Investor Relations | IREvents | Performance Briefing

[ Performance Briefing]Q&A

Q1. My question concerns capacitors. First, I would like to confirm the third-quarter results that TDK posted in this product category: based on the presentation materials, it seems that capacitor sales dipped slightly relative to the previous quarter. Why was this? Second, I would like to check TDK's position on capital investment in this area. In the previous conference, we heard that TDK planned to raise monthly production capacity from 17.0 billion to 20.0 billion units by spring 2007, but the third-quarter data suggest this plan may have changed. Could you please confirm your progress to date in expanding production capacity?
A1. Capacitor sales in the third quarter were largely unchanged compared with the second quarter. On the question of capital investment, we finished raising monthly production capacity to 17.0 billion units during September 2006. On current plans, we expect to complete the ongoing shift to 20.0 billion units per month by the end of September 2007.
Q2. Given the higher production capacity, one would perhaps have hoped for a little more from capacitor sales in the third quarter. At the interim earnings release conference, you said that you expected growth in sales over the second quarter in the high single digits. How do you explain the gap between projected and actual performance?
A2. Although we finished expanding monthly production capacity for capacitors to 17.0 billion units in September 2006, our capital investment program in this area has still lagged behind that of competitors. We believe that these delays in capacity upgrading during the fiscal first half created delivery lead-time issues with some of our mainstay high- and large-capacitance capacitors, and this cost us market share. Our estimates suggest that this may have had a negative impact on capacitor sales in the third quarter as well.
Q3. What guidance are you providing for capacitor sales in the January to March quarter?
A3. Setting sales in the first quarter of fiscal 2006, the three-month period from April to June 2005, at 100, sales for the October to December 2006 quarter were 129. On that basis, we expect capacitor sales in the fourth quarter to be around 120.
Q4. What trend are you seeing in capacitor margins?
A4. Capacitor margins in the third quarter were roughly the same as the second quarter. We expect margins to be flat in the fourth quarter due to the compensating effects of factors such as higher production yields.
Q5. My question concerns HDD heads. First, what quarterly trend are you seeing in shipment volumes? Second, what proportion of sales derives from heads with femto sliders, and how do you see this ratio increasing going forward? Third, with the shift toward perpendicular magnetic recording (PMR) technology, at this stage what are your thoughts on the impact of PMR on head number in PC drives, especially in the 3.5-inch drive segment?
A5. Setting HDD head shipment volumes in Apr-Jun 2005 at 100, quarterly volumes for the rest of that year were 103 in the second quarter, 124 in the third quarter and 129 in the fourth quarter. On the same basis, quarterly volumes in the fiscal year to date were 111 in the first quarter, 130 in the second quarter and 131 in the third quarter. For the fourth quarter we project a level of 130. In terms of the volume ratio by head type, in the third quarter the ratio was 45% for heads with femto sliders against 55% for pico sliders. Currently, we expect the femto-pico mix to cross over during the fourth quarter, with the femto ratio rising to 64% and the pico ratio falling to 36%.
Q6. Over the next fiscal year, how do you see head number shifting with PC drives as the introduction of PMR technology progresses?
A6. In 3.5-inch drives, we expect head number to edge downward from 2.8 to 2.78. In 2.5-inch drives, we do not expect the number to change as much as that, although it may fall slightly from the current average level of 2.9.
Q7. Subtracting the nine-month cumulative total from your full-year projection for operating income, your forecast for fourth-quarter operating income is a little over 20.0 billion yen. This figure is less than the third quarter actual. Are lower HDD head sales the main factor in this projected dip in profit? Please explain.
A7. Our full-year estimate for operating income is 82.0 billion yen. We are forecasting operating income of 20.6 billion yen in the fourth quarter. Your supposition is correct: we expect lower head sales to be the primary factor behind a drop in profit relative to the third quarter.
Q8. What was the GMR-TMR-PMR split for HDD head shipment volumes in the third quarter? How do you see these numbers moving in the fourth quarter and over the coming fiscal year?
