Investor Relations | IR Events | Performance Briefing

[ 1st Half of fiscal 2006 Performance Briefing ]Q&A

Q1. TDK is projecting operating income of 68.0 billion yen for fiscal 2006. Could you please break this figure down between the electronic materials and components segment and the recording media segment? Also, has there been any change to your planned 4.5 billion yen in structural reform expenses for the full fiscal year? Please explain how these expenses are split between the first and second halves and also by segment.

My second question is about first-half results. Second quarter sales in the electronic materials and components segment were 14.1 billion yen higher than in the first quarter. However, operating income increased by only about 1.4 billion yen. If possible, could you please explain in terms of product categories why earnings didn't increase in proportion to the increase in sales?
A1. Regarding the operating income projection, since the first-half results have now been released, you can calculate the second-half forecasts for each segment by deducting the first-half results from the full-year forecast. In the recording media segment, the operating loss isn't expected to be as bad as in the first half. However, we are still forecasting an operating loss due to structural reform expenses. The remainder of the operating income forecast represents the operating income for the electronic materials and components segment.

As we explained at the earnings conference at the start of the fiscal year, we budgeted a total of 4.5 billion yen for restructuring expenses for fiscal 2006, 4.0 billion yen for the first half and 0.5 billion yen for the second half. We stated that all these expenses were to be incurred in the recording media segment. In actuality, first-half restructuring expenses were only 1.3 billion yen. Nevertheless, in the second half, we plan to take a charge for the remaining amount of the expenses budgeted for the first half as well as the 0.5 billion yen originally planned for the second half. These restructuring expenses of 4.5 billion yen are incorporated in our projections for the full year.

Regarding the comparison between the first and second quarters, earnings didn't track the increase in net sales mainly because of production-related problems with capacitors, which meant that profitability failed to recover as much as we had expected. Other than that, there were no major changes in the electronic materials and components segment.
Q2. Based on your remarks, I calculate that operating income in the electronic materials and components segment will improve from 32.3 billion yen in the first half to 44.0 billion yen in the second half of fiscal 2006. What products will drive this improvement? Please provide the amount and extent of the contribution for each product.
My second question concerns HDD head shipments by quarter. Please also discuss profitability for HDD head operations in the second half.
A2. Problems with capacitors worsened considerably in the fourth quarter of fiscal 2005 and this situation spilled over into the first quarter of the current fiscal year. There was an improvement in the second quarter, but the situation was less than satisfactory. However, our performance in September gives us confidence that profitability has finally started to improve. We thus expect a significant recovery in the capacitor business in the third and fourth quarters. This is the single biggest reason for the projected improvement in operating income between the first and second halves. We are also forecasting better earnings in other businesses on expectations for higher sales in the third and fourth quarters than in the first and second quarters.

Regarding your question about HDD heads, at the previous earnings conference, we stated that, if fiscal 2005's first quarter was 100, actual shipments were 154 in this fiscal year's first quarter and were projected to be 163 in the second quarter. Actual second-quarter shipments were 160, down 3 points on our projection. At the same earnings conference, we stated that our projections for the third and fourth quarters were 174 and 167, respectively. We are now more upbeat about the second half of the year and are forecasting shipments of 185 and 183 for those two quarters, respectively.

Discounting, however, is extremely severe. Furthermore, with sales of 80GB/P products accounting for a greater share of sales than we had expected, we are projecting second-half earnings on a par with the first half in HDD heads.
Q3. Please provide details of changes in absolute sales figures for capacitors in the first and second quarters as well as forecasts for the third and fourth quarters. Please also explain recent price trends.

I'd also like to ask a question about the treatment of goodwill on TDK's acquisition of the Lambda Power Division. There is a difference in opinion among accountants in Japan about the amortization of goodwill. Will TDK treat the goodwill as it has in the past or will you be applying the new standards in Japan?
A3. Let me address you question about Lambda Power Division goodwill first. At this stage, we cannot answer your question with accurate figures because we are yet to evaluate the assets in detail. In terms of SEC standards, there may be some assets which must be treated immediately as expenses, whereas intangible assets are normally amortized over a number of years. Goodwill is not amortized; instead, impairment accounting is applied. We will be examining this matter over a period of some months. We will use the findings of this examination to determine which items to expense immediately and which items to amortize. So I'm sorry, but I can't provide you with any numbers now.

