Investor Relations

[ 1st Half of fiscal 2008 Performance Briefing ]Q&A

Q1. TDK reported 8% year-on-year growth in capacitor sales in the second quarter, but your rival Murata said that growth during this period was nearly 20%. I believe the comment at the time of the initial forecast was that slightly higher growth was expected for the second quarter. What reason can you give us for growth falling short of expectations? Also, what is TDK planning to try out or change with the new factory that is due to come on stream in Apr-Jun 2008?
A1. Let me answer the capacitor question first. During the second quarter, capacitor sales were about 8% higher than in the second quarter of the previous year, or up approximately 7% year on year in real terms. Compared with the first quarter, sales were up around 10%. Our initial forecast saw sales in the second quarter being 15% higher than in the first quarter, but in the event we fell short of this figure. The main reason is that we have lost share due to lack of production capacity, which has caused problems with delivery lead times. Our analysis suggests that the most serious loss of market share has been in the high-capacitance segment.
Next let me address the other part of your question. Besides expanding our production capacity, the new plant coming on stream in Apr-Jun 2008 is our way of catering to medium-term product demand, in line with our technology roadmap. In particular, we expect to use this plant to manufacture mainly thin and multilayer high-capacitance lines. Our plan is to create a production line that can handle these advanced products as well as the more basic technology.
Q2. On page 25 of the supplementary handout, it shows that projected full-year sales for the electronic materials segment have been reduced by around 16 billion yen. Is most of this downward revision due to capacitors?
A2. Yes, most of it is due to capacitors.
Q3. Could you comment on capacitor profitability during the second quarter?
A3. Frankly speaking, profits from capacitors did not meet our expectations.
Q4. Based on the first-half operating income net of the one-time gain of 15 billion yen from the business transfer, TDK has to improve second-half operating income by about 11 billion yen in terms of its profit plans. Could you provide us with some details on how TDK plans to achieve such growth? You have already announced some related developments, such as an anticipated 2 billion yen from higher profits at Densei-Lambda and further progress within the recording media segment to get to break-even, which would generate another few billion yen. Beyond these gains, how do you expect to achieve the second-half operating income forecast? Please break down your answer by product group and segment.
A4. I realize that a comparison of the first half and second half does reveal that we need to achieve a substantial increase in operating income if we are to hit the full-year target. As we explained earlier, first-half operating income posted by the electronic materials and components segment was 36 billion yen. To hit the fiscal 2008 target, the company as a whole therefore needs to achieve a second-half figure of 42.8 billion yen. The recording media segment may post a profit at the operating level, but let us assume for the moment that it only breaks even. That means that the real growth in profits must come from the electronic materials and components segment. Hence, we see the required growth as 42.8 billion yen minus 36 billion yen, or 6.8 billion yen.
There are several areas where we see potential for growth in the second half. The first is in electronic devices. As Densei-Lambda has announced, for commercial reasons its profits will be biased significantly toward the second half of the year. This will confer a positive benefit for the full-year consolidated results. We also recorded 43% growth in high-frequency components, which is quite a remarkable achievement for us. In the second half, we expect to see further growth in this area. We also expect a jump in profits from inductors, which is another strong sector for TDK. Although we did not produce the results we had hoped for in the first half with capacitors, in the second half we do expect things to improve a bit. For these reasons, we expect profits in the electronic materials sector to increase in the second half of the year relative to the first half. In addition, we are also projecting growth from other electronic components. With HDD heads, due to the uncertainty surrounding prospects in the fourth quarter, we are currently forecasting that sales and profits will be roughly flat in the second half of fiscal 2008 compared with the first.
Q5. What sort of breakdown are we looking at for this operating income improvement of about 7 billion yen between the two halves? Based on the announcement, the likely contribution from Densei-Lambda will be about 2 billion yen. Are you looking for roughly similar gains in the other areas that you mentioned?
A5. The order is roughly as I said just now. The leading contributor is expected to be electronic devices, followed closely by electronic materials. We also see slight profit growth in the second half from other electronic components, with HDD heads coming in more or less flat. That's the picture as we see it currently.
Q6. I'd like to address my question to President Kamigama. In the medium-term business plan that TDK unveiled, the operating margin goal for the fiscal year ending March 2010 is 15%. As I see it, the current fiscal year is positioned as one of preparation, and full-fledged efforts to boost profitability will get underway next year (fiscal 2009). In this context, how much do you think that TDK can realistically raise margins next year? And which businesses do you envisage contributing to growth? Also, are there any areas where you believe that TDK is behind and needs to catch up in terms of boosting margins in order to reach the plan target? Please identify clearly any problem areas and outline what actions that TDK must take in this regard.
