Investor Relations | IR Events | Performance Briefing

[ 2nd Quarter of fiscal 2009 Performance Briefing]Q&A

Q1. As per usual, I would like to ask about shipment volumes for HDD heads during the second quarter and your projections for the third quarter.
A1. If we index volume sales in the first quarter of the previous fiscal year at 100, then fiscal 2009 sales were 112 in the first quarter and 127 in the second quarter. We are forecasting sales of 143 for the third quarter.
Q2. I would like to address my question to President Kamigama. I presume that you must have toured numerous facilities now that EPCOS has become part of the TDK Group. What do you believe are the major action priorities right now?
A2. As you say, I have visited a number of EPCOS facilities as well as other TDK Group sites in Japan and overseas. One obvious conclusion is that there is a need for rationalization. In China, in particular, we have used a lot of labor. Going forward, one of the major themes will be to capture the various synergies with EPCOS so that we can accelerate the rationalization process, which we hope will happen fairly quickly.
Production integration is another area where we need to excel. Currently, we have a number of products where the finishing processes occur in different facilities. This is problematic in terms of production lead times and from an inventory perspective, so we aim to integrate production as quickly as possible. These are the two main goals.
Q3. If we look to next fiscal year or even to shorter-term prospects, do you have any concerns that, say, more than half of the sales of EPCOS are in sectors that are relatively susceptible to a macroeconomic downturn, such as automotive and industrial equipment? Or are you confident that EPCOS will weather the conditions?
A3. As you say, the automotive sector has slowed in Europe, as well. EPCOS is without a doubt involved in highly specialized product areas, as well as the industrial machinery sector. Our strategy is to try to offset any sales weakness by being more aggressive in promoting products such as filters for communications applications.
Q4. I would like to direct two questions to President Kamigama.
First, now that you have spent more than a year visiting factories and other parts of TDK's operations, what are the main management issues that you believe you need to address over the coming year when you consider the TDK Group as a whole? Second, now that you have to make the recent acquisition work, how do you see the prospects for EPCOS in light of the severe deterioration in macroeconomic conditions?
A4. In terms of management issues, I plan to focus on rationalization of TDK Group production facilities and on revising our development systems. Looking at EPCOS, it has an extremely efficient development system. At TDK, we employ a lot of people within our centralized development functions. We aim to boost efficiency by shifting as much of the development work as possible to operating divisions once the project approaches the commercialization phase.

In terms of making things work with EPCOS, one of the critical decisions is how to structure product development by determining the extent to which work is assigned to central development functions.
Q5. Linking to the earlier discussion on manufacturing facilities, there have been recent reports in the media that TDK plans to reorganize its operations in China and reduce the size of its local workforce. What will be the cost savings of these downsizing measures and the impact on performance? Also, how long do you think it will take for the benefits to emerge?
A5. We expect the effects of rationalization of our Chinese operations to materialize in the second half of fiscal 2009 as far as HDD heads are concerned. Facility rationalization is proceeding at EPCOS. We expect this process to have similarly positive benefits for other electronic components, which should emerge during the first half of fiscal 2010. Our main emphasis will be on generating positive results prior to the establishment of the new company on October 1, 2009.
Q6. So you would expect the performance benefits from rationalizing the operating bases in China of TDK and EPCOS to begin emerging in the latter part of the first half of fiscal 2010?
A6. Correct.
Q7. The press reports have mentioned downsizing projections of 15,000 or so.
A7. That is the figure that we are targeting for the HDD head operations. We still have to work out the precise implications of planned rationalization measures with electronic components.
Q8. From estimates of per capita personnel expenses we can calculate the potential labor cost savings from a workforce reduction of 15,000 people. Can we assume that the annual cost saving would be around the same?
A8. Your method for calculating the cost savings is correct, but please bear in mind as well that we see these moves generating additional synergy effects. For example, we expect rationalization to improve product quality.
Q9. Are we reaching a point where you may have to rethink your business model for HDD heads? Recently, the news emerged that Western Digital is in talks to buy the HDD division of Fujitsu, and there has also been speculation that a vertically integrated HDD manufacturer might try to acquire one of your customers. These moves come amid stories that TDK has begun shipping 250GB/P products to Seagate and evidence that vertically integrated HDD manufacturers are focusing more intently on the 2.5-inch drive sector, which could weaken the grip of Samsung and Toshiba. All of these various developments have the potential to reshape the industry.

