Daikin Industries Ltd. Annual Report 2017

Plain-text annual report

Annual Report 2017 Fiscal Year Ended March 31, 2017 Meeting Your Expectations and Earning Your Trust by Both Solving Problems of Society and Expanding Our Business Focusing on the air-conditioning and fluorochemicals business, Daikin Industries, Ltd. operates in more than 150 countries, contributing to healthy and comfortable lives through the providing of air conditioners and a wide range of other products and services. Constantly refining the atmosphere- and environment-related technologies that it has developed since its founding, Daikin strives to both solve problems of society and expand its business. That is how Daikin Industries’ corporate value is born. Under the “FUSION 20” strategic management plan started in fiscal 2017, Daikin Industries is working to meet your expectations and earn your trust by contributing to the sustainable development of global society through new value co-created by bringing together not only internal expertise of our Group but also external expertise obtained via open innovation. Contents Our Group Philosophy/ Process of Value Creation ...................... 1 Financial Highlights .................................. 2 At a Glance ............................................... 3 A Message from the CEO ......................... 4 Interview with the CEO ............................ 6 Review of Operations Air Conditioning .................................... 10 Chemicals ............................................. 14 Oil Hydraulics ........................................ 16 Defense ................................................. 17 Corporate Governance ........................... 18 Directors, Audit and Supervisory Board Members, and Executive Officers ................................ 21 ESG Summary .......................................... 22 CSR (Corporate Social Responsibility) .... 24 Financial Section Eleven-Year Financial Highlights ............... 32 Financial Review .................................... 34 Consolidated Balance Sheet .................. 42 Consolidated Statement of Income ........ 44 Consolidated Statement of Comprehensive Income ....................... 45 Consolidated Statement of Changes in Equity ............................... 45 Consolidated Statement of Cash Flows .......................................... 46 Notes to Consolidated Financial Statements ............................ 47 Independent Auditors’ Report ............... 73 Corporate Data ..................................... 74 Forward-Looking Statements This annual review contains statements regarding the future plans and strategies of Daikin Industries, Ltd. (the Company), as well as the Company’s future performance. These statements are not statements of past facts but are based on judgments made by the Company on the basis of information known at the time. Therefore, readers should refrain from drawing conclusions based only on these statements regarding the future performance of the Company. The actual future performance of the Company may be influenced by economic trends, strong competition in the industrial sectors where it conducts its operations, foreign currency exchange rates, and changes in taxation and other systems. For these reasons, these forward-looking statements are subject to latent risk and uncertainty. Our Group Philosophy 1. Create New Value by Anticipating the Future Needs of Customers 2. Contribute to Society with World-Leading Technologies 3. Realize Future Dreams by Maximizing Corporate Value 4. Think and Act Globally 5. Be a Flexible and Dynamic Group 1. Flexible Group Harmony 2. Build Friendly yet Competitive Relations with Our Business Partners to Achieve Mutual Benefit 6. Be a Company that Leads in Applying Environmentally Friendly Practices 7. With Our Relationship with Society in Mind, Take Action and Earn Society’s Trust 1. Be Open, Fair, and Known to Society 2. Make Contributions that Are Unique to Daikin to Local Communities 8. The Pride and Enthusiasm of Each Employee Are the Driving Forces of Our Group 1. The Cumulative Growth of All Group Members Serves as the Foundation for the Group’s Development 2. Pride and Loyalty 3. Passion and Perseverance 9. Be Recognized Worldwide by Optimally Managing the Organization and its Human Resources, under Our Fast & Flat Management System 1. Participate, Understand, and Act 2. Offer Increased Opportunities to Those who Take on Challenges 3. Demonstrate Our Strength as a Team Composed of Diverse Professionals 10. An Atmosphere of Freedom, Boldness, and “Best Practice, Our Way” Process of Value Creation Environmental Awareness Air conditioning as a part of society’s infrastructure enables the creation of comfortable lives. When our products are used, a large amount of electricity is consumed. Reducing the impact on climate change is a top-priority issue for us. Strategic Assumptions Strategy: “FUSION 20” FY2021 Goals Direction for Group Development SWOT Strengths • Heat pump technology • Inverter technology • Refrigerant control technology • Sales and service network • Development and production closest to market Weaknesses • Sales skewed towards main products (air conditioners) Opportunities • Global cooperation on climate change (Paris Agreement) • Setting of sustainable development goals (UN SDGs) Threats • Changes in de facto standards for air conditioning 12 Group Strategies Basic Approaches Existing business domains (AC, Chemicals, Filters) 2. AC in Asia 4. Filters 1. AC in North America 3. Chemicals New business domains/structure (Environment/Energy, IAQ/AE Engineering) 5. New businesses to quickly produce results Heating/Water Heaters, Energy Solutions 6. Strategic business in the long-term Commercial Refrigeration, Next-generation Refrigerants/Gas, IAQ/Air Environment (AE) Engineering Technologies and monozukuri 7. Differentiated technologies/products with the Technology and Innovation Center 8. Enhanced monozukuri in the AC business Corporate management 9. Lean and competitive fixed-cost structure 10. Optimal inventory aiming at cash flow maximization 11. Financial operation standardization and IT integration Unique corporate philosophy 12. Enhanced HR based on people-centered management Contribute to solving problems of customers and society while working to achieve sales of ¥3.0 trillion and an operating income margin of 12% Create new value and contribute to the sustainable development of society through our business An enterprise group that will "Co-Create New Value in the Air and Environment Fields" Corporate Governance, Environment, New Value Creation, Customer Satisfaction, Human Resources, Compliance Risk Management, Risk Management, CSR Promotion System, Respect for Human Rights, Supply Chain Management, Stakeholder Engagement, Regional Society 1 ESGDAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017Financial Highlights Daikin Industries, Ltd. and Consolidated Subsidiaries Years Ended March 31 Operating Results (for the year): Net sales Gross profit Operating income Net income attributable to owners of parent Cash Flows (for the year): Net cash provided by operating activities Net cash used in investing activities Free cash flow (Note) Net cash used in financing activities Financial Position (at year-end): Total assets Total shareholders’ equity Per Share Data (yen): Net income (basic) Shareholders’ equity Cash dividends Cash flow per share Ratios (%): Gross profit margin Operating income margin Return on shareholders’ equity (ROE) Shareholders’ equity ratio Note: Free cash flow = Net cash provided by operating activities + net cash used in investing activities Millions of Yen 2016 2017 ¥2,043,691 ¥2,043,969 711,576 217,872 136,987 ¥226,186 (105,493) 120,693 (85,422) 730,935 230,769 153,939 ¥267,663 (128,823) 138,840 (73,544) ¥2,191,105 ¥2,356,149 1,014,409 1,111,636 ¥ 469.23 ¥ 526.81 3,473.54 3,802.10 120.00 413 130.00 475 34.82% 35.76% 10.66 13.44 46.30 11.29 14.48 47.18 Net Sales, Gross Profit, and Gross Profit Margin Operating Income and Operating Income Margin (¥ billion) 2,400 1,800 1,200 600 0 (%) 40 30 20 10 0 (¥ billion) 250 200 150 100 50 0 ROE （%） 15 12 9 6 3 0 (%) 15 12 9 6 3 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Net Sales Gross Profit Gross Profit Margin Operating Income Operating Income Margin 2 At a Glance Percentage of Net Sales E Air-Conditioning 90.0% Chemicals 7.7% Defense 0.8% Oil Hydraulics 1.5% Net Sales and Operating Income Major Products Description Air-Conditioning (¥ billion) 2,000 208.7 1,835.4 1,500 1,000 500 0 (¥ billion) 200 150 100 50 0 2013 2014 2015 2016 2017 • Room air-conditioning systems • Air purifiers • Heat-pump hot-water-supply and room-heating systems • Packaged air-conditioning systems • Multiple air-conditioning systems for office buildings • Air-conditioning systems for facilities and plants • Absorption refrigerators • Freezers • Water chillers • Turbo refrigerator equipment • Air-handling units • Air filters • Industrial dust collectors • Marine-type container refrigeration Chemicals (¥ billion) 180 120 60 0 18.3 156.8 (¥ billion) 24 16 8 0 • Fluorocarbons • Fluoroplastics • Fluoroelastomers • Fluoropaints • Fluoro coating agents • Semiconductor-etching products • Water and oil repellent agents • Pharmaceuticals and intermediates • Dry air suppliers Since becoming the first in Japan to manufacture packaged air-conditioning systems in 1951, Daikin has supported comforta- ble living based on the strengths of technologies that it has itself nurtured as the world’s sole manufacturer to create a full line of products from refrigerants to air conditioners. In 1933, Daikin was the first in Japan to engage in research on fluorinated refrigerants. Today, our activities range from research and development to commercial- ization, and we offer a lineup of 1,800 fluorine compounds. 2013 2014 2015 2016 2017 Oil Hydraulics (¥ billion) (¥ billion) 40 0 30 20 10 0 2.6 31.5 4 3 2 1 0 2013 2014 2015 2016 2017 • Oil hydraulic pumps • Oil hydraulic valves • Cooling equipment and systems • Inverter controlled pump motors • Hydrostatic transmissions • Centralized lubrication units and systems Daikin’s unique hydraulic technologies offer outstanding energy-conservation performance and are contributing to the development of industry by unleashing the potential of power control. Defense (¥ billion) 0.1 15.8 20 15 10 5 0 (¥ billion) • Warheads for Japan’s Ministry of Defense/ Warhead parts for guided missiles • Home-use oxygen therapy equipment 0.8 0.6 0.4 0.2 0 2013 2014 2015 2016 2017 Daikin’s superior machining and quality control technologies are used in the production of defense-related products and other industries where high lev- els of precision and performance are critical. 3 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017For the success of our “FUSION 20” strategic management plan, we will further strengthen management and steadily implement policies leading to new growth and development of the Group. In fiscal 2017, we were able to achieve a good performance despite the severe busi- ness environment. Maintaining that momen- tum, we will move forward with the “FUSION 20” priority policies of thor- oughly strengthening existing businesses, expanding into new business domains, and trans- forming our business structure. June 2017 Masanori Togawa President and CEO A Message from the CEO 4 For the success of our “FUSION 20” strategic management plan, we will further strengthen management and steadily implement policies leading to new growth and development of the Group. In fiscal 2017, the degree of recovery seen varied between countries and regions, but overall the world economy tended to slow, and the business environ- ment was severe due to factors such as the rapid rise of the yen in the first half. Viewing this kind of difficult business environment as a good chance to further strengthen management for the future, Daikin moved ahead with the fundamen- tal reinforcement of sales and marketing capabilities, aggressive introduction of differentiated products, and reduction of total costs. As a result, we were able to greatly raise the level of Group profitabili- ty, setting new records for both net sales and income on a consolidated basis for the fourth consecutive year. Also in fiscal 2017, we started our “FUSION 20” (fiscal 2017 to fiscal 2021) strategic management plan and imple- mented various policies aimed at new growth and development of the Group. In our core business of air conditioning, with the goal of becoming a top player in air conditioning in North America, our subsidiary Goodman Global Group, Inc. began full-scale operation of the Daikin Texas Technology Park, which integrates its four factories and two logistics cen- ters. This facility introduced cutting-edge production lines (known as module lines), shortened the production cycle, and introduced a system that can respond immediately to production vol- ume changes. In addition, the utilization of new technology such as AI and IoT has greatly increased production-process efficiency. The start-up of the new factory strengthened our production capacity, cost-competitiveness, and R&D functions, and it enabled us to introduce innovative products not previously seen in the North American market. In Asia, demand from middle-income classes continues to expand, and, in order to build an organization that can handle the expansion of sales, we are moving forward at a rapid pace with sales network improvements, sales personnel increases, factory expansion, and new factory construction. We were also able to further strength- en our business bases in filter business and commercial refrigeration business, two areas we are developing as key future income sources. In filter business, we are accelerating efforts to create syn- ergy now that we have acquired Flanders Holdings LLC (of the United States), which is strong in high-performance filters for the pharmaceutical and food industries, and Dinar AB (of Sweden), which manufactures and sells air filters primarily for Northern Europe, the largest filter market in Europe. In commercial refrigeration business, we were able to further expand the range of our European business through the acquisi- tion of Zanotti S.p.A. (of Italy), which is strong in refrigerators and freezers for food distribution. We have also strengthened our global R&D organization so that we can continue to provide innovative products and ser- vices and new value to our customers. We will enhance our Technology and Innovation Center (based in Osaka), which serves as a control tower for global technology and product development and which drives our technology strategy preparation/promotion, differentiated technology search/development, and technical staff acquisition/development, etc. In addition, in order to improve the AI and IoT technology that we need for the coming era, we are establishing a Silicon Valley Technology Office, and we will implement industry-pioneering open innovation strategies, such as actively promoting industry, government, and academia collaboration aimed at merging the technology of different fields. While the world economy can be expected to expand steadily in fiscal 2018, there is also uncertainty about the future due to factors such as politi- cal risk in the United States and Europe and geopolitical risk in the Middle East and Asia. In this operating environment, we will continue to thoroughly strengthen our core business and work to expand into new business domains as specified in our basic strategy “FUSION 20,” and we will strive for even greater medium- and long-term growth and development by making forward- looking investments based on careful consideration of priorities. We look forward to your continuing support and understanding. 