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Annual Report 2006
Management’s Discussion and Analysis of
Business Results and Financial Position
(1) Overview
In the year ended March 31, 2006, healthy global demand helped to boost the NSK Group’s business performance. Worldwide production by Japanese automotive manufacturers showed strong growth, and capital expenditures continued to generate firm demand, especially in Japan. Demand from semiconductor and liquid crystal production equipment sectors also shifted toward recovery in the second half of the year.
Overseas, market trends in the Americas and Europe moved upward. Demand in Asia remained generally firm, despite corrections in some sectors in China. Contributing factors in Asia included robust automobile production in Thailand.
A key strategic measure for the NSK Group amid this healthy demand environment was the implementation of sales price increases. We also worked aggressively to capture demand, while planning for the capacity increases needed to accommodate demand growth. Another priority was the development of new procurement strategies in response to price increases and supply problems affecting steel materials.
Our forecasts for the business environment for the year ending March 31, 2007 point to the continuation of high demand in Japan, especially in the automotive sector and areas linked to capital investment. Overseas, demand trends should remain firm in the Americas, despite some uncertainty about the outlook for the automotive sector. In Europe, a gradual recovery trend is expected to continue, but in Asia, the outlook for automobile production in China and Thailand is uncertain. Another source of concern is the impact of high crude oil prices and other factors on the economies in various regions of the world.
Based on this outlook, we are predicting growth in both sales and income in the areas of industrial machinery bearings, automotive products and precision machinery and parts.
(2) Analysis of Business Results for the Year Ended March 31, 2006
1. Scope of Consolidation
The consolidated financial statements reflect the financial performance of NSK Ltd. and its 81 consolidated subsidiaries (23 in Japan and 58 overseas). NSK’s investments in 18 affiliates (10 in Japan and 8 overseas) are accounted for by the equity method.
In the year under review, Amatsuji Steel Ball Manufacturing Co., Ltd., which is NSK’s most important ball supplier, became a consolidated subsidiary as a result of a tender offer launched in December 2005 and a share exchange implemented in March 2006. Five other subsidiaries were added because of the change in NSK’s holding of Amatsuji Steel Ball Manufacturing Co., Ltd. One subsidiary was added through the establishment of a sales company in China, and one was eliminated through the sale of a non-core business in Europe. Overall, there was a net increase of six in the number of subsidiaries in the year ended March 31, 2006.
The number of equity method affiliates decreased by four from the previous year’s level. One new affiliate was added with the establishment of company in China to manufacture automatic transmission components. Amatsuji Steel Ball Manufacturing Co., Ltd. and three of its subsidiaries became consolidated subsidiaries of NSK, while one aerospace company in the United Kingdom was sold.
2. Overview of the Year ended March 31, 2006
Despite some areas of weakness, including slow export growth in the early part of the year and inventory corrections in the IT sector, the Japanese economy continued its gradual recovery in the year ended March 31, 2006. The impetus for this improvement came from increased consumer spending and robust capital investment. Although the economic environment in the U.S. was influenced by hurricane damage and a jump in energy prices, the overall economy remained healthy, with increases in consumer spending and capital investment. The ongoing housing boom also helped to maintain economic expansion. Economies in the eurozone remained on a gradual recovery trend, evidence of which included export growth and increased production in Germany. Asian economies, including China, Taiwan and Thailand, continued to expand, although there were signs of deceleration in South Korea’s export growth.
In this business environment, the NSK Group continued to focus on mid-term management priorities, especially improvement of profitability initiatives such as production innovation and balance sheet reform. We also pursued aggressive growth strategies, especially in the areas of industrial machinery bearings and automotive products.
These strategies produced record sales and profits in the accounting period ended March 31, 2006. Our consolidated net sales were ¥47.5 billion, or 8.2%, higher year on year at ¥628.5 billion (US$5,372 million), while operating income increased by ¥4.3 billion, or 11.2%, to ¥42.6 billion (US$364 million), ordinary income by ¥5.8 billion, or 17.6%, to ¥38.9 billion (US$333 million), and net income by ¥3.2 billion, or 14.5%, to ¥25.6 billion (US$219 million).
The yen exchange rates used to translate the financial statements of overseas subsidiaries declined by approximately 2% against both the U.S. dollar and the euro.
