Harmonic Drive Systems Inc. (6324)

Transcription

1 Harmonic Drive Systems Inc. (6324) Shared Research Inc. has produced this report by request from the company discussed in the report. The aim is to provide an owner s manual to investors. We at Shared Research Inc. make every effort to provide an objective, and neutral analysis. In order to highlight any biases, we clearly attribute our data and findings. We will always present opinions from company management as such. Our views are ours where stated. We do not try to convince or influence, only inform. We appreciate your suggestions and feedback. Write to us at sr_inquiries@sharedresearch.jp or find us on Bloomberg.

2 Contents Key financial data... 3 Recent Updates... 4 Highlights... 4 Trends & Outlook... 5 Quarterly Orders Data... 5 Quarterly Trends & Results... 6 Full-Year (FY03/15) Outlook Outlook Business Business Description Core Business Strengths & Weaknesses Market and Value Chain Strategy Historical Financial Statements Income Statement Balance Sheet Statement of Cash Flows Other Information History News & Topics Major Shareholders Top Management Employees Dividends and Shareholder Benefits Investor Relations Company Profile Copyright (C) Shared Research Inc. All Rights Reserved 2/59

3 Key financial data Income Statement FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 (JPYmn) Cons. Cons. Cons. Cons. Cons. Cons. Est. Total Sales 16,165 12,057 22,001 20,159 18,131 21,084 26,000 YoY -15.9% -25.4% 82.5% -8.4% -10.1% 16.3% 23.3% Gross Profit 6,459 4,530 9,930 8,297 7,368 9,118 YoY -25.7% -29.9% 119.2% -16.4% -11.2% 23.7% GPM 40.0% 37.6% 45.1% 41.2% 40.6% 43.2% Operating Profit 2,427 1,072 5,848 4,334 3,436 4,668 7,350 YoY -45.0% -55.8% 445.6% -25.9% -20.7% 35.9% 57.5% OPM 15.0% 8.9% 26.6% 21.5% 19.0% 22.1% 28.3% Recurring Profit 2,710 1,066 5,964 4,398 3,576 4,823 7,730 YoY -42.8% -60.7% 459.4% -26.2% -18.7% 34.9% 60.3% RPM 16.8% 8.8% 27.1% 21.8% 19.7% 22.9% 29.7% Net Income 1, ,952 2,140 1,961 2,994 4,900 YoY -44.6% -67.2% 492.0% -27.5% -8.4% 52.7% 63.7% Net Margin 9.4% 4.1% 13.4% 10.6% 10.8% 14.2% 18.8% Per Share Data Number of Shares (thousands) , , ,583.1 EPS Dividend Per Share Book Value Per Share Balance Sheet (JPYmn) Cash and Equivalents 6,667 4,600 6,988 10,094 11,958 9,057 Total Current Assets 11,157 11,431 16,170 17,860 18,897 17,930 Tangible Fixed Assets, net 3,878 3,582 4,817 5,466 5,691 5,834 Other Fixed Assets 9,310 11,414 13,107 12,045 12,214 14,684 Intangible Assets Total Assets 24,460 26,531 34,268 35,544 36,954 38,626 Accounts Payable 1,414 1,572 2,060 1,478 1,498 1,742 Short-Term Debt ,763 1, Total Current Liabilities 3,133 3,516 7,102 5,177 5,642 5,079 Long-Term Debt 2,986 2,291 1,558 4,910 3, Total Fixed Liabilities 3,898 3,957 4,209 6,834 5,325 3,026 Total Liabilities 7,031 7,472 11,311 12,010 10,967 8,105 Net Assets 17,429 19,058 22,958 23,534 25,987 30,521 Interest-Bearing Debt 3,757 3,047 2,309 6,672 4, Cash Flow Statement (JPYmn) Operating Cash Flow 3, ,338 2,477 4,700 3,643 Investment Cash Flow -4,516-2,739-2,345-5,909 3,272-1,103 Financing Cash Flow 2, ,483 3,296-2,546-5,591 Financial Ratios ROA 6.2% 2.0% 9.7% 6.1% 5.4% 7.9% ROE 8.7% 2.8% 14.5% 9.5% 8.2% 11.0% Equity Ratio 69.2% 69.6% 64.6% 63.9% 67.5% 75.9% Source: Company data Figures may differ from company materials due to differences in rounding methods. EPS and DPS figures for FY03/15 have been adjusted for the 3-for-1 stock split that took place on October 1, Copyright (C) Shared Research Inc. All Rights Reserved 3/59

4 Recent Updates Highlights On November 12, 2014, Harmonic Drive Systems Inc. (HSDI) announced 1H earnings results for FY03/15; see the results section for details. On the same day, the company announced a revision to its full-year FY03/15 earnings results and an increase in its dividend, from JPY6 to JPY7 per share. The company issued a 3-for-1 stock split on October 1, On October 15, 2014, the company announced quarterly orders and sales data for Q2 FY03/15 (parent level); see the quarterly orders data section for further details. On September 4, 2014, Shared Research updated comments on the company after interviewing management. On August 27, 2014, the company announced investment in additional manufacturing capacity for precision reducers. The company will invest a total of about JPY2.8bn in additional manufacturing capacity at three locations. According to the company, this capex will allow it to provide a stable supply of precision reducers to meet expected growth in demand, particularly related to industrial robots. It will also provide the company with a competitive edge in terms of quality, delivery times, and manufacturing efficiency. Specifically, the company will invest about JPY2.0bn in its Hotaka facility, the main production center of Harmonic Drive strain wave gearing (about JPY1.0bn on equipment; JPY1.0bn on buildings). The company thus plans to increase production capacity at this facility from 10,000 units per month to 50,000. The company also plans to invest about JPY300mn and JPY500mn in subsidiaries Harmonic Precision Inc. (manufactures cross roller bearings) and Harmonic AD Inc. (manufactures planetary gears) respectively. The aim is to increase manufacturing capacity and efficiency at these subsidiaries. For corporate releases and developments more than three months old, please refer to the News & Topics section. Copyright (C) Shared Research Inc. All Rights Reserved 4/59

5 Trends and outlook Quarterly Orders Data Total orders in Q2 FY03/15 were JPY5.2bn (+11.8% YoY; -16.2% QoQ), marking higher sales year-on-year, but falling short of the record sales seen in Q1 FY03/15. Sales in Q2 were JPY5.8bn (+23.7% YoY; -10.4% QoQ). Orders by end use Orders for industrial robots, oil drilling equipment, and metalworking equipment increased compared to the previous year. Quarter-on-quarter, orders for drilling equipment were up, but orders for industrial robots were down as capital spending decreased for equipment used in smartphone manufacturing in China. Exports Exports increased year-on-year, but were down compared to the previous quarter. On a year-on-year basis, exports to South Korea and North America were down, while exports to China were up. Compared to the previous quarter, exports to China, Europe, and South Korea decreased. Copyright (C) Shared Research Inc. All Rights Reserved 5/59