Regarding your question about capacitors, first-half sales dropped about 10% year on year. For the third and fourth quarters, our current forecasts are for year-on-year increases of around 10%. Accordingly, we are projecting sales for the full year on a par with the previous fiscal year, with third- and fourth-quarter growth offsetting declines in the first two quarters.

Regarding capacitor prices, there was a drop of several percent between the first and second quarters. We expect a further decline of 2-3% in the third quarter and again in the fourth quarter. For the full year, therefore, prices may drop by more than 10%.
Q4. My question concerns the HDD head business. Compared to the first half, you are forecasting a large increase in volume in the second half but flat earnings. Yet you are also assuming an exchange rate of 100 yen to the U.S. dollar for the second half. Assuming sales prices are all denominated in U.S. dollars, would a second-half exchange rate of 110 yen increase earnings, or would second-half earnings still be flat in comparison with the first half?

I'd also like to ask a question about the share of head shipments for 3.5-inch and 2.5-inch HDDs. Please provide quarterly figures in percentage terms by platter size. Also, is there likely to be any change in the share of TMR head shipments between now and the fourth quarter and the first and second halves of fiscal 2007?
A4. Regarding exchange rates, basically if the yen depreciates, this will raise foreign exchange gains. However, earnings would not necessarily increase by the amount of those gains.

Regarding the share of head shipments by HDD type, 80GB/P products for 3.5-inch drives accounted for 57% of shipments in the second quarter. We expect this share to drop to 43% in the third quarter and then further to 34% in the fourth quarter. 100GB/P products represented 26% to 27% of shipments in the fiscal 2006. 120~130GB/P products accounted for 17% of shipments in the second quarter. In the third and fourth quarters, they are expected to account for 31% and 35%, respectively. 160GB/P products are forecast to represent 4% of shipments in the fourth quarter.

You asked also about TMR heads. We expect all 60GB/P products and above for 2.5-inch HDDs to use TMR heads. As a result, we expect the share of TMR heads to rise from 3% in the second quarter to 7% in the third quarter and then to 13% in the fourth quarter. We expect that TMR heads will still be below 30% of shipments during the first half of fiscal 2007. However, we foresee a major change in the second half of fiscal 2007, with more than 50% of shipments accounted for by TMR heads.
Q5. First-half operating income in the electronic materials and components segment was 32.3 billion yen and you are projecting a 10.0 billion yen increase in the second half. Assuming that the Lambda Power Division contributes 2.0 billion yen to operating income in the second half, that means there must be an improvement on a continuing operations basis of 8.0 billion yen. However, Mr. Kamigama stated that second-half earnings from HDD heads would be flat compared with the first half. Would it be correct therefore to assume that the 8.0 billion yen will be generated by the electronic materials and electronic devices sectors? Furthermore, would operating income be flat if second-half head sales were 6-7 billion yen less than in the first half? Your forecast for operating income was raised by 1.0 billion yen from 67.0 billion yen to 68.0 billion yen. Could you please explain in a little more detail your plan for the second half in light of this revision? I'd also like to ask about sales in the other electronic components sector, which you are projecting will fall from 13.4 billion yen in the first half to less than 10.0 billion yen in the second half. What is your basis for this projection?
A5. I think your question concerns the basis for our forecast that operating income in the electronic materials and components segment will exceed the first-half result by about 10.0 billion yen. One reason for this projected increase is capacitors. Capacitor sales began to show signs of increasing in the second quarter, leading us to project improved earnings on even higher sales in the third and fourth quarters. Another reason is our forecast for higher earnings from inductors. Many other electronic components are also expected to deliver better earnings in the second half of fiscal 2006.
Q6. Would earnings increase from products other than HDD heads if the exchange rate is 100 yen to the U.S. dollar as assumed?
A6. If the actual second-half exchange rate is 110 yen to the U.S. dollar, the 10 yen difference from our assumed rate of 100 yen for the second half would boost earnings in the form of exchange rate gains. However, because of intense discounting pressure, earnings might not necessarily increase by the same amount as the exchange rate gains from the yen's depreciation.

