter of the past fiscal year. Actual shipments were 155. In this fiscal year, we are forecasting shipments of 145 in the first quarter and 160 in the second quarter. In the second half, we expect shipments to be even higher than in the first half.
Q7. Please discuss capacitor sales on a quarterly basis using an index. Also, how did capacitor earnings change from the third to fourth quarter? I would also like to know how the capacitor business has changed in the current fiscal year. Finally, please tell us your price assumptions for capacitors in the current fiscal year.
A7. Capacitor sales increased about 5% in the past fiscal year. Sales were weaker in the second half. Furthermore, fourth-quarter capacitors sales were lower than in the third quarter. We are forecasting a sales growth rate in the low single digits in the March 2006 fiscal year. Our current forecast is based on a discount rate in the double digits but below 15%. Therefore, we are planning on double-digit growth in terms of volume.
Q8. How much will effective operating income in the electronic materials and components segment increase in the current fiscal year? In addition, to give us an idea of where most of this growth will come from, please summarize the one-time positive and negative factors that affected the segment's operating income of 67.5 billion yen in the past fiscal year. In other words, what was the segment's effective operating income? You are forecasting segment operating income of 70.5 billion yen in this fiscal year. Please explain how you arrived at this figure.
A8. Last year's segment operating income of 67.5 billion yen includes a one-time gain of 5.0 billion yen of the total 6.2 billion yen gain from the return of the substitutional portion of the Employees' Pension Fund. And the 67.5 billion yen does not include semiconductor-related discontinued businesses.

So if you begin with 62.5 billion yen, which is last year's segment earnings less the 5.0 billion yen gain, we are projecting an increase of about 8.0 billion yen this year to 70.5 billion yen. By product sector, we expect that electronic devices will be the main source of this growth. We expect that inductive devices will have the greatest earnings growth. Next will be electronic materials. Presently, capacitors and heads are the primary sources of earnings. But it is unlikely that these earnings will continue to grow because of the intense pressure for discounting. Looking at other product categories, we are beginning to establish inductive devices, and sensors and actuators as our second core profit center. In addition, we are seeing an improvement in relatively low-margin businesses in other product categories because of actions we have taken to make them more profitable. Due to these factors, we plan to increase earnings this fiscal year in the electronic materials and components segment.
Q9. This is a question for Mr. Sawabe. The V-shaped recovery has, in a sense, brought earnings back to a suitable level. You stated that you are aiming for an operating income margin in the mid-teens. That means operating income of 100 billion yen. How do you plan to accomplish this? In other words, can this figure be reached through growth in established businesses? Or will this require new initiatives like mergers and acquisitions? Please outline a 15% operating income margin scenario?
A9. To generate an operating income margin of 15%, it is vital that we quickly stop the red ink in the recording media & systems segment. And in the head business, we must preserve the current profit margin. Naturally, we are also anticipating growth in our businesses, and we have good prospects for growth. In heads, we have distinguished our products from those of competitors, a feat that is leading to significant growth in orders from captive head makers. In addition, we are making progress in starting to supply heads for new applications outside the PC and server domains.