5 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Interview with the CEO For the success of “FUSION 20,” Daikin will secure short-term profit, while seeking additional medium- and long-term growth and development through forward-looking investments with carefully defined priorities. “FUSION 20” proclaimed that Daikin will “Co-Create New Value in the Air and Environment Fields with Wisdom and Passion.” Making an all-out effort in pursuit of a number of strategic themes, Daikin will aim for sustainable global growth, while also fulfilling its social responsibilities as a company. Q1 Could you please review Daikin’s fiscal 2017 performance and the progress status of the “FUSION 20” strategic management plan? Solid results for new growth and development Togawa: Fiscal 2017 consolidated net sales were ¥2,043,969 million and operating income was ¥230,769 million, so Daikin achieved a record-setting performance for the fourth consecutive year and income and profit increases for the seventh consecutive year. I believe that we were able to further strengthen our management practices by improving our sales and marketing power, by aggressively introducing high-value-add- ed products, and by moving forward with total cost reductions centered in global procurement. In our main business of air conditioning, we expanded sales in many key regions (Japan, the Americas, China, Asia, and Europe), and in “FUSION 20”’s priority regions of the Americas and Asia, sales (on a local currency basis) grew greatly to 115% and 113% of the previous year’s levels, respectively. Along with the strengthening of existing business, using measures that included M&A, Daikin was also able to move forward steadily with another priority strategy, the building of a base for expan- sion of our business domains and transfor- mation of our business structure. Looking back at fiscal 2017, for our existing core business and for our new businesses, I feel it was a year in which we achieved solid results in preparing for the new growth and development of the Group. A pressing management issue at the moment is to, first of all, achieve quanti- tative targets defined for intermediate points (fiscal 2019 medium-term imple- mentation plan) so that we can realize “FUSION 20.” Consequently, for the two years of fiscal 2018 and 2019, Daikin will execute forward-looking investments for the purpose of securing short-term profit while also building an infrastructure for the future. “FUSION 20” Goals and Medium-term Implementation Plan Goals (FY2021) To achieve sales of ¥3.0 trillion and an operating income margin of 12%, • Enhance existing businesses (AC, Chemicals, Filters) • Expand new businesses (Heating/Water Heaters, Energy Solutions, Commercial Refrigeration, Next-generation Refrigerants/Gas, IAQ/Air Environment (AE) Engineering) Medium-term implemen tation plan for FY2019 Net sales Operating income Operating income margin FCF (3-year cumulative) ROE Exchange rates FY2017 Result FY2018 Plan FY2019 Target (¥ billion) 2,044.0 230.8 11.3% — 14.5% 2,190.0 243.0 11.1% — — 2,500.0 270.0 10.8% +270.0 13.5% USD1=JPY108 EUR1=JPY119 RMB1=JPY16.1 USD1=JPY108 EUR1=JPY118 RMB1=JPY16.0 USD1=JPY110 EUR1=JPY125 RMB1=JPY17.0 Investment plan • Actively make investments mainly in North America and Asia in prioritized order Investment plan (3-year cumulative) FY2017–19 325.0 6 Q2 What are the main policies you expect to follow for the forward-looking investments? Three themes for aggressive forward-looking investments Togawa: Daikin’s forward-looking invest- ments can be divided overall into three main themes. The first theme is to “strengthen the production organization in air-conditioning business.” To prepare for further business expansion in the United States, we will build additional production capacity (Daikin Texas Technology Park) at Goodman Global Group, Inc. In Asia, where there is rapidly increasing demand from the growing middle-income classes, we will build a new factory (in Vietnam) and expand existing factories (in Thailand, India, and Malaysia). The second theme is to “strengthen the global R&D organization.” Daikin’s main focus here is to further improve underlying technologies and accelerate the develop- ment of differentiated products. We will further enhance the functions of our Technology and Innovation Center (TIC) in Osaka, Japan, which serves as the mother facility for global R&D, and we will establish a structure in which the TIC is the technolo- gy and product development control tower leading our eight development sites world- wide. In the United States, we are establish- ing a North American R&D center and a Silicon Valley Technology Office, and we are also working to enhance the applied develop- ment center. The third theme is to “acquire new technology, such as AI and IoT.” To do this, Daikin will accelerate open innovation through the active use of industry, government, and academia collaboration. Trends in Capital Expenditure, Depreciation, and Research and Development Expenses Capital Expenditure and Depreciation Research and Development Expenses (¥ billion) 120 90 60 30 0 (¥ billion) 60 50 40 30 20 10 0 2013 2014 2015 2016 2017 2018 (plan) 2013 2014 2015 2016 2017 2018 (plan) Capital Expenditure Depreciation 7 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 not only production capacity but also cost-competitiveness. In addition, the new manufacturing know-how and production technology developed by the initiative will raise the productivity of our Group as a whole by being put to good use globally at other new factories now being planned. Q4 M&A occurred in rapid succession in fiscal 2017. What were the aims of that M&A? Realizing synergy via business domain expansion Togawa: In our filter business in fiscal 2017, we acquired the U.S. company Flanders Holdings LLC and the Swedish company Dinar AB. The United States is the world’s largest filter market, and Europe is the second largest. Daikin is seeking to create synergy between these two companies and American Air Filter Company, Inc. (a sub- sidiary of O.Y.L. INDUSTRIES BHD, which was acquired in 2007) and Nippon Muki Co., Ltd. (acquired in 2009). Our aim is to become the global No. 1 in filter business by having these companies introduce new products that utilize the strengths of each and by raising cost-competitiveness with centralized purchasing and a production system that manufactures products as close to the market as possible. In our commercial refrigeration business, Daikin acquired the Italian company Zanotti S.p.A. The aim is to expand our business by making mutual use of the sales and service networks of Daikin and Zanotti. There is a high level of environ- mental awareness in Europe, and custom- ers are looking for the development of refrigerators and freezers that place the smallest possible burden on the environ- ment. We think that incorporating energy- saving technology developed by Daikin for air-conditioning equipment will help expand our business and also be very meaningful as a contribution to society. In order to expand Daikin’s business domains in the future, we will also pro- mote fundamental strengthening measures (M&A and alliances/collaboration with other companies) for our heating business and energy solution business, etc. Q5 Please give us some background and policy information concerning the need to move quickly in developing and acquiring new technology. Moving forward aggressively with industry, government, and academia collaboration as well Togawa: In our air-conditioning business, Daikin did global rollouts of base models developed in Japan, and made adaptations at development sites in each region to handle local needs. However, with changes occurring rapidly in each market, it is criti- cal for Daikin to create differentiated prod- ucts at a faster pace, and, therefore, it is a pressing need to put in place differentiated technology. At the new Silicon Valley Technology Office mentioned earlier, we will introduce the latest technology (AI, IoT, etc.) at an early stage, and we will also acquire, bolster, and train technical Q3 In the United States, Goodman Global Group, Inc. has begun full-scale operation of the Daikin Texas Technology Park. Please give us an overview. A productivity increase by approxi- mately 50% over the current level Togawa: At the Daikin Texas Technology Park, we have introduced a new produc- tion line, called the “Module Line,” which enables us to flexibly handle demand fluc- tuations. This line has brought together the best of today’s state-of-the-art produc- tion technology, including IoT technology and manufacturing know-how accumulat- ed by our Group at production sites world- wide. By the final fiscal year of “FUSION 20,” initiatives such as this are expected to increase productivity by about 50% over the current level and also strengthen 8 will intensify its efforts to reduce emissions, with a CO2 emission reduction target of 60 million tons for fiscal 2021. Daikin supports the United Nations Global Compact, which sets forth 10 principles concerning the four areas of human rights, labor, the environment, and anti-corruption. As we expand our business globally, Daikin will, of course, act in accordance with the laws and ordinances of each country as well as international norms, and we will also maintain high levels of transparency, soundness, and ethics, with the value chain as a whole taken into account. In addition, at Daikin, the identification of concerns and expectations via a dialogue with stakeholders (i.e., stakeholder engagement) is considered as an important foundation for CSR, and we put into practice management that contributes to the development of all parties involved through symbiosis with each region. Using atmosphere- and environ- ment-related technology to both solve problems of society and expand our busi- ness, Daikin will contribute to the sustainable development of global society. We hope you will look forward to our future progress under “FUSION 20” as we will work to cre- ate new value for the atmosphere and the natural environment. June 2017 Masanori Togawa President and CEO personnel in various fields, including leading-edge fields essential for the coming era. In addition, in order to lead the industry with an open innovation strategy, we believe that Daikin should move quickly in acquiring new technology by aggressively promoting comprehensive alliances with universities possessing advanced knowl- edge and by collaborating with leading- edge AI and IoT companies, new business ventures, and the world’s top-class research institutions. In view of its favorable performance, in fiscal 2017, Daikin paid a ¥60 interim divi- dend and a ¥70 final dividend for an annu- al total of ¥130 per share, which is ¥10 higher than in the previous fiscal year. We plan to pay a total dividend of ¥130 per share for fiscal 2018 (a ¥65 interim divi- dend and a ¥65 final dividend). Under a policy of paying dividends on a steady and continuing basis, Daikin will work to maintain its consolidated ratio of dividends on equity (DOE) at a level of 3.0%, while also seeking to further increase its consolidated dividend payout ratio. Q6 What are your thoughts on returns to shareholders? Basic policy of using both dividends and enterprise value increases for returns to shareholders Togawa: Under “FUSION 20,” Daikin will further strengthen its position in its core business, and it will concentrate manage- ment resources in clearly defined priority areas, such as boldly taking up the challenge of entering new businesses. For future growth and development, there are many themes that we will work on, and in fiscal 2018 we are planning capital investment of ¥100 billion and R&D expenses of ¥57 billion. For total investment (capital investment and loans and other investments) over the three years from fiscal 2017 to 2019, the initial plan was ¥325 billion. We expect to exceed that number, but we will also continue to thoroughly strengthen our financial position with measures such as reducing interest-bearing liabilities and increasing the efficiency of working capital. Through this combination of offense and defense, Daikin will work both to achieve “FUSION 20” goals and to further enhance its enterprise value and returns to shareholders. Q7 Please tell us your thoughts on CSR and give us a message for stakeholders. Contribute to the sustainable development of society through environmental protection, compliance, and symbiosis with regional societies Togawa: Daikin’s core business of air conditioning is already indispensable to society’s infrastructure. On the other hand, we are also aware that restraining the impact on global warming by reducing air-conditioning power consumption is the social issue that we should give the most attention. We are promoting the spread of the use of air conditioners utilizing R32 refrigerant, which has a lower impact on global warming than other refrigerants, and we are also working to expand global sales of inverter air conditioners, which have higher energy conservation perfor- mance. Combined, these initiatives suc- ceeded in reducing fiscal 2017 CO2 emissions by approximately 45 million tons. Throughout the world, and especially in emerging countries, the use of air conditioners will increase, but Daikin 9 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Review of Operations Air Conditioning Current Record high results on global sales expansion despite negative impact from the strong yen Net sales in the air-conditioning equipment business rose slightly during fiscal 2017 from the previous fiscal year, with expanded sales in major regions offsetting the negative impact from the strong yen. Japan Americas Sales in Japan rose 4% year on year Sales in the Americas rose 3% year amid increased industry demand for on year. In a favorable business climate both residential and commercial units supported by firm consumer spending, for replacements and upgrades to more Daikin strengthened its sales network, energy-efficient systems, as well as the and achieved year-on-year gains in unit heat wave in western Japan. sales volume and market share for its Daikin achieved record high mainstay unitary products, both high- revenue and earnings on efforts volume zone and high-efficiency units. to expand sales of high-value- In the growing ductless