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SDK Makes Progress in Implementation of “SPROUT Project”

December 10, 2003

Showa Denko K.K. (SDK) is making progress in implementation of its growth-oriented consolidated business plan, the “Sprout Project,” that extends from 2003 through 2005. The plan has been carried out following the successful completion of the previous plan, the “Cheetah Project,” that focused on restructuring.

As part of the Sprout Project, SDK has identified 12 strategic market units (SMUs): the business segments in the electronics, automotive parts, and personal care/environmental good markets where SDK can expect high growth through interconnections of its proprietary inorganic/aluminum and organic chemical technologies.

SDK is allocating its resources preferentially to SMU Projects corresponding to these specific market segments in order to develop individualized, competitive, high-value product lines. By doing so, SDK aims to establish itself as an individualized chemical company.

The following explains the progress made in the first year of the Sprout Project, centering on how SDK’s hard disk media and petrochemical operations have been reorganized and what kind of new strategic growth businesses have been developed.

Part 1: Improvement in financial strength

1. Performance forecast for 2003 (as announced on August 12, 2003)

Net sales ¥686 billion
Operating income ¥38 billion
Ordinary profit ¥26.5 billion
Net income ¥10 billion
Retained earnings ¥14.3 billion
Interest-bearing debt ¥531.6 billion
Cash dividend will be resumed in March 2004 at ¥2 per share.

2.Substantial increase in earning power (Estimates for 2003 as announced on August 12)

  • (a)Operating income
    Operating income for 2003?the first year of the Sprout Project?is expected to amount to ¥38 billion, surpassing the target of ¥37.6 billion. (Operating income for 2002 was ¥31.3 billion.)
  • (b)Sales profit ratio
    The ratio has improved from 4.6% in 2002 to estimated 5.5% for 2003 as a result of the restructuring and the expansion of high-value businesses.

3. Cost reductions

Actual cost reductions in 2003 are expected to reach ¥11 billion, exceeding the target of ¥10 billion. The ¥11 billion figure consists of ¥1 billion in personnel expenses, ¥5.5 billion in manufacturing, ¥2.4 billion in purchasing, and ¥2.1 billion in SCM costs.

4. Interest-bearing debt

The debt is steadily decreasing. In 2003, a ¥49.5 billion debt reduction is expected.

  2002 2003 (estimates)
Interest-bearing debt ¥581.1 billion ¥531.6 billion
Debt equity ratio ¥3.9 times 3.3 times

Part 2: Strategic business expansion

1. Basic policy

As announced earlier, SDK has classified its businesses into three categories: strategic growth businesses, base businesses, and businesses that need restructuring. The roles of respective categories have been clarified and their specific business strategies have been established.

SDK will further reduce costs in all sectors and reform its business structure from medium- and long-term perspectives. In particular, SDK aims to expand strategic growth businesses through the SMU approach.

2. HD: Restructuring based on state-of-the-art technology

¡¦Change in sales policy: Shift from sales to HDD makers with in-house production to sales to HDD makers without in-house production

¡¦Strategic alliance/acquisition: Purchased Mitsubishi Chemical’s operation, establishing a production site in Singapore and carrying out capacity expansion Obtained preferential right of purchase from TRACE of Taiwan R.O.C. based on licensing of production technology; becoming the largest OEM maker having the capacity of up to 8.3 million disks a month.

¡¦Demand increasing rapidly and applications broadening: Other than PCs, used in DVD recorders, car navigation systems and MP3 players

Successfully laid a strong foundation as OEM supplier of HDs

3. Petrochemicals: Strategic alliance and cost reductions

  • (a)Ensured high operating rate of naphtha cracker in Oita
    Strengthening acetyls business: Joint venture with Kyowa Hakko Kogyo for the production of ethyl acetate (This means that we secured stable source of demand for ethylene.) Integration of polyethylene operations: Establishment of Japan Polyethylene, the largest PE maker in Japan
  • (b)Cost reductions
    The ratio has improved from 4.6% in 2002 to estimated 5.5% for 2003 as a result of the restructuring and the expansion of high-value businesses.

