Canon (CAJ)

Third Quarter Earnings

On October 27, 2008, Canon Inc. reported results for the third quarter of fiscal 2008 ended September 30, 2008. Revenue for the quarter was below our estimate of $10,886.7 million ( 1,140.6 billion). Total revenue for the third quarter was $9,153.8 million ( 986.0 billion), a decrease of 6.2% year-over-year (y-o-y). This decrease was driven by the negative effect of strong appreciation of the yen against the dollar, coupled with flagging demand and falling prices due to the economic downturn, which was partially offset by the increased sales of digital SLR cameras. Net income for the quarter was $770.9 million ( 83.0 billion) or $0.61 per ADR ( 65.91 per diluted share), compared to net income of $893.0 million ( 105.3 billion) or $0.69 per ADR ( 81.93 per diluted share) in the year-ago quarter. Gross margin fell 210 basis points y-o-y to 48.2% due to escalating raw material costs and fluctuations in currency exchange rates, despite continued product launches and ongoing cost-cutting efforts. In spite of group-wide expense reduction efforts, CAJ's operating margin fell to 13.1% from 16.6% in the year-ago quarter. Third quarter results were affected due to lower-than-expected business confidence, particularly in the developed countries the financial crisis arising from the subprime loan mortgage, which worsened following the failures of several security firms amid stagnant housing investment and sluggish consumer spending a greater impact of the yen appreciation compared with the second quarter of 2008 and a steep increase in raw material cost. It is to be noted that all the y-o-y changes reflect the change in local currency.

Segment-wise, Cameras recorded $2,318.9 million ( 249.8 billion) in revenues, a decrease of 6.8% from the year-ago quarter and $418.6 million ( 45.1 billion) in operating income, a decrease of 41.3% y-o-y due to drop in sales, declining gross margins caused by the rapid appreciation of the yen as well as intensifying price competition. Within the digital camera segment, digital SLR models such as the high-resolution, competitively priced EOS Rebel XSi (EOS 450D) and the advanced amateur model EOS 40D achieved healthy sales growth. Sales of digital compact cameras remained relatively unchanged due to the impact of declining market conditions, despite being bolstered by the launch of 9 new models, including 2 new ELPH (IXUS) series models and 7 new PowerShot-series models catering to the need of photographic demands. Accordingly, unit sales of digital cameras for the third quarter grew approximately 4.0% compared to the year-ago period.

The Business Machines segment recorded revenue of $6,043.8 million ( 651.0 billion), a decrease of 5.1% y-o-y, and operating income fell by 12.0% to $1,244.2 million ( 134.0 billion)as a result of the decline in sales and lower gross margins due to yen appreciation. The decrease in sales was due to the appreciation of the yen along with restrained investment in office equipment, as a result of concerns regarding business performance, led to decrease in demand for office imaging products in major regions. In the field of computer peripherals, sale of laser beam printers remained at a level comparable to the year-ago period, while sale of consumables increased steadily y-o-y, despite the significant impact of yen appreciation, which resulted in an increase in sales. As for inkjet printers, home-use multifunction models as well as business-use MFDs equipped with a facsimile function recorded an increase in both unit sales with expanded sales of related consumables resulting in a slight increase in sales on a local-currency basis. As for business information products, a drop in demand for personal computer sales in the Japanese domestic market resulted in a reduction of sales.

In Optical and Other products, net sales (excluding inter-segment sales) were down by 12.2% to $791.1 million ( 85.2 billion) y-o-y. While unit sales of LCD aligners, gained momentum owing to the recovery of demand by LCD panel manufacturers, sales of steppers used in the production of semiconductors continued to lag as market conditions deteriorated. As a result, the company reported an operating loss of $462.7 million ( 49.8 billion), an increase of 9.4% y-o-y.

Geographically, revenue mix in the third quarter was 20.0% from Japan, 29.0% from the Americas, 32.1% from Europe, and 18.9% from Other Areas in total, 80.0% of net sales were from overseas. During the quarter, cash flow from operating activities was $926.9 million ( 99.8 billion). Including capital expenditure of $941.0 million ( 101.4 billion), the company generated 0free cash flow of $34.9 million ( 3.8 billion). The dollar values are based on an average exchange rate of approximately 107.7 per U.S. dollar for the quarter ended September 30, 2008.

Canon exited the quarter with $7,016.2 million ( 743.0 billion) in cash and short-term investments, down $1,341.4 million ( 144.3 billion) from the previous quarter. Long-term debt was $90.5 million ( 9.6 billion), down $5.0 million ( 0.6 billion) sequentially. These dollar values are based on a period-end exchange rate of approximately 105.9 per U.S. dollar.