A6. As you pointed out, next year is the critical one for the plan. In terms of the areas where we see potential for boosting profit growth in fiscal 2009, while we expect HDD heads to generate flat earnings comparable with the current year, our acquisition of suspension assembly operations provides significant potential to raise profits going forward.
Another area was mentioned earlier when we were discussing capacitors, and that is the new production facility. While we do expect to increase production, another major aim with this development is to improve profitability. We are targeting volume gains, but our first aim with the new plant is to raise margins. With regard to other potential products-although I cannot give details at this time-the uptrend in production volumes with these lines gives us confidence that we can reach the relevant medium-term business plan targets. Elsewhere, power supplies are likely to generate steady growth. Ferrites are also a promising sector this fiscal year, as are transformers. At this point, we are in the process of formulating various measures for fiscal 2009. This area is of course bound up with the power supplies sector, but we do expect to generate higher profits from transformers.
Q7. This year TDK is purchasing some HDD heads manufacturing equipment from Alps Electric, which should help to boost your return on investment within the sector. While this might ultimately push up depreciation expenses, might it not also generate some benefits in terms of cost reductions?
A7. That is our aim. TDK's position is one where we have to take on the in-house manufacturers, and basically our sales price must compete with their base production cost. In this respect, I think this purchase will prove to be extremely beneficial. Of course we will derive volume gains. But we see these gains being offset by sales price erosion, which means that earnings are likely to be on a par with this year. On the other hand, the acquisition of suspension assembly manufacturing capabilities should feed into earnings growth more directly.
Q8. Suspension assemblies are not yet profitable for you, but what gains, if any, do you expect to make from next year onward?
A8. At the moment, we hardly use any suspension assemblies made by Magnecomp Precision Technology Public Company Limited (MPT). We have been supplied either by Hutchinson Technology or by NHK Spring. So I think you can see how it will work out. Is that OK?
Q9. Do you expect some sort of benefit to emerge next year?
A9. Yes, I do.
Q10. The margins achieved in the power supplies business in the first half by TDK parent operations and by Densei-Lambda in the TDK Group were both in the single digits. Do you think that you can realistically target the 10% level next year by, for example, reducing fixed costs?
A10. Our aim is 10% the year after next, in fiscal 2010.
Q11. How can you raise margins in the case of capacitors?
A11. Profits come from having an efficient production line at the plant. The most important point is to have a single, integrated process within one plant from materials to the final product. We have that set-up at the Kitakami plant, but not yet at our other facilities. Now that we have seen positive results emerge at Kitakami following the moves to achieve full process integration, we expect to be able to improve efficiency further going forward. We think that we can generate efficiency gains in this way.
Q12. From start-up in spring 2008, will it not take at least three months to get the new integrated processes fully running?
A12. We expect to see the benefits come through in fiscal 2010.
Q13. I would like to confirm the figures on the second point. We heard various things about increases in fixed costs such as bonuses, depreciation and one-off expenses in the second quarter. Of the 5.9 billion yen increase in fixed costs in the second quarter, how much of this was due to one-off factors? Also, turning to the second half, do you expect to have to revise the amount of the projected restructuring charges for electronic components? I would like to confirm whether or not TDK expects to book any one-off costs for the electronic components business in either the third or fourth quarter.
A13. Any increase in costs due to revision of accounting standards relating to dead inventory is classed as non-recurring. So related costs for the first half onward will not increase as long as these inventory levels do not rise. With other costs such as depreciation and R&D expenses, because we are actively investing in and using facilities, we would not class these as one-off costs. In fact, we would expect them to increase in proportion to our investments. With bonuses, on occasion there is an increase between the first and second quarters, but generally we would not expect that much change when comparing the first half against the second half. Next, at the start of the year we were forecasting structural reform expenses of 6.2 billion yen, but this was a combined figure for the electronic materials and components and recording media businesses. For the electronic materials and components operations alone, you would need to use a different figure. We've already used 4.4 billion yen. Based on that number, the remainder would be 1.8 billion yen. However, this is not a fixed figure, and it might increase slightly. But that's the kind of figure we are looking at for the second half.