 3. Net Sales
Net sales increased by ¥47.5 billion, or 8.2%, to ¥628.5 billion (US$5,372 million). Excluding exchange rate fluctuations, the increase was ¥37.6 billion, or 6.5%. Sales in Japan showed year-on-year growth of ¥19.8 billion, or 6.4%, to ¥330.0 billion (US$2,821 million). In addition to buoyant demand from the automotive sector, we also recorded increased sales to manufacturers of machine tools and general industrial machinery, the result of the strong capital investment. Overseas sales increased by ¥27.7 billion, or 10.2%, year- on year to ¥298.4 billion (US$2,551 million). Excluding exchange rate fluctuations, the increase was ¥17.8 billion, or 6.6%. Sales increased in Asia, especially China and Thailand. Sales grew, as well, in the Americas and Europe, where positive factors included strong demand for automotive products.
4. Cost of Sales, Selling, General and Administrative Expenses, Operating Income
The cost of sales increased from ¥450.3 billion in the previous year to ¥487.7 billion (US$4,169 million) in the accounting period ended March 31, 2006. Despite our efforts to improve productivity and reduce external procurement costs, higher raw material prices, increased depreciation resulting from capacity expansion, higher labor costs and other factors caused the ratio of cost of sales to net sales to worsen by 0.1 percentage points to 77.6%.
Selling, general and administrative expenses amounted to ¥98.2 billion (US$839 million), compared with ¥92.4 billion in the previous year. Reasons for the higher figure include increases in distribution cost and labor expenses. The ratio of selling, general and administrative expenses to net sales improved by 0.3 percentage point to 15.6%.
As a result, consolidated operating income increased by ¥4.3 billion, or 11.2%, year on year to¥42.6 billion (US$364 million). The consolidated operating income margin improved by 0.2 percentage point to 6.8%.
5. Business Segment Information
(a) Industrial Machinery Bearings
In Japan, the NSK Group recorded strong sales to manufacturers of machine tools, automotive electrical components, steel and rail cars. In the Americas, sales of aftermarket products were strong, but sales to manufacturers of electrical machinery and general industrial machinery declined. Reasons for this include a rise in the value of the Brazilian real, and a shifting of demand to other regions. In Europe, we recorded healthy aftermarket sales and sales to electrical machinery manufacturers. In Asia, there were declines in sales to electrical machinery and IT sector in ASEAN and South Korea, but sales to steel and machine tool manufacturers in China and South Korea were strong. Total sales in the industrial machinery bearings segment amounted to ¥195.6 billion (US$1,671 million), a year-on-year increase of ¥10.1 billion, or 5.4%. Improved capacity utilization, resulting from volume growth, and higher sales prices largely offset the effects of cost increases, including higher raw material prices, labor expenses and selling, general and administrative expenses. As a result, operating income rose by ¥2.1 billion, or 10.6%, to ¥22.1 billion (US$189 million).
(b) Automotive Products
In the area of automotive bearings, we recorded strong global sales of wheel hub units and needle roller bearings. In the automotive components category, there were increases in sales of electric power steering (EPS) systems and automatic transmission parts in Japan, while steering columns sold well in the Americas, Thailand and China. These trends have helped to boost sales in this segment by ¥37.0 billion, or 11.7%, year on year to ¥353.1 billion (US$3,018 million). Volume growth and the resulting improvement in capacity utilization, together with reduced external procurement costs, helped to offset higher costs, including increases in raw material prices, labor expenses, facility expenses and selling, general and administrative expenses. This was reflected in operating income for this segment, which rose by ¥1.6 billion, or 10.4%, to ¥17.4 billion (US$149 million).
(c) Precision Machinery and Parts
Sales to manufacturers of injection molding machines and machine tools remained steady, and sales to manufacturers of semiconductor and liquid crystal production equipment followed a recovery trend. There was a dramatic increase in sales of photofabrication equipment for LCD color filter production. As a result, total sales in this segment rose by ¥1.6 billion, or 2.6%, year on year to¥65.8 billion (US$563 million). Improved productivity was reflected in reduced labor expenses. Other positive factors included the discontinuation of unprofitable lines, and increased sales of photofabrication equipment for LCD color filter production. As a result, operating income for this segment was ¥0.8 billion, or 16.8%, higher at ¥5.6 billion (US$48 million).