Electronic components are the problem. We have seen a big upturn in earnings. There have been improvements in inductors and other magnetic products. But profit margins are still low. We are now making a schedule for raising earnings by channeling R&D resources to promising fields like the environment and energy conservation. We want to develop materials that are smaller in size but deliver higher performance. Orders for power supplies for hybrid cars and other applications are climbing. We are seeing growth in applications for power supply transformers. We will consider mergers and acquisitions if they can generate synergies within our business domains and make TDK even stronger. However, the acquisitions we have made in the past have taught us that the success rate is extremely low when we target businesses that are outside our core business domains. So we will conduct mergers and acquisitions only in cases where a company is in a field in which we operate and we can thus evaluate and where we believe we can manage the company well.
Q10. How much did the return of the substitutional portion reduce pension expenses?
A10. You are asking how much the decline in pension expenses will be because of the return of the substitutional portion. The answer is 2.0 to 3.0 billion yen. This figure has already been incorporated in our plans for the current fiscal year.
Q11. The 2004 annual report stated that TDK pays 12.4 billion yen annually for royalties and patent licenses. How much did you pay for royalties and licenses last fiscal year for optical discs? And what was the impact on earnings? How will this change in the current fiscal year?
A11. In the optical disc business, a certain level of royalty payments is unavoidable. I cannot disclose the precise figure. These payments are included in our business plans. I think these payments will decrease because we are working on having them lowered. But there will be no change in the fundamental structure of these payments.
Q12. The outlook for head sales is for an 8% decline in sales between the past fiscal year's second half and this year's first half. Why are you projecting this decrease? In the current fiscal year, you are forecasting a 19% volume increase in heads and 8.3% growth in sales, based on a unit-price drop of about 10%. Where do you expect the biggest drop in unit prices among the 3.5-inch, 2.5-inch, 1.8-inch and 1-inch categories? If possible, please give us an idea of how much you think prices will drop in each category.
A12. The figures in our plan are conservative numbers. Due to seasonal factors, we always see a drop in sales volume in the fiscal year's first half, so our plan for the current fiscal year includes a similar drop. However, no volume decline is occurring yet. Orders from customers are strong. Nevertheless, volumes always decline in April, May and June, so we think there'll be an inventory adjustment in the near future. Regarding price discounts, we are projecting an average annual price decline of 14% to 15%. I cannot provide separate figures for 2.5-inch and 3.5-inch drives.
Q13. The handout materials include data on the shift in 3.5-inch drive sales composition of 80GB/P products for the March 2005 fiscal year. Can you provide ratios for these products for each quarter of the current fiscal year?
A13. In the current quarter, the 80GB/P share of the 3.5-inch drive market is roughly 62%. We expect this to be 41% in the second quarter, 32% in the third quarter and 27% in the fourth quarter. So these heads will decline but they will not go away. The 100GB/P share is 26% in the current quarter and will be 32% in the second and third quarters and 31% in the fourth quarter. Turning to 120GB/P-133GB/P products, the share is 12% in the first quarter and will rise to 27% in the second quarter, 36% in the third quarter and 41% in the fourth quarter. In the fourth quarter, 160GB/P products will emerge with a share of about 1%.
Q14. If results are adjusted for the gain from the return of the substitutional portion, operating income declined in fiscal 2005 from fiscal 2004. Is this because of a greater than expected fall in earnings in the capacitor and recording media categories. And can we assume that the decline in HDD head earnings did not exceed your projections?
A14. The decline in HDD head earnings did not exceed our projections.
Q15. You have stated that you are forecasting a 14% to 15% decline in HDD head sales prices in the current fiscal year. Please comment on current market conditions.
A15. We are expecting an average fall of 14% to 15% in sales prices. Since the price of 80GB/P products has been declining for some time now, we do not expect the average sales price decline to be more than this.
Q16. Once perpendicular magnetic recording technology gains acceptance, I believe that we will see average annual growth of about 100% in recording density during the following two years. How do you think this would affect the number of heads per HDD? And can you provide the latest information on this subject for each HDD size?
A16. I think that raising recording density at an annual rate of 100% is feasible from a technological standpoint. However, this would probably occur only for 1-inch and 0.85-inch drives. Regarding 2.5-inch drives, I think that we are already at the point where perpendicular recording can be used to produce 80GB/P models. When it comes to mass production of perpendicular recording 2.5-inch and higher drives, though, even if the heads can be fabricated, it will be very difficult to produce the discs. Consequently, I think that 100% annual growth in recording density will occur only for 1-inch and smaller HDDs. The current longitudinal recording method will undoubtedly continue to be used for 3.5-inch and 2.5-inch drives for the next two or so years.