6 Quarterly Trends & Results Quarterly Performance FY03/13 FY03/14 FY03/15 FY03/15 FY03/15 (JPYmn) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2(*) % of 1H 1H Est. % of FY FY Est. Sales 4,957 4,890 4,158 4,126 4,969 5,443 5,475 5,197 6,155 6, % 12, % 26,000 YoY -11.8% -10.9% -8.0% -9.0% 0.2% 11.3% 31.7% 26.0% 23.9% 20.2% 20.1% 23.3% GP 2,119 2,070 1,665 1,515 2,172 2,430 2,436 2,080 2,797 3,237 YoY -12.5% -12.4% -3.8% -15.0% 2.5% 17.4% 46.3% 37.3% 28.8% 33.2% GPM 42.7% 42.3% 40.1% 36.7% 43.7% 44.6% 44.5% 40.0% 45.4% 49.5% SG&A , ,079 1,118 1,102 1,151 1,189 1,213 YoY -4.3% 0.2% 6.7% -5.6% 10.6% 12.3% 6.3% 24.6% 10.2% 8.4% SG&A / Sales 19.7% 20.4% 24.9% 22.4% 21.7% 20.5% 20.1% 22.1% 19.3% 18.5% OP 1,143 1, ,093 1,312 1, ,608 2, % 3, % 7,350 YoY -18.4% -21.6% -17.2% -26.5% -4.3% 22.1% 112.2% 57.3% 47.1% 54.4% 39.3% 57.5% OPM 23.1% 22.0% 15.1% 14.3% 22.0% 24.1% 24.4% 17.9% 26.1% 30.9% 26.8% 28.3% RP 1,183 1, ,196 1,362 1, ,796 2, % 3, % 7,730 YoY -20.8% -28.3% -22.1% 15.9% 1.0% 32.8% 95.4% 34.7% 50.2% 53.5% 34.9% 60.3% RPM 23.9% 21.0% 16.8% 16.2% 24.1% 25.0% 24.9% 17.3% 29.2% 31.9% 27.6% 29.7% NI ,113 1, % 2, % 4,900 YoY -4.6% -34.9% -23.6% 157.4% 5.2% 80.9% 121.8% 37.9% 46.7% 57.5% 38.1% 63.7% NPM 14.6% 9.8% 9.1% 9.2% 15.3% 16.0% 15.4% 10.0% 18.1% 20.9% 18.0% 18.8% 5,361 4,313 4,098 4,414 5,316 5,323 5,282 6,400 7,015 6,008 YoY -12.3% -8.3% 6.1% -4.0% -0.8% 23.4% 28.9% 45.0% 31.9% 12.9% 3,270 2,659 2,582 2,962 3,387 3,321 3,119 4,400 5,224 4,677 Quarterly sales and orders (parent) FY03/13 Source: Company data Q2 FY03/15 figures are the difference between 1H FY03/15 forecasts and Q1 FY03/15 results. Figures may differ from company materials due to differences in rounding methods. FY03/14 (JPYmn) 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q Sales 4,442 4,237 3,761 3,717 4,416 4,673 4,853 4,640 5,584 5,781 Semiconductor production equipment Flat panel displays Industrial robot applications 1,687 1,700 1,220 1,276 1,278 1,629 1,521 1,628 2,606 2,491 Gear heads (for electric motor makers) Machine tools Oil-Drilling Equipment Others 1,095 1,143 1,187 1,063 1,315 1,211 1,383 1,218 1,147 1,271 YoY -13.4% -14.0% -3.2% -9.9% -0.6% 10.3% 29.0% 24.8% 26.4% 23.7% Semiconductor production equipment -18.4% -28.1% -30.4% -30.9% -11.2% 29.0% 95.4% 41.6% 8.7% 0.0% Flat panel displays -58.1% -35.0% -8.2% 62.4% 101.7% 81.1% 85.9% 1.0% -47.0% 0.5% Industrial robot applications -8.5% -13.7% -14.6% -5.6% -24.2% -4.2% 24.7% 27.6% 103.9% 52.9% Gear heads (for electric motor makers) -11.0% -23.9% -20.9% -16.1% -13.9% 41.2% 59.1% 42.9% 13.3% -15.6% Machine tools -8.3% -21.3% 9.2% -8.0% -2.3% 1.1% 5.1% 12.9% 18.1% 39.6% Oil-Drilling Equipment 120.9% 77.1% 67.9% -53.5% 17.3% 17.7% -9.6% 109.3% 31.9% 47.6% Others -12.0% -7.2% 15.6% -8.5% 20.1% 5.9% 16.5% 14.6% -12.8% 5.0% Orders 4,732 3,707 3,763 4,077 4,647 4,693 4,537 5,966 6,260 5,247 Semiconductor production equipment Flat panel displays Industrial robot applications 1,853 1,370 1,349 1,179 1,478 1,609 1,463 2,685 2,854 1,946 Gear heads (for electric motor makers) Machine tools Oil-Drilling Equipment Others 1,181 1,094 1,145 1,137 1,349 1,231 1,261 1,382 1,274 1,189 YoY -10.0% -12.8% 9.0% -6.7% -1.8% 26.6% 20.6% 46.3% 34.7% 11.8% Semiconductor production equipment -22.6% -22.0% -36.1% -22.0% 3.9% 70.1% 86.6% 25.8% 9.4% -14.6% Flat panel displays -48.3% -27.1% 47.5% 89.5% 93.8% 108.2% 20.9% -27.2% -8.1% -12.3% Industrial robot applications -11.0% -16.2% 18.5% -23.8% -20.2% 17.4% 8.5% 127.7% 93.1% 20.9% Gear heads (for electric motor makers) -17.9% -28.8% -13.7% -26.1% 2.7% 66.7% 48.1% 45.6% -1.2% -8.3% Machine tools -13.7% -9.5% 1.3% -5.5% -0.4% 4.9% 13.8% 7.4% 48.0% 32.9% Oil-Drilling Equipment 200.0% -10.9% 230.0% 61.8% -37.0% -1.1% 31.8% -1.9% 78.0% 178.1% Others -3.5% 3.2% 15.8% -1.7% 14.2% 12.5% 10.1% 21.5% -5.6% -3.4% FY03/15 1H FY03/15 results (released on November 12, 2014) Earnings results for 1H FY03/15 were as follows: Sales: JPY12.7bn (+22.0% YoY) Gross profit: JPY6.0bn (+31.1%) Copyright (C) Shared Research Inc. All Rights Reserved 6/59

7 GPM: 47.5% (+3.3pp) Operating profit: JPY3.6bn (+51.1%) Recurring profit: JPY3.9bn (+52.0%) Net income: JPY2.5bn (+52.4%) The market environment was favorable, supported primarily by the electronics sector in Asian countries primarily China in which there was active investment in automation and power saving initiatives. On November 12, 2014, the company announced a revision to its full-year FY03/15 earnings results and an increase in its dividend, from JPY6 to JPY7 per share. The company issued a 3-for-1 stock split on October 1, HDSI cited a favorable forecast for order procurement during 2H, primarily in industrial robots. Revised FY03/15 Est. Initial FY03/15 Est. Difference (JPYmn) 1H 2H FY 1H 2H FY 1H 2H FY Sales 12,700 13,300 26,000 12,500 12,000 24, ,300 1,500 YoY(%) 22.0% 24.6% 23.3% 20.1% 12.4% 16.2% Operating Profit 3,633 3,717 7,350 3,350 3,050 6, YoY(%) 51.1% 64.2% 57.5% 39.3% 34.8% 37.1% OPM(%) 28.6% 27.9% 28.3% 26.8% 25.4% 26.1% Recurring Profit 3,886 3,844 7,730 3,450 3,150 6, ,130 YoY(%) 52.0% 69.7% 60.3% 34.9% 39.1% 36.9% RPM 30.6% 28.9% 29.7% 27.6% 26.3% 26.9% Net Income 2,483 2,417 4,900 2,250 1,950 4, YoY(%) 52.4% 77.1% 63.7% 38.1% 42.9% 40.3% Source: Company data, SR Inc. research Sales Sales were JPY12.7bn (+22.0% YoY). By product category, sales of parts for small industrial robots used in manufacturing smartphones were significantly higher, and there was also growth in products geared toward semiconductor manufacturing equipment, machine tools, and oil drilling equipment. Operating profit Although there was in an increase in SG&A expenses, this was more than offset by a corresponding increase in sales, leading to operating profit of JPY3.6bn (+51.1% YoY). Sales by product Reducer sales were JPY10.5bn (+28.6% YoY; 82.3% of total sales); mechatronics sales were JPY2.2bn (-1.5% YoY; 17.7% of total sales). Orders The company won orders worth JPY13.0bn, a 22.4% increase from a year earlier, with an order backlog totaling JPY4.7bn, down JPY547mn from the end of Q1 FY03/15, but maintaining a high level. Results by segment Japan Although sales for flat panel display manufacturing equipment fell, increases were seen in machine tools and machinery for manufacturing of industrial robots, semiconductors, and oil drilling. As a result, sales were JPY11.1bn (+25.8% YoY), and recurring profit was JPY4.2bn (+48.6%), in line with the increase in sales. Copyright (C) Shared Research Inc. All Rights Reserved 7/59

8 North America Sales were down on a local currency basis due to reduced demand for semiconductor manufacturing and medical machinery. However, due to a weaker yen, sales on a yen basis were JPY1.6bn (+1.2% YoY). Recurring profit was JPY126mn (-31.3% YoY), due to lower sales on a dollar basis and low levels of operation in manufacturing, despite higher profitability in import sales, a result of changes in exchange rates. Europe Sales on a Euro basis were up, backed by increased demand for industrial robots, and a weaker yen and stronger euro led to higher profits at equity-method affiliates. As a result, recurring profit was JPY197mn (+40.8% YoY). Q1 FY03/15 results (released on August 8, 2014) Earnings results for Q1 FY03/15 were as follows: Sales: JPY6.2bn (+23.9% YoY) Gross profit: JPY2.8bn (+28.8%) GPM: 45.4% (+1.7pp) Operating profit: JPY1.6bn (+47.1%) Recurring profit: JPY1.8bn (+50.2%) Net income: JPY1.1bn (+46.7%) Q1 FY03/15 overview The market environment was favorable, supported primarily by the electronics sector in Asian countries primarily China in which there was active investment in automation and power saving initiatives. HDSI stated that its Q1 results were in line with forecasts and that it will likely achieve its full-year earnings target judging from the current monthly sales and order backlog. The company has left its 1H and full-year forecasts unchanged. Investments to increase output capacity for precision reducers, particularly Harmonic Drive The company in August 2014 announced that it would increase its output capacity for precision reducers in response to rising demand for use in industrial robots. Production capacity will rise to 500,000 units a month (if plants are operated fully during regular hours) by the end of March 2015, an increase of 25% from the current 40,000. Sales and orders Sales were JPY6.2bn (+23.9% YoY). By product category, sales of parts for small industrial robots used in manufacturing smartphones were significantly higher, and there was also growth in products geared toward semiconductor manufacturing equipment and oil drilling equipment. The company won orders worth JPY7.0bn, a 31.9% increase from a year earlier, with an order backlog totaling JPY5.2bn, up JPY824 from the end of FY03/14. The company expects order backlog to start declining during Q2 and fall to JPY3.2bn-JPY3.3bn by the end of Q3. Sales of parts used in industrial robots for smartphone production surged from February through May of The company had expected sales to stagnate in June. However, demand for automobile production robots remained strong. As a result, the company may continue to receive orders worth JPY500mn to JPY600mn on a monthly basis. Copyright (C) Shared Research Inc. All Rights Reserved 8/59