(d) Others
Sales of facilities and equipment to group companies in Japan and overseas increased, but there was a reduction in sales resulting from the sale of a non-core business operation in Europe. Total sales in this segment increased by ¥0.3 billion, or 1.2%, to ¥23.5 billion (US$201 million). Operating income was ¥0.5 billion, or 29.3% below the previous year’s level at ¥1.3 billion (US$11 million) because of factors that included a higher cost of sales ratio for facilities and machinery supplied to group companies in Japan and overseas.
6. Geographical Segment Information
(a) Japan
We recorded healthy sales to a number of industries, including machine tools, automotive electrical components, steel and rail cars. In the automotive products segment, sales of needle roller bearings were strong in the bearings category, as were sales of electric power steering (EPS) systems and automatic transmission parts in the automotive parts category. In the precision machinery and parts segment, sales to manufacturers of injection molding machines and machine tools followed a firm trend, and the closing months of the financial year also brought a recovery in sales to semiconductor and liquid crystal production equipment which had previously been slow.
Total sales in Japan in the accounting period ended March 31, 2006 amounted to ¥476.2 billion (US$4,070 million), an increase of ¥36.7 billion, or 8.4%, over the previous year’s level.Operating income was affected by rising raw material prices. However, increased volumes were reflected in improved capacity utilization. Other positive factors included reduced external procurement costs, and an improvement in export profit margins due to the depreciation of the yen. As a result operating income for this region increased by ¥4.1 billion, or 13.2%, year on year to ¥35.6 billion (US$304 million).
(b) The Americas
Sales of industrial machinery bearings to the aftermarket were strong, but sales to electrical machinery and general industrial machinery manufacturers declined. Sales of automotive products benefited from successful marketing to automobile manufacturers, especially Japanese-owned companies. In the precision machinery and parts segment, there was a decline in sales in the key area of parts for semiconductor production equipment. Exchange rate movements helped to lift sales in this region, which increased by ¥9.8 billion, or 12.2%, year on year to ¥90.4 billion (US$772 million). Operating income declined by ¥0.1 billion, or 5.3%, year on year to ¥2.4 billion (US$21 million). Reasons for the lower result include cost increases resulting from factory restructuring in North America, and reduced production volumes in the precision machinery and parts segment.
(c) Europe
In the industrial machinery bearings segment, sales to aftermarket and electrical machinery manufacturers were buoyant. In the automotive products segment, sales of automotive bearings were strong, but there was a decline in sales of automotive components, in part because of the termination of production of some existing models. Total sales in this geographical segment amounted to ¥104.9 billion (US$897 million), a year-on-year increase of ¥4.8 billion, or 4.8%. Positive factors affecting operating income included higher volumes and the resulting improvement in capacity utilization, as well as lower external procurement costs. These gains were not sufficient to offset negative factors, including higher raw material prices, cost increases resulting from the appreciation of the Polish zloty, and losses on doubtful receivables. As a result, operating income for this region declined by ¥0.6 billion, or 11.6%, to ¥4.2 billion (US$36 million).
(d) Asia
There was a decline in sales of industrial machinery bearings to the electrical machinery and IT sectors in South Korea and the ASEAN markets, but sales to steel and machine tool manufacturers in China and South Korea remained strong. Sales of automotive products increased in the ASEAN markets, China, and South Korea, and there were healthy sales of precision machinery and parts in South Korea and Taiwan. Total sales in this region amounted to ¥75.8 billion (US$648 million), a year-on-year increase of ¥11.6 billion, or 18.0%. At ¥5.1 billion (US$44 million), operating income was ¥1.9 billion, or 57.7%, higher than the previous year’s result. Contributing factors include improved capacity utilization resulting from increased production volumes.