market, Daikin added products, including the strengthened relationships with architec- residential Urusara 7 model and tural firms and contractors, expanding commercial FIVE STAR ZEAS sys- sales of new VRV products for the high- tem using the R32 refrigerant, as end, residential-use market. Sales of well as variable refrigerant volume applied units (commercial-use large-scale (VRV) units for buildings in cold air conditioners) also rose from the previ- regions. ous fiscal year on continued efforts to strengthen the sales and service network. Expanded residential unitary lineup of high-efficiency products with inverters 10 Expanded sales of Urusara 7 products with excellent energy-saving and environmental performance to differentiate from competitors and provide high added value Air Conditioning China Sales in China declined 5% from the previous fiscal year, but operating income rose due to cost reduction efforts. In residential-use air condition- ers, Daikin leveraged the solutions and construction capabilities of its retail/con- sumer-oriented PROSHOPs to expand sales in the mid- to high-end market, mainly the “New Life Multi Series” resi- dential multi-air units designed to meet varied customer lifestyles. In the com- mercial-use market, Daikin enhanced its solutions capabilities with a new VRV model, and appealed to architectural firms with further built-in specifications. Sales of applied units increased despite the slowdown in large-scale real estate investment, mainly for small and mid- sized projects due to an expanded prod- Daikin PROSHOP specialist retailers provide one-stop solutions, including design, installation, and after-services. Expanding sales in the growing market of Asia uct lineup, and strengthened service heater business, sales of heat pump-type was particularly high in Vietnam, India, business. Europe water heating units rose in Germany and Indonesia, and Thailand for both residen- Italy, with increased sales of combustion tial and commercial air conditioners. In heaters (gas boilers) in Turkey. Australia, sales expanded for high-end, residential-use VRV units. Sales in Europe were on a par with the previous fiscal year. In residential-use air Asia/Oceania conditioners, sales of high-value-added Sales in the Asia/Oceania region were on products using the R32 refrigerant a par with the previous fiscal year. In resi- increased amid demand growth since the dential-use air conditioners, sales were 2015 heat wave. In the commercial-use firm for inverter air conditioners with market, unit sales volume increased as a exceptional energy efficiency. In the com- result of efforts to strengthen sales capa- mercial-use market, Daikin gained posi- bilities by country, and capturing renewal tive results from enhanced efforts for demand with the launch of new VRV built-in specifications in VRVs, and devel- products to meet regional needs. In the opment of sales offices. Sales growth 11 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017Air Conditioning Future Proactive up-front investments mainly in North America and Asia to drive further business expansion Daikin anticipates revenue and earnings gains in fiscal 2018 as a result of global sales expansion, comprehensive cost reductions, and sales price strategies, offsetting a substantial negative impact from higher material costs. Japan in the Tokyo metropolitan area ahead Daikin will work to increase earnings of the 2020 Tokyo Olympics, and through expanded sales of high-value- increase its market share. added products and comprehensive pricing strategies, as well as fundamen- Americas tally strengthening sales capabilities by With stable market growth expected as market and sales channel. For residen- a result of firm consumer spending and tial-use air conditioners, Daikin will capital investment, Daikin will accelerate increase sales of its uniquely differentiat- measures to strengthen competitiveness ed products, such as the Urusara 7 and and expand its business, including multi-air conditioners that offer superior enhancing cost-competitiveness with design. In the commercial market, the start of full-fledged operations of Daikin will work to expand sales of its new production plan, developing high-value-added systems, and establish region-specific products around expanded eco-related businesses such as inspection R&D functions, and building its own services for compliance with CFC emissions wholesale base. regulations. For applied units, Daikin will seek to capture redevelopment demand Shifting production into full gear at our new U.S. plant to aim for further business expansion 12 Building a recycling-oriented business that goes beyond simple device sales Air Conditioning China Daikin will expand its network of retail and consumer-oriented shops, including the PROSHOPs that handle residential multi-air conditioners, from urban areas to regional cities, and accelerate community-oriented sales activities. For residential-use air conditioners, Daikin will expand its “New Life Multi Series” lineup, and implement new measures such as opening interactive showrooms. In the commercial market, Daikin will launch new energy-efficient variable refrigerant volume (VRV) units, and new types of applied units. Further, Daikin aims to increase profits by increasing the ratio of units made in-house, expanding the number of units procured locally, accelerating cost reduction efforts, and shifting to integrated develop- Enhancing our ability to supply products to meet increasing middle-class demand Expanding our business to include commercial freezers and refrigerators ment, production, sales, and service. Daikin will seek to maximize synergistic and launch new residential multi-air benefits with the recently acquired firm units to meet the needs of middle-class Europe Zanotti S.p.A. of Italy. With demand for air conditioning expected to expand at a moderate pace Asia/Oceania consumers in Vietnam and Thailand. In the commercial market, Daikin will launch differentiated products such as on the back of firm consumer spending, With demand for air conditioning cooling VRV units in India. For applied Daikin will work to increase sales by expected to expand significantly among units, Daikin will establish a foundation launching differentiated products utilizing the growing middle-income classes, for business expansion by strengthening the R32 refrigerant, and strengthening its Daikin will continue to strengthen its local production structures, enhancing sales network. In the heater business, national sales networks and increase the product lineups, and developing service Daikin will introduce new types of highly number of sales personnel. In India and businesses. energy-efficient, heat pump-type water Thailand, Daikin will enhance its supply heating units, and expand sales of com- capacity to increase sales. In terms of bustion heaters (gas boilers). In the com- products, Daikin will strengthen its mercial freezer and refrigerator business, lineup of air-conditioning inverters, 13 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017Chemicals Current Sales expansion in growth markets and comprehensive cost reductions Net sales in the Chemicals business during fiscal 2017 declined 3.4% from the previous fiscal year. Despite efforts to expand sales in well-performing sectors, such as fluoroplastics resins for use in semiconductors, fluoroelastomers for automotive applications, and anti-smudge surface coating agents for smartphone touch screens, results were adversely affected by price pressure from com- petitors in China and the United States, and the negative impact from the strong yen. In the fluorocarbon gas business, overall In the fluoroelastomer business, despite sales of refrigerant gas rose from the a recovery in sales for automotive applica- previous fiscal year on higher sales to tions, mainly in Japan and China, overall the after-sales market in the United sales declined as a result of the considerable States. negative impact from the strong yen. In the fluoroplastics resin business, In the chemical products business, Daikin captured semiconductor-related sales of the OPTOOL™ anti-smudge demand in Japan and the rest of Asia, surface coating agent for smartphones but overall sales declined as a result of were favorable as Daikin captured positive intensifying competition in the U.S. LAN demand in China, but overall sales cable market and downward price pres- declined as a result of a slowdown in sure on commodities in China. water and oil repellent agents. Anti-smudge surface coating agent for smartphones 14 Chemicals Future Revenue and earnings growth expected from the strengthening of sales capacity, new product launches, and application development Daikin anticipates a sales increase of 5% in its Chemicals business in fiscal 2018. Although orders from major customers specifications with the aim of increasing for the OPTOOL™ anti-smudge surface market share. coating agent are expected to decline, Concentrating on the United States, this will be offset by expanded sales of the largest market for air conditioning, fluoroplastics resin in the continually Daikin will focus on after-sales businesses favorable semiconductor market, a such as the recovery and recycling of regaining of market share with the refrigerant gas, and establish a recycling- launch of new water and oil repellents, oriented business encompassing the life and application development tailored to cycle of refrigerants and air-conditioning customer needs. equipment. In the semiconductor market in Further, in Asian markets where demand particular, Daikin will capture growing for fluorochemicals products is growing, demand from the utilization of the Daikin will conduct detailed marketing and Internet of Things (IoT), strengthen its sales activities by industry sector. supply capacity, and promote built-in Highly chemically resistant fluoroplastics products are essential for semiconductor manufacturing equipment. 15 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Oil Hydraulics Current Steady sales and record earnings amid sluggish demand in Japan and China The oil hydraulics business comprises a Net sales in the oil hydraulics business range of oil hydraulic equipment to sup- declined in fiscal 2017 from the previous port the smooth movement of various fiscal year. Sales of oil hydraulic equip- types of machinery, contributing to ment for construction equipment and energy efficiency and electricity savings. vehicles increased to major customers in Daikin units are used mainly in industrial Japan and the United States, but perfor- machinery such as factory processing mance was significantly impacted by a equipment, construction equipment such slowdown in demand for products for as power shovels, and small vehicles such industrial equipment in Japan and China. as tractors. Oil cooling units adopting energy-saving technology Future Strengthen the business foundation in the United States and Europe, and accelerate global business expansion During fiscal 2018, Daikin will focus on and operation (MRO) and hydrostatic launching new products and strengthening transmissions (HST) businesses, and solutions-oriented sales capabilities in accelerate expansion of both businesses. order to further strengthen its position Europe is also being positioned as a in the Japanese market for oil hydraulic priority market, with comprehensive equipment used in industrial machinery. marketing activities conducted in a rapid Outside Japan, mainly in the United manner to facilitate full-scale market States, Daikin will strengthen the foun- entry. Daikin will also further strengthen dations for the maintenance, repair, its service structure in Japan and overseas. Hydraulic devices to drive construction machinery and automobiles 16 Defense Current Steady sales of home-use oxygen therapy equipment, mainly in Japan Daikin designs and manufactures synchronizers and oxygen concentrators, products for Japan’s Ministry of Defense products that require the highest levels based on the defense budget, including of precision, performance, functionality, various types of artillery shells, warheads, and quality. and fuses, as well as aircraft parts. These Net sales in this segment declined precision processing technologies are also from the previous fiscal year. Sales of leveraged for private-sector purposes, home-use oxygen therapy equipment including the manufacture and sale of increased in Japan, but sales of practice home-use oxygen therapy equipment. ammunition to the Ministry of Defense Daikin provides patients suffering from declined. chronic respiratory failure with respiration Future Accelerate business expansion in the private sector With the Japanese government scaling fiscal year. In the Chinese market, back orders for practice ammunition, Daikin will collaborate with local firms Daikin will accelerate its shift to the pri- to enhance its sales capabilities, and vate sector. In Japan, Daikin will expand strengthen product solutions and sales of the new oxygen concentrator cost-competitiveness, including the launched at the end of the previous possibility of supplying OEM products. 17 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017Corporate Governance Basic Policy of Corporate Governance Through its corporate governance, the Daikin Group works to raise corporate value by carrying out its decision making with foresight and by executing business with increasingly greater speed, transparency, and soundness, all in line with Group man- agement challenges and the changing business environment. Aiming for management with even greater speed, soundness, and transparency, we will continue to boost corporate value by seeking and implementing new ways to achieve optimal corpo- rate governance as we undertake best practices in all facets and at all levels of the Daikin Group. Regarding Japan’s Corporate Governance Code, Daikin has already implemented the principles of “enhancing information disclosure,” “making effective use of independent external directors,” and “the policy of having constructive dialogue with shareholders.” Going forward, Daikin will continue to enhance these initiatives. Management and Operational Execution Systems Rather than adopting a U.S.