Canon Q2 2007 Earnings Call Transcript

Jul.31.07 | About: Canon, Inc. (CAJ)
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Canon Inc. (NYSE:CAJ)

Q2 2007 Earnings Call

July 26, 2007, 2:00 AM ET

Executives

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Analysts

Matthew Troy - Citigroup

Shannon Cross - Cross Research

Keith Bachman - Banc of America

Gregory Paul - Burgundy Asset Management

Presentation

Operator

Good day everyone and welcome to the Canon’s Fiscal Year 2007 First Half Results Conference Call. This presentation from Canon is for 20 minutes and the Q&A session is going to be about another 30 minutes after the presentation. During the presentation, all lines will be placed in a listen-only mode.

And I would like to hand the call over to Mr. Masahiro Osawa, Managing Director and Group Executive, Finance and Accounting Headquarters. And I will be standing by for the Q&A session. Please go ahead. Thank you.

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Hello, everyone and welcome to Canon’s conference call. My name is Masahiro Osawa. I am in charge of Finance and Accounting. Today, I will review our second quarter and first half results. And then explain our revised projections for the second half and full year. Please note that all financial comparisons made during my presentation would be on a year-on-year basis, unless otherwise stated.

Please refer to slide two. This slide outlines today’s agenda. Please come to slide three. From the second quarter of this year, Canon implemented a change in the method used to calculate depreciation of tangible fixed assets. I would now like to comment on this change. Due to the growing diversification of customer needs and rapid progress in technology development, product’s life cycles have been getting shorter, this led to a difference between actual equipment utilization and the conventional method used to calculate depreciation such as reconsider methods of calculation and depreciation expense that more accurately to reflect business conditions towards creating business practice. That enabled us to adopt to market changes. And to make timely and accurate management judgments. As a result, from the second quarter, we utilized the 250% of difference… methods to calculate the depreciation of tangible fixed assets including those that were acquired before the second quarter and the depreciation of assets to a fixed value of one yen.

Based on this change in calculating depreciation compared with the previous methods, you can see that depreciation for the full year is projected to increase 67 billion yen. In the future, as the changes in the business environment will go more extreme [ph] management marked by freshness will become increasingly important. Rich management means, the ability to carry out quick business responses, and it’s possible by analyzing market conditions and decide to acquire management information, thus anticipate business changes.

Over the years, we have implemented various management reforms by implementing further program majors improving this change in the depreciation calculation method, we aim to further improve our ability to cope with the changing business environment, and to achieve and grow our excellent corporation strength, page three, targets. To begun our corporation, let’s continue to look for 100 and even 200 years..

In today’s presentation, in addition to our off shore results and the reduction, post depreciation change figures, we also show pre-depreciation changes preview, our financial information. This excludes the impact from the change in the depreciation methods. For you to better understand development, we related to our business situation. I will focus my discussion on these figures. Please go through slide four.

I will now discuss on our second quarter results on a pre change basis. Second quarter net sales increased 9.5%, reflecting continued strong sales were quite robust expect for semiconductor production equipment and the depreciation.. The second quarter gross profit increased 15% and our gross profit ratio increased by 2.5 points to 52.1% of net sales. This is manly due to increased sales on the higher margin product such as based on camera and the printer… printer consumables along with depreciation… Ceruza [ph] increased in gross profit and expense with a plan. And second quarter operating profit increased 19.3%. Net income increased 27.6%. On a post-change basis, we secured an increase of 7.8% and 17.8% for operating profit and net income respectively.

Based on our revised assumptions and the outlook for the second half, our current full year projection on a pre change basis now shows operating profit and the net income increasing 17.8% and 18.6% respectively. Please refer to slide five. This slide compares our second quarter results and current projection for the full year with our previous projection on a post-change basis.. We did not achieve our previous projection for the second quarter operating profit and not expecting to achieve our previous full year projection for operating profit and net income. However, on a pre-change basis, in the second quarter and for the full year, we soundly exceeded and expect to significantly exceed our previous projections by a substantial amount for the full year. This slide shows our full year projection by 43 billion yen and 35 billion yen for operating profit and the net income respectively.