Furthermore, in the other electronic components sector, there is a division that isn't discussed much called Mechatronics, which makes industrial machinery equipment. This division has performed relatively well to this point, with sales increasing. However, because we don't think that the current levels of private-sector capital expenditures are sustainable for a long time, we are forecasting a drop in sales in this division in the second half. Furthermore, we expect sales of anechoic chambers to fall slightly in the second half. This business is also included in the other electronic components sector.
Q7. I'd like to confirm your assumptions for depreciation expenses and R&D expenses. Looking at the handout, there seems to be no change from your previous figures. But if one simply uses the first-half results to calculate these expenses for the second half, there seems to be a 10.0 billion yen increase from the first half in depreciation expenses and R&D expenses. Does this mean that the figures simply haven't been revised and that they won't actually increase by that much? Or does it mean that TDK will post higher operating income in the second half of fiscal 2006 as explained today while absorbing this sort of increase in fixed expenses?
A7. At the start of the fiscal year, we said that depreciation expenses would be 60.0 billion yen. If you simply double the actual depreciation expenses in the first half of 26.5 billion yen, the full-year amount would be 53.0 billion yen. I believe your question refers to the reason for the difference of 7.0 billion yen. We believe that depreciation expenses will be close to 60 billion yen because we will start depreciating certain capital investments. The addition of Densei-Lambda K.K. and other companies to the TDK group will also result in some additional depreciation expenses and amortization of goodwill.

At the start of the fiscal year, we stated that R&D expenses would be 40.0 billion yen. If you simply double the actual expenses in the first half of 18.4 billion yen, the full-year amount would be 36.8 billion yen. But with R&D expenses also, we are planning higher R&D expenses in the second half of the fiscal year than in the first half. With the addition of R&D expenses at Densei-Lambda, we are projecting R&D expenses of close to 40.0 billion yen, if not slightly more than that.
Q8. TDK has been bringing to market a number of new products, most notably inductive devices. Is the projected increase in operating income in the second half compared with the first half in the electronic materials and components segment due to the benefits of an improved product mix from these new products? Mr. Enami, the General Manager of the Finance & Accounting Department, said before that other electronic components would improve the profitability. Is my understanding correct?
A8. Our forecast at the start of the fiscal year was for new products to account for 31% of net sales, but they have risen to 34-35%. We now think that new products will also account for a greater share of sales in the second half than we initially projected. We make new products to minimize the effects of falling prices of existing components and to raise profitability. If new products perform better than planned, we think this has a beneficial effect on earnings. However, I cannot answer your question accurately because we have still to perform detailed calculations. That said, we would expect that a higher ratio of new products would lift earnings.
Q9. Earlier you discussed the growth in earnings in the electronic materials and components segment from the first quarter to the second quarter. How did profitability in HDD heads trend? I believe that earnings in capacitors, while low, recovered in the second quarter from the first quarter. Could you please specify the level of improvement in profitability in percentage point terms?
A9. Second-quarter capacitor margins were only slightly better than in the first quarter, with margins finally improving in September. With regard to HDD heads, discounting was more severe in the second quarter than the first quarter. We also experienced problems with production yields when we started shipping new products. As a result of these factors, profit margins were slightly worse in the second quarter than in the first quarter.
Q10. Actual shipments of HDD heads were lower in the second quarter than forecast. Yet for the third quarter you have increased the forecast that you issued three months ago. Moreover, you expect fourth-quarter volumes to remain at a very high level despite seasonal corrections. Please explain the market trends that are behind these forecasts. Also, what share of your HDD head volume is accounted for by captive head makers? At your business explanation meeting held on October 5, TDK stated that it planned to increase the assembly of hard disk drives. Please provide the schedule for this increase for the next fiscal year.
A10. HDD head shipments in the second quarter fell short of our July forecasts. This was mostly due to the slow emergence of demand for 125GB/P products. However, we expect to see demand start to increase steadily in the third quarter. HDD makers are purchasing more heads from external manufacturers such as TDK. Naturally, our share has climbed as a result. However, demand itself is strong, leading to our upbeat forecast of 185 mentioned earlier for the third quarter. In the fourth quarter, we expect companies that produce HDD heads in-house, so-called captive manufacturers, to account for a higher share of our HDD head sales. These manufacturers represented 24% of our head sales in the first half, but this is expected to rise to an average of 31-32% in the second half.

At our October 5 business explanation meeting we did indeed talk about assembling HDDs on an OEM basis. We are currently holding discussions with two companies. However, this business will not commence until the second half of fiscal 2007 at the earliest. Since negotiations are underway, we can't be more specific.
Q11. You said that you expect 160GB/P products to account for several percent of shipments in the fourth quarter. If that is the case, I would expect TDK to be shipping a greater volume in the first quarter of fiscal 2007. If the head price of 80GB/P products is assumed to be 100 at that time, would you expect the price of 160GB/P products to be 200?
A11. That depends on customers. It also depends on whether the heads are of the HGA or HSA type. So, I can't generalize, but I don't think the price would double.

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