9 Sales of semiconductor-manufacturing equipment parts remained at around JPY200mn a month (at the parent-company level). However, clients have told the company that they may place more orders during 2H and thereafter. The company stated that it expects an increase in demand for flat-panel display (FPD) equipment, leading to sales of parts used in conveyer robots. Sales of parts for oil drilling equipment tend to fluctuate from month to month. In August, the company won a sizable contract, raising overall order amount to about JPY1.9bn. Sales by product Reducer sales were JPY5.0bn (+30.8% YoY; 82.0% of total sales); mechatronics sales were JPY1.1bn (-0.1% YoY; 18.0% of total sales). Operating profit Although there was in an increase in SG&A expenses, this was more than offset by a corresponding increase in sales, leading to operating profit of JPY1.6bn (+47.1% YoY). Results by segment Japan Although sales for flat panel display manufacturing equipment fell, increases were seen in machinery for manufacturing of industrial robots, semiconductors, and oil drilling. As a result, sales were JPY5.4bn (+27.3% YoY), and recurring profit was JPY2.0bn (+46.4%). North America Sales were down on a local currency basis due to reduced demand for semiconductor manufacturing and medical machinery. However, due to a weaker yen, sales on a yen basis were JPY773mn (+4.3% YoY). Recurring profit was JPY30mn (-60.5% YoY), due to lower sales on a dollar basis, low levels of operation in manufacturing, and increased SG&A expenses. Europe Sales were up, backed by increased demand for industrial robots, and a weaker yen and stronger euro led to higher profits at equity-method affiliates. As a result, recurring profit was JPY116mn (+39.4% YoY). HDSI is also raising its output capacity in Europe to meet rising demand. Increase in output capacity for precision reducers As mentioned above, the company decided to spend JPY2.8bn to raise production capacity for precision reducers to meet an expected increase in demand. The company s output capacity for the Harmonic Drive strain wave gearing is expected to rise 25% to 50,000 units a month by the end of March Background for capital investment HDSI has decided to raise capex in response to an expected increase in demand, particularly from manufacturers of industrial robots. It is also the result of the JPY2.3bn contract in won April 2014 (at the parent level), that will necessitate higher production capacity. The company currently makes Harmonic Drive and mechatronics at its Hotaka plant in Azumino City, Nagano Prefecture. Harmonic Precision Inc., a subsidiary, makes core cross roller bearings for the group's Copyright (C) Shared Research Inc. All Rights Reserved 9/59

10 unit-type precision speed reducers, while Harmonic AD Inc., another unit, makes planetary gear reducers. HDSI won orders totaling JPY6.3bn at the parent level in Q1, which averaged JPY2.1bn a month. The company raised output by keeping its factory running after regular hours. As a result, production at the parent level has been exceeding JPY2.0bn a month since June. The company expects this situation to continue until October. The Hotaka plant s monthly output capacity during regular hours is about JPY1.8bn, increased by overtime operation of the factory. The company will upgrade the plant and raise its capacity to about JPY2.1bn a month. Capex of JPY2.8bn breakdown: -JPY2.0bn: Hotaka plant (JPY1.0bn for Harmonic Drive, JPY1.0bn for a building) -JPY300mn: Harmonic Precision (equipment for core cross roller bearings) -JPY500mn: Harmonic AD (equipment for planetary gear reducers) Comparison with the initial target The company had initially planned to spend JPY1.7bn. Of the 2.8bn yen announced this time, JPY800mn had already been earmarked under the initial plan. Of the JPY2bn investment for Harmonic Drive, JPY1bn was not included in the original plan. (Another JPY1bn, for the building, is allocated for FY03/16). Under the initial plan, HDSI was going to invest in lathes and machining centers, which had been under increasing strain due to a surge in production. The company also planned to improve efficiency, renew facilities, and upgrade information technology systems while reducing outsourcing to raise its marginal profit ratio. The company had not reached a decision to raise production capacity for Harmonic Drive when the initial plan was released, although it was being considered at the time. Investment timetable and depreciation expenses HDSI plans to install new equipment for Harmonic Drive as soon as they are delivered. There is no space on the first floor of the existing plant, only on the second floor. As a result, the company will transfer some production from the first floor to the second floor to make room for the new equipment. A new 3,000sqm building will be completed in March Until then, the 25% capacity increase will be achieved by installing new equipment in the existing building. In other words, the new building, when completed, will be used when demand rises further. The company stated that its depreciation expenses may not change significantly from the initial plan (JPY1.2bn) because most of the new equipment will be delivered in March. The company expects to write off JPY250mn in FY03/16 and JPY270mn in FY03/17. Productivity increase Production capacity will rise 25% as a result of this investment. However, the company does not plan to increase factory workers. It is difficult for the company to entirely automate the production of Harmonic Drive because each order is small and the products vary. However, the company will increase production without hiring workers by automating part of the production process, eliminating bottlenecks, and minimizing retooling. The company has succeeded in a similar effort in the past, and company executives stated that they were confident that the success could be repeated. Harmonic Precision Harmonic Precision Inc. (a wholly owned subsidiary) will increase output capacity for core cross roller bearings, which are sold in conjunction with about half of Harmonic Drive products that HDSI supplies. HDSI experienced a shortage of core cross roller bearings in the spring of 2014 that caused a production bottleneck. Therefore, an increase in the production of these products was included of the initial investment plan. The company will acquire new equipment from November 2014 through February Copyright (C) Shared Research Inc. All Rights Reserved 10/59

11 Harmonic AD Harmonic AD Inc. (a wholly owned subsidiary) will acquire new production equipment for planetary gear reducers. Unlike core cross roller bearings, planetary gear reducers are not currently in short supply. However, demand is expected to increase in the future. HDSI also plans to increase production of planetary gear reducers as it seeks to reduce outsourcing add more internal value. Therefore, the move is intended more as an effort to improve efficiency. For details on previous quarterly and annual results, please refer to the Historical financial statements section. Copyright (C) Shared Research Inc. All Rights Reserved 11/59

12 Full-Year (FY03/15) Outlook FY03/14 Revised FY03/15 Est. Initial FY03/15 Est. (JPYmn) 1H 2H FY 1H 2H FY 1H 2H FY Sales 10,412 10,672 21,084 12,700 13,300 26,000 12,500 12,000 24,500 YoY(%) 5.7% 28.8% 16.3% 22.0% 24.6% 23.3% 20.1% 12.4% 16.2% CoGS 5,810 6,156 11,966 6, Gross Profit 4,602 4,516 9,118 6, YoY(%) 9.9% 42.0% 23.7% 31.1% GPM(%) 44.2% 42.3% 43.2% 47.5% SG&A 2,197 2,252 4,450 2, SG&A/Sales 21.1% 21.1% 21.1% 18.9% Operating Profit 2,405 2,263 4,668 3,633 3,717 7,350 3,350 3,050 6,400 YoY(%) 8.5% 85.6% 35.9% 51.1% 64.2% 57.5% 39.3% 34.8% 37.1% OPM(%) 23.1% 21.2% 22.1% 28.6% 27.9% 28.3% 26.8% 25.4% 26.1% Recurring Profit 2,557 2,265 4,823 3,886 3,844 7,730 3,450 3,150 6,600 YoY(%) 15.8% 65.7% 34.9% 52.0% 69.7% 60.3% 34.9% 39.1% 36.9% RPM 24.6% 21.2% 22.9% 30.6% 28.9% 29.7% 27.6% 26.3% 26.9% Net Income 1,629 1,365 2,994 2,483 2,417 4,900 2,250 1,950 4,200 YoY(%) 35.5% 80.0% 52.7% 52.4% 77.1% 63.7% 38.1% 42.9% 40.3% FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/15 (JPYmn) 1H 2H 1H 2H 1H 2H 1H 2H FY % of 1H 1H Est. Sales (parent) 9,534 9,920 10,055 8,014 8,680 7,478 9,089 9,494 11, % 11,200 Semiconductor production equipment 1,330 1,346 1,248 1, ,021 1,207 1, % 1,150 Flat panel displays 1, % 500 Industrial robot applications 2,862 3,346 3,813 2,780 3,387 2,497 2,907 3,149 5, % 5,600 Gear heads (for electric motor makers) % 650 Machine tools Oil-Drilling Equipment % 480 Others 2,423 2,343 1,928 1,615 1,680 1,761 1,926 1,947 2, % 1,850 YoY 169% 43% 5% -19% -14% -7% 5% 27% 25% 23% Semiconductor production equipment 297% 51% -6% -22% -23% -31% 6% 66% 4% 13% Flat panel displays 178% 29% -17% -59% -50% 26% 92% 33% -26% -39% Industrial robot applications 217% 87% 33% -17% -11% -10% -14% 26% 75% 93% Gear heads (for electric motor makers) 195% 15% -14% -16% -17% -18% 11% 50% -3% -2% Machine tools 144% 55% 29% 15% -15% 0% -1% 9% 28% - Oil-Drilling Equipment 940% 34% -52% -45% 96% 4% 18% 18% 39% -14% Others 76% 15% -20% -31% -13% 9% 15% 11% 26% -4% Orders (parent) 10,127 9,939 9,507 7,823 8,439 7,840 9,340 10,503 11,507 Semiconductor production equipment 1,366 1,418 1,084 1, ,107 1,194 1,068 Flat panel displays Industrial robot applications 3,143 3,441 3,717 2,685 3,223 2,528 3,087 4,148 4,800 Gear heads (for electric motor makers) Machine tools Oil-Drilling Equipment Others 2,490 2,518 2,284 2,146 2,275 2,282 2,580 2,643 2,463 YoY 144% 24% -6% -21% -11% 0% 11% 34% 23% Semiconductor production equipment 230% 38% -21% -22% -22% -29% 31% 52% -4% Flat panel displays 120% 2% -25% -63% -41% 71% 100% -9% -10% Industrial robot applications 209% 63% 18% -22% -13% -6% -4% 64% 55% Gear heads (for electric motor makers) 159% -24% -13% 3% -23% -20% 28% 47% -5% Machine tools 157% 57% 19% -1% -12% -2% 2% 11% 40% Oil-Drilling Equipment 147% -33% -59% -19% 67% 86% -25% 7% 122% Others 75% 13% -8% -15% -0% 6% 13% 16% -5% Figures may differ from company materials due to differences in rounding methods. Source: Company data The following comments were written prior to a revision of the company s full-year FY03/15 earnings results on November 12, Copyright (C) Shared Research Inc. All Rights Reserved 12/59