On the next slide, I would like to review our second quarter results against our previous projections. Overall, the impact of foreign exchange rate changes on projected net sales and operating profit was positive.. While overall impact of changes in Ceruza volumes and projected net sales and operating profit was negative, reflecting lower than projected sales across all the products group, except for cameras. Sales volumes of imaging products were below our projection as we did not achieve our high expectation for copying machine. For the computer spare retails, performance [inaudible] printer business was basically we are inline with our projections. Sales of inkjet printers suffered under greater than expected pricing pressure by competitors. For cameras, as was the case in the first quarter, we exceeded our projection through stronger tariffs of [inaudible] higher price digital camera and interchangeable ranges and by maintaining, our price premiums. [inaudible] premium, our results in conductor production was [inaudible] while basically inline with our projection. The performance for the segment overall reflects the results on the independent business carried out by our manufacturing subsidiaries.

In the other categories, our [inaudible] competition for such products. Copying machines and printers. We limited the growing [ph] as much as possible and focused on profitability. In the [inaudible] as a category, despite flaws [ph] and projected cost reductions, we are more than able to call the negative impact of this shortfall through controlled price decline and by controlling SG&A spending.

Please refer to slide seven. Next I will discuss our second quarter and first half results by products group. Starting with business machines, second quarter net sales with business machine increased 11.6% reflecting continued sales growth of all the core products including printer consumable color copying machines on a pre-change basis. Operating profits for business machines in the second quarter increased 17.7% boosted by increased sales and cost reduction.

Please turn to slide 8. I will now discuss net sales of business machines by products. Starting with office imaging products. Growth in unit sales of color copying machines was relative low in Europe due to severe price competition in local markets. However, we achieved increase in unit sales reflecting the launch of new color image runners during the quarter. We also experienced continued strong demand for our imaging products and started bookings growth of our image [inaudible]. As a result, second quarter net sales of color copying machines, including consumables increased 21.6%. As for monochrome copying machines, sales of new high-speed models fared well in North America and sales of low end models continued to be strong in emerging markets. As a result, second quarter [inaudible] to office imaging products increased 9.3%.

Please refer to slide 9. Next I will discuss computer peripherals, starting with laser beam printers. The market for both color and monochrome laser beam printers continues to expand reflecting demand for equipment offering improved performance at old prices. Amid these market conditions, we increased unit sales of low-end models promoting the advantage of our products such as [inaudible] printer speed, reliability and the high image quality. Second quarter sales of color laser beam printers continues to grow strongly increasing 3% [ph]. Unit sales of monochrome laser beam printers increased 20% reflecting on the lower end of the imagining market, but also efforts to expand sales of a mid-range model. This along with increased installed base and growth in consumable sales contributed to the 14.3% growth in second quarter sales for laser beam printers as a whole.

Next, I will discuss inkjet printers. In our competitive inkjet printer market, amid harsh price competition and the shrinking demand for single function printer second quarter net sales including consumables increased 15.8%. This performance reflects the strong market acceptance for our product which differentiated in terms of performance, design and usability.

Please turn to slide 10. Now I will discuss cameras. Second quarter net sales of cameras increased 10.8%. This number reflects continued strong market for camera digital cameras, and strong sales of such high value added products, especially of cameras and the interchangeable ranges. As a result, on a pre-change basis, operating profits increased 21.4% and our operating profit ratio improved by 2.3 points to 26.4%. These reflect [Inaudible].

Next, I will focus on digital cameras. Second quarter net sales of digital cameras increased 14.3% with continued strong sales in both North America and Asia. And increased unit sales of both compact and SLR models as opposed to compact digital cameras, we sold [inaudible] in each region for our strong product buying. Sales of the digital SLR cameras were also strong. As our entry model launched in September maintained the top share in major markets.

Please turn to slide 12. Next I will discuss Optical and other products. Second quarter sales of optical and other products decreased 6.4% reflecting a significant decrease in net sales of the semiconductor production equipment due to lower unit sales of LCD aligners. Within the categories, however we continued to record strong sales of large format printers, despite cost reductions and improved profitability in our large format printer business. Operating profit for the optical and other products segment decreased reflecting the impact of lower sales of semiconductor product equipment. For the first half however, despite the drop in sales in the second quarter, we are able to secure an increase in profits on a pre-change basis. So, these are the factors [inaudible].

In the next slide, we will discuss net sales of the semiconductor production equipment in different markets. For IC steppers, the market in term of… are generally stable. Our sales to memory manufacturers demand strong within this market we exceeded our unit sales projection and our unit sales for the same period last year, [inaudible] significantly lower reflecting the lower level of investment by panel manufacturers. As a result, second quarter net sales of the semiconductor production equipment decreased 13.3%. Although, this was a tough quarter for semiconductor production improvement, we made significant progress in terms of implementing our business strategies.