-style “committees system” that completely separates decision making from operational execu- tion, the Daikin Group has adopted an “integrated manage- ment” system, in view of the special characteristics of the Group’s business, judging that this is a more-effective means of accelerat- ing decision making and operational execution. The “integrated management” system is a system that calls for directors to bear responsibility for management duties as well as for operational execution duties through speedy, strategic decision making and sound, appropriate supervision and guidance. Directors also bear responsibility for the execution and completion of their decisions by carrying out their decision making, business execution, and supervision/guidance in an “integrated” manner. Daikin also appoints multiple external boards of directors who monitor the Group’s business execution status from an independent standpoint and gives appropriate guidance and advice on decision making, and are responsible for supporting the “integrated management” system in terms of transparency and sound management. In addition, the Group has introduced an “executive officer system” to accelerate the speed of execu- tion based on autonomous judgments and directions in units handling each region, division, and function. The Group appoints directors, while giving emphasis to the diversity of directors’ backgrounds regarding characteristics such as nationality, gender, and career history. As of the end of June 2017, there were 11 directors (including one female and one non-Japanese director), ensuring practical and prompt debate through a smaller number. Daikin’s Board of Directors includes three external directors (as of June 2017), conditional upon their being free of any conflict of interest. Daikin seeks to recruit external directors who can provide supervision and advice from a sophisticated perspective on a broad range of issues, based on their abundant experience and deep insight. Accordingly, we nominate external directors with primarily director and similar experiences in listed companies. 18 None of Daikin’s external directors have five or more concurrent posts. To ensure that the external directors can effectively contribute to Daikin’s corporate governance system, assistants to the exter- nal directors are assigned in the Management Planning Office. They strive to provide the external directors with Daikin-related information, early notice of Board of Directors meetings, and prior notice of Board of Directors meeting agenda items, as well as implementing prior explanations of particularly important agenda items. In addition, when external directors are unable to attend a Board of Directors meeting, the assistants provide them with related materials and subsequent explanations of meeting proceedings. Audit System Daikin employs an Audit and Supervisory Board System. As of June 2017, Daikin’s four Audit and Supervisory Board members included two external Audit and Supervisory Board members. The principal nomination criteria for external Audit and Supervisory Board members are the same as those for external directors and include independence from the Company in terms of not having a relationship of interest with the Company. The Audit and Supervisory Board members attend meetings of the Board of Directors, as well as other important meetings, and receive reports. In addition, they are able to express diverse opin- ions. To ensure effective audit functions, the Audit and Supervisory Board receives reports on important issues related to manage- ment and performance when necessary and also investigates relevant units, confirms approval of documents, and regularly exchanges opinions with representative directors, executive offi- cers, and the independent auditors. In addition, the Audit and Supervisory Board Member Office has been established to assist the auditors, with the staff performing their duties under the orders and direction of the Audit and Supervisory Board mem- bers. The opinions of the Audit and Supervisory Board are respected with regard to personnel transfers, work evaluations, and other matters pertaining to Audit and Supervisory Board Member Office staff members. Accounting Auditor Board of Corporate Auditors Corporate Auditors Group Auditors Meeting Shareholders’ Meeting Audit Appointment, dismissal Board of Directors Internal Control Committee, Corporate Ethics and Risk Management Committee, Information Disclosure Committee, CSR Committee Appointment, supervision HRM Advisory Committee Compensation Advisory Committee Group Steering Meeting Group Management Meeting Executive Officers Meeting Executive Officers (The rest is abbreviated) External Director/Audit and Supervisory Board Members’ Principal Activities Name Position Principal Activities Chiyono Terada Tatsuo Kawada Akiji Makino Ryu Yano Toru Nagashima External Director Ms. Terada attended 16 of the 16 Board of Directors meetings held during the fiscal year. Based on her abundant experi- ence and deep insight as a corporate manager, she provides appropriate supervision of Company management from an independent perspective; advises management from the consumers’ point of view, including the importance of the Company’s corporate brand; and makes proactive proposals for measures to further promote achievements of female employees. Mr. Kawada attended 12 of the 13 Board of Directors meetings held during the fiscal year. Based on his abundant experi- ence in management and high-level insight, he is able to provide appropriate supervision of management from an inde- pendent perspective and actively provides suggestions, from his broad and sophisticated perspective regarding changes in business models, innovation, and other matters. Mr. Makino attended 13 of the 13 Board of Directors meetings held during the fiscal year. Based on his abundant experi- ence in management and high-level insight, he is able to provide appropriate supervision of the Company’s management from an independent perspective and actively provides suggestions from his broad and sophisticated perspective regarding matters in the fields of energy, the natural environment, and service businesses. External Audit and Supervisory Board Member Mr. Yano attended 12 of the 16 Board of Directors meetings held during the fiscal year as well as 13 of the 15 Board of Auditors meetings held. Based on his abundant experience and deep insight as a corporate manager, he accurately audits the supervision of the conduct of management by the directors. From his broad and advanced perspective developed over many years of experience overseas, he makes necessary statements in a timely fashion. Mr. Nagashima attended 13 of the 13 Board of Directors meetings held and 10 of the 10 Board of Auditors meetings held during the fiscal year. Based on his abundant experience in management and high-level insight, he makes necessary state- ments in a timely fashion based especially on his broad and sophisticated experience in the management of global compa- nies and manufacturing enterprises. Reasons for Election as External Director/Audit and Supervisory Board Member Name Position Reasons for Election Chiyono Terada External Director Ms. Terada has abundant experience and deep insight as a corporate manager, and, drawing on her background, she Tatsuo Kawada Akiji Makino Ryu Yano Toru Nagashima provides appropriate supervision from an independent perspective. She has an excellent understanding of the consumers’ perspective, including the importance of the corporate brand, and makes proactive proposals for measures to further promote achievements of female employees. The Company management wants Ms. Terada to continue to contribute to the Company’s corporate value looking forward and, therefore, was elected as external director. Mr. Kawada has served as representative director of SEIREN CO., LTD., and has abundant experience and deep insight as a corporate manager. His experience includes changing his company’s business model, innovation creation, and reforming corporate cultures. The Company management wants Mr. Kawada to provide appropriate supervision of the conduct of management from an independent perspective, and, by offering proposals regarding management from his broad and high-level perspective, contribute to increasing Daikin’s corporate value. He has, therefore, been elected as external director. Mr. Makino has served as representative director of Iwatani Corporation and has abundant experience and deep insight as a corporate manager, especially in the fields of energy and the natural environment as well as the services business. The Company management wants Mr. Makino to draw on his background and experience to provide appropriate supervision of the conduct of management from an independent point of view, and, offering proposals regarding management from his broad and high-level perspective, contribute to increasing Daikin’s corporate value. He has, therefore, been elected as external director. External Audit and Supervisory Board Member Mr. Yano has served as representative director at Sumitomo Forestry Co., Ltd., and has abundant experience and deep insight as a corporate manager, particularly in the field of expanding business operations overseas. The Company manage- ment wants Mr. Yano to draw on his experience to supervise overall management and to significantly upgrade the appropriateness of the audit function. He has, therefore, been elected as external auditor. Mr. Nagashima has served as representative director at TEIJIN LIMITED, and has abundant experience and deep insight as a corporate manager, particularly in the field of implementing paradigm shifts from manufacturing to services. The Company management wants Mr. Nagashima to draw on his experience to significantly upgrade the appropriateness of the audit function. He has, therefore, been elected as external auditor. Note: All of the Company’s external directors and external auditors meet the qualifications for independence established by the Tokyo Stock Exchange. Agile Management Support System Daikin has three main management bodies—the Board of Directors, the Group Steering Meeting, and the Executive Officers Meeting—which minimize the number of directors and ensures speedy decision making based on the virtual discussion. The Board of Directors is the decision-making institution for all matters related to the Group as a whole that are stipulated by laws and regulations and by the articles of incorporation, and it also performs supervision and guidance to ensure sound and appropriate operational execution. The Board of Directors appro- priately makes decisions based on open and active discussions and performs an effective role in increasing corporate value over the medium-to-long term. They also perform self-evaluation on the effectiveness of the Board of Directors on a regular basis. In fiscal 2017, it met 16 times, and the average attendance rates of external directors and external Audit and Supervisory Board members at those meetings were 98% and 88%, respectively. 19 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 The top deliberative unit in the Group’s management system is the Group Steering Meeting. This unit determines the direction of important management policies and strategies in a rapid and timely manner, thereby accelerating the resolution of issues. In fiscal 2017, it met 12 times. In principle, all of the Executive Officers attend the Executive Officers Meeting, and it met 11 times in fiscal 2017. In addition, to respect and protect the interests of diverse stakeholders other than stockholders, Daikin has, based on the Board of Directors, established its Internal Control Committee, Corporate Ethics and Risk Management Committee, Information Disclosure Committee, and CSR Committee. Corporate Officer Remuneration, Etc. To ensure the transparent management of its corporate officer personnel and remuneration processes, Daikin has established the HRM Advisory Committee and the Compensation Advisory Committee. These committees engage in discussions and delib- erations regarding issues including corporate officer nomination criteria, corporate officer candidates, and remuneration. As of the end of June 2017, the committees consist of five members, including three external directors, one in-house director, and one executive officer, with the committee chairman being chosen from the external directors. The remuneration of directors and Audit and Supervisory Board members is determined so as to fall within the aggregate remuneration ceiling for directors and Audit and Supervisory Board members as set by a resolution at the general sharehold- ers’ meeting. Based on a report from the Compensation Advisory Committee, the directors’ remuneration is determined by a resolution of the Board of Directors, while the Audit and Supervisory Board members’ remuneration is determined by a resolution of the Audit and Supervisory Board. Directors’ remuneration consists of “fixed compensation,” “performance-linked compensation” that reflects the Group’s short-term performance (net sales and operating income) and each director’s job responsibilities, and “stock options” that reflect the Group’s medium- to long-term performance. The remuneration of external directors and corporate auditors consists of “fixed compensation” only. Compensation levels are determined based on consideration of Daikin’s performance and remuneration levels compared to those of other leading manufacturing companies in Japan after analyzing and comparing data from an outside specialized insti- tution on the remuneration of corporate officers active in approximately 200 Japanese companies listed on the First Section of the Tokyo Stock Exchange. In addition, responding to shareholders’ expectations, in order to maintain the motivation of in-house directors at a high level continuously over the medium-to-long term towards enhancing the Daikin Group’s performance and corporate value, the performance-linked compensation of such directors is given at a somewhat higher ratio than average to ensure the incentive is sufficient. 