13 FY03/15 Target HDSI targets sales of JPY24.5bn (+16.2% YoY), operating profit of JPY6.4bn (+37.1% YoY), and recurring profit of JPY6.6bn (+36.9% YoY), and net income of JPY4.2bn (+40.3% YoY; EPS: JPY138). The company also plans to pay an annual dividend of JPY40 per share (JPY22 for half year and JPY18 for year-end, with a payout ratio of 29.1%). These forecasts are based on the assumption that the yen would trade at 100 against the US dollar, and 135 against the euro. Record earnings expected due to strong orders HDSI may continue to post an increase in sales and profit for FY03/15 following the favorable FY03/14 results as it continues to win more orders. If HDSI achieves its target for this fiscal year, the company s earnings will exceed the previous record reached in FY03/11. Factors that may influence parent operating profit The company posted an operating profit of JPY4.2bn at the parent level in FY03/14. For the current fiscal year, an increase in sales may raise the figure by JPY1.8bn, while changes in the marginal profit ratio caused by a shift in product composion may further raise the figure by JPY30mn. As for fixed production costs, an increase in labor expeses will be offset by a larger decrease in leasing payments, raising operating profit by another JPY20mn. On the other hand, an increase in SG&A expenses will reduce operating profit by JPY300mn. As a result, the company expects parent-only operating profit of JPY5.8bn for FY03/15. SG&A expenses will rise because of an increase in labor and R&D costs. Current condition HDSI executives stated at a May 2014 briefing session that the company began to receive a high volume of orders in February for small industrial robots and that the company s monthly orders for February, March, and April have reached a record. However, strong demand for small robots may be temporary. The company does not expect sales to rise after May. The chances are high that the company may achieve its first-half earnings target as it has an order backlog. However, orders and sales may slow in the latter half, according to the company. Product applications Semiconductor-manufacturing equipment Demand for semiconductor-manufacturing equipment is expected to remain strong. However, sales may decline in the first half compared with the latter half of FY03/14, when the demand was particularly strong. Sales may recover in the latter half of this fiscal year, after summer. Manufacturing equipment for flat panel displays Demand for manufacturing equipment for flat panel displays may decline compared with the latter half of FY03/14. The company expects a recovery in demand in the latter half, after summer, as in the case for semiconductor-manufacturing equipment. Industrial robots Demand for small robots for smartphone production remains strong. However, the company does not expect the current demand to last after May. Sales are expected to reach JPY5.6bn during the first half of this fiscal year, compared with JPY2.9bn for the first half of the previous fiscal year and JPY3.1bn for the latter half of the previous fiscal year, due to strong demand and an order backlog from FY03/14. (These sales are at the parent level.) The company also expects that sales may rise in Q4 of this fiscal year as was Copyright (C) Shared Research Inc. All Rights Reserved 13/59

14 the case a year earlier. If the company meets its FY03/15 target, sales may decline in the following year in reaction. The company is well aware of this. However, the company stated that the impact of a decline in the current demand could be cushioned when industrial robots become more common. The use of industrial robots is not yet widespread at this time. Oil-well drilling equipment The company expects parent-level sales of JPY1.2bn in FY03/15, compared with JPY995mn a year earlier. The current market condition, according to the company, is favorable for undersea oil drilling. Other HDSI is seeking to propose the use of its reducers for various applications before the current demand for industrial robots declines after FY03/15. In particular, the company will monitor new uses of robots. Subsidiaries In the US, the company will seek to expand sales and profits by selling products for semiconductor-manufacturing equipment. In Europe, the company expects an earnings increase thanks to strong demand for products used in robots, even as demand from the aerospace industry declines as is the case in the US. Harmonic AD, Inc., which makes planetary gear, may post sales of JPY2.1bn, up 11.2% YoY, and operating profit of JPY60mn, up 9.3% YoY. Capital investment, etc. The company plans capital investment of JPY1.7bn, depreciation expenses of JPY1.2bn, and R&D spending of JPY1.4bn. The company will invest in lathes and machining centers, some of which have a high production load that prevents a further increase in output. Such equipment will be overhauled or replaced. The company will at the same time improve its information technology and marginal profit ratio. As a result, capital investment may increase JPY365mn from a year earlier. At the same time, the company will increase its R&D spending by JPY114mm. R&D is the company s lifeline. Therefore, R&D spending is a strategic decision. Copyright (C) Shared Research Inc. All Rights Reserved 14/59

15 Outlook Mid-Term Plan FY03/12 FY03/13 FY03/14 FY03/15 FY03/15 (million yen) Cons. Cons. Cons. Est. MT Plan Sales 20,159 18,131 21,084 24,500 26,000 Operating Profit 4,334 3,436 4,668 6,400 7,500 OPM 21.5% 19.0% 22.1% 26.1% 28.8% Net Income 2,140 1,961 2,994 4,200 4,700 NPM 10.6% 10.8% 14.2% 17.1% 18.1% Source: Company data, SR Inc. Research Together with the FY03/12 results announcement, the company announced its new medium-term plan. This plan calls for sales of 26.0 billion yen, operating profit of 7.5 billion yen, and net income of 4.7 billion yen in FY03/15. The plan includes management indicator targets, such as sustaining operating profit margins of at least 20% and a total asset turnover of at least 1x per annum. The company already had approximately 1.8 billion yen per month of production capacity (parent) up to FY03/12, and additional capital expenditure will most likely be focused on molds used in new product development. Earnings in FY03/13 fell short of the company s initial forecasts, mainly attributable to stagnant growth in China and other emerging markets, economic uncertainty in Europe, and the sluggish domestic economy. The company stated that a lack of new products and the lack of urgency to develop such products over the past several years also contributed to the shortfall in earnings for FY03/13. The company considers products introduced less than five years ago as new (per the company new technological advances for its Harmonic Drive components are made every five to 10 years). Consequently the pace of new developments has stagnated since 2000, and hurt earnings in recent years. The company's plan for FY03/15 seems ambitious compared with its earnings in FY03/13. However, the company intends to achieve its forecasts for FY03/15 by focusing on strategic measures. 1) Introducing new products in the expanding precision speed reducers market in Asia. 2) Developing a market for its new Harmonic Drive products. And 3) expanding sales in Asia. Though sales and profits are increasing, it seems to be difficult for the company to achieve the targets in the medium-term plan. Achievements should be behind the plan by around a year. 1) It intends to develop high-precision, high-priced equipment. The company intended to introduce the HPN series, a new version of its AccuDrive products (May 2013), as a strategic product to compete in Asia, a market that requires quality products at competitive prices. It also intends to target industries resembling the general machinery market, such as transportation and processing equipment, while maintaining quality. The company formed a joint venture subsidiary, SAMICK ADM, in South Korea in February 2013, and targets sales of 1.5 billion yen in Copyright (C) Shared Research Inc. All Rights Reserved 15/59

16 Source: Company data, SR Inc. Research 2) The company started aggressively introducing new products that improved basic performance since FY03/13. According to the company, this means products that are lighter, stronger, more precise and compact. In line with this aim, the company launched several new products, such as a CSF series lightweight component type of unit in FY03/13. This is roughly 30% lighter than conventional units thanks to a new design, as well as lighter parts and components. Accordingly the new unit is expected to contribute to lighter end-products, faster robotic operations, and higher load capacity. Main applications include vertical articulated robots wrist bending and twisting, as well as horizontal articulated robots arm controls. The company will continue to make efforts to speed up product development and raise the ratio of new products to 13%. It also plans to make further progress with unit type Harmonic Drives in order to make products even easier to use. 3) The company will seek to expand sales in China and other emerging markets by introducing industrial robots that help raise productivity. HDSI's business is characterized by high marginal profitability, with its operating profit margins thus driven by the top line. Therefore, sales growth is key to clearing the 20% OPM and 1x total asset turnover targets mentioned above. Looking back at HDSI's financial performance, sales trends over the medium term have been cyclical, due to the cyclical nature of its end markets such as industrial robots, SPE, and FPD manufacturing equipment. Capex trends in these industries thus have a big impact on HDSI s top line. In particular sales for semiconductor and FPD production equipment are particularly volatile, impacted by semiconductors and FPD market conditions. Historically the company has been able to sustain sales growth for many years (for details see the Market Overview section). Generally once HDSI s products are used as a component in a certain type of industrial Copyright (C) Shared Research Inc. All Rights Reserved 16/59

17 equipment they tend to become a default choice for years to come. The number of industries where its products are used has been growing steadily. SR Inc. believes that as long as no groundbreaking product capable of superseding the Harmonic Drive emerges, then growth is likely to continue relatively uninterrupted as both existing end markets grow and new applications emerge. Chairman Mitsumasa Ito said that based on historical trends he wants to see his company averaging 5% compound annual growth in sales in the years ahead. Copyright (C) Shared Research Inc. All Rights Reserved 17/59