For the global economic outlook for the fourth quarter of fiscal 2008, Canon expects an economic weakness to spread globally due to the worldwide plunge in stock prices triggered by the financial turbulence as a result of failing financial institutions in the United States. Moreover, increased fluctuations in currency exchange rates have led to uncertainty over the future and the company expects significant appreciation of the yen y-o-y. Raw material prices are expected to remain at a high level. Amid this environment, Canon expects emerging-market economies such as Asia and Russia to continue posting favorable growth despite the negative economic influence of developed countries, which is expected to post lackluster growth in the fourth quarter. For Canon, while the digital SLR are expected to continue achieving healthy expansion, the compact digital camera market is expected to record modest growth amid intensifying price competition. Demand for color network digital MFDs and color laser beam printers are expected to remain at a low level overall. The market for steppers is likely to remain stagnant, while the market for aligners is expected to continue to recover due to large-scale facility investment by LCD panel manufacturers. CAJ expects to curtail inventory and launch new products and realize further reductions in cost and expenses. For the full year 2008, CAJ expects a total of 10.0 billion in other income, net. CAJ expects capital expenditure of 410 billion, depreciation and amortization of 360 billion, free cash flow of 175 billion and operating cash flow of 660 billion. Canon expects cash and cash equivalents to be 800 billion with a dividend of $1.04 ( 110) per share by the year-end 2008. Canon expects to raise its consolidated payout ratio at 36.8% in fiscal 2008. CAJ expects to curtail inventory, launch new products, and realize further reductions in cost and expenses. Taking into consideration the first nine months of the business results, Canon has made a downward revision for the full year of fiscal 2008 results. Also, Canon expects to post weak results in fiscal 2009 due to challenging economic environment. We therefore lower our estimates for fiscal 2009.

Current Forecast for Q408

(billions of yen)

Previous forecast for fiscal 2008

(billions of yen)

Revised forecast for fiscal 2008

(billions of yen)

Current Forecast for Q408

(millions of dollar)

Revised forecast for fiscal 2008

(millions of dollar)

% Change in forecast

Net Sales

1,150.6

4,590.0

4,250.0

$11,506.0

$40,837.9

-7.4%

Gross Profit

518.4

2,261.1

2,035.0

$5,184.0

$19,554.1

-10.0%

Operating Income

119.8

770.0

580.0

$1,198.0

$5,573.2

-24.7%

Income before income taxes and minority interests

785.0

590.0

$5,669.3

-75.2%

Net Income

77.5

500.0

375.0

$775.0

$3,603.3

-25.0%

Exchange Rate (yen against dollar)

1$ = 100

1$ = 104.86

1$ = 104.07

Exchange Rate (yen against euro)

1 = 135

1 = 163.03

1 = 153.23

Revenue by Product

Current Forecast for Q408

(billions of yen)

Current Forecast for fiscal 2008

(billions of yen)

Current Forecast for fiscal 2008

(millions of dollar)

Business Machines

674.0

2,713.7

$26,075.7.0

Cameras

344.0

1,123.3

$10,793.7

Optical and Other Products

185.0

648.2

$6,228.5

Corporate and Eliminations

52.0

235.2

$2,260.0

Exchange Rate (yen against dollar)

1$ = 100

1$ = 104.07

Exchange Rate (yen against euro)

1 = 135

1 = 153.23

Establishment of Canon Institute and Foundation

On December 1, 2008, Canon Inc. announced the establishment of the Canon Institute for Global Studies and the Canon Foundation with the aim of contributing to the development of Japan and the rest of the world. Canon Institute for Global Studies and Canon Foundation has been funded with 1.0 billion (at time of establishment). Canon Institute for Global Studies research areas include macro economy, natural resources, energy and the environment, as well as foreign diplomacy and defense. Canon Foundation includes information and electronics, machinery and precision equipment, nanotechnology and materials, applied physics and applied chemistry and research.

Unsecured Convertible Debentures

On December 1, 2008, Canon announced that the Third Series of Unsecured Convertible Debentures Due 2008 issued by Canon on November 24, 1993 will mature on December 19, 2008. The Convertible Debentures will not be able to get exchanged for common stock after December 18, 2008 (the expiry date of the conversion period). The conversion price is 998.0 per share and must be converted before the expiry date. After the date of maturity, no interest will accrue on such debenture.