Under these conditions, manufacturers such as TDK that have good technology and can supply cost-competitive products could end up controlling over half of the global market for HDD heads-although it must also feel as if you are losing customers. Do you believe that TDK can maintain its position as a component manufacturer within this market indefinitely, or, going forward, is it perhaps time to consider revising the business model by becoming involved in HDD manufacturing?
A9. I understand your argument, but I'm sure you appreciate that this is an extremely delicate strategic matter and it would not be appropriate for me to comment here.
Q10. You have indicated that you expect capacitors to record a similar bottom-line in the second half amid challenging conditions. Given that top-line sales are under pressure and that operating conditions are extremely harsh, how do you see this sector staging a recovery?
A10. The first part of the answer to your question is the start-up of the Honjo facility. Initially, we were planning a 20% increase in production, but we have scaled that back to a 15% expansion due to the unfavorable market conditions. In these circumstances we must do two things: the first is to cut costs through rationalization, and the second is to improve production yields. We plan to trim our material and labor costs as much as possible through such measures.

Next, we plan to integrate production facilities outside Japan so that we can reduce inventories and boost operational efficiency. By integrating production facilities, we aim to cut lead times by up to 50%. At the same time, we are targeting higher yields and smaller inventories.
Q11. You projected capital investment of 70 billion yen when you announced first-quarter earnings on July 31, but this figure has now increased to 85 billion yen. What is the reason for this increase? Also, you state that capital spending in fiscal 2009 to date was 67.7 billion yen at the end of the first half, yet this is about the same amount as you were projecting for the full year at the end of July. Is there perhaps some exceptional factor at work here?
A11. The figure of 60 billion yen mentioned in the press was 70 billion yen less 10 billion yen, but that was just what we had officially approved not what was paid in cash. Capital spending in the first half amounted to 67.7 billion yen and we are projecting a total of 85 billion yen for the current fiscal year. This primarily reflects the slippage from fiscal 2008 into the first quarter of fiscal 2009 of 20-odd billion yen in capital expenditures relating to the Honjo facility.
Q12. On the subject of capital spending, given that you are expecting the pace of this investment to slow substantially in the second half of fiscal 2009, what sort of figure do you think it will be necessary to spend at the very minimum next year for maintenance purposes?
A12. While we will not be investing aggressively in greater production capacity, we must still invest in rationalization and yield improvements. In that sense, I would expect ongoing capital spending to be in the region of 60 billion yen, which would be within the scope of depreciation.
Q13. TDK's estimated market share for HDD heads in the first half was about 30%. How far do you see this figure climbing over the next six months and into the medium term? Or are you targeting a certain level? Please explain.
A13. As you said, in the first half our global market share in HDD heads was a little over 30%. Our aim is to increase this figure to 33% in the second half of fiscal 2009 and 35% over the medium term.
Q14. What sort of timeframe do you consider appropriate for reaching the 35% goal?
A14. We hope to reach this figure sometime in calendar 2010.
Q15. You are currently starting up production at a new capacitor plant even as the industry balance between supply and demand is deteriorating. This is bound to hit your capacity utilization. What level and form of operating capacity do you plan to employ going forward? If you have scaled back planned increases in output capacity, which plants will you use to supply which products, and what will be your strategy in this sector? Please comment as well on your projections for demand and general market conditions.
A15. Current market conditions suggest that demand has fallen below the level that we initially projected. With capacitors, we are currently operating production facilities at about 75-80% of capacity. In terms of individual facilities, the basic reason for constructing the Honjo plant was to realize improved quality and yields for thin-layer, multilayer capacitors. So we plan to use it mainly to supply high-end product lines. Next is the integrated line at the Kitakami plant, which we are using mainly to make high-capacitance product lines. We also plan to concentrate production of general-purpose capacitors, including the low-ESL product lines, at the Akita plant.
Q16. There are various ways that you could allocate capacitor production between plants. For instance, you could concentrate high-capacitance lines at one site or else try to increase efficiency by using one facility to supply most of the high-voltage devices for industrial or automotive applications. You could also allocate orders to various facilities depending on which had the lowest capacity utilization. Are you planning to make any changes to your method of allocation?
A16. The machinery used to make multilayer capacitors does not vary all that much. Although there are issues due to the fact that different materials cause variation in the product lines, it is not as if we cannot use the Honjo plant to make products supplied from the Kitakami facility. What we try to do is make production plans taking into account the supply-demand balance and productivity. At the moment, as you pointed out, we can naturally expect some revisions to orders. So typically we would factor changes into production plans so that our output remains in line with the supply-demand balance, while taking productivity into consideration.
Q17. You have significantly reduced your full-year operating income forecast to the point where it is now 52.2 billion yen less than last year's result. Could you please provide a breakdown and factor analysis for this revised forecast, as you did for the first two quarters of fiscal 2009?
A17. Full-year operating income was 87.2 billion yen in fiscal 2008. If we exclude the approximately 15.0 billion yen in profit that was generated by the sale of the recording media sales business, the adjusted figure was roughly 72.0 billion yen. Our revised forecast of 35.0 billion yen for fiscal 2009 is thus a year-on-year decline of about 37.0 billion yen. The first-half operating income result was down 32.8 billion yen compared with last year, but this contained the 15.0 billion yen from the business transfer. So the adjusted figure for the first half is about 17.8 billion yen. Simply doubling this figure gives you a projected annual total of 35.0-36.0 billion yen.