In April, we started shipping our new ArF IC Stepper. Onsite evaluation of this stepper is going smoothly and production, we have now in process. As for LCD aligners, we started shipping our new age S-generation model in March contributing to second quarter sales, this aligner has been highly evaluated, and is currently being used to match LCD panels.

Please turn to slide 14. Next, I will discuss our projections for the second half. This slide shows our exchange rate assumptions for the second half, and the projected impact of one yen change in days rate would have on second half net sales and operating profit.

Please turn to slide 15. Taking into account our new exchange rate assumptions and the current outlook for each business segment, we revised our second half projections. Based on what we saw in the second quarter, we expect the favorable exchange rate environment to stimulate right competition in the second half. Given this outlook, our revised projections includes additional allowance for price deduction and promotional spending. Thus in the second half, our aim is to continue expanding sales through the launch of competitive new products and improve the profitability by further enhancing our cost of reduction [inaudible].

On the next slide, I would like to compare our current second half projections with our previous projections. Based on our revised assumption, the impact of exchange rate that we projected on both previous projected net sales and operating equipment. On sales volumes, however, the impact will be negative, despite [inaudible] that we will exceed our previous projections for Canon.

Within the office imaging products segment, given the pre-change, we faced in the second quarter, we have lowered our projection for monochrome and for our office copying machines, thus raised our projection for color, COD equipment. For computer peripherals, we expect to fall short of our previous projection due to a strong projected through the low end printers which will be [inaudible] prices.

Our [inaudible] based on what we sold in the historical [inaudible], our expectation of sales of relatively higher priced digital cameras which will have positive impact. For optical and other products, we expect to fall short of our previous projections due to further shrinking of the IC Stepper in the LCD aligner market and decline in the unit sales. The positive net sales figures within the other categories… consolidation of R21 [ph] a company acquired in June of this year offsetting further price declines expected particularly in the cameras segment.

For the full operating profit in the other category, we expect additional cost reductions and other factors will absorb the impact of further price declines. For the full year, we expect to realize cost reductions of 116 billion yen and 5 billion yen, less than our previous projection mainly due to continued high price for low and processed [inaudible]. Please refer to slide 17.

Next, I will discuss office imaging products. In the second half, we project net sales of office imaging products will increase 14.5% mainly driven by growth in sales of color copying machines as we expect increased competition in the area of office use copying machine, we aim to actively engage in promotional activity to expand sales of color [inaudible]. In addition, we anticipate sales of our image plus [inaudible] where we have some original projections. Based on this statement, we project an increase in unit sales of color copying machines of 20%, and an increase in net sales including consumables of 26.8%. As for monochrome models, we will forecast [inaudible] upgraded line up of mid-to-high speed and low-end air cooled models. In the other categories, we projected sales to increase 27% , this represents expansion of our [inaudible] and sales of RO21

Please to turn slide to 18. This slide will discuss laser beam printers. We project second half net sales of laser beam printers including consumables to grow at a relatively low rate. This is not representative of the market overall, which is expected to continue expanding steadily. Our projection reflects the high level of sales we recorded in the second half of last year as a result of a large number of new products launched during last year. As a result, based on the continued steady growth of our installed base, expanded sales of color laser beam printers and the print growth in sales of consumables, we are projecting 4.9% increase in second half net sales of laser beam printers.

I will now discuss Inkjet printers. In the second half, we will continue to make the most of our proprietary printer technology. Certainly launching competitive new product in time for the year-end selling season, we were also… wanted to drive continued sales expansion in emerging markets where growth is high through the promotion of our product [inaudible] models. By enhancing the appeal of new trends and high-end products, we aim to expand sales of consumables to further improve profitability. As a result, we project second half unit sales of inkjet printers to increase 16% and net sales including consumables to increase 15.7%.

Please refer to slide 19. Next slide I will discuss cameras, focusing on digital cameras. In 2007, we expect the worldwide digital camera market to grow at the rate of 9% reaching 106 million units, including 6 million digital SLR models. Within this market, we aim to maintain the price premium we enjoyed in the first half promoting the proven competitiveness of our compact digital camera line up in the second half. As for SLR cameras, we aim to make a still broad product lineup and extensive range of interchangeable ranges to contribute to sales growth in the second half.

Taken together, we project a 13.5% increase in the second half. In cameras, we are making smooth progress throughout our full year projection of 24 million units including 3 million SLR cameras representing 14% year-on-year growth.