Q14. So, operating income for the electronic materials and components segment was 17.6 billion yen in the first quarter and 18.4 billion yen in the second quarter. If we then exclude non-recurring expenses by adding in the 0.5 billion yen inventory charge and the 1.1 billion yen charge for restructuring that you just mentioned, this puts adjusted first-half operating income at just less than 26 billion yen. This is against a nominal target of 43 billion yen for operating income in the second half. We also need to adjust this figure to take into account projected one-off costs of just over 1.8 billion yen, most of which are for the electronic materials and components segment. So, excluding non-recurring items, the adjusted second-half operating income target is about 45 billion yen. In terms of real target earnings, should we just then split this figure between the third and fourth quarters?
A14. Yes, that's correct.
Q15. How much will the goodwill be on TDK's acquisition of HDD head-related assets from Alps Electric? What about the amortization period? Finally, could you also tell us what sort of savings might accrue in terms of the capital investment budget as a result of this purchase?
A15. This is an asset purchase rather than the acquisition of a business. That means that we have to check the book value of each individual piece of equipment purchased to determine price. With the patents, other intellectual property and know-how, since we have already called in valuation professionals to provide accurate data, basically we do not expect any goodwill to arise from this acquisition. It will just be treated as a sale of assets. As for the patents, we have valued them based on an estimated useful life of about 16-17 years, and so that will be the amortization period. Most of the know-how is expertise relating to that specific equipment. As Mr. Kobayashi said earlier, because this is expertise that we previously lacked, we expect it to translate into potential labor savings and reduced use of consumables. Another benefit is that it is not just applicable to the purchased equipment, but we can also expect to make use of it with some of our existing equipment. We plan to amortize these particular assets over a period of 5-7 years. We see the cost involved being offset both by the capex savings and the various positive benefits. As far as the patents and other intellectual property are concerned, the related costs will not rise even if we use the assets for 16 years. Also, the costs involved are not that large anyway. So, overall, we feel that the acquisition reinforces our IP portfolio at an extremely acceptable cost.
Q16. So what level of capex savings do you expect from this purchase?
A16. I believe the saving will be of the order of 10 billion yen.
Q17. I'd like to ask a question about production capacity for capacitors. Previously, TDK said that output or capacity would increase by around 20% in the first half of fiscal 2008. Has that in fact happened? Also, what sort of production capacity growth are you thinking in terms of for the second half of the year and then into fiscal 2009?
A17. We completed the expansion of production capacity for capacitors by 20% during the first half. Capacity will remain at this level during the second half of fiscal 2008. Next year, once we have the new factory at Yurihonjo up and running, we expect to add another 20% to total capacity. Of course we will have to take a closer look at the major demand trends at that time.
Q18. Did the first-half 20% capacity expansion contribute to capacitor sales in the second quarter?
A18. Yes, it did make a contribution.
Q19. My question relates to the inductor business. TDK integrated the transformer product operations with those of inductors last year. President Kamigama also talked about synergies with the power supplies business. Having lost competitiveness, the inductor business now appears resurgent. In that context, how far do you think that you can push up the profitability of inductors from current levels? Also, I thought that the story with transformers sounded promising. At the moment, the inductor business generates annual sales of around 90 billion yen. What sort of developments do you see for this business in the future?
A19. Let me answer the question about the inductor business. Currently our order book for these products is growing well. Over the medium term we also see potential to boost our market share. Under our present organizational set-up, the same division manufactures inductors, transformers, ferrite and other items. Although our business has faced additional cost pressures due to sharply rising raw material prices, our integration of these operations has resulted in efficient materials development. This in turn has provided us with the scope to absorb at least some of the raw material price increases.
While I'm on the subject of the integration of inductors and transformers, there is yet another synergistic benefit that is worth mentioning that relates to core technology. We are developing new transformers with completely novel miniaturized structures based on the application of core coil-related inductor technology that we found could also be used with transformers. We are now preparing to show these new products to customers, starting in the second half of the year. This is the new transformer product with potential that President Kamigama was talking about. At the moment, TDK's market share in inductors is around 20%, but we are now making major progress. This should boost our share over the medium term.
Q20. Previously, TDK was able to improve margins with inductors year after year, and the products have been extremely profitable for the company. However, I think that the margins with transformers are much lower. How do you see margins with both of these product classes two or three years down the road from integration of the various operations?
A20. It's difficult to say at present, but our aim is to achieve average margins within the 10-15% range.
Q21. Unlike capacitor operations, do you have any concerns regarding the supply and demand trends with this business?
A21. As far as the transformers are concerned, the major hikes in material prices are causing some manufacturers to quit the business altogether, which is leading to a weeding out within the industry. So we see this as a good opportunity for us.