Product News

On November 26, 2008, Canon Inc. announced the development of a new portable flat-panel DR (digital radiography) system capable of both viewing dynamic and capturing static X-ray images with plans to enter the medical fluoroscopic device market. With the development of its new system, Canon established a crossover to the dynamic imaging market. Building on the image quality and speed of the CXDI series for radiography, Canon developed a compact, lightweight DR system capable of both viewing moving images and capturing static X-ray images. While the newly developed prototype accommodates the standard static X-ray image capture of the chest area and extremities, it also enables X-ray fluoroscopy', which radiographers can use to observe dynamic images of internal organs. Canon is currently developing the system for a release in the latter half of 2009. Improving and expanding the lineup of its X-ray DR systems to include a system capable of capturing both fluoroscopic and radiographic images will allow Canon to further expand the market for these products, as well as support the advancement of medical institutions for digitization and soft copy diagnostic reading.

On October 10, 2008, Canon and Toray Industries, Inc. announced the development of a bio-based plastic achieving the highest level of flame retardance. The new bio-based plastic includes more than 25% (by weight) a plant-derived component, and will be used in exterior plastic parts for Canon multifunction office systems to be launched beginning in 2009. The new bio-based plastic developed by Canon and Toray offers an expected reduction in manufacturing-related CO2 emissions of approximately 20%. The development of the new bio-based plastic will help replace petroleum-based plastics used for exterior parts, which require a high level of flame retardance. Beginning next year, Canon intends to introduce multifunction office systems that incorporate the newly developed bio-based plastic, with initial plans to use approximately 100 tons of the material per year.

Tender Offer by Subsidiary

On November 18, 2008, Canon Inc. announced that Canon Electronics Inc., a subsidiary of Canon, completed the tender offer for the shares certificates of the common stock of Asia Pacific System Research Co., Ltd. Canon Electronics Inc. resolved the commencement of the tender offer at its Board of Directors meeting held on October 14, 2008 and carried out the tender offer from October 15, 2008 to November 17, 2008. The company expects 5,507,400 shares to be purchased and converted to shares at a purchase price of 650.0 per share of common stock A total of 7,909,651 shares were tendered in the tender offer. As the total number of share certificates in the tender offer was not less than the minimum number to be purchased if converted to shares (5,507,400 shares) all of the tendered share certificates will be purchased. Currently, the company has no intention to purchase additional shares of the target company after the tender offer and intends to maintain the listing of the shares of the target company after the tender offer. The tender offer's influence on the operating results of the company during the fiscal term of 2008 will be slight.

On October 31, 2008, Canon Electronics Inc., a subsidiary of Canon Inc., submitted to the Director of the Kanto Local Finance Bureau, an amendment statement to the tender offer registration statement, in which Canon Electronics Inc. described its tender offer for the common stock of Asia Pacific System Research Co., Ltd. Accordingly, Canon Electronics Inc. amended its tender offer for the shares of Asia Pacific System Research Co., Ltd. dated October 14, 2008. Period of the offer at the time of filing the tender offer period will be from October 15, 2008 to November 17, 2008.

Delay in Production Facilities

On November 17, 2008, Canon Inc. announced that it will delay the start and construction of operation of Hita Canon Materials Inc., the manufacturing base in Hita City, Oita Prefecture, established in June 2008, by approximately six months. Construction is scheduled to begin in June 2009, with operations to begin in March 2010. Total capital requirement is of 80 million and the company plans to make investments of approximately 40 billion by the end of 2011 and approximately 100 billion by the end of phase 2, including the phase 1 investment. The rapid increasing demand for toner cartridges has led to the need to expand production capacity not only for toner cartridge units but also the highly functional components used to produce toner cartridges, including rollers and toner. The company had originally planned to start the Hita Canon Materials construction in December 2008 and commence operation in September 2009. However, the increase in demand for toner cartridges has been slower due to the global economic downturn triggered by the subprime mortgage crisis, which has necessitated a revision of earlier production plans. Additionally, the company expects this trend in demand to continue. These factors led to the company's decision to delay both the start of construction and operations at Hita Canon Materials. However, this decision is expected to have no impact on the hiring of employees.

Share Repurchase

On November 7, 2008, Canon announced that it has acquired its own shares and has completed the acquisition resolved at its Board of Directors meeting held on October 30, 2008. The company acquired 13,795,800 shares of its common stock for 50.0 billion from October 31, 2008 to November 6, 2008 on the Tokyo Stock Exchange.

On October 30, 2008, Canon announced at its Board of Directors meeting held on October 30th that it has resolved to acquire its own shares. The Board announced the acquirsition up to 20 million shares of common stock at a total cost of up to 50 billion from October 31, 2008 to November 28, 2008. The company decided to acquire its own shares with the aim of improving capital efficiency and ensuring a flexible capital strategy.

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