20 11 2 7 Position Directors (excluding external directors) Audit and Supervisory Board Members (excluding external directors) Total Compensation for Directors and Audit and Supervisory Board Members (Fiscal 2017) Total Compensation (Millions of yen) Total Compensation by Type (Millions of yen) Basic Stock Options Bonus Number of Individuals 1,220 750 120 350 66 66 70 — — — — External Directors 70 Corporate Officers Receiving Total Compensation and Other Exceeding ¥100 Million (Fiscal 2017) Total Consolidated Compensation (Millions of yen) 380 250 176 121 131 108 Position Company Name Director Director Director Chair- man Daikin Industries, Ltd. Daikin Industries, Ltd. Daikin Industries, Ltd. Consolidated Subsidiary, Daikin (China) Investment Co., Ltd. Director Daikin Industries, Ltd. Director Director Director Consolidated Subsidiary, Daikin Europe N.V. Daikin Industries, Ltd. Daikin Industries, Ltd. Total Consolidated Compensation by Type (Millions of yen) Basic Stock Options 245 153 108 10 7 66 79 65 26 26 13 — 13 — 13 11 Bonus 107 70 43 — 34 — 38 31 Name Noriyuki Inoue Masanori Togawa Ken Tayano Masatsugu Minaka Jiro Tomita Takashi Matsuzaki Total Compensation and Other for Independent Accounting Auditors (Fiscal 2017) Audit expense 209 (Millions of yen) Group Governance To meet governance needs on a Group basis including M&A- related Group companies, Daikin holds meetings of the Group Steering Meeting. By working to thoroughly ensure that all Group units share the Group’s important management policies and basic strategy and by endeavoring to promote and strengthen support for the resolutions of challenges of Group companies, the Group Steering Meeting seeks to make the Group undertake corporate activities based on unified objectives. Principal Group companies appoint Group auditors to participate in Group Auditors’ meetings, which seek to strengthen Groupwide auditing and auditing func- tions by undertaking activities to strengthen the operation of those functions. To further strengthen corporate governance and Group man- agement as a multinational company, Daikin has appointed a Chief Global Group Officer, who endeavors to further improve the Group’s cohesiveness. Directors, Audit and Supervisory Board Members, and Executive Officers (As of June 29, 2017) Position(s) Name Responsibilities & Principal Jobs Chairman of the Board and Chief Global Group Officer Noriyuki Inoue President and CEO, Member of the Board Masanori Togawa Chairman of Internal Control Committee Member of the Board (external) Chiyono Terada President of Art Corporation Member of the Board (external) Tatsuo Kawada Chairman and CEO of SEIREN CO., LTD. Member of the Board (external) Akiji Makino Chairman and CEO at Iwatani Corporation Member of the Board and Senior Executive Officer Member of the Board and Senior Executive Officer Member of the Board and Senior Executive Officer Member of the Board and Senior Executive Officer Member of the Board and Senior Executive Officer Member of the Board (non-resident) Ken Tayano Responsible for Domestic Air-Conditioning Business, Representative of China Region, Chairman and President of Daikin (China) Investment Co., Ltd., Chairman of Daikin Fluorochemicals (China) Co., Ltd., and Member of Global Air-Conditioning Committee Masatsugu Minaka Representative of Air-Conditioning Operations in the Europe/Middle East/Africa Region, President of Daikin Europe N.V., and Member of Global Air-Conditioning Committee Jiro Tomita Responsible for Global Operations Division, Manufacturing Technology and Promoting PD Alliances Takashi Matsuzaki Responsible for North America Research and Development and Applied R&D Center and General Manager of Silicon Valley Technology Office Koichi Takahashi Responsible for Accounting, Finance, Budget Operations and IT Development, General Manager of the Finance and Accounting Division Yuan Fang Regional General Manager of Air-Conditioning Business in emerging nations in the ASEAN and Oceania Regions of Global Operations Division, Vice Chairman and Vice President of Daikin (China) Investment Co., Ltd., Chairman of Daikin Airconditioning (Hong Kong) Limited Audit and Supervisory Board Member (external) Audit and Supervisory Board Member (external) Ryu Yano Chairman of the Board of Sumitomo Forestry Co., Ltd. Toru Nagashima Advisor of TEIJIN LIMITED Audit and Supervisory Board Member Kenji Fukunaga Audit and Supervisory Board Member Kosei Uematsu Senior Executive Officer Junichi Sato Representative of Air-Conditioning Operations in Central America and South America (including American Air Filter) and Member of Global Air-Conditioning Committee Senior Executive Officer Senior Executive Officer Senior Executive Officer Yukio Hayashi Responsible for Liaison Business and Defense Systems Business and General Manager of Tokyo Office Shigeki Hagiwara Responsible for Applied Solution Business, Service Operations and Training Yoshikazu Tayama General Manager of Budget and Administration Group, Finance and Accounting Division Senior Executive Officer Masayuki Moriyama Senior Executive Officer Yoshihiro Mineno Responsible for Applied Solution Business in China, ASEAN and Oceania Regions, Director and Vice President of Daikin (China) Investment Co., Ltd., COO of McQuay China General Manager of Global Operations Division, Director (non-resident) of Goodman Global Group, Inc., Director of Daikin Holdings (Houston), Inc. Senior Executive Officer Senior Executive Officer Satoshi Funada General Manager of Air-Conditioning Sales Division Yasushi Yamada Responsible for Safety Executive Officer Katsuyuki Sawai Executive Officer Hitoshi Jinno Responsible for Corporate Communication, Human Resources, and General Affairs and General Manager of Shiga Plant Responsible for PL/Quality, Air-Conditioning/Applied/Refrigeration, Responsible for Alliance Promotion with Gree Electric Appliances Inc., General Manager of Air-Conditioning Manufacturing Division, and General Manager of Sakai Plant Executive Officer Executive Officer Executive Officer Executive Officer Kota Miyazumi Responsible for Corporate Planning, General Manager of Marketing Research Division, Director of Planning Group in Marketing Research Division Tsutomu Morimoto Responsible for Executive Secretarial Department, Goodman Group Business Yuji Yoneda Responsible for Air-Conditioning Research and Development (including Applied Solution Business and Refrigeration Business) and General Manager of Technology and Innovation Center Masaki Saji General Manager of Human Resources Division and Department Manager of Diversity Promotion Group Executive Officer Masafumi Yamamoto Executive Officer Makio Takeuchi Responsible for CSR, Global Environment Affairs, Corporate Ethics, Compliance, Legal Affairs, General Manager of the Legal Affairs, Compliance and Intellectual Property Center, Chairman of CSR Committee, Chairman of Corporate Ethics and Risk Management Committee and Chairman of Information Disclosure Committee Responsible for Global Procurement, Deputy Manager of Air-Conditioning Manufacturing Division (Research and Development), Responsible for Refrigeration Division, Research and Development, Co-Creation Projects member of Technology and Innovation Center Executive Officer Executive Officer Yoshiyuki Hiraga Responsible for Chemical Business and Chemical Environment/Safety Toshio Ashida General Manager of Corporate Planning 21 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017ESG Summary The Daikin Group’s core business of air conditioning is essential for economic development and a comfortable lifestyle, and demand for air conditioning continues to expand in developing nations and around the world. As an industry-leading spe- cialized manufacturer, the Daikin Group sets CSR priority themes for the sustainable development of society. By evaluating the overall impact on society, Daikin provides people around the world with comfortable and rich lifestyles, while working to limit environmental impact by leveraging its accumulated technologies. Materiality In fiscal 2016, along with the establishment of a strategic management plan known as “FUSION 20,” the Group’s relevance has been evaluated. In the course of this evaluation, priority themes were selected according to two core topics: “The interests of stakeholders and what impacts on them,” which includes stakeholder engagement and global guidelines and requirements from the SRI research institution, and the “Importance of Daikin” based on management philosophy as well as mid-and-long-term management strategies. e c n e u l f n I d n a t s e r e t n I l r e d o h e k a t S Importance for Daikin Nine Priority Initiatives With the Group’s relevance established as the CSR priority for sustainable development of both the corporation and society, the Group has focused on four“Value Delivery” themes and five“Grounding” themes. Attention to these initiatives in management activities is incorporated into our strategic management plan, “FUSION 20.” Daikin Group CSR 22 Dealing with Climate ChangeEfficient Use of Resources and EnergyNew Value CreationEnsuring Product Quality and SafetyPursuit of Customer SatisfactionMost ImportantImportantCSR for Value ProvisionFundamental CSR ESG Positioning/Objectives EEnvironmental Environment p. 24 Introduce state-of-the-art technologies to the market in order to address environmental and energy issues P Promote spread of the use of environmentally friendly products worldwide SSocial New Value Creation p. 25 Share dreams and ambitions inside and outside Daikin to realize a healthy, comfortable lifestyle through air P Provide value to the Earth P Provide value to cities P Provide value for people’s health and comfort Customer Satisfaction p. 26 Provide peace of mind and reliability through a focus on customer orientation, experience, performance, and advanced technologies P Build a service network covering the entire globe P Build product development capabilities that can satisfy customer needs worldwide P Achieve the optimum level of quality Through the global spread of environmentally friendly prod- ucts, reduce greenhouse gas emissions by 60 million tons of CO2 in fiscal 2021 P By fiscal 2021, reduce the Group’s production-time green- house gas emissions to one-fourth of the fiscal 2006 level (75% reduction) P Implement and expand environmental activities carried out in collaboration with stakeholders Human Resources p. 27 Respect individual personalities and values, and maximize the potential of each employee P Maintain and expand hiring P Build an organization in which employees with diverse characteristics can each work with energy and motivation and can each grow in a way that maximizes their potential Respect for Human Rights p. 29 Taking into account the laws and regulations of each country and region, understand the diverse international standards concerning human rights and respect basic human rights Supply Chain Management p. 29 Understand Daikin’s social responsibility as encompassing the entire supply chain, not just the environmental burden, quali- ty assurance, and labor safety and health within the Group Stakeholder Engagement/Regional Society p. 30 Develop strong bonds with local communities as a member of the regional society operating a business while respecting the culture and history of each country and region GGovernance Corporate Governance p. 18 Accelerate decision making and execution with respect to management tasks and the management environment while at the same time promoting higher levels of transparency and soundness, thereby seeking to increase corporate value Environment A priority task for us is to contribute to the resolution of environmental and energy problems by bringing leading-edge technologies together with mar- kets. By promoting the spread of environmentally friendly products, in fiscal 2017 we reduced greenhouse gas emissions by 45 million tons of CO2, and our sales ratio for environmentally friendly home air conditioners rose to 74%. New Value Creation As initiatives to create new value meeting the expectations of customers and society, in fiscal 2017 our R&D expenses were ¥53.9 billion (consolidated: ¥46.1 billion in fiscal 2016), and, in fiscal 2016, we applied for 1,116 pat- ents (non-consolidated: 1,292 in fiscal 2015). Customer Satisfaction Reflecting our efforts to provide the highest level of customer satisfaction, in fiscal 2017 our after-sales service customer satisfaction rating (Japan) was 4.13 out of a total of 5.0 points (fiscal 2016: 4.05), and we had operations in more than 150 countries and production facilities at over 90 locations. Human Resources We recognize that by respecting individuality and value systems and by drawing out the unlimited potential of individuals, we make both our orga- nization and society stronger. In fiscal 2017, our percentage of female man- agers (non-consolidated) was 4.4% (fiscal 2016: 3.6%), our percentage of local employees serving as presidents at overseas bases was 52% (fiscal 2016: 51%), and the number of construction technology personnel we have developed reached 16,000 (Japan, China, and Malaysia). 23 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017CSR (Corporate Social Responsibility) Energy Conservation and Refrigerant Conversion Support in Emerging Countries In emerging countries, where the use of air conditioning is pro- jected to expand along with economic growth, promoting the use of energy-efficient products and low environmental impact refrigerants will make a considerable contribution to controlling global warming overall. Accordingly, Daikin is attempting to enhance people’s understanding of R32, working in cooperation with the Japanese government and international organizations, for example, by holding seminars for Indian government officials and air-conditioning industry groups. In addition, we have con- ducted training for 3,600 local AC installation and service engi- neers on how to appropriately handle R32, promoting the enhancing of technical levels. We are implementing the same level of support in Thailand and Malaysia. In fiscal 2017, Daikin was entrusted by Japan’s Ministry of the Environment with a survey aimed at supporting developing countries. In collaboration with the United Nations Environment Programme, we sampled 40 Sri Lankan factories and carried out a basic survey on the spread of energy-efficient air-conditioning units and the building of schemes for the recovery, recycling, and disposal of refrigerants. Over 70 participants from government, academia, and industry took part in the seminar that was held to report on the findings. ZEB Demonstration Tests The implementation of the Net Zero Energy Building (ZEB) that maintains a pleasant air-conditioning experience while having an energy consumption of zero is being accelerated worldwide. Even in Japan, the government aims to make new public build- ings ZEB by 2020. In order to achieve this, as energy-saving in air conditioning, that accounts for more than 40% of a building’s energy consumption is vital, Daikin is proceeding with ZEB demonstration tests at the Technology and Innovation Center (TIC) established in 2015. In fiscal 2017, at a building in the TIC, we achieved an overall 72% reduction of energy consumption in comparison with standard values and an 82% reduction when taking into account solar power. In addition, in July 2016, the TIC obtained the highest- ranked Platinum certification for Leadership in Energy and Environmental Design (LEED), the world’s most widely used certification system for environmentally friendly buildings. Environment L Materiality of Environmental Measures While air conditioners, the main product of the Daikin Group, support the enhancement of economic growth and quality of life in hot regions, they consume a lot of electricity during use and have an impact on climate change through the fluorocarbon used as a refrigerant. For this reason, the Daikin Group believes that providing for both business development and environmental protection is essential for the sustainable growth of society, and we are taking steps to reduce emissions of greenhouse gases throughout the entire supply chain. We are working to develop and provide products and services that mitigate climate change, and promote technical training aimed at supporting widespread market adoption. L Daikin’s Initiatives Promotion of Eco-Friendly Technologies and Products Daikin is aiming to reduce CO2 emissions from the energy consumption of air conditioners through promoting the wider usage of inverter units globally. In addition, based on our accumulation of research on refrig- erants and investigations into its adoption, we have determined that at present R32, with approximately a third of the global warming impact of existing refrigerants, is the refrigerant best suited for residential and commercial air conditioners, and have adopted it at Daikin. Furthermore, Daikin has designated a total of 93 basic patents related to the manufacture and sale of air conditioners using R32 as a refrigerant for royalty-free use worldwide. As of the end of March 2017, Daikin has sold more than 10 million R32 AC units worldwide in 52 countries. We estimate that the global market for R32 AC units, including the products of competitors, has expanded to more than 27 million units. Accordingly, together with the wider usage of inverter units, we calculate there has been a contribution towards the suppressing of 45 million tons of CO2. Daikin Receives the METI Minister Award in the Energy Conservation Grand Prize In fiscal 2016, Daikin’s “Retrofit System” received the top award, Japan’s Ministry of Economy, Trade and Industry (METI) Minister’s Award in the product/business sector of the Energy Conservation Grand Prize, sponsored by the Energy Conservation Center. This system, which has been designed for existing Daikin multiple air-conditioning systems for office buildings with five years or more having passed from installation, is the world’s first service to replace pressure units and energy-efficient control software with the latest specification items. Currently, there are approximately one million eligible units worldwide. This is expected to reduce greenhouse gas emissions as, while utilizing the advantages of conventional maintenance, annual power consumption may be reduced by a maximum of 15% through only the replacement of main components. 