The reason why first-half profits slumped was the dip in sales caused by the stronger yen. There was no compensating increase in volumes, and we were also unable to cut costs sufficiently to offset the decline in sales. This is just the way it works when you are a manufacturer: the lack of volume growth meant that we could not raise capacity utilization, and so we could not offset the negative impact of discounts and currency movements. Since the basic structural issue remains, we do not expect the situation to improve in the second half and the earnings variation analysis will probably be similar to the first half of the year.
Q18. I may have missed what you said about multilayer ceramic chip capacitors (MLCC), so could you please cover this point as well? Did you say that, due to the deterioration in market conditions, capacity utilization at the Honjo plant had dropped to 70% and that you are now trying to improve yields?
A18. Our original plan with Honjo was to install the latest production machinery so that we could boost TDK's overall MLCC production capacity by 20%. However, due to the deterioration in market conditions since the start of 2008, we are restricting the total capital investment to end up with an overall increase of about 15% in our total capacity, rather than 20%.
Q19. There have been stories in the press or other parts of the media that TDK had already been forced to adjust production levels at Honjo. Is that correct?
A19. The adjustment has been in the capital investment, not the production.
We plan to have several production lines operating at Honjo eventually, but now is not the time to invest in unlimited capacity. That is why we have decided to restrict our investment to a limited number of lines. We are minimizing the installation of additional lines-and that is the real adjustment that has occurred. Clean production facilities such as Honjo are becoming increasingly vital to manufacture new products. Moreover, not investing in such capabilities now might endanger TDK's future. So we would like you to understand that, while we are not leaving idle those production lines that we have already installed at Honjo, we have adjusted our investment plans so that we do not create unneeded capacity under worsening market conditions.

A final point is that the investments in Honjo are necessary to the extent that we will be able to derive higher quality for new products from this facility.
Q20. So are you utilizing the capacity that you have installed at Honjo?
A20. Yes, we most certainly are.
Q21. I would like to confirm one point regarding HDD heads. You said that TDK's market share in the first half was 30% and that this would increase to 33% for fiscal 2009, based on your projections of HDD shipment volumes and Head Gimbal Assembly (HGA) demand. Are you saying that you expect your market share to increase to 36% in the second half of the year, or is the figure of 33% just a target? If you did 30% in the first half and are targeting 33% for the whole year, then presumably you would need to average 36% in the second half to achieve such a figure.
A21. I think I used the expression 'a little over 30%,' which does not imply that we are forecasting a 36% share for the second half of the year.
Q22. But are you targeting a 33% share for the whole year?
A22. No, that figure refers to our market share at the end of the year.
Q23. So then are you are aiming for a 33% market share in the second half?
A23. Correct.
Q24. You mentioned that the performance of EPCOS had not been factored into the second-half forecasts for TDK. What can you tell us in numerical terms about the likely impact on the consolidated results?
A24. EPCOS has not released its results for the fiscal year that ended on September 30, although we understand that both sales and profits were up. The company's new financial year began in October and EPCOS became a consolidated subsidiary effective October 17. So the firm's sales will be added to the consolidated total without a doubt. However, given the straitened economic circumstances that have also affected Europe, we cannot be certain yet whether there will be a positive contribution to earnings from EPCOS in fiscal 2009.