A8. I believe that our explanation of the TMR-PMR shift at the previous conference may have been confusing, so this time I will answer the question by looking first at the shift from GMR to TMR and then at the PMR ratio. The sales proportion of TMR heads by volume was 24% in the first quarter, 31% in the second quarter and 46% in the third quarter. We expect this ratio to increase to 58% in the fourth quarter. Turning to the PMR ratio, this was almost zero in the first quarter, but jumped to 6% in the second quarter, 8% in the third quarter, and we are projecting 10% for the fourth quarter. We are currently examining the likely trends during the next fiscal year, but we are confident that both the TMR and PMR ratios will increase further.
Q9. On a US GAAP basis, what was the contribution of the Densei-Lambda Group to TDK's consolidated performance during the third quarter? What level of operating income are you projecting for the Densei-Lambda Group in the current fiscal year?
A9. The Densei-Lambda Group announced its results for Oct-Dec 2006 yesterday. The company recorded a small operating loss for the quarter. Under Japanese accounting rules, the acquisition-related goodwill will be completely written off during the current fiscal year ending March 2007. Since we use SEC standards when compiling TDK's consolidated accounts, the Densei-Lambda Group will record an operating income of several hundred million yen for the third quarter.

The Densei-Lambda Group is projecting higher sales from its uninterrupted power supply (UPS) business during the fourth quarter. Its forecast for non-consolidated operating income in the current fiscal year is around one billion yen. Once we take into account the goodwill write-off, we expect this division to contribute to TDK's full-year results by at least this amount at the consolidated level.
Q10. In HDD heads, when do you expect the TMR ratio to level off?
A10. We are in the process of switching out of GMR heads through the introduction of new HDD head product lines based on TMR. However, the question of exactly when our existing lineup of GMR heads will be phased out depends on sales trends at our leading customers. So at this stage it is not possible to give a precise answer to your question.
Q11. What degree of price erosion did HDD heads suffer in the third quarter relative to the second quarter? Is it feasible for the HDD heads business to achieve higher sales and profits in the coming fiscal year? Also, what is TDK's strategic and conceptual approach to this business?
A11. Quarter-on-quarter price erosion in HDD heads was in the 3-4% range during the third quarter, which was more or less in line with our expectations. For next fiscal year, we estimate the size of the HDD market at 500 million units, with the market for head gimbal assemblies (HGAs) expanding as well. We expect HDD unit prices to suffer further erosion. In light of this, we are looking at ways of cooperating with leading customers to make our offering more competitive. While higher sales volumes will offset erosion to some extent, we anticipate that operating conditions in this market will be as least as harsh as those we have experienced to date. We are in the process of drawing up plans for this business with these various considerations in mind.
Q12. Are you considering any business development ideas in this sector that diverge from the path taken to date, such as undertaking more HDD assembly work? Or do you still see the HDD heads business as the main earnings driver for next year?
A12. We are always looking to develop win-win relationships with our customers through cooperation in various forms. In doing so, we aim to establish a solid operating structure in the HDD head business.
Q13. Your explanation that supply remains tight in the capacitor market sits oddly with the fact that TDK managed to lose share during the third quarter. The impression given at the previous earnings conference was that you expected TDK's market share to rebound during Oct-Dec 2006, but the figures show that this did not materialize. What went wrong? Also, could you please provide any indications, targets or thoughts relating to the projected growth of the large-capacitance capacitor segment in 2007 and to TDK's forecast growth in sales within this sector?
A13. Conditions are extremely favorable in the capacitor market. We maintained our monthly production capacity at 17.0 billion units during the third quarter. However, as stated earlier, our capital investment program has lagged behind that of competitors, which has led to delivery lead-time problems with some of our mainstay high- and large-capacitance capacitor lines. As a result, we lost some market share, and sales in the third quarter were merely on a par with the second quarter.
Q14. Supply remains tight in the capacitor industry. In a market where customers are scrambling to secure supplies, isn't it easy to find new customers even after the loss of market share due to delivery problems? Or, will you find it difficult to increase sales if the delivery problems that plagued you in this quarter persist into the next quarter, even with higher production capacity?