24 New Value Creation L Materiality of New Value Creation In today’s society, globalization and technological change and advancements are progressing at a remarkable pace, making dif- ferentiation from rival products difficult. To achieve sustainable growth, a company must integrate cutting-edge technologies, and generate technologies and products that contribute to the resolution of social issues such as energy, the environment, and health. Companies need to offer the world unprecedented new value. Daikin is deepening its collaborative creation across a broad range in the areas of energy, space, and the environment, in pur- suit of new value creation centered on air conditioning. Daikin’s diverse workforce, along with external researchers and engi- neers, shares dreams and ambitions, offers the world new value through the power of air, and resolves social issues. L Daikin’s Initiatives Expanding Filter Business Air pollution in emerging economies as a result of PM2.5 and the tightening of regulations related to air hygiene in the pharmaceutical and food industries are generating the need to improve atmospheric environments in indoor spaces worldwide. Daikin is responding to these needs by integrating air-condition- ing and filter technologies with its engineering capabilities to expand its filter business, in addition to air-conditioning business. It is said that a person spends more than 90% of the day indoors. The scale and type of the spaces our filter business cov- ers extend from offices and residential buildings to large-scale industrial facilities, such as power stations and steelworks, and are contributing to the enhancement of a diverse range of atmospheric environments. Responding to Increasingly Sophisticated Needs In addition to the development and selling of air-conditioning and filter products, Daikin utilizes its engineering capabilities that combine technologies with product systems while engaging in dialogue with customers, and thereby proposes optimum atmo- spheric environments that respond to the needs of its customers. In addition, Daikin is enhancing its total support framework, including maintenance. Going forward, Daikin will not only meet already visible needs, but also proactively respond to the increasingly sophisticated needs that contribute to health and pleasant experiences, such as the construction of “spaces to better focus in” and “relaxing spaces” for offices and residences, and will create new value. Upgrading and Expanding the Technology and Innovation Center (TIC) The TIC is the Daikin Group’s core facility for technological development, bringing together engineers from various fields. In order to accelerate the Group-wide sophistication of component technologies and development of differentiated products, we are upgrading and expanding the TIC’s framework as a global con- trol tower to enhance collaborations among development loca- tions around the world, as well as strengthening the functions of our global locations. The stimulation of open innovation is also one of the roles of the TIC, and it proactively promotes cooperation and partner- ships with companies, universities, and research institutions that possess unique technologies in varied industries and fields. Centered on the TIC, Daikin is moving beyond the boundaries of conventional air-conditioning technologies and will step even into physiology and psychology to conduct research on relation- ships between the air environment and human body, working to generate new lifestyle values. Implementing Open Innovation In October 2016, Daikin began joint research with NEC on creating atmospheres and spaces that increase intellectual productivity through the utilization of AI/IoT. In addition to such numerous collaborations with other companies, we are pushing forward comprehensive collaboration and research with universities and research institutions in Japan and abroad, with the TIC playing a central role. In 2016, within RIKEN (Institute of Physical and Chemical Research), we established the “RIKEN-DAIKIN Wellness Life Collaboration Program” and began research in the life sciences field, such as on the construction of anti-fatigue spaces. 25 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Developing Our Service Structure in Japan and Abroad The Daikin Contact Center accepts inquiries regarding repair requests, technical consultations, and purchasing information 24 hours a day, 365 days a year, from customers in Japan. Overseas, we have put in place an after-sales service structure based on the principle of “fast, reliable, and friendly” in order to respond to the variety of requests specific to each country or region. We are working to enhance customer satisfaction through such measures as establishing call centers and providing technical information online. Utilizing the Views of Our Customers In Japan, we regularly conduct customer surveys for each busi- ness in order to understand the level of customer satisfaction. In fiscal 2017, our air-conditioning business obtained an over- all satisfaction score of 4.13 out of a total 5.0 points, its highest score to date. We believe this is the result of our efforts to “put customers first” and training programs focused on speedy repairs, technical capabilities, and customer service skills. In addition, we share the views of our customers received by the Daikin Contact Center with our development division, con- tinually soliciting and analyzing feedback to utilize in the further enhancement of our products and services. Our Chemicals business was evaluated highly in fiscal 2017 in such areas as quality, delivery deadlines, technical service, and communication with customers. Responding to the “Fluorocarbon Emission Control Law” In April 2015, the Fluorocarbon Emission Control Law, designed to limit greenhouse-gas emissions, became effective. As a result, the owners of commercial-use air conditioners became obligated with various management responsibilities, such as inspections. Accordingly, Daikin is leveraging its expertise to list all the many air-conditioning units of its customers, including those of other manufacturers, and provide support on identifying which units the law applies to, as well as undertaking simple inspec- tions and periodic inspections on the units on behalf of our customers. In addition, since June 2016, we have been providing the industry’s first periodic inspection and repair warranty system, “Fluorocarbon Care,” which also covers the products of other manufacturers. Customer Satisfaction L Materiality of Customer Satisfaction Daikin is developing business in over 150 countries around the world. With consideration to the climate, culture, and regula- tions of each area, Daikin works to provide products and services that meet local needs. However, in order to satisfy customers, not only just providing products and services of superior perfor- mance and quality, but also exceeding the expectations of cus- tomers is important. In particular, we believe that anticipating problems that occur during the life cycle of a product, from pur- chase, use, replacement, to disposal, and appropriately resolving such problems as a specialist company, will lead to a high level of customer satisfaction. L Daikin’s Initiatives Working Out Global Quality Guidelines The Daikin Group has prescribed its basic stance on quality stan- dards across the Group companies as well as responsibilities and authorities for the efficient implementation of quality monitoring and corrective measures in its Global Quality Guarantee Rules. We have acquired ISO9001 certification at all production facili- ties, and thoroughly implement a management system for the maintenance of quality levels in all development, procurement, and production divisions. Furthermore, we are also working to enhance quality with the cooperation of our outsourcing part- ners. To assess the operating status of the quality management sys- tem, the Daikin Group conducts internal audits and operates a continual cycle of implementation, evaluation, and improve- ment. Each year, quality priority measures and targets for each busi- ness division based on the Group’s annual policy guidelines are set, establishing and implementing a quality program for the fiscal year. First “Service Olympics” Held The Daikin Group is increasing the number of its service engi- neers in countries and regions along with the expansion of the global market. Aiming to further enhance the services of these engineers, we held the first “Service Olympics” in November 2016. A total of 28 service engineers selected from 20 different countries undertook written and practical examinations and were evaluated on both. Through the Service Olympics, we could gain an understanding of the level of each country and region, give feedback to the participants on factors which decreased scores, and provide guidance on how to further raise their levels. 26 Human Resources L Importance of Initiatives Related to Human Resources Daikin has advanced with rapid globalization in the last 10 years, and the number of employees working overseas has increased substantially. In order to meet the expectations of its various stakeholders in the midst of this effort and to realize the strengths of the Daikin Group including the “Environment,” “New Value Creation,” and “Customer Satisfaction,” “human resources” have become of utmost importance as the team responsible for these activities. Daikin has positioned “People-Centered Management,” which emphasizes that the source of a company’s competitiveness is its people, at its very core, and gets its organizational strength by respecting individuality and value systems, and by drawing out the unlimited potential of individuals. L Daikin’s Initiatives Human Resource Development Policy One of the corporate philosophies of the Daikin Group is the idea that “the cumulative growth of all Group members serves as the foundation for the Group’s development.” In addition, based on the concept that “people grow through job experi- ence,” we have positioned OJT as the basis of human resource development and, including off-the-job training (Off JT), are working to enhance growth opportunities. In our “Overseas Base Practical Training,” which cultivates global human resources, young employees are dispatched to countries different from that of their birth, broadening their horizons through practical work experience and developing the future pillars of the global business. As of fiscal 2017, we have sent 221 employees from Japan abroad, and 15 employees from abroad to Japan. In the “Daikin Leadership Development Program,” we train executives who can play an active role on the front lines of global business operations. Contributing to the Development of Air-Conditioning Engineers in India Since 2000, Daikin India has held technical training not only for its service engineers but also for the service engineers of retail and service cooperation stores that handle the prod- ucts of other manufacturers. In fiscal 2017, a total of more than 20,000 people participated. The production of air conditioners that can withstand such rough environments as “frequent blackouts and voltage fluc- tuations” and “fugitive dust lodging in heat exchange equip- ment in India,” and the development of engineers regarding the installation, maintenance, and repair of such units are urgent tasks. We believe that contributing to resolving the local social challenge of lacking air-conditioning engineers both in quality and in quantity will lead to sustainable growth. Promotion of Local Personnel at Overseas Bases In conjunction with the globalization of the Daikin Group’s business, we are also advancing with efforts to globalize our management team, and are aggressively promoting local employees at overseas bases to executive and managerial positions. As of the end of fiscal 2017, local employees accounted for 52% of the presidents at our overseas bases and 50% of the directors. Furthermore, 15 of our 20 sales companies in Europe have local employees serving as presidents. Accelerating the Active Role of Women in Japan In Japan, Daikin is aiming to further the active role of women and is working toward a work environment that allows all employees to fully exhibit their capabilities regardless of gender. As a goal, by the end of fiscal 2021, we aim to have at least one female director of Daikin Industries, and to increase our per- centage of female managers to 10% (approximately 100 people) from the current level of 4.4% (47 people). We are also promot- ing the early cultivation of female managers and reforming the awareness of male managers and female employees. In addition, in order to prevent childbirth and child rearing becoming career breaks, we are enhancing our measures that support the early return from maternity leave. In fiscal 2017, we held a total of five “female employee devel- opment management training” sessions aimed at approximately 150 male managers and leaders with female subordinates. Daikin Industries has been recognized for its excellence in these efforts to promote women and, in August 2016, was certi- fied as a highest ranked “Eruboshi” company, accredited by the Minister of Health, Labour and Welfare. In addition, in March 2017, Daikin was selected by the Ministry of Economy, Trade and Industry (METI) and the Tokyo Stock Exchange as a “Nadeshiko Brand” (excellent company in promoting the advancement of women in the workplace) for the fourth time in three consecutive years. Acquired OHSAS18001 Certification In order to ensure operational and employee safety, the Daikin Group is independently creating occupational health and safety management systems (OHSAS) at each base worldwide, and is acquiring certification for international standards, such as OHSAS18001. As of the end of fiscal 2017, 3 manufacturing facilities in Japan and 24 companies overseas have received certification. We hold Groupwide joint safety and security meetings twice a year for the purpose of improving safety levels and sharing expertise. Every Daikin facility also carries out its own safety activities, such as education and safety patrols, aimed at achiev- ing zero workplace accidents. In 2016, the frequency rate of industrial accidents throughout the Group was 1.50, an improve- ment of 0.4 from 2015. 