4. Electronics: Active preparations for growth

  • (a)Solid conductive polymer aluminum capacitors
    Doubling production capacity (construction of the second production line)
    Placing new grades on the market (thinner package, higher quality and capacitance)
  • (b)Compound semiconductors
    Participating in the market for LED chips with exceptional brightness (emitting red/orange light)
  • (c)VGCFR
    Planning capacity expansion to meet growing demand for use in lithium-ion batteries Established a joint venture with Professor Endo of Shinshu University for the development of VGCFR applications
  • (d)Specialty gases for semiconductor processing
    Starting full-scale sales of C4F6?next-generation dry etching gas
  • (e)Chemical mechanical polishing (CMP) slurries
    Capable of serving the needs of next-generation devices; Increasing production capacity
  • (f)Rare earth
    Trial run started at new plant in Baotou, China (Production in Japan and China)

5. Aluminum: Optimizing production setup and increasing value of products

Strategic growth businesses and base businesses
  • (a)Shotic
    Achieved record sales due to its technical and quality advantages
  • (b)Photosensitive drums for laser beam printers
    Built a new plant in Dalian, China (production in Japan, U.S.A. and China)
  • (c)Heat exchangers
    Transferring production overseas
  • (d)High-purity foil for capacitors
    Cost reductions as a result of separating Sakai Plant into a subsidiary; maintaining the leading share of the market
  • (e)Highly conductive aluminum alloy ST60
    Substantial increase in demand following the rapid growth of the plasma display panel (PDP) market
  • (f)Aluminum cans
    Participating in the aluminum bottles business
Businesses that need restructuring
  • (a)Commodity sheet
    Cost reductions as a result of separating Sakai Plant into a subsidiary
  • (b)Extrusions
    Consolidation of production sites from three to two; Reduction in the number of extruders
  • (c)SKY Aluminium
    Merged with Furukawa Electric’s aluminum business

6. Chemicals: Concentration on selected areas

  • (a)Specialty chemicals
    Pharmaceutical/agrochemical intermediates: New products being sold on the European market Micropowder-containing resin: Broadening applications for TiO2 photocatalyst masterbatches
  • (b)Agrochemicals/disinfectant
    SDS Biotech Acquired three kinds of agrochemicals from Ube Industries
    Obtained exclusive marketing right in Japan for new biofungicides
  • (c)Basic chemicals
    Ammonia Completion of a new plant that uses waste plastic as raw material
    Epichlorohydrin Withdrew from the operation, and sold the business to Daiso

7. Inorganic materials: Restructuring production setup

  • (a)Commodity ceramic abrasives (fused alumina, cubic boron nitride, silicon carbide)
    Transferring production to China to strengthen cost competitiveness
  • (b)Graphite electrodes
    Becoming more cost competitive as a result of synergies of the two plants in Japan and U.S.A.
    Graphite electrode in short supply all over the world
  • (c)Ferrochrome
    Withdrew from domestic business; dissolved production subsidiary Shunan Denko

Part 3: SMU - Key concept in growth strategy

1. Strategic Market Units (SMUs)

SMU Projects are cross-functional projects corresponding to the 12 market segments with high growth potential focusing on the three target areas of electronics, automotive parts and personal care/environmental goods. SDK positions those SMU Projects as growth engines for the Group, allocating its resources on a preferential basis.

2. SMU Projects and supporting technologies

The 12 SMUs have been identified after analyzing target markets and SDK’s proprietary technologies. We have established 27 technology platforms (TPF) to solve technical problems the SMU Projects will face and to facilitate the growth of the new businesses.

3. Shift from seller’s viewpoint to customer’s viewpoint

In the past, SDK’s business was conducted mainly from a seller’s viewpoint, resulting in the lack of clear focus in market strategy. Under the Sprout Project, we have shifted to a customer’s viewpoint and identified the 12 SMUs. We will fulfill the needs of our customers by developing individualized products through the interconnection of wide-ranging technologies.

4. Examples of growth based on the SMU Projects

  • (a)Battery Materials SMU Project: Sharing market information and interconnecting technologies
    This project aims to supply battery cases, electrolyte, cathode material, separator, and electrode material to the markets of lithium-ion batteries, fuel cells and solar batteries. Through the sharing of market information and technology interconnections, the project has been successful in commercializing individualized products based on SDK’s proprietary technology in such areas as aluminum laminate, conductive polymer, separator and gas-phase-process titania.
  • (b)VGCFR (Battery Materials SMU Project)
    Demand for VGCFR (vapor-grown carbon fiber) is growing fast due to the expansion of the lithium-ion battery market. SDK is now studying the possibility of expanding its VGCFR production capacity. To facilitate the development of new applications for VGCFR and other advanced carbon materials, SDK has established MEFS Co., Ltd. jointly with Professor Morinobu Endo of Shinshu University, who is an authority on the research of vapor-grown carbon fiber.
  • (c)Titania: Strengths based on market-oriented approach
    SDK provides fine particles of titania having excellent dielectric/UV shielding/photocatalyst properties. Market development is under way based on the SMU approach. In the Life Science SMU Project, a joint development with a textile maker is progressing to take advantage of the photocatalyst function. In the Cosmetics Raw Materials SMU Project, coated titania particles are being marketed to cosmetics manufacturers for UV shielding applications.
  • (d)High-purity C4F6 (Semiconductor-processing Materials SMU Project)
    To meet the trend toward further miniaturization in the LSI production, SDK started supplying commercial quantities of C4F6 gas that allows dry etching at line width of 90 nm or less. SDK became the first to obtain the Japanese Government’s approval based on the Law Concerning Examination and Regulation of Manufacture of Chemical Substances. C4F6 provides excellent aspect ratio and high selectivity. At the same time, C4F6 features very low environmental load as it is decomposed in less than two days in the atmosphere.
  • (e)LED chips with exceptional brightness (Communications Device SMU Project)
    SDK has succeeded in tripling the brightness of its aluminum indium gallium phosphide (AlInGaP) LED. AlInGaP LEDs emit bright light in the wavelengths from red to yellow-green. They are increasingly used in combination with indium gallium nitride (InGaN) LEDs, which emit blue/green light, for such applications as automotive parts, outdoor displays, mobile phones and traffic light.
  • (f)Solid conductive polymer aluminum capacitors (Capacitor SMU Project)
    This product features low ESR, high resistance to heat, and high retardance to flame. It also features high capacitance and small size. Applications center on power source for CPU in PCs. To meet growing demand for this product, SDK has strengthened its tie-up with KEMET Corporation of the U.S.A. Specifically, front-end processes will be consolidated at SDK, and SDK’s production capacity will be doubled through construction of the second line. SDK is also placing on the market new grades with double capacitance and thinner packaging.