Please turn to slide 20. Next slide, I will discuss semiconductor production equipment starting with IC stepper. Overall, we expect the drop in memory price to have an impact on investment for the full year. We expect the IC stepper market in terms of units will be around the same level as last year. Amid such market conditions, we project second half unit sales will be significantly lower than sales compared with same period last year is particularly strong.

As for LCD aligners, we do not expect sales to recover in the second half. We are however now starting to see an improvement in order, particularly for our new age generation aligner. This is excluding our expectations for recovery next year.

Overall, we project a 0.9% decrease in net sales of semiconductor production equipment reflecting the impact of lower unit sales which will be rightly offset by sales of new products namely the ArF, which has relatively high offsetting price.

And finally, I would like to say a lot about the ArF while [inaudible] 1.35. We are currently in the final stages prior to shifting the AeF 7 and making every effort to launch the model of a margin based, mass production shifting to [inaudible] in 2008. Overall, net sales of optical and other products are projected to remain reflecting an increase in sales of large form of [inaudible] and the contribution from independent business of our subsidiaries offsetting the growth in sales of semiconductor production equipment. Please refer to slide 21.

I will now discuss second half and the full year operating profit on pre-change basis by product growth. Of full Business Machines, our reserve rates increased price competition and the shift in demand through the low price to continue. We project an increase in operating profit for the second half and the full year. We have based this projection on the increase in sales over products such as color copying machines and printers as well as cost reduction efforts and expanded sales of consumer products. At the same time, we also expect profitability to improve. In the camera segment upped by competitive product lineup, we aim to maintain the pricing premium, and expand the sales of higher value added products such as mid to high-end compact digital cameras and digital SLR models. At the same time we will focus on reducing costs through such major procurement and integrated production. Through these activities, we expect to be able to maintain our high operating product ratio for the second half and for the full year. And for optical and other products, we project second half unit sales of LCD aligner, where it will be almost half compared with same periods over last year.

And unit sales of IC steppers to be down 21 units, given these factors, we project a decline in second half operating profit. For the full year, however, we expect operating profit will [inaudible]. In the second half, although it is difficult to predict degree of competition we will face due to price erosion of trends in exchange rates, we expect the synergies to maintain the momentum we have innovated to achieve our [inaudible] year of sales and profits growth. This ends my presentation.

Question and Answer

Operator

At this time we’ll open the floor for questions [Operator Instructions].

Your first question will be coming from Matt Bryce from Citigroup. Please go ahead.

Matthew Troy - Citigroup

Thank you. You indicated in the comments that the demands increased to 7,000 was stronger than anticipated and as a result you would be taking your projections up to the back half of the year. I was wondering if you could give us a refresh with respect to manufacturing capacity in the past. In the last call you said about 100 units per month. I was wondering if you could give an update to what that manufacturing capacity would be and what your unit projections are for the 7,000. Thank you.

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

On depending on the manufacturing capacity, yes I believe you heard that previously we said 100 units per month. Now we are prepared to increase by 20% to 30%.

Matthew Troy - Citigroup

Okay. Thank you. I have one follow-up. Could you prudentially give us a roadmap of follow on products to the timely successful T-7000 specifically, you plan to expand the family in early 2008 and beyond, any sense of timeframe there. Thank you for the time.

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Well, we have decided on the T-7000, therefore we would first want to establish our commissions with it and then go on to think about what steps to take as our next strategy.

Matthew Troy - Citigroup

Thank you

Operator

Thank you. Does that include your question sir?

Matthew Troy - Citigroup

Yes, it does.

Operator

Thank you very much. Our next question will be coming from Sharon Gross of Cross Research. Please go ahead.

Shannon Cross - Cross Research

Yes, I had two questions on your laser beam printers and then a follow-up. The first question on the laser beam printers is on consumables growth. Can you tell us what consumables growth was whether you can break out for laser beams and inkjet or give us the combined number for the quarter?

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

First of all, for consumables, for the LBP, we are expecting growth 10% plus. And for the inkjet consumables, we are looking at a growth of 20% plus.

Shannon Cross - Cross Research

And is that growth for projections and if so then can you give us what your growth rates were for the current quarter… for second quarter?

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

For the LBP in the second quarter, it grew almost 10%. But for the inkjet in the second quarter, we recorded a growth of 30%.