18 Business Business Description Harmonic Drive Systems Inc. (HDSI) focuses on the development, production, and sale of precision reducers as well as mechatronics products using such reducers. It is the dominant manufacturer globally of compact precision reducers. Core Business The company specializes in the development, production, and sale of Harmonic Drives (precision reducers) within the precision motion control field. In addition it makes mechatronics products that combine a Harmonic Drive with motors, sensors, drivers, and controllers. Sales by Product FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 (million yen) Est. Sales (Cons.) 16,165 12,057 22,001 20,159 18,131 21,084 24,500 YoY -15.9% -25.4% 82.5% -8.4% -10.1% 16.3% 16.2% Speed Reducers 12,700 9,654 18,069 16,047 14,486 16,518 YoY -12.6% -24.0% 87.2% -11.2% -9.7% 14.0% Composition 78.6% 80.1% 82.1% 79.6% 79.9% 78.3% Mechatronics 3,464 2,402 3,931 4,111 3,644 4,565 YoY -25.9% -30.7% 63.7% 4.6% -11.4% 25.3% Composition 21.4% 19.9% 17.9% 20.4% 20.1% 21.7% Sales (Par.) 14,277 10,486 19,456 18,069 16,159 18,584 21,800 YoY -14.6% -26.6% 85.5% -7.1% -10.6% 15.0% 17.3% Speed Reducers 11,471 8,460 16,179 14,735 13,274 15,128 18,200 YoY -12.7% -26.2% 91.2% -8.9% -9.9% 14.0% 20.3% Composition 80.3% 80.7% 83.2% 81.5% 82.1% 81.4% 83.5% Harmonic Drive 9,743 7,102 13,589 12,489 11,212 12,856 15,600 YoY -13.4% -27.1% 91.3% -8.1% -10.2% 14.7% 21.3% Composition 68.2% 67.7% 69.8% 69.1% 69.4% 69.2% 71.6% AccuDrive 1,728 1,358 2,590 2,246 2,062 2,272 2,600 YoY -8.7% -21.4% 90.7% -13.3% -8.2% 10.2% 14.4% Composition 12.1% 13.0% 13.3% 12.4% 12.8% 12.2% 11.9% Mechatronics 2,805 2,025 3,277 3,333 2,883 3,456 3,600 YoY -21.5% -27.8% 61.8% 1.7% -13.5% 19.9% 4.2% Composition 19.6% 19.3% 16.8% 18.4% 17.8% 18.6% 16.5% Source: Company data, SR Inc. Research While the company only reports one business segment, it is possible to break this down by product type into two parts: Reducers: stand-alone speed reducers Mechatronics: speed reducers integrated with other components Reducers accounted for 79.9% of FY03/13 sales while Mechatronics comprised the remaining 20.1%. Product offering: Harmonic Drive (component type): the company refers to stand-alone speed reducers as component types. Harmonic Drive (unit type): the company refers to component type speed reducers that are outfitted with its own cross roller bearings and covered by its own warranties as unit types. AccuDrive : a high-precision, high-rigidity planetary gear. Copyright (C) Shared Research Inc. All Rights Reserved 18/59

19 Actuators: unit types that incorporate motors and sensors. Controllers: used for controlling the movements of robots and manufacturing equipment. Harmonic Drive (component type) and AccuDrive are classified as reducers products, whereas actuators and controllers fall into the mechatronics product category. FY03/13 parent sales breakdown: Component types 21.9% Unit types 47.4% AccuDrive 12.8% Actuators 16.1% Controllers 1.7% Reducers Harmonic Drive The company's core product: a speed reducer that exploits metal s flexibility and elastic dynamics using the differential motion of a circle versus an ellipse in gear design. This compact, lightweight, high-efficiency product is used frequently for servo motors. Harmonic Drive is a registered trademark that can only be used on products that are produced and sold by Harmonic Drive Systems Inc. The generic term for products using the Harmonic Drive principles is strain wave gearing, and harmonic drive is a generic name in English. Principles of Harmonic Drive Speed reducers are mechanical devices for lowering the rotational speed of power sources (e.g. motors and engines) via gears or similar parts. Reducers serve two primary purposes: To reduce speed of motion to a necessary level To increase torque Taking industrial robots as an example, a speed reducer by means of its gears reduces the rotational speed of the motor powering the robot down to an ideal speed and generates a large increase in torque that is conveyed to another part of the robot, such as its arm. The gear is a mechanical component that uses successive mated teeth to transfer motion. Gears range from spur gears to the more complex wave gear design used in the Harmonic Drive. The following is an example of a simple spur gear mechanism. The two gears (Gear A with 10 teeth and Gear B with 20) engage each other, with Gear A having been fitted with a motor that produces 1 kg of rotational power. For every two rotations Gear A makes, Gear B makes one rotation. Gear A turns 1/2 as many revolutions as Gear B does. Subsequently, if gear A is rotating with a force of 1kg, then gear B will produce approximately 2kg of force. That is, the halving of the number of revolutions yields approximately twice as much torque. The resulting reduction ratio (i.e., the measure of how much the spin speed is reduced by) is 1/2. A high reduction ratio indicates a large difference between the number of revolutions of the input and output shafts. Copyright (C) Shared Research Inc. All Rights Reserved 19/59

20 Spur Gear System Source: Company data, SR Inc. Research Planetary Gear System Both spur gear and planetary gear systems are widely used as general-use speed reducers. In planetary gear systems, one or more outer gears (i.e., the planets) rotate around a central gear (i.e. the sun), which has a different number of teeth causing the central gear to revolve in the opposite direction. Since the difference in the number of teeth determines the reduction ratio, a large variation in this number between the outer and central gears is optimal for producing a high reduction ratio. However, single-stage speed reduction, which relies on a central gear with just one set of outer gears, results in a lower number of teeth engaging each other leading to increased load and friction on those teeth. Therefore, most systems perform multi-stage reduction by utilizing several sets of gears. The Harmonic Drive (strain wave gearing) is a precision speed reducer. Contrary to the common method of increasing the gear s rigidity to achieve precision, precision is instead achieved by applying the flexibility and elastic dynamics of metal to gear design. The Harmonic Drive was invented by American C.W. Musser in 1955 and was further developed by United Shoe Machinery Corp. (USM). In 1964, HDSI s predecessor Hasegawa Gear Works Ltd. licensed the technology from USM and began production in Japan. Subsequently, the company created its own designs, processing techniques, and mass production technologies. Harmonic Drive consists of three components: An elliptically shaped wave generator. The wave generator has small ball bearings built into the outer circumference of its elliptical cam. While the bearings inner faces are fixed to the cam, their outer faces are subjected to elastic deformation as the bearings move (i.e., as the wave generator rotates the outer face bends in a wave shape). As its name suggests, the wave generator is a device for generating elliptically shaped waves. A thin gear with external teeth called a flexspline. The flexspline is a thin cup-shaped component made of flexible metal that has external teeth around the circumference of its mouth opening. When the wave generator is inserted into the flexspline s mouth opening, the flexspline becomes deformed into an elliptical shape it acts as an elastically fluctuating gear with external teeth. A thicker gear with internal teeth called a circular spline. The circular spline is a rigid ring-shaped component with teeth along its inner circumference. The number of teeth is usually two more than the accompanying flexspline has. Essentially, the circular spline is a rigid-bodied gear with internal teeth. Copyright (C) Shared Research Inc. All Rights Reserved 20/59

21 Generally, the wave generator is attached to the input shaft and the flexspline to the output shaft, while the circular spline is usually secured to the machine's casing. Harmonic Drive Design Source: Company data, SR Inc. Research Harmonic Drive Design II When these three components are joined together on a single axis, the flexspline is forced into an elliptical shape by the wave generator. The circular spline, however, retains its circular form. As a result, the flexspline teeth engage with those of the circular spline at two points on the major axis of the ellipse while the teeth are completely disengaged across the minor axis (see following diagram, above left). By rotating the wave generator clockwise as the circular spline remains stationary, the flexspline is subjected to elastic deformation and its teeth sequentially engage with those of the stationary circular spline as it rotates (see following diagram, above right). A 180-degree clockwise rotation of the wave generator turns the flexspline by a single tooth counterclockwise (see following diagram, bottom left). One full rotation of the wave generator, thus, causes the flexspline to turn counterclockwise by two teeth (i.e., the difference in number of teeth between the flexspline and circular spline). (See following diagram, bottom right.) If the flexspline has 200 teeth and the circular spline 202, the reduction ratio is ( )/200 = 1/100. As the wave generator makes one clockwise rotation the flexspline turns counterclockwise by two teeth. The flexspline will complete one full counterclockwise rotation when the wave generator completes its 100th clockwise rotation. Therefore, the torque (i.e., rotative force) of the flexspline is 100 times greater than that of the wave generator. The flexspline torque is harnessed as output. Taking another example, if the flexspline has 100 teeth and the circular spline 102, the reduction ratio is ( )/100 = 1/50. As the wave generator makes one clockwise rotation, the flexspline advances counterclockwise by two teeth, and the flexspline will finally complete one full counterclockwise rotation when the wave generator finishes its 50th clockwise rotation. By utilizing this kind of mechanism, standard Harmonic Drive products support reduction ratios from 1/30 to 1/ Copyright (C) Shared Research Inc. All Rights Reserved 21/59

22 Circular Spline Wave Generator Flexspline Source: Company data, SR Inc. Research Advantages of Harmonic Drive The mechanical characteristics of the Harmonic Drive, such as the ability to achieve high reduction ratios using only three components and the utilization of the elastic dynamics of metal, result in the product having the following characteristics: Compact and lightweight Large hollow ratio Zero backlash (lost motion) Single-stage high reduction ratio High efficiency High positioning accuracy and repeat positioning accuracy High torsional stiffness Simple installation and assembly Quiet, smooth operation The compact and lightweight design is possible due to the small number of components and simple mechanism. In contrast, speed reducers that use other kinds of mechanisms generally have many components and more complex construction. As a result, the Harmonic Drive can be used in applications where other types of speed reducers cannot (e.g., small robots, satellites). Since the gears are on the same axis, the hollow ratio is large (i.e., given the size of the circular spline, there is a large amount of space available within the flexspline). For this reason, the Harmonic Drive also has the advantage of being able to accommodate another drive shaft or cable, thereby diminishing the space used. Unlike an ordinary gear, a Harmonic Drive is free of backlash (the space/clearance between mated gear teeth). Ordinary gears require a certain amount of backlash for smooth rotation; if the backlash is too small then the surfaces of the engaged teeth will encounter a large degree of friction and wear quickly. Copyright (C) Shared Research Inc. All Rights Reserved 22/59