A14. We acknowledge that we had some problems in the third quarter. We expect to have these delivery issues fully resolved from the fourth quarter onward, which we anticipate will eliminate any related market-share drag.
Q15. What operating conditions do you expect in the capacitor business during 2007?
A15. We expect to see further steady progress. We see the capacitor market growing at a double-digit pace in volume terms, with value growth in single digits.
Q16. Factoring in the start-up costs incurred in the second quarter, it looks like the operating profit generated by the electronic materials and components segment was basically flat in the third quarter relative to the second quarter. Given that sales of HDD heads dipped in the third quarter and sales of other products were virtually flat, the fact that this segment generated a similar level of profit presumably points to a lot of hard work on TDK's part. Could you provide any more details? Also, are you expecting to incur any further start-up costs in the fourth quarter?
A16. As you pointed out, sales posted by the electronic materials and components division did not generate much growth in the third quarter relative to the second quarter. Capacitors were one of the main factors. In HDD heads, operating income did not decline much despite a significant dip in sales; in fact, the level of profit was not that different from what we achieved in the second quarter this year or the third quarter last year. The major contributory factor was higher production yields. Another factor was that recording media turned a slight profit. The rest was attributable to good sales performances from other electronic components.
Q17. Sales of HDD heads declined from the second quarter to the third quarter, so should we conclude that TDK generated higher profits in the third quarter from other electronic components?
A17. Correct.
Q18. Sales of capacitors fell in quarter-on-quarter terms, but this did not seem to have an impact on operating income. Was this due to higher depreciation and amortization?
Sales of capacitors fell in quarter-on-quarter terms and I assume depreciation and amortization costs went up, but these factors do not seem to have had an impact on operating income. Can you confirm this?
A18. The sales decline in capacitors was very slight-certainly not large enough to have any impact on profit. Capacitor profitability remains on a slight upward trend.
Q19. If your production yields on HDD heads are increasing and you expect further gains in the fourth quarter in this regard, presumably even a dip in sales would not result in much of a dent to profits?
A19. Well, it would be nice to think so-but given the level of aggressive discounting in the marketplace, we would not presume to entertain any such expectations.
Q20. How do you plan to raise TDK's market share in HDD heads during the coming fiscal year? What are your expectations about TDK's share? Growth in the third quarter over the second quarter was virtually flat on a volume basis, but undershot your target by a small amount. Please tell us what you intend to do, including your approach with those manufacturers that produce HDD heads in-house.
A20. We are currently formulating market share targets for the coming fiscal year as part of our planning process. But the basic strategy will be to advance beyond the 31% share we currently have by securing new customers while also gaining share through our existing customer base. However, at this stage we cannot afford to be particularly bullish-for instance, a five-point gain in share does not look feasible at the moment. Nonetheless, our focus remains firmly on activities aimed at boosting our market share, rather than merely settling for maintaining our current share.
Q21. Do you think that you can realistically gain share in the HDD head market going forward, given that TDK does not supply the largest HDD manufacturer and that there is a possibility that your customers could lose share within the HDD market?
A21. We are working hard to make market share gains a reality.
Q22. The ratio of HDD heads using PMR technology is set to increase going forward. What is your forecast for the PMR ratio for next fiscal year? Also, what overall effect do you expect the shift to PMR technology to have in terms of unit prices, production yields, profitability and other factors?
A22. As we explained earlier when we were talking about the qualification schedule, we are shifting all new HDD heads to perpendicular recording technology. We expect the ratio of such PMR heads to reach 10% in the fourth quarter and to keep on rising steadily thereafter. However, given the projected long life of the 160GB/P products for 3.5-inch drives in our existing lineup, we cannot say at this point exactly when the shift to PMR will be completed. What we can say is that the proportion of new products within the HDD head lineup will increase steadily, and so the PMR ratio is definitely set to rise.