7. Other Income and Expenses
Other income and expenses shifted from net expenses of ¥3.3 billion in the previous year to a net
gain of ¥0.5 billion (US$4 million) in the year ended March 31, 2006. Net financial expenses were
reduced by ¥0.8 billion to ¥2.8 billion (US$24 million), reflecting group-wide efforts to reduce interest-
bearing debts. Other expense items included expenditure of ¥2.5 billion (US$21 million) on business
restructuring in the Americas and Europe, and a ¥0.9 billion (US$8 million) transfer to a cost
related to environmental safety measures. Income items included ¥5.9 billion (US$50 million) from
sales of investment securities, and ¥1.7 billion (US$14 million) from sales of fixed assets.
8. Income Before Income Taxes and Minority Interests
There was a year-on-year increase of ¥8.0 billion, or 22.9%, to ¥43.1 billion (US$368 million). This increase reflects higher figures for operating income, non-operating income (net) and extraordinary income (net).
9. Tax Expenses
The effective corporate tax rate applied to income before income taxes and minority interests was 38.1%, which is 2.4 percentage points lower than the effective statutory tax rate in Japan, which is 40.5%. This difference was mainly attributable to a reduction in tax expenses due to increased tax deductions resulting from the introduction of the consolidated tax payment system in Japan, effective from the year ended March 31, 2006.
10. Minority Interests
Minority interests consist mainly of the interests of minority shareholders in subsidiaries. In the accounting period ended March 2006, these remained approximately the same as in the previous
year at ¥1.1 billion (US$9 million).
11. Net Income
Net income increased by ¥3.2 billion, or 14.5%, year on year to ¥25.6 billion (US$219 million) in the year ended March 31, 2006. Net income per share was ¥47.28 (US$0.404), up from ¥41.35 in the previous year. The rate of return on shareholders’ equity (ROE) improved by 0.2 percentage points, from 11.9% in the previous year to 12.1%.
12. Cash Flows and Financial Position
(a) Cash Flows
Net cash provided by operating activities increased by ¥8.3 billion year on year to ¥66.3 billion (US$567 million). Components of this total include net income before income taxes of ¥43.1 billion (US$368 million), and depreciation of ¥30.1 billion (US$257 million).
Despite income from sales of investment securities and other sources, net cash used in investing activities amounted to ¥62.4 billion (US$533 million), a year-on-year increase of ¥30.7 billion. Reasons for the increase include capital investment in areas offering growth potential, the acquisition of tangible fixed assets, and the conversion of Amatsuji Steel Ball Manufacturing Co., Ltd. into a consolidated subsidiary.
Net cash from financing activities increased by ¥53.7 billion year on year to ¥7.6 billion (US$65 million) in the year ended March 31, 2006. Expenditure items, including bond redemptions totaling¥10.0 billion (US$85 million), as well as dividend payments, were offset by income, including ¥25.0 billion (US$214 million) from bond issues.
Cash and cash equivalents at the end of the fiscal year amounted to ¥51.8 billion (US$443 million). This represents a net increase of ¥12.4 billion over the position at the end of the previous fiscal year.
(b) Financial Position
Total assets increased by ¥114.4 billion year on year to ¥743.0 billion (US$6,351 million). The main reasons for this increase were the addition of Amatsuji Steel Ball Manufacturing Co., Ltd. and its subsidiaries as consolidated subsidiaries, and an increase in receivables and inventory assets as a result of sales growth. Current assets increased by ¥34.9 billion year on year to ¥313.6 billion (US$2,680 million). Current liabilities also rose, by ¥32.5 billion to ¥266.8 billion (US$2,281 million). This was mainly the result of an increase in accounts payable because of sales growth. The current ratio was 1.18 times, compared with 1.19 times in the previous year. Though interest-bearing debts increased by ¥15.7 billion year on year to ¥222.9 billion (US$1,905 million), the debt-equity ratio improved from 1.10 to 0.95. Total shareholders’ equity reached ¥235.7 billion (US$2,015 million), an increase of ¥47.5 billion over the previous year’s total. Among the factors that reduced assets were the inclusion of the retirement benefits by subsidiaries in the United Kingdom, and dividend payments by the parent company. The increase in total shareholders’ equity in the year ended March 31, 2006 was attributable to increase in unrealized holding gain on securities due to the recovery in the stock market, and higher net income. Equity per share was ¥436.48 (US$3.729), up from ¥349.07 in the previous year. NSK’s ratio of net worth to total capital improved from 30.0% to 31.7% in the year ended March 31, 2006.
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