Q22. My question concerns the HDD head business. There have been various stories within the HDD industry about companies acquiring other firms. What changes have you observed within the industry over the past few years? Also, how do you think TDK should act in the current difficult environment? Is the only response under the current conditions to try to boost share through captive manufacturers? What sort of changes do you see occurring within the HDD industry over the next few years, and how does TDK plan to act?
A22. That's an extremely difficult question. Certainly, I believe that all the movement going on in hard disk drives makes it a very exciting time for the industry. Rather than just responding to external developments, I think that one of the things that we need to do to survive in the HDD head industry is to continue building up our technical capabilities. We were talking just now about sales prices. With new products it is possible to maintain your sales price to a certain extent if you have the necessary technical and product strengths, particularly with the ongoing shift to Perpendicular Magnetic Recording (PMR) technology. In this area, we are continuing to maintain our competitive edge over our in-house rivals. And I think that our challenge is to maintain this situation.
As Mr. Kamigama mentioned as well, the other key issue for us is how to maintain a competitive level of costs so that we can compete with the in-house manufacturers. As I said earlier, we plan to reinforce our own capabilities by utilizing the assets that we bought from Alps Electric as well as introducing new equipment. In addition, we plan to develop a stronger position through further vertical integration of the HDD head, which means developing the suspension assembly and the head as a single unit. We aim to continue developing this business while maintaining competitiveness in all of these various areas.
Q23. The in-house manufacturers are also looking to make similar acquisitions, with the result that the technology in this field continues to move forward. In this light, is it TDK's view that steady and sustained efforts will pay off?
A23. Yes, we believe that steady, sustained efforts add up over time to create major performance results.
Q24. I have two questions that I would like President Kamigama to address. First, I would like to know what sort of market share you are targeting in HDD heads. The reason I ask is because, in my view, this is the sort of business with high fixed costs where if TDK gains a certain amount of market share it will naturally tend to have a cost advantage over in-house manufacturers. In this sense, do you see market share as a strategic parameter within this business?
A24. Just as you say, yes - we do view market share as a strategic parameter. At its peak it was 36%, and this is the number that we are aiming to achieve again.
Q25. What factors will enable you to do that?
A25. Cost is the main factor. Of course, performance and quality are also vital, but they are a given. So cost is the major consideration. We see our acquisition of a head suspension manufacturer as conferring a strategic advantage in that sense.
Q26. My second question concerns high-frequency components. I understand that sales of these products are growing, but what is happening in terms of profits? TDK is using modularization and other approaches to increase sales in this sector. What is your strategy to improve profits with high-frequency components?
A26. Concentration and selectivity have a part to play in this because we aim to focus on our strengths within this field. Modularization is not something that we are doing with the specific goal of improving margins or creating profits. It tends to work the other way round. Creating modules means that we are developing individual, discrete products, which means that we acquire expertise in build-up or packaging technology. Also, by incorporating some of the various thin-film products that we make into these modules, it gets us talking to the customer at an early stage of development. And the fact that we are in discussions with customers at the development stage means that we get to sell components and develop them. I think this is one of the main benefits.
Q27. Could you please reconfirm the breakdown of restructuring costs by quarter, both the results for the first and second quarters and the forecast for the third and fourth quarters (dividing the latter figures between the electronic materials and components and recording media segments)?
A27. First, overall restructuring costs at the consolidated level were 0.2 billion yen in the first quarter and 4.2 billion yen in second quarter, resulting in a total figure of 4.4 billion yen for the first half. For the electronic materials and components segment, the first-quarter figure was 0.2 billion yen and the second-quarter figure was 1.3 billion yen. For the recording media segment, restructuring costs were zero in the first quarter and 2.9 billion yen in the second quarter. Since 1.0 billion yen of that was included in the calculation of the gain on the sale of operations, the adjusted restructuring charge for the recording media segment in the first half was 1.9 billion yen. For the third quarter we are forecasting an overall restructuring charge of 1.6 billion yen, of which 1.5 billion yen is for the electronic materials and components business and 0.1 billion yen is for the recording media segment. In the fourth quarter, we expect the electronic materials and components segment to post a charge of 0.2 billion yen. Since we are committed to the process, that last figure might increase slightly.
Q28. During the explanation about changes in profit in the first and second quarters, although you said that profits from HDD heads moved in line with sales, the story with other electronic components was that cost increases outweighed the gains from higher sales. What were the specific factors behind this result?