Based on the best information that we have, we are expecting EPCOS to have a tough first quarter followed by some kind of recovery in the subsequent three quarters. But since we do not at this stage have any highly reliable data to judge the likely impact, we have not factored the performance of EPCOS into our consolidated forecasts.
Q25. By subtracting the first-half result from the full-year consolidated forecast, we can calculate that operating income needs to reach 20.6 billion yen or so in the second half. If results in the October-December quarter are worse than in the July-September quarter, are you confident that performance can recover sufficiently during the first three months of 2009?
A25. Our feeling is that the fourth will probably be the one when performance tends to be more depressed. The third quarter tends to be a good quarter for sales provided equipment makers stick to end-of-year production plans. Output typically drops off in January, February and March.
Q26. You mentioned that costs are an increasingly critical factor in HDD heads, and I seem to remember you saying that cost is the determining factor in whether vertically integrated HDD manufacturers buy heads from external suppliers. Please explain in either qualitative or quantitative terms what cost advantage you expect to derive once the automated back-end processing equipment sourced from Alps Electric Co., Ltd. becomes operational in the second half of the year. Production cost analyses for HDD heads generally show that back-end processing is the primary factor pushing up costs, so I would expect that being able to reduce these costs would improve TDK's relative cost-competitiveness. Could you also explain how you plan to exploit any advantage in strategic terms?
A26. Your analysis is correct. The benefits of automated back-end processing should come through in the second half. I cannot give you any quantitative estimates, but in simple terms the introduction of this machinery will halve the labor requirement in the assembly processes. For fabrication processes, the labor saving is about one-third. So the installation of this equipment will significantly lower our labor costs for back-end processes. We also derive various other benefits from automation-for example, the reduced handling helps to increase product quality. All of this will tend to make us more competitive in cost terms, but it is difficult to pinpoint the value in strategic terms. Some of it emerges from subsequent negotiations with customers.
Q27. Returning to capacitors, you explained before how the plants at Kitakami and Honjo are integrated facilities. What are your plans in the second half for the Akita plant, which is quite separate from these two? More specifically, if using integrated production facilities and improving yields are necessary conditions for generating increased earnings from capacitors, what do you need to do with respect to those production facilities that are non-integrated?
A27. For those plants other than Kitakami and Honjo, we are aiming to improve the flow of the existing production processes by making them more integrated. This will involve relocating and moving equipment. We expect to complete most of this by the end of fiscal 2009. The result should be shorter lead times and reduced inventories, both of which are areas that have been problematic.
Q28. One area where TDK has been struggling is high-capacitance capacitors. You have already made certain improvement at Honjo. Are you planning to do the same at Akita?
A28. We have been conducting research into the materials, including work on the use of barium titanate. We have a production facility for such materials at the Akita site. Currently, we are progressing with preparations to design a new plant to supply next-generation materials. In the future, we will also be considering plans to make fine materials with a high crystallinity at the Akita site as well.
Q29. What restructuring costs do you plan to charge in the second half, and do you have any plans to incur further such costs in fiscal 2010 and beyond?
With regard to EPCOS, we realize TDK will be attempting to capture as many synergy benefits as possible from rationalization efforts, but is there not the risk that next year you will be forced to incur more fixed costs amid deteriorating operating conditions? Realistically, will it not be difficult to reduce fixed costs within Europe? Please give us your thoughts on this issue.
A29. I'll start with the question about the second half. EPCOS has already undergone major structural reforms that have reduced the number of factories in Europe. In our view, the company has already done much to squeeze its fixed cost base and reduce SG&A expenses. So we do not believe that the risk you are talking about is that high.

In terms of the ongoing restructuring measures for fiscal 2009, we do not have any more specific details to divulge at this point. We are looking at closing facilities and exiting operations. The personnel reductions will be concentrated in the HDD heads business. We may also discontinue some unprofitable product lines. We do expect to post a restructuring charge this year to cover the costs of relocating production lines as part of efforts to optimize operating bases. Whilst the restructuring costs are likely to be larger next year, by then we also expect to see offsetting cost savings coming through as well. On this assumption, we are projecting a broadly neutral bottom-line impact next fiscal year from our restructuring moves with some upside profit-boosting potential. Our main emphasis this year and next will be on countering harsh operating conditions. From fiscal 2011 onwards, we hope that conditions will be improving again. Our plan is to act now so that restructuring benefits emerge once the cycle enters another upswing.

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