Furthermore, TDK agrees with the current consensus that 2.5-inch drives will replace 3.5-inch models once 80GB/P technology is used. On the other hand, we believe that this replacement process will require two to three years because these 2.5-inch drives are more costly than 3.5-inch drives.
Q17. I have heard that TDK has started medium-volume production of TMR heads. Are your yield figures on target during this start-up process? And do you expect that growth in TMR head demand will raise the number of TDK's HDD head customers?
A17. I cannot disclose data on production yield, but I can say that the yield is higher than for the 133GB/P GMR head. We would like to increase the number of customers.
Q18. Please discuss the fourth-quarter downturn in production yields for capacitors. What was the cause? How much did your profit margin drop from the third quarter in the fourth quarter? And what is the status of actions to remedy this situation?
A18. There was a decline in production yields when we started manufacturing new types of capacitors. However, we determined the causes last March, so I don't think capacitor profitability will be impacted by yield problems in the current fiscal year.
Q19. TDK has property and equipment of about 200 billion yen. How much of this is in the recording media & systems segment? And what does Mr. Sawabe believe is a suitable level of earnings relative to this asset base?
A19. About 23.0 billion yen is in the recording media & systems segment. Although I don't view this level of assets as satisfactory, we will be disposing of our pre-production processes for VHS videocassettes, as was mentioned earlier. Regarding profitability, we are aiming for a profit margin of at least 10% for Blu-ray discs and data storage tape products. I think it will be difficult to achieve a 10% profit margin for DVDs, though, because we purchase some disks and there is a large volume of ODM (original design manufacturer) products in our sales. As explained earlier, we expect to achieve a big cut in selling, general and administrative expenses. I can't give you a number right now because we are still studying how much we should aim for.
Q20. TDK reported fourth-quarter operating income of about 16.3 billion yen. How much was operating income after exclusion of the quarter's gain on the return of the substitutional portion, the effect of discontinued businesses, streamlining expenses and other special items?
A20. The 16.3 billion yen includes a 6.2 billion yen gain on the return of the substitutional portion, so we generated operating income of about 10 billion yen from ordinary business operations. These earnings include the impact of about 2.6 billion yen in structural reform expenses.
Q21. So after deducting 6.2 billion yen for the return of the substitutional portion and adding 2.6 billion yen for structural reforms, fourth-quarter operating income was effectively 12.5 billion yen. Is that correct?
A21. Yes.
Q22. Your operating income forecast for the first half of the current fiscal year is 25.6 billion yen. That's about twice the effective operating income of 12.5 billion yen in the fourth quarter. Since you are expecting an improvement in capacitor earnings, shouldn't you be projecting a higher level of operating income for this period?
A22. Our plans for the first half include structural reform expenses of 4.0 billion yen in the recording media & systems segment.
Q23. The presentation by Mr. Shikanai gave us a very good picture of TDK's stance regarding the recording media business. But my impression is that patent licensing payments rise with volume and that competition with hard disks and other media is creating a difficult operating climate. In this environment, what is your outlook for optical disc demand? I think this may have been a problem five or six years ago when Mr. Sawabe was named president. Looking back, TDK has failed to generate earnings from optical discs during this time even though the company assigned many talented engineers to this business. Looking ahead two or three years, do you really think the recording media & systems segment can generate meaningful earnings as we see a big drop in the price of LTO-standard tapes. I know you have discussed this before, but please tell us why we should believe that TDK can sustain recording media & systems segment earnings at the 1.0 billion yen level that you are forecasting for the current fiscal year.
A23. As was explained earlier, we are reducing the share of optical disks that we manufacture ourselves. Because of this, we are seeing a big drop in payments of patent licensing fees. Looking only at optical disks, these fees are less than 1.0 billion yen. It appears that you are concerned about the outlook for the recording media market. There's no doubt that we will see growth in demand for various recording formats, including flash memories and hard disks. TDK's focus is on removable media. There are many opinions concerning the outlook for demand in this category. DVD video recorders are a good illustration of our assumptions.

The DVD video recorder is spawning a new source of demand for the storage of programs on a hard disk so that a library of programs and other content can be accumulated. This so-called "library business," or "storage business," did not exist when people used videocassette decks. These decks are used mainly for time-shift recording. But DVDs will be used for libraries. That will create enormous demand because individuals will use many disks each month. In the optical media world, enormous growth in demand was seen for CDs when this format appeared. Now we are seeing the same trend emerging for DVDs. So we do not have any major concerns about prospects for the DVD market. I think that new applications will appear as these discs coexist with hard disks, flash memories and other media. But how do we generate a profit in this environment? As was discussed earlier, the only way is to restructure our businesses. And we must do this as quickly as possible.
Q24. You are projecting a 7.4 billion yen improvement in recording media & systems segment earnings this fiscal year. If possible, can you tell us how much fixed expenses will contribute to this increase?
A24. We are projecting contributions of 2.5 billion yen from fixed selling expenses and 1.0 billion yen from fixed manufacturing expenses.
Q25. Fourth-quarter head sales were slightly higher than in the third quarter. Was there an improvement in the profit margin?
A25. There was an improvement, but I cannot provide details.
Q26. I believe that head manufacturing capacity is becoming insufficient as output volume rises. What are TDK's planned capital expenditures this fiscal year for heads, and how much are head-related depreciation expenses in the past and current fiscal years?
A26. Heads accounted for about half of our 61.0 billion yen in capital expenditures in the past fiscal year. This year, we are planning to make capital expenditures of 65.0 billion yen and expect that heads will account for about 45% of these outlays.
Q27. In the HDD drive industry, Seagate is raising its market share by using advanced head technology. How does TDK's HDD head technology compare with Seagate's and the technology used at your other competitors? Also, please tell us if there is a possibility of a big shift in industry composition due to technology-based competition. You mentioned captive head makers earlier. I believe that you are projecting that sales to captive makers will account for 35% to 40% of TDK's head sales. How do you think this share will increase from the standpoint of head technology?
A27. We do not believe that we are behind our competitors with regard to TMR technology. Regarding heads for perpendicular recording, I have not seen the products of other companies. But TDK has completed a design for these heads. We are at a medium-volume output level where we are determining how to achieve the desired production yield. I think it will take about six months to prepare for mass production of these heads.

Captive makers are expected to account for 25% of head sales volume in the first half and 27% in the second half.

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