A28. Comparing the first and second quarters, while profits tended to move in line with sales in the case of HDD heads, profits from electronic materials and electronic devices did not grow as fast as sales in overall terms. As I said before, the increase in fixed costs was 5.9 billion yen, but only about 1.0 billion yen of this figure was attributable to HDD heads. Most of the rest of the increase was due to electronic materials and electronic devices. Since the growth in sales was only around 10 billion yen, the fact is that we were not able to absorb the rise in fixed costs with this category of products.
Q29. If we assume that HDD head sales increased by 16 billion yen and that profits also rose accordingly, presumably you are saying that the earnings structure in this sector was not capable overall of absorbing a 5.9 billion yen rise in fixed costs?
A29. It depends on the relationship between sales and profits for HDD heads. The second quarter was better than the first quarter, but in the second quarter we were still seeing extensive discounting that cut profits by more than we had anticipated. The situation is likely to improve again in the third and fourth quarters because the product mix is always shifting.
Q30. I would like to ask about the figures for HDD heads, specifically the indexed quarterly sales volumes now that the situation with Alps Electric is clear. Please also provide us with the actual and projected quarter-on-quarter changes in prices. I would also like to ask whether TDK was able to improve margins between the first and second quarters.
A30. In terms of these figures, actually the deal with Alps Electric is not entirely closed yet, so the forecasts are slightly hedged in that respect. If the level of sales in the first quarter of the previous year was 100, then sales this year were 116 in the first quarter and 141 in the second quarter. We expect sales to increase further in the third quarter.
Next let me talk about discounting. I fear that I may have confused some people when I mentioned the figure of 9% price erosion for the first quarter, when we talked about a 19% drop for that quarter at the previous earnings announcement. Please allow me to explain these two figures. The 19% year-on-year fall in price quoted at the previous meeting was a figure based on the average sales prices for all types of HDD heads. It included the customers that get Head Gimbal Assemblies as well as those that purchase head stacks. One particularly large customer received head stacks from us during the first and second quarters of last year, and that is why the average unit price in the first and second quarters of this year fell so steeply, producing a figure of 19%.
The year-on-year price declines of 9% in the first quarter and 6% in the second quarter that we reported today for this fiscal year are calculated by comparing sales price discounts over time for each different product line. We thought that perhaps this method would be more realistic since it more accurately captures changes in profitability. Returning to the change in average unit prices, the average unit price remained largely flat during the first and second quarters of this year due to improvements in the product mix. We are also expecting prices to hold up comparatively well during the second half of the year, reflecting a greater proportion of new products. Altogether this means that we expect price erosion with HDD heads to be fairly benign overall in fiscal 2008.
Q31. We heard from President Kamigama just now that the HDD heads business was basically a cash cow for TDK, and that you do not expect it to generate any growth in earnings. For instance, the assumption is that if hard disk volumes rise by 10%, then the average sales price will fall by around 10%. So you can only really increase sales by either gaining market share or by increasing the amount of value added. You said that cost was the key to increasing share with these products, but on the other hand your roadmap implies aggressive investment to develop TDK's next generation of HDD heads. In that context, my question is whether the HDD head business is simply a cash cow for TDK, or whether there is not also a possibility that the sector could generate sales and profit growth for you in fiscal 2009? How would you answer that from a strategic perspective?
A31. To the question of whether HDD heads have potential to contribute to growth, I would answer "yes," but at the same time we do not want our earnings structure to be that heavily dependent on HDD heads. This is TDK's targeted earnings structure.
Q32. Turning to recording media, we understood that the transfer of operations would be completed during the first half, but there had been talk earlier of some post-transfer costs possibly arising in the second half. Today you said that this would not be the case. Can we infer that the business will basically break even in real terms?
A32. We had been planning for a charge of 500-600 million yen in the second half, but that figure has now been reduced to 100 million yen because we have basically set aside the necessary provisions. Hence, the second-half goal for the remaining recording media business, which we believe does have potential, is to restore its profitability.
Q33. I would like to direct my question to President Kamigama now that he has been in his job for more than a year. What do you think that TDK should focus its efforts on changing most in order to achieve the goals set out in the medium-term business plan?
A33. Capacitors, I think.
Q34. I would agree with you in terms of the divisional situation, but what overall aspect of the company, for example, do you think requires effort?
A34. I think we are too slow in some areas, and the key to success will be in finding ways to accelerate. We have to find ways to deliver products quicker from our plants. This first means speeding up operations within the Production Division, I think. Other staff must follow suit.