In terms of the effect that the PMR shift will have on our HDD heads business, PMR heads will give us a wider margin for meeting technical and performance specifications. We expect production yields to be extremely stable, which should allow us to bring in new product lines without any significant start-up problems. We certainly do not anticipate any significant negative impact on our business from the shift.
Q23. In the presentation you provided a product breakdown for electronic devices in the third quarter. What is your forecast for the fourth quarter?
A23. In terms of fourth-quarter sales, our forecast is for broadly flat sales of inductive devices and high-frequency components, along with higher sales of power supplies.
Q24. Could we possibly return to the discussion of HDD head unit prices and yields? At the interim results conference three months ago, I think that you said price erosion was running at around 10% every six months, or 18% in annualized terms. The figure you quoted earlier of a 3-4% drop every quarter is consistent with the forecast given at the time of the interim results. Can we assume therefore that price erosion remains in line with your expectations?
A24. Correct. Price erosion in HDD heads remains 10% every six months, or about 18% in year-on-year terms.
Q25. In the current HDD market, pricing is particularly keen in the 2.5-inch segment because these products are supplying mobile device applications. Are you noticing a similar trend in your HDD head business? In other words, is the stiff level of price erosion in the 2.5-inch HDD segment having an impact at the component level?
A25. From our perspective price erosion in HDD heads is harsh overall, and we are not seeing much difference between the various market segments. We are hearing from our customers (the HDD manufacturers) that the 2.5-inch segment is especially tough, but this is not being reflected in significant head pricing differentials.
Q26. In HDD heads, can I confirm that you are saying that sales fell in the third quarter relative to the second quarter, but profits were flat?
A26. Yes, sales declined but profitability did not. In that sense, our margins on HDD heads were higher in the third quarter than in the previous quarter.
Q27. This may be a sensitive topic, but to what do you attribute the increase in HDD head production yields? At the interim results presentation, Mr. Kamigama was saying that the means of yield improvement had been realized. What sort of effect are you anticipating in the current quarter? Will you be able to realize these higher yields in the fourth quarter or the coming fiscal year? Also, you were saying just now that the PMR shift is translating into extremely high yields, but the PMR ratio was still not that high as of the third quarter. So have the benefits materialized yet or not? Please provide more details.
A27. To the best of my knowledge, shifts to an entirely new head technology tend to depress production yields at first, but these rebound once we have ironed out all the mass-production issues. In this case, however, we have been able to generate high yields rapidly during the start-up phase, and we anticipate minimal yield losses with the PMR heads going forward.
Q28. Do you expect the same to apply with later PMR heads?
A28. I think that the situation will probably vary with each new product, depending on the particular difficulties involved. What is certain is that there is a substantial jump involved in shifting from GMR to the new TMR and PMR technologies. With GMR heads the start-up phase of production would always be a struggle, and it would generally take us a little time to ascend the production learning curve for each new line. With the new technologies, however, we are experiencing less problems in the start-up phase, and the yield-related issues are also far fewer. Both of these factors are working to our advantage.
Q29. Could you tell us more about the differences between TDK and your rivals in terms of PMR head technology? For instance, there are a number of possible technical elements involved, such as the monopole and the trailing edge of the main pole.
A29. Perpendicular magnetic recording (PMR) technology is a completely novel approach compared with conventional longitudinal recording technology. This affects not just the head, but also the way that the head interacts with the recording media. With PMR we have a greater range of options in solving the various assembly issues. In that sense, there will inevitably be some slight differences in the way our design approach differs from that of rivals. I think that solution optimization comes into play once you consider the combination of the head with the media in question. We are likely to see some solution convergence once PMR technology has become better established, since this is the trend that we observed with longitudinal technology. At this stage, however, PMR remains an area where there are various ways to go. I think that our competitors will have the same broad array of options as we have in terms of solving the head-media interaction issues. In this regard, one possible approach is to develop a head structure that gives you certain operating characteristics. We are moving forward by focusing on what our customers want while at the same time cooperating with the media manufacturers as much as possible.

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