23 However if the backlash is too great then the teeth will not engage with each other well, reducing the transmission efficiency of the gear. In contrast, on a Harmonic Drive it is possible in principle to reduce backlash to zero. Backlash 1m Usage Backlash Backlash after 1m Our Products General Industrial Machinery 0.5 (degree) 8.7mm - Transporters and Processing Machinery (degree) mm AccuDrive Robot and Semiconductor Equipment (degree) 0-0.3mm Harmonic Drive Source: Company data, SR Inc. Research As for high rotational accuracy and torque, on a Harmonic Drive the flexspline and circular spline teeth mate with each other in two separate places on the ellipse's major axis, resulting in a higher number of simultaneously engaged teeth, compared with general-use spur gears, which only have one or two teeth engaged at a time. As there are a large number of engaged teeth the effect of the gear teeth's pitch error and accumulative pitch error on rotational accuracy is standardized, which results in high positioning and rotational accuracy. As detailed above, the Harmonic Drive supports high reduction ratios from 1/30 to 1/320 and thus produces high torque. For very low reduction ratios, however, Harmonic Drives are unsuitable speed reducers and for this purpose the company offers the AccuDrive, which supports ratios from 1/3 to 1/45. Evolution of the Harmonic Drive While the basic structure of the Harmonic Drive remains largely identical to the initial design, progress has been made in areas such as gear tooth profile, capacity, and torque. The company improved upon the gear teeth in 1988 when it developed and began using a new IH tooth type, whereas until then it had utilized a standard involute tooth design. Due to this advancement, the number of simultaneously engaged teeth rose to 30% from 10% of the total number of teeth, and torsional stiffness was improved twofold. The core CSF series is 40% thinner and has roughly twice the rotational accuracy and torque capacity of the R series that was launched in 1981, according to the company. The CSD series will be 2/3 thinner than the R series and capable of producing high torque and rotational accuracy. Left: General Teeth, Right: IHI Teeth Source: Company data, SR Inc. Research Larger Torque/Smaller Volume Copyright (C) Shared Research Inc. All Rights Reserved 23/59

24 Orders, Manufacturing and Inventory The company's main Hotaka production facility is located in Azumino City, Nagano Prefecture, in central Japan. Production is characterized by a mix of build-to-order and small lot production (the average Harmonic Drive order lot was seven pieces as of FY03/13). The assembly of components and materials for its diverse product lineup is complex, and changes in the production setup often arise (i.e., retooling is required when the type of product or manufacturing process changes). Consequently, the company s production process is not one that lends itself to automation. However, the lead time from when an order is placed to the time it ships averages one month, making for very small order backlogs. As such, the company does not keep an inventory of finished goods in anticipation of new orders (although it does maintain a store of semi-processed goods). As of May 2013, regular production capacity was 1.8 billion yen per month at its main Hotaka facility. AccuDrive The AccuDrive is a high-precision, highly rigid planetary gear. The company created the product, which supports reduction ratios of between 1/3 and 1/45, with the goal of entering the low-reduction-ratio field by leveraging the precision processing technology used in the Harmonic Drive. While ordinary planetary gears have a backlash of least 0.5 degrees, the AccuDrive keeps backlash to between 0.05 and 0.25 degrees. The product is suitable for applications require high-precision positioning and speed reduction. Source: Company data, SR Inc. Research Copyright (C) Shared Research Inc. All Rights Reserved 24/59

25 Mechatronics Mechatronics is a category of products that includes output devices (actuators), which equip a speed reducer with cross roller bearings, motors, sensors, etc., as well as products that combine drivers, controllers, etc. The company has expanded into this business by embracing additional technologies related to its core competence in speed reducers. The company s focus is on creating controllers with human-level ability to manage the movements of robots and manufacturing equipment (hence its corporate motto, total motion control). Controllers rely on switches and sensors to capture incoming signals from various input devices and respond to this data using program-based output devices (actuators). Actuators are comprised of a speed reducer and motor and are analogous to the integrated use and functioning of muscles and joints in the human body, while sensors are used to measure variables such as positioning, distance, pressure, speed, etc. and then transmit this data to the controller. Generally, purchasers of speed reducers will then add a motor and/or sensor to the component to form an actuator, which they will then use. The company s selling point to mechatronics customers is its ability to combine its speed reducers with its in-house developed motors, bearings, and sensors. Source: Company data, SR Inc. Research The company's mechatronics offerings can be roughly divided into the following four categories based on the type of movement the product performs. 1. Rotary type: has the largest amount of applications and highest sales volume. 2. Linear type: targets equipment that requires linear motion, such as the precision XY stages for semiconductor manufacturing equipment. 3. Oscillating type: also called an optical scanner, this type makes rapid back and forth movements at a finite angle and is generally used in laser markers. 4. Complex/Module type: rather than a single movement, this type makes complex movements on Copyright (C) Shared Research Inc. All Rights Reserved 25/59

26 multiple axes. For example, a high-speed, three-fingered robot hand was developed through a combination of the company's technology and a vision sensor produced from the research of Professor Ishikawa of Tokyo University. Source: Company data, SR Inc. Research End-applications for the company's mechatronics products include semiconductor manufacturing equipment where the products are widely utilized from the front to the back-end of the manufacturing process. HDSI s mechatronic components are also widely used in optical devices and measuring equipment. For example, in addition to applications in oscillating-type optical scanners that are used in laser markers, rotary- and linear-type actuators are also utilized in super high-precision spectroscopes. Industrial robots do not account for much end-demand for the company's mechatronics products as the main robot manufacturers tend to make such components themselves. The company's products are widely used in semiconductor manufacturing equipment, from front-end all the way through to downstream processes. Optical devices and measuring equipment also provide many applications. In addition to oscillating-type optical scanners used for laser markers, rotary- and linear-type actuators are used in ultra-high precision spectroscopes. Meanwhile, major makers of industrial robots make their motors on their own, so there are not many orders for the company s components for industrial robots. Copyright (C) Shared Research Inc. All Rights Reserved 26/59

27 Applications Applications FY03/07 FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 (million yen) Parent Parent Parent Parent Parent Parent Parent Parent Sales (parent) 16,515 16,719 14,277 10,486 19,456 18,069 16,159 18,584 Industrial Robot Applications 3,067 2,717 1,520 1,226 2,678 2,299 1,690 2,228 Semiconductor Production Equipme 1,287 1,196 1,348 1,128 2,012 1, ,499 Flat Panel Displays 3,969 4,327 3,647 2,695 6,213 6,593 5,883 6,056 Gear Heads (for Electric Motor Mak 1,513 1,694 1, ,543 1,312 1,079 1,385 Machine Tools 1,071 1,254 1, ,093 1,334 1,232 1,285 Oil-Drilling Equipment , , Optomechanical Equipment Measuring Test Instrument Printing Presses Cargo Transporters Others 3,751 3,672 3,199 2,666 3,563 3,541 3,446 3,893 YoY 18.5% 1.2% -14.6% -26.6% 85.5% -7.1% -10.6% 15.0% Industrial Robot Applications 32.3% -11.4% -44.1% -19.3% 118.4% -14.2% -26.5% 31.8% Semiconductor Production Equipme -5.6% -7.1% 12.7% -16.3% 78.4% -37.5% -25.6% 60.1% Flat Panel Displays 7.6% 9.0% -15.7% -26.1% 130.5% 6.1% -10.8% 2.9% Gear Heads (for Electric Motor Mak 20.6% 12.0% -35.4% -18.2% 72.2% -15.0% -17.8% 28.4% Machine Tools 11.1% 17.1% -8.0% -49.8% 88.8% 22.0% -7.6% 4.3% Oil-Drilling Equipment 4.5% 7.7% 72.2% -60.0% 116.2% -48.3% 41.9% 17.8% Optomechanical Equipment 7.4% 1.2% -23.4% -29.4% 70.7% 13.1% 5.4% 22.0% Measuring Test Instrument 7.2% -14.7% -14.6% 14.8% 48.4% -7.1% -19.5% 21.4% Printing Presses 18.5% 1.2% -2.4% -35.7% 32.5% -7.1% -10.6% 3.5% Cargo Transporters -17.1% -13.2% 56.6% -39.9% 85.5% -48.4% -28.5% 15.0% Others 44.9% -2.1% -12.9% -16.7% 33.7% -0.6% -2.7% 13.0% Composition Industrial Robot Applications 18.6% 16.3% 10.6% 11.7% 13.8% 12.7% 10.5% 12.0% Semiconductor Production Equipme 7.8% 7.2% 9.4% 10.8% 10.3% 7.0% 5.8% 8.1% Flat Panel Displays 24.0% 25.9% 25.5% 25.7% 31.9% 36.5% 36.4% 32.6% Gear Heads (for Electric Motor Mak 9.2% 10.1% 7.7% 8.5% 7.9% 7.3% 6.7% 7.5% Machine Tools 6.5% 7.5% 8.1% 5.5% 5.6% 7.4% 7.6% 6.9% Oil-Drilling Equipment 4.3% 4.6% 9.3% 5.1% 5.9% 3.3% 5.2% 5.3% Optomechanical Equipment 2.9% 2.9% 2.6% 2.5% 2.3% 2.8% 3.3% 3.5% Measuring Test Instrument 1.9% 1.6% 1.6% 2.5% 2.0% 2.0% 1.8% 1.9% Printing Presses 1.4% 1.4% 1.6% 1.4% 1.0% 1.0% 1.0% 0.9% Cargo Transporters 0.7% 0.6% 1.1% 0.9% 0.9% 0.5% 0.4% 0.4% Others 22.7% 22.0% 22.4% 25.4% 18.3% 19.6% 21.3% 20.8% Source: Company data, SR Inc. Research *Full-year sales have been calculated using quarterly and half-year data, as well as sales composition ratios. Therefore, these figures may differ from official company data. Within the broader speed reducer field, the company's products are largely utilized in applications that demand high-precision positioning. Required functionality for speed reducers varies based on their end application. For example, general industrial machinery, such as belt conveyors, requires constant-speed high torque but high rotational accuracy is not necessary. The Harmonic Drive is a precision speed reducer used when high positioning accuracy is required due to its compact size, light weight and zero backlash characteristics. Its primary application is for use in the joints of robots that require precision control. Precision speed reducers are also used in robots used in semiconductor manufacturing because these robots must be able to exactly position wafers during processing, loading, dismounting, inspection, and testing. Looking at FY03/13 parent sales by end application: 36.4% of sales were for industrial robot applications. Company analysis showed around half of these industrial robot sales were for automobile manufacturing equipment. 10.5% of sales went toward semiconductor production equipment. Copyright (C) Shared Research Inc. All Rights Reserved 27/59