Shannon Cross - Cross Research

Okay. Thank you. And then with regard to your laser beam printer unit growth forecast for second half '07, 4% year-over-year growth obviously a significant deceleration from the unit volumes that we have seen in the past few quarters. Is that because of tougher comps? Is there an inventory issue, any color that you can provide us to why only 4% year-over-year for second half?

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Well, the question was on you think or you seem to maybe the laser beam printer unit growth is rather decelerating compared to growth we have seen in the previous years. But actually last year we had a new product launch and the initial demand was at a very high level. Therefore, on printing of the growth may seem to be a bit low. However, we do not see that the growth of the market has stopped in any way.

Shannon Cross - Cross Research

Okay. And then if you could finally just discuss in a bit more detail what you expect from a pricing environment for both laser beam printers as well as inkjet. And if you expect, for instance, in laser beam, the new range will continue to sell well which should be good for ASP’s in laser? And then on inkjet, if you expect the competitor to continue to be aggressive in the market? Thank you.

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Well, you asked and I commented to the previous question concerning the laser beam market. We see that laser beam market is still growing. It is showing very strong growth and also in that market, we believe our product share will increase.

And now going on to your question the visiting Hong Kong in the laser beam printers in that the market seems to be taking for a lower price range, especially in the emerging markets. However, even if that could occur, we see a stable consumption of our consumables. Therefore, we do believe that there is expense some basis here. And for the inkjet, our competitors are aggressively reducing their prices. However, we still maintain its command in the market and therefore, we see that our price decline is much more milder than the average that we see in the market.

Shannon Cross - Cross Research

Okay. Thank you. And I have one final question, to complete my questions. The question is basically; can you provide us with any details on inventory you see in laser beam printers and the channel with your partner. Are you comfortable with the level of inventory that is out there?

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Well, in the first quarter, we did have a high number of sales to our OEM partners and including you we believe that everything will move as we climb, therefore presently we see more concern concerning the inventory levels

Shannon Cross - Cross Research

Thank you very much. This concludes my questions.

Operator

Thank you very much. Our next question will be coming from Keith Bachman from Banc of America. Please go ahead

Keith Bachman - Banc of America

Thank you very much. My question is to a follow-on from Shannon’s question with Kodak strategy being less aggressive in terms of the hardware and in terms of pricing which is trying to have a different model on the buyer side equation. Have you seen an impact in the market from Kodak in the inkjet side of the business? Thank you.

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Well, when we compare our products with the current products that Kodak has we believe that our products have potential against them therefore we have no concerns about our prices against Kodak products

Keith Bachman - Banc of America

Okay, if I could ask a follow-up question please. You mentioned your expectation for consumer durables supplies both on the inkjet and the laser beam side for the second half of calendar year ‘07 I was hoping you could give some thought on what you think the industry looks for with more supplies on both the inkjet consumables durables will be in the second half of '07. Thank you.

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Well, we can only say that we do not have any fears on of what the competitors will be doing in terms of consumables for inkjet or the laser beam printers.

Keith Bachman - Banc of America

Okay. That concludes my question. Thank you.

Operator

Thank you very much, sir. [Operator Instructions].

Our next question will be coming from Greg Paul from Burgundy Asset Management. Please go ahead

Gregory Paul - Burgundy Asset Management

Thank you. I just had a question about free cash flow on page 30, you are projecting 380 billion I believe in free cash flow, your payout ratio you are targeting 26%. It comes around to about 130 billion yen in this year. Your projected cash count at the end of the year is essentially flat year-over-year, so what will you do with the additional free cash flow that is being generated. Thank you.

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Well, I think though this is much or not much we have surpassed 200 billion of our shares and so that’s about it

Gregory Paul - Burgundy Asset Management

Thank you

Operator

Does that complete your question sir?

Gregory Paul - Burgundy Asset Management

Yes, fine. Thank you very much.

Operator

There appears to be no further questions at this point. Thank you. That concludes today's conference call. If you have further questions, please send them to Canon's email address prj-ircall@list.canon.co.jp. Canon will respond as soon as possible.

And I would like to hand the call over to Masahiro Osawa. Please go ahead, sir.

Masahiro Osawa - Managing Director and Group Executive, Finance and Accounting Headquarters

Well, first of all, thank you very much for participating in this conference call, which was done through an interpreter.

Although, this is my first time or first opportunity to speak to, I would like to take the opportunity to thank you for your support and cooperation. And I would like to ask you for your continued support and cooperation. Thank you very much.

Operator

On behalf of Canon, I would like to thank everyone for participating in today's conference. All lines may now disconnect and good day to you all. Thank you.

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