5. R&D expenses allocated mainly to growth businesses

In 2003, strategic growth businesses accounted for 50% of the total R&D expenses. Base businesses and businesses that need restructuring accounted for 26% and 24%, respectively.

Part 4: Showa Denko continues to change

1. Giving incentives to motivated and capable employees

Introduction of a new human resources system as from 2004
Employees in managerial positions will receive reward according to accountability and performance (Basic annual salary for the position plus performance-based reward)
The set annual pay raise system will be abolished.
Business results of a given sector will be reflected on bonuses for employees of that sector. (To be implemented first with employees in managerial positions)

2. Advancing rapidly into China

  • (a)Footholds for business support
    Showa Denko (Shanghai), established in 2000
    Shoko (Shanghai), set up in 2001
  • (b)Production sites in Shanghai to serve customers’ local plants
    Waste gas scrubbers for semiconductor industry (since 1999)
    Resins (BMC*, vinyl ester) (since 2000) *Showa Highpolymer’s unsaturated polyester compound
    Semiconductor-processing specialty gases (since 2003)
  • (c)Ongoing projects
    Rare earth in Baotou (making a trial run): Intended as a means of securing feedstock
    Photosensitive drums in Dalian (making a trial run): For the purpose of serving customer’s local plant
    Abrasive grains in Lianyungang (to begin construction): Intended as a means of securing feedstock

3. Cost reductions in 2004

SDK is planning to reduce a total of ¥20 billion in costs during the three-year period of the Sprout Project. For 2004, cost reductions of ¥5 billion are planned, comprising ¥2.5 billion in manufacturing cost, ¥1.5 billion in purchasing cost and ¥1 billion in SCM & logistics cost.

4. Continued reductions in interest-bearing debt

2002 year-end ¥581.1 billion
2003 year-end (estimate) ¥531.6 billion
2005 year-end (Sprout target) ¥520 billion
(D/E ratio: less than 3 times)

Additional reductions will be made by 2005. In the “post-Sprout” business plan, interest-bearing debt will be reduced further.

[Reference]
  2002 2003 (Plan) 2003 (E) 2004 (Plan) 2005 (Plan)
Sales O.I. Sales O.I. Sales O.I. Sales O.I. Sales O.I.
Petrochemicals 227.8 10.0 172.0 9.1 223.0 11.5 174.0. 8.9 173.0 9.1
Chemicals 68.5 5.7 81.0 7.3 79.0 7.1 85.0 8.0 87.0 8.7
Electronics 75.2 6.2 95.0 10.6 94.0 10.0 108.0 12.8 116.0 14.6
Inorganic materials 56.9 1.4 47.0 1.1 51.0 2.2 48.0 2.4 49.0 3.8
Aluminum, etc. 245.6 12.9 255.0 14.4 239.0 12.4 255.0 14.2 255.0 15.7
Common expenses   (4.8)   (4.9)   (5.2)   (4.7)   (1.9)
Total 674.0 31.3 650.0 37.6 686.0 38.0 670.0 41.6 680.0 50.0

Notes:
Sprout target figures for respective segments were announced in January 2002.
Estimates for 2003 were announced in August 2003.
The performance forecast and plan are based on the economic conditions and the Company’s policy at this point of time. Please note that actual results may differ from the forecast and the plan due to a variety of factors, including changes in the market conditions.
SDK aims to establish itself as a truly individualized chemical company, enhance corporate value, and realize its vision through achievement of strategic goals under the Sprout Project.

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