28 5.8% went to flat panel displays (LCD manufacturing equipment etc.). 6.7% toward gear heads (for precision/electric motor manufacturers). 7.6% for machine tools. We note a variety of other applications including oil-drilling equipment, measuring test instruments, printing presses, and cargo transporters. Note: Others includes sales of finished and semi-finished products to affiliate companies. Source: Company data, SR Inc. Research Examples of further applications: Honda Motor Co.'s (TSE1: 7267) humanoid robot "ASIMO" uses the Harmonic Drive in the drive sections of its arms and legs. Harmonic Drives are used in Airbus' inertial navigation systems (INS). The optical-infrared telescope "Subaru" installed on Mt. Mauna Kea, Hawaii, utilizes an actuator that combines a Harmonic Drive with an AccuDrive to help maintain the reflector's mirror surface. Carl Zeiss Group (unlisted, Germany) utilizes HDSI's products for positioning the arms of its neurosurgical systems. The Mars Exploration Rover uses a Harmonic Drive for the positioning/axel movements of its cameras and antennas. Overseas Operations Sales by Region FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 (million yen) Cons. Cons. Cons. Cons. Cons. Cons. Cons. Sales 19,212 16,165 12,057 22,001 20,159 18,131 21,084 YoY 2.4% -15.9% -25.4% 82.5% -8.4% -10.1% 16.3% Japan 14,671 12,369 8,120 15,655 14,495 12,125 14,635 YoY 4.5% -15.7% -34.4% 92.8% -7.4% -16.4% 20.7% Composition 76.4% 76.5% 67.3% 71.2% 71.9% 66.9% 69.4% North America 3,085 2,400 2,081 3,438 3,027 2,769 3,184 YoY -3.7% -22.2% -13.3% 65.2% -12.0% -8.5% 15.0% Composition 16.1% 14.8% 17.3% 15.6% 15.0% 15.3% 15.1% Europe 1,361 1, ,570 1,628 1,391 1,512 YoY -4.0% -6.3% -23.2% 60.4% 3.7% -14.5% 8.7% Composition 7.1% 7.9% 8.1% 7.1% 8.1% 7.7% 7.2% Others ,336 1,006 1,846 1,753 Source: Company data, SR Inc. Research Figures may differ from company materials due to differences in rounding methods. The company has operations in the US, Germany and China. FY03/13 sales breakdown: Japan 66.9% North America 15.3% Europe 7.7%. Copyright (C) Shared Research Inc. All Rights Reserved 28/59

29 North America Harmonic Drive LLC, which the company jointly established with Nabtesco Corp. (TSE1: 6268) in 2005, develops and manufactures Harmonic Drive and mechatronics products for sale in North America. Sales by market segment Semiconductor equipment: a little over 20%; medical equipment: a little less than 20%; machine tools: a little over 10%; public sector: a little less than 10%; printing presses: a little less than 10% Europe Harmonic Drive AG, the company's German-based equity method affiliate, manufactures some company products under the HDSI brand. Harmonic Drive AG sells products its imports from HDSI, as well as products it manufactures under the HDSI brand, in Europe and the Middle East. Sales by market segment Industrial robots: 20-30%; machine tools: about 20%; semiconductor equipment: about 10%; printing presses: about 10%; public sector: about 10% (FY03/14). Asia In Asia, the company founded a sales subsidiary in China called Harmonic Drive Systems (Shanghai) Co. in January The company indicated it expanded into China because Chinese manufacturers are shifting towards automated assembly lines, and are focusing on improving production quality and controlling labor costs amid sharp wage rises. While HDSI has no plans to shift production to China, it intends to pursue sales activities there. HDSI also established a subsidiary, SAMICK ADM Co., Ltd., in South Korea in February SAMICK ADM, a joint venture with Korea s SAMICK HDS Co., Ltd., makes and sells precision planetary gears. These precision planetary gears manufactured by the venture are sold in South Korea exclusively by SAMICK HDS. In China, Taiwan, and elsewhere in Asia, the products are sold by HDSI and Harmonic Drive Systems (Shanghai) Co. The company indicated international expansion as one of its core objectives for FY03/13 and beyond. HDSI stated that its Japan, North America, and Europe operations will collaborate on basic research, product development, and manufacturing improvements. Its European, North American, and Chinese subsidiaries will engage in local marketing to strengthen brand awareness. Copyright (C) Shared Research Inc. All Rights Reserved 29/59

30 Profitability Snapshot, Financial Ratios Profitability and Profit Margins FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 (million yen) Cons. Cons. Cons. Cons. Cons. Cons. Gross Profit 6,459 4,530 9,930 8,297 7,368 9,118 Gross Profit Margin 40.0% 37.6% 45.1% 41.2% 40.6% 43.2% Operating Profit 2,427 1,072 5,848 4,334 3,436 4,668 OP Margin 15.0% 8.9% 26.6% 21.5% 19.0% 22.1% EBITDA 3,225 1,816 6,588 5,342 4,556 5,839 EBITDA Margin 20.0% 15.1% 29.9% 26.5% 25.1% 27.7% Net Profit Margin 9.4% 4.1% 13.4% 10.6% 10.8% 14.2% Financial Ratios ROA 6.2% 2.0% 9.7% 6.1% 5.4% 7.9% ROE 8.7% 2.8% 14.5% 9.5% 8.2% 11.0% Total Asset Turnover Inventory Turnover Days of Inventory Working Capital Requirement 2,380 4,782 6,402 5,691 4,836 6,457 Current Ratio 356.1% 325.1% 227.7% 345.0% 334.9% 353.0% Quick Ratio 295.8% 272.7% 194.9% 308.3% 301.6% 310.4% OCF / Current Liabilities Net Debt / Equity 16.9% 12.0% 20.7% 17.9% 27.2% 29.1% OCF / Total Liabilities Cash Cycle (days) Changes in Working Capital -2,514 2,402 1, ,621 Figures may differ from company materials due to differences in rounding methods. Source: C ompany data, SR Inc. Research The company's profit structure is characterized by high incremental profit margins (marginal profitability). For this reason, when sales decline, fixed costs become a burden and its operating profit margin takes a hit. Conversely, when sales increase, there tends to be large improvements in its operating profit margin. For example, FY03/09 operating profit margin (OPM) was 15.0% while FY03/10 s OPM was a depressed 8.9%. Looking at the top-line figures, FY03/09 sales decreased 15.9% YoY, and FY03/10 sales fell 25.4% YoY. In contrast, FY03/11 s OPM came in at a high 26.6% as sales rebounded by 82.5% YoY. Marginal profitability is high both for speed reducers and mechatronics offerings. However, SR believes that speed reducers, which include the Harmonic Drive precision speed reducer, have a slightly higher additional value than mechatronics-related products. Copyright (C) Shared Research Inc. All Rights Reserved 30/59

31 Group Companies At end March 2013, the group had 10 companies: Harmonic Drive Systems Inc. (HDSI), eight consolidated subsidiaries, and two equity method affiliates. HDSI manufactures and sells precision actuators (i.e., precision speed reducers that have been combined with motors, sensors, etc.) and controllers. It also produces and sells precision positioning equipment and related systems. Finally, the company manufactures and sells the Harmonic Drive and sells a precision planetary gear called AccuDrive. Domestic consolidated subsidiaries (equity ownership follows in parentheses.) HD Logistics Inc. (100.0%): handles the group's logistics. Harmonic Precision Inc. (100.0%): manufactures and processes the core cross roller bearings component for the group's unit-type precision speed reducer products. Harmonic AD Inc. (100.0%): manufactures and sells the AccuDrive. Winbel Co. (51.9%): development, manufacturing, and sales of various motors. SAMICK ADM Co., Ltd. (51.0%): manufactures and sells AccuDrive Overseas consolidated subsidiaries HD Systems Inc. (100%): US-based holding company that is de jure owner of the subsidiary Harmonic Drive LLC. Harmonic Drive LLC (51.0%): development, production, and North American sales of the Harmonic Drive and mechatronics products. Nabtesco also invested 49.0% of the capital for Harmonic Drive LLC, thus the company is also a Nabtesco equity method affiliate. Harmonic Drive Systems (Shanghai) Co. (100%): sales and technical services for mechatronics products and reducers. SAMICK ADM Co., Ltd. (South Korea) (51.0%): manufactures and sells AccuDrive Equity-method affiliates Harmonic Drive AG (35.0%): based in Hessen, Germany, this affiliate manufactures a portion of the company's products under the HDSI brand. It also sells products its imports from HDSI, as well as products it manufactures under the HDSI brand, in Europe, Middle East, Africa, India, and South America. Ome Iron Casting Co. (49.2%): development, production, and sales of high-strength cast-iron products. Copyright (C) Shared Research Inc. All Rights Reserved 31/59