27 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 The Corporate Ethics and Risk Management Committee is chaired by the director in charge of corporate ethics and compli- ance, and is configured from the managers of each division and the presidents of each of the main Group companies in Japan. As a general rule, the committee meets twice a year to identify issues and promote their solutions, together with also receiving reports on the status of overseas Group companies. A Compliance Risk Management Leader (CRL), appointed in each division and for each of the main Group companies in Japan and overseas, promotes compliance based on the Group Code of Conduct, which sets forth the conduct of corporate officers and employees. In addition, regular CRL meetings are held to share information and ensure the Group Code of Conduct is adhered to, aiming to foster a “culture free of com- pliance violations” and to elevate “mechanisms to ensure that there are no compliance violations.” Enhancing Activities throughout the Group Daikin Industries also participates in the compliance committees of each region overseas. With the goal of mutually confirming situations in Japan and abroad as well as sharing information, efforts are made to enhance compliance and risk management activities throughout the Group. L Risk Management Promotion System With the rapid expansion of Daikin’s business, the overall picture of risks from a global perspective must be understood in an accurate and prompt manner, and alleviated. To achieve this, we have introduced a Groupwide risk management. First, each division and main Group company implement risk assessments to identify and select critical risks, and formulate the necessary countermeasures. In addition, each company identifies critical risks from the assessment results, and efforts are made to develop and implement risk-reducing countermeasures. For example, in fiscal 2017, Daikin Industries made efforts toward the key themes such as “Earthquake Risk,” “PL Quality Risk,” “Intellectual Property Risk,” “Information Leakage Risk,” “Overseas Crisis Management,” and “Risk of Improper Accounting.” CSR Management/Compliance Risk Management/Risk Management Promotion System L CSR Management The CSR of the Daikin Group is based on being thorough in its corporate ethics and compliance. Together with carrying out our responsibilities to society, we are working toward resolving social problems through our business activities. The CSR & Global Environment Center, a staff division, was established under the CSR Committee (chairman: director in charge of CSR), which sets the overall direction of CSR activities and monitors the execution of those activities, and promotes comprehensive and Groupwide CSR activities. In order to integrate management strategies with CSR, we identified materiality (important themes) in conjunction with the formulation of the “FUSION 20” strategic management plan (fiscal 2017-21). Surveying the value chain and taking into consideration changes in the external environment, such as expectations and requests from outside and the acceleration of business expansion, we divided materiality broadly into “value-providing CSR” and “fundamental CSR,” incorporating them into the “FUSION 20” plan. L Compliance Risk Management Thorough Compliance and Risk Management At the Daikin Group, the Internal Control Committee, chaired by the President, checks and confirms that internal controls, includ- ing risk management, are functioning properly Groupwide. In addition, the Corporate Ethics and Risk Management Committee promotes the management of individual operational risk and thorough compliance. Self-Inspection of Code of Conduct Compliance The Daikin Group has established its own “self-inspection” system in which each employee annually carries out a self- check on compliance with the Group Code of Conduct. Based on the results, organizational issues are identified and the necessary countermeasures are implemented. These issues and countermeasures are reported to and shared with the Corporate Ethics and Risk Management Committee. In addition to the self-inspection, compliance with the Group’s Code of Conduct and laws and ordinances is also confirmed in the Legal Department’s legality audit and the Audit Department’s operational audit. 28 Respect for Human Rights/ Supply Chain Management L Respect for Human Rights Based on the laws and ordinances of countries and regions around the world, the Daikin Group respects basic human rights in accordance with the various international norms. The Daikin Group participates in the United Nations Global Compact for supporting and putting into practice universally accepted principles relating to such matters as human rights and labor. Our Group Code of Conduct stipulates policies for respect- ing human rights, diverse values, and sense of work, and policies for no child labor or forced labor. In addition, upon specifying humans rights issues within the Group’s business, we evaluate the risk across the whole value chain and work to prioritize the identification of risks that need resolving. Respect for Human Rights in the Self-Inspection An item relating to respect for human rights was included as part of the self-inspection that is conducted each year from the viewpoint of compliance, and now the inspection includes con- firming that there are no human rights violations or other such problems. Such an item was also included in the Supply Chain CSR Promotion Guidelines, devised in April 2017, and we are also asking our suppliers to be thorough. In addition, Group companies overseas are also creating their own Corporate Ethics Handbooks based on the Group Code of Conduct, and are making efforts to ensure total respect for human rights in the workplace. The Daikin Group also participates in the activities of the Global Compact Network Japan, through which we learn from experts and cases at other companies regarding global human rights issues, and this helps us improve our own efforts in this area. Regular Human Rights Awareness and Education Daikin Industries conducts human rights education and aware- ness activities each year for all of its directors, new employees, including those of affiliates, and newly appointment managers. In addition, we also publish a series of human rights articles in the Company newsletter to raise awareness of human rights. At Daikin America, focus is centered on creating a workplace environment that respects coworkers, and all employees are pro- vided with opportunities to be educated in this area each year. L Supply Chain Management At the Daikin Group, we believe that our scope of social respon- sibility includes our entire global supply chain. In 1992, the Daikin Group established the Basic Procurement Guidelines. In addition to being thorough in green procurement and fair trade practices with our suppliers, we promote CSR activities from perspectives such as quality, human rights, and labor. Establishment of “Supply Chain CSR Promotion Guidelines” Among CSR activities in our supply chain, we are endeavoring in particular to understand CO2 emission levels and to properly control substances subject to international regulations, such as designated chemical substances and conflict minerals. In April 2017, we established and implemented the Supply Chain CSR Promotion Guidelines. These are guidelines for the promotion of CSR, aimed at stable continuation and growth of business. In addition to general compliance requirements, the said Guidelines cover the whole of CSR, such as environmental protection, respect for human rights, occupational health and safety, and prohibition of trade with conflict zones, and we are asking our suppliers to promote such efforts. Furthermore, we plan to evaluate such efforts with the cooperation of our suppliers. Growth and Development alongside Suppliers In order to provide products that satisfy the trust of our custom- ers, the cooperation of our suppliers is vital. Working hard to build strong relationships of trust with all suppliers, the Daikin Group endeavors to continue to meet our mutual expectations, and to build relationships in which we can both grow and develop. Daikin Group companies both in Japan and abroad periodical- ly conduct dialog at the production sites of our suppliers on quality audits and quality improvements, collaborating with our suppliers on quality improvement efforts through support for enhancing the required technological capabilities, etc. We also hold safety-related briefing sessions and support efforts to prevent work-related accidents before they occur. For example, McQuay China (Shenzhen) provided suppliers with quality control training in fiscal 2017, and 41 persons from 37 companies participated in the session. Through lectures by external instructors and discussions on quality control, we clari- fied the core points of the fiscal 2018 quality control activities. 29 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Stakeholder Engagement/Regional Society L Stakeholder Engagement The Daikin Group’s main stakeholders are the customers to whom we provide products and services, the shareholders and investors who have a direct impact on our business, our suppli- ers, our employees, and everyone in the regional societies that our business evolution affects. In addition, the spread of air-con- ditioning technologies and the enhancement of the environmen- tal friendliness of our products and services involve national and local governments and industry associations. The Daikin Group believes that it is important to understand the concerns and expectations of its stakeholders through proactive communica- tion and report such voices to management so that it can utilize them in our business. Continuing Exchange of Opinions with Experts Since 1995, the Daikin Group has held “air-conditioner forums” in Japan where it can exchange opinions relating to the “future of air conditioning” with experts in the field. In addition, in light of the rapid global development of our business, since fiscal 2008, we have also held forums in Europe, China, the United States, Asia/Oceania, and Central America/South America. Exchanging opinions with experts from each region about envi- ronmental and energy issues, we utilize that information in our technology as well as product and business development. In fiscal 2017, we held discussions in Asia/Oceania and Europe, regarding energy conservation and indoor air quality within buildings. Furthermore, in Central America/South America, we held the first exchange of opinions with govern- ment officials and university professors from various countries on “promotion of energy conservation environmental technology for a sustainable society,” introducing Daikin’s relevant technologies and efforts. Responsibility to Shareholders and Investors To live up to the expectations of shareholders and investors, the Daikin Group believes that it must increase its corporate value. It therefore emphasizes free cash flow as a source of corporate value and focuses on augmenting its profitability while lowering the levels of its trade receivables and inventories. Furthermore, Daikin works to stably maintain its consolidated ratio of dividends on equity (DOE) at 3.0%. In addition, to increase its management transparency toward shareholders and investors, Daikin is executing diverse kinds of IR activities. Furthermore, to enable shareholders to exercise voting rights easily at general shareholders’ meetings, Daikin provides share- holders with invitations to meetings early and produces English- language versions, as well as enabling shareholders to exercise their voting rights via personal computers and mobile phones. L Regional Society The Daikin Group is made up of 245 consolidated subsidiaries worldwide and is expanding business in over 150 countries. Premised on fulfilling our social responsibility of expanding regional employment and cooperating with local companies, our basic policy is to develop strong bonds with local communities as a member of the regional society operating a business while respecting the culture and history of each country and region. With our employees taking the initiative, we carry out social activities mainly in the areas of “environmental protection,” “supporting education,” and “living symbiotically with the local region” and are contributing to the resolution of social issues from a global perspective based on sustainable development goals (SDGs). Environmental Protection Forest and Biodiversity Preservation Daikin has been carrying out the “Forests for the Air” project for protecting forests in seven locations across the world in partner- ship with Conservation International, an international NGO, and the Shiretoko Nature Foundation. In the Shiretoko Peninsula, Indonesia, Brazil, Cambodia, India, China, and Liberia, we work with governments, NGOs, employees, and customers among others to provide support for the coexistence of the lifestyles of local residents and forest biodiversity, contributing to achieving SDGs. By 2024, we will preserve 11 million hectares of forests and inhibit seven million tons of CO2. In addition, we are also making efforts toward tree-planting activities, the conservation activities for nature such as seas and rivers, and biodiversity conservation in the vicinity of our production and sales locations around the world. Supporting Education Cooperating in the Education of Future Generations Since 2010, Daikin has offered a “Circle of Life” environmental education program for elementary school children centered on a theme of biodiversity. As well as providing elementary schools with educational materials, Daikin employees visit schools to teach lessons. In fiscal 2017, 27 schools participated (approxi- mately 2,000 students) in the program, and 15 schools were visited by our employees. In addition, since fiscal 2016, we have been cooperating in the “Mirai no Hakase” training laboratory, a scientist develop- ment program held by Osaka Prefecture University and aimed at junior high school students in Sakai City, Osaka Prefecture. Moreover, Daikin Group plants around the world are accept- ing tours from children and students, the future generations. 30 Symbiosis with Regional Societies Supporting the Regional Revitalization of Okinawa Since 1988, Daikin Industries has held the “Daikin Orchid Ladies Golf Tournament,” and, through sports, we are endeavoring to revitalize Okinawa and encourage economic interchange with the local area. In conjunction with this tournament, we solicit donations that we then present as an “Orchid Bounty” on an ongoing basis to individuals and organizations that promote such areas as the arts, culture, education, and sports in Okinawa. Holding “Bon Festival” in Japan and Abroad Daikin has deepened interchange with local residents through regional festivals and sports, building relationships of trust. As part of those efforts, the Bon Festival, which is planned and operated by Daikin employees, is a large event that attracts attention by numerous local residents. In addition to manufac- turing plants in Japan, the festival is also held at our main pro- duction bases in China, the United States, and other areas. Contributing to Local Communities around the World Employees from Daikin Group locations around the world are working toward contributing to society by meeting local needs, such as through volunteering activities. In fiscal 2017, for exam- ple, in China, we held a Christmas party at a welfare facility for people with disabilities, donating presents and putting on per- formances. In addition, in Europe, we sent financial aid and relief supplies, such as emergency air conditioners, to areas affected by the central Italy earthquakes. 31 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Eleven-Year Financial Highlights Daikin Industries, Ltd. and Consolidated Subsidiaries Years Ended March 31 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Millions of Yen Operating Results (for the year): Net sales Gross profit Selling, general and administrative expenses Research and development expenses (Note 1) Operating income EBITDA (Note 2) Net income attributable to owners of parent Cash Flows (for the year): Net cash provided by operating activities Net cash used in investing activities Free cash flow (Note 3) Net cash provided by (used in) financing activities Financial Position (at year-end): Total assets Total interest-bearing liabilities Total shareholders’ equity Per Share Data (yen): Net income (basic) Shareholders’ equity Free cash flow Cash dividends Ratios (%): Gross profit margin Operating income margin EBITDA margin Return on shareholders’ equity (ROE) Shareholders’ equity ratio ¥911,749 312,688 231,934 27,204 80,754 115,315 45,420 ¥ 83,725 (305,251) (221,526) ¥1,291,081 441,549 313,451 32,075 128,098 179,469 74,822 ¥1,202,420 363,660 302,266 30,535 61,394 118,325 21,755 ¥1,023,964 319,301 275,263 28,220 44,038 96,462 19,391 ¥103,329 (76,428) 26,902 ¥62,238 (99,302) (37,065) ¥129,227 (39,848) 89,379 245,975 3,367 48,382 (34,942) (37,623) (1,113) 143,520 (38,249) (83,073) (85,422) (73,544) ¥1,161,364 456,074 397,542 ¥1,210,094 356,928 545,641 ¥1,117,418 417,919 471,686 ¥1,139,656 399,313 496,179 ¥ 172.66 1,511.47 (842) 28.00 ¥ 262.24 1,867.79 94 38.00 ¥ 74.51 1,615.98 (127) 38.00 ¥ 66.44 1,701.29 306 32.00 34.30% 8.86 12.65 12.31 34.23 34.20% 9.92 13.90 15.87 45.09 30.24% 5.11 9.84 4.28 42.21 31.19% 4.30 9.42 4.01 43.54 ¥1,160,331 ¥1,218,701 ¥1,290,903 ¥1,787,679 ¥1,915,014 ¥2,043,691 ¥2,043,969 361,665 286,210 30,771 75,455 127,168 19,873 ¥78,411 (23,306) 55,105 371,902 290,709 32,987 81,193 131,719 41,172 ¥44,967 (62,955) (17,988) 388,046 299,419 33,569 88,627 140,151 43,585 568,323 411,786 40,177 156,537 235,439 92,787 649,902 459,314 42,892 190,588 268,354 119,675 711,576 493,704 46,138 217,872 302,075 136,987 730,935 500,166 53,870 230,769 315,798 153,939 ¥103,161 (218,386) (115,225) ¥179,713 ¥160,423 (80,835) 98,878 (77,331) 83,092 ¥226,186 (105,493) 120,693 ¥267,663 (128,823) 138,840 ¥1,132,507 ¥1,160,564 ¥1,735,836 ¥2,011,870 ¥2,263,990 ¥2,191,105 ¥2,356,149 372,481 487,876 389,891 502,309 705,871 618,118 693,944 801,854 662,413 1,024,725 608,981 1,014,409 609,430 1,111,636 ¥ 68.14 1,672.74 189 36.00 ¥ 141.37 1,725.64 (62) 36.00 ¥ 149.73 2,123.10 (396) 36.00 ¥ 318.33 2,748.08 339 50.00 ¥ 410.19 3,511.34 285 100.00 ¥ 469.23 3,473.54 413 120.00 ¥ 526.81 3,802.10 475 130.00 31.17% 30.52% 30.06% 31.79% 33.94% 34.82% 35.76% 6.50 10.96 4.04 43.08 6.66 10.81 8.30 43.28 6.87 10.86 7.78 35.61 8.76 13.17 13.07 39.86 9.95 14.01 13.10 45.26 10.66 14.78 13.44 46.30 11.29 15.45 14.48 47.18 Notes: 1. R&D expenses are included within general and administrative expenses and manufacturing expenses. 2. EBITDA = Operating income + depreciation and amortization. 3. Free cash flow = Net cash provided by operating activities + net cash used in investing activities. 4. Accompanying a change in accounting policy, effective from April 1, 2014, the consolidated financial statements for the fiscal year ending March 31, 2014 and subsequent years have been revised. Operating Income Net Income Attributable to Owners of Parent (¥ billion) 240 180 120 60 0 (¥ billion) 160 120 80 40 0 07 08 09 10 11 12 13 14 15 16 17 07 08 09 10 11 12 13 14 15 16 17 07 08 09 10 11 12 13 14 15 16 17 Net Sales (¥ billion) 2,000 1,500 1,000 500 0 32 Operating Results (for the year): Net sales Gross profit Selling, general and administrative expenses Research and development expenses (Note 1) Operating income EBITDA (Note 2) Net income attributable to owners of parent Cash Flows (for the year): Net cash provided by operating activities Net cash used in investing activities Free cash flow (Note 3) Net cash provided by (used in) financing activities Total assets Financial Position (at year-end): Total interest-bearing liabilities Total shareholders’ equity Per Share Data (yen): Net income (basic) Shareholders’ equity Free cash flow Cash dividends Ratios (%): Gross profit margin Operating income margin EBITDA margin Return on shareholders’ equity (ROE) Shareholders’ equity ratio ¥911,749 ¥1,291,081 ¥1,202,420 ¥1,023,964 312,688 231,934 27,204 80,754 115,315 45,420 441,549 313,451 32,075 128,098 179,469 74,822 ¥ 83,725 (305,251) (221,526) ¥103,329 (76,428) 26,902 363,660 302,266 30,535 61,394 118,325 21,755 ¥62,238 (99,302) (37,065) 319,301 275,263 28,220 44,038 96,462 19,391 ¥129,227 (39,848) 89,379 ¥1,161,364 ¥1,210,094 ¥1,117,418 ¥1,139,656 456,074 397,542 356,928 545,641 417,919 471,686 399,313 496,179 ¥ 172.66 1,511.47 (842) 28.00 ¥ 262.24 1,867.79 94 38.00 ¥ 74.51 1,615.98 (127) 38.00 ¥ 66.44 1,701.29 306 32.00 34.30% 34.20% 30.24% 31.19% 8.86 12.65 12.31 34.23 9.92 13.90 15.87 45.09 5.11 9.84 4.28 42.21 4.30 9.42 4.01 43.54 Notes: 1. R&D expenses are included within general and administrative expenses and manufacturing expenses. 2. EBITDA = Operating income + depreciation and amortization. 3. Free cash flow = Net cash provided by operating activities + net cash used in investing activities. 4. Accompanying a change in accounting policy, effective from April 1, 2014, the consolidated financial statements for the fiscal year ending March 31, 2014 and subsequent years have been revised. 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Millions of Yen ¥1,160,331 361,665 286,210 30,771 75,455 127,168 19,873 ¥1,218,701 371,902 290,709 32,987 81,193 131,719 41,172 ¥1,290,903 388,046 299,419 33,569 88,627 140,151 43,585 ¥1,787,679 568,323 411,786 40,177 156,537 235,439 92,787 ¥1,915,014 649,902 459,314 42,892 190,588 268,354 119,675 ¥2,043,691 711,576 493,704 46,138 217,872 302,075 136,987 ¥2,043,969 730,935 500,166 53,870 230,769 315,798 153,939 ¥78,411 (23,306) 55,105 ¥44,967 (62,955) (17,988) ¥103,161 (218,386) (115,225) ¥179,713 (80,835) 98,878 ¥160,423 (77,331) 83,092 ¥226,186 (105,493) 120,693 ¥267,663 (128,823) 138,840 245,975 3,367 48,382 (34,942) (37,623) (1,113) 143,520 (38,249) (83,073) (85,422) (73,544) ¥1,132,507 372,481 487,876 ¥1,160,564 389,891 502,309 ¥1,735,836 705,871 618,118 ¥2,011,870 693,944 801,854 ¥2,263,990 662,413 1,024,725 ¥2,191,105 608,981 1,014,409 ¥2,356,149 609,430 1,111,636 ¥ 68.14 1,672.74 189 36.00 ¥ 141.37 1,725.64 (62) 36.00 ¥ 149.73 2,123.10 (396) 36.00 ¥ 318.33 2,748.08 339 50.00 ¥ 410.19 3,511.34 285 100.00 ¥ 469.23 3,473.54 413 120.00 ¥ 526.81 3,802.10 475 130.00 31.17% 6.50 10.96 4.04 43.08 30.52% 6.66 10.81 8.30 43.28 30.06% 6.87 10.86 7.78 35.61 31.79% 8.76 13.17 13.07 39.86 33.94% 9.95 14.01 13.10 45.26 34.82% 10.66 14.78 13.44 46.30 35.76% 11.29 15.45 14.48 47.18 Research and Development Expenses Shareholders’ Equity Total Assets (¥ billion) 60 50 40 30 20 10 0 (¥ billion) 1,200 900 600 300 0 (¥ billion) 2,500 2,000 1,500 1,000 500 0 07 08 09 10 11 12 13 14 15 16 17 07 08 09 10 11 12 13 14 15 16 17 07 08 09 10 11 12 13 14 15 16 17 33 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Financial Review Summary of the Period Japan The global economy slowed down overall during fiscal 2017, as recoveries In the Japanese commercial air-conditioning equipment market, industry varied from country to country and region to region. In the United States, demand rose year on year, pushed upward by the impact of the heat wave in robust personal consumption drove the economy, while in Japan the econo- western Japan and the government’s subsidy system for replacement to my showed a moderate recovery trend, backed by improvement in corporate high-performance, energy-saving equipment. The Daikin Group captured earnings and a recovery in exports. Meanwhile, the Chinese economy slowed demand for air conditioners for stores and offices, especially those of “FIVE moderately, while highly resource-dependent emerging economies continued STAR ZEAS” and “Eco-ZEAS” models, and net sales increased year on year. to experience stagnation. In addition, with the rapid strengthening of the yen In the Japanese residential air-conditioning equipment market, industry in the first half of fiscal 2017, currency exchange rates were highly volatile. demand increased year on year due to robust demand that began in the first Amid this environment, the Daikin Group’s consolidated net sales half from the impact of the heat wave in western Japan and continued into slightly increased compared to the previous fiscal year to ¥2,044.0 billion, the third quarter onward. The Daikin Group utilized the brand power of its due to strong sales in the air-conditioning business in each region, while the room air conditioner Urusara 7, an energy-saving, high-value-added product, yen appreciated against other currencies, including the Chinese yuan, U.S. in an effort to expand sales for all models of residential air conditioners, and dollar, and euro, which had a negative impact, such as a decrease in the net sales exceeded that of the previous fiscal year. yen-equivalent. As for profits, sales volume increased in each region and gross margin rates improved through cost reductions, despite a factor of Europe (Including Turkey, the Middle East, and Africa) profit decline due to conversion to the yen-equivalent. As a result, consoli- In Europe, while sales were strong, net sales after converting to the dated operating income increased by 5.9%, to ¥230.8 billion, and net yen-equivalent remained flat year on year in the region as a whole. Net sales income attributable to the owners of the parent company increased by of residential air-conditioning systems increased year on year in the local cur- 12.4%, to ¥153.9 billion. rency, owing to the increased demand stemming from the heat wave in 2015, which remained strong. Commercial air-conditioning equipment sales Performance by Business Segment were also strong because of the capturing of demand for the renewal and • Air-Conditioning and Refrigeration Equipment replacement of existing air-conditioning systems in main countries, although Total sales of the Air-Conditioning and Refrigeration Equipment segment the European economy remained sluggish. Despite stagnant demand in increased to ¥1,835.4 billion, up 0.4% from the previous fiscal year. France, which is a major market, net sales of heat pump hot water heating Operating income increased 7.7%, to ¥208.8 billion. systems grew in Europe overall in the local currency from the previous fiscal year due to significant sales growth in Italy and other countries. Domestic and Overseas Sales Operating Income and Operating Income Margin Net Income Attributable to Owners of Parent (¥ billion) 2,400 1,800 1,200 600 0 0 (¥ billion) 240 180 120 60 0 (%) 12 (¥ billion) 160 9 6 3 0 120 80 40 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Domestic Overseas sales Operating income Operating income margin 34 In emerging economy markets, while sales in the Middle East and Africa conditioners that offer enhanced product appeal, including energy-saving were strong, net sales after converting to the yen-equivalent decreased year performance; enhancing advertising and ‘spec-in’ for architectural firms; and on year in the region as a whole. Net sales increased year on year in the broadening the range of the target markets to extend from new construction local currency, thanks to efforts to boost orders for private-sector projects to replacement. In the large-building (Applied Systems) air-conditioning amid a series of temporary suspensions or delays, particularly for large-scale equipment market, the Group expanded sales by carrying out sales activities government projects, due to prolonged stagnation of crude oil prices and in a wide range of projects, from large to small- to medium-scale, based on growing geopolitical risks. In Turkey, net sales increased year on year in the an enhanced product lineup and reinforced after-sales service business. local currency, as a result of boosting orders for small to medium-scale com- mercial projects and strengthening sales of residential air-conditioning sys- Asia/Oceania Region tems. This was despite a series of delays in delivery, mainly for large-scale In Asia and Oceania, net sales after converting to the yen-equivalent projects and others, and amid the continuing political unrest that followed remained flat year on year in the region as a whole. Nevertheless, net sales the attempted coup détat in July. in the local currency increased considerably year on year thanks to efforts China such as dealer development, expanded sales of differentiated energy-saving products that met local needs, and the reinforcement of the service structure, In China, while economic growth has been slowing down, the Group intensi- which led to the capturing of demand among the growing middle class. In fied its retail sales to capture firm personal consumption. Net sales in the the residential air-conditioning systems, sales of inverter-type, cooling-only local currency rose year on year in all regions and for all products. Although air conditioners with exceptional energy-saving performance were strong, net sales after converting to the yen-equivalent fell slightly year on year due and sales grew particularly in Thailand, Vietnam, Indonesia, and India. Sales to the depreciation of the Chinese yuan, operating income increased year on of multi-split type room air conditioners for buildings grew due to enhanced year