32 Strengths & Weaknesses Strengths Unique core product, sole manufacturer. The Harmonic Drive has a number of compelling features that have been developed by the company, and HDSI is the only company globally with the technological expertise to manufacture the product. This increases HDSI s pricing power and allows it to focus on refining its technology and responding to emerging customer needs without having to fend off competition. Secular growth of markets for the company's products. The market for compact precision reducers is steadily growing driven by secular trends in robotics, aerospace, and defense. New applications continue to emerge. Despite short-term cyclicality in the end markets, demand for HDSI s Harmonic Drive should continue to expand unchallenged by competition. Solid financial position. Against a backdrop of growing retained earnings, the company maintains an equity ratio in excess of 60% and is net-debt free (end March 2013). Weaknesses Short-term sales trends are volatile. As the company's products are mostly sold as components to such industries as industrial robotics, SPE, and FPD equipment manufacturers, these industries' capex trends have a large effect on sales. In particular, semiconductor and flat-panel end-market conditions are cyclical and heavily influence the company s product sales into this space. Small batch production limiting growth rate. HDSI manufactures a broad range of products in small lots. The assembly of components and materials for the company's products is complex, and changes in the production setup are frequent due to the small batches and diverse orders it receives (i.e., the re-tooling is required from changing product or manufacturing processes). It is thus impossible to automate its production line, which creates a high fixed cost base and severely limits the company s ability to scale production. This situation appears to constrain growth rates, despite secular growth in end markets. Limited ability to develop and market new products, and end applications. Looking at the company's history, the company does not have a track record of creating new markets for its products. Rather it has grown by supplying products that meet the demands of customers who come to the company looking for solutions. HDSI has a unique technology and has excelled in responding to customer needs but this has been and remains a reactive strategy. While this has not impacted the company's ability to make money, it makes its future less predictable. Copyright (C) Shared Research Inc. All Rights Reserved 32/59

33 Market and Value Chain Market Overview ( 百万円 Million ) 20,000 売上高 ( 単体 ) History of Sales(Non-consolidated basis) 15,000 10,000 5,000 成長の牽引役 Demand Drivers ロボット Robotics 半導体製造装置 Semiconductor Equipment 0 工作機械 Working Machines '71 '72 '73 '74 '75 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 ( 年度 FY) Source: Company data, SR Inc. Research According to the company, the size of the precision speed reducer market is approximately 150 billion yen. As there are no public statistics relating to market size, the chart above plots the company's annual sales to give an idea of market trends. The company has continued to refine its product lineup (centered on the Harmonic Drive ) to higher levels of precision, while expanded end-use applications and increased demand have driven growth. Initially the Harmonic Drive had trouble finding applications following its invention in While the company was founded in 1970, it wasn t until the late 1970s that its products began to find uses in machine tools and consequently up until then it struggled with sales. The catalyst for wider use of harmonic drives in the late 1970s was KUKA AG (Germany KU2) and ASEA (now part of ABB Ltd. (Sweden ABBN)) adoption of speed reducers as they began rolling out electrically powered industrial robots (previously these had been hydraulically operated). From there, HDSI's products became more widely used, especially in robotics. Semiconductor manufacturing equipment was added to the mix of end applications from the 1990s, and growth continued in the 2000s with new demand for applications in the production of flat panel displays and automobiles. Two points are apparent from the company's sales trends: Sales are volatile. This can be traced back to demand fluctuations for industrial robots, semiconductor production equipment, and flat panel displays that most of the company's sales go toward. Over the long term sales have been growing. Existing end applications continue to provide the company with sales, while new end-use applications have also grown. Copyright (C) Shared Research Inc. All Rights Reserved 33/59

34 Source: Company data, SR Inc. Research Industrial robot and semiconductor manufacturing equipment fields equipment will likely become smaller and more complex (e.g., more joints) while micro-fabrication needs at semiconductor fabs are also set to rise. As the company specializes in compact precision speed reducers, such conditions could act as a tailwind on its financial performance. HDSI s products have already started finding use in service robots, medical equipment, as well as aerospace, environmental, and energy fields. The company thinks that these areas could provide growth opportunities. Competition Nabtesco and Sumitomo Heavy Industries Ltd. (TSE1: 6302) are two other major precision speed reducer manufacturers. However, these companies specialize in different types of precision speed reducers compared with HDSI. Both companies specialize in planetary-gear type reducers; the main product lines for Nabtesco and Sumitomo Heavy are RV Series reducers and Cyclo type speed reducers, respectively. Both products are different from Harmonic Drive in their principles and design, with the key differentiating characteristic being the number of parts. As described, the Harmonic Drive only requires a few parts while planetary gear systems have many more. This difference ensures Harmonic Drive@ has dominance in applications where the combination of light/backlash-free/hollow is key. As a result, while Nabtesco and Sumitomo Heavy are technically competitors, their speed reducers have different end applications and there is little competing product overlap. HDSI offers products in 17 sizes from 13mm to 330mm, whereas Nabtesco's smallest RV speed reducer is 70mm. While RV speed reducers are suitable for high-load, high-precision work, their complex structure makes it difficult to construct them in compact, lightweight forms. SR Inc. understands that this is even more true for the Sumitomo Heavy Cyclo product that is the strongest in areas where weight is less of a consideration. Given its unique advantage, the Harmonic Drive is used in areas that have relatively small torque requirements, such as in small robots, and arm joints in the upper half of robots' bodies. Meanwhile, RV and cyclo speed reducers are primarily used in areas with large torque requirements like large-scale robots and the lower half (fundamental axes) of robots' bodies. Also in Europe, HDSI, Sumitomo Heavy and Nabtesco nearly dominate the market of speed reducers for industrial robots, with SPINEA of Slovakia holding a small share. In terms of planetary-gear type reducers, WITTENSTEIN has a high market position in Europe, and HDSI is dominant in Japan. The two companies are competing for dominance in China. Copyright (C) Shared Research Inc. All Rights Reserved 34/59

35 Barriers to Entry While the patents surrounding the basic concept of the Harmonic Drive have expired and competitors have access to the basic technology, the company notes that anyone can make a harmonic drive but only we can make money making harmonic drives. The barrier is not the patents but the manufacturing technology. In 1991, Nabtesco Corp. acquired the strain wave gearing (harmonic drive) division of America s Quincy Technologies. However, in 2005 Nabtesco jointly established Harmonic Drive LLC with HDSI. SR Inc. understands Nabtesco may have attempted to make strain wave gear devices but failed to manufacture commercially viable ones. In December 2008, Citizen Chiba Precision Co. (part of Citizen Holdings Co. (TSE1: 7762)) announced it had completed work on a strain wave gearing speed reducer enclosed in a servo-motor. As of Q3 FY03/14, there were not many cases that the two companies were competing. Source: Company data, SR Inc. Research As SR Inc. understands it, HDSI excels in precision processing technology and the formulation of high-precision process management techniques. The Harmonic Drive s flexspline component, with thin metal walls just 100 micrometers thick, is a good example of the company s precision processing technological prowess that is reliant on its accumulated expertise in metal cutting techniques. The entire manufacturing process of the Harmonic Drive is dependent on experienced mechanics that test products by hand. While the company relies upon unique production processes and the manual fitting and checking of products (for example, properly assembled units produce a particular feel when rotated due to the elliptic wave generator expanding the elastic metal of the flexspline), the company has a system in place whereby it is not solely reliant on select workers abilities and their precision measurement techniques. Copyright (C) Shared Research Inc. All Rights Reserved 35/59

36 Substitutes Speed reducers may become redundant if compact, high-torque motors that feature direct precision positioning and conveyance are developed. Direct-drive motors (DD motors) are the best example of such technology. HDSI is developing DD motors itself, but it has commented that on various criteria, such as torque capacity, weight, price, etc. these motors do not provide a true substitute for mechanical speed reducers. The company maintains that the progress in gear technology is incremental and slow the simplest forms of reducers were developed in ancient times and harmonic drive was an unusual and rare invention in the space where everything has already been invented. Unlike high tech world were disruptive innovation occurs regularly, the technological niche HDSI finds itself in is much more stable and substitutes are harder to come by. Strategy The company sees as its goal the continued leadership in the precision control market through what it calls Total Motion Control. As HDSI s Chairman Ito said, "if we continue to focus only on responding to specific customer requests with our Harmonic Drive solutions, one day we will hit a wall. Instead the company needs to learn to proactively offer mechatronics-based solutions to clients problems. That s the key for sustained growth. While we are working on further advancing the capabilities of the Harmonic Drive, we are focusing on actuators and particularly mastering the sensor component of actuator design and see that area as important." Source: Company data, SR Inc. Research Copyright (C) Shared Research Inc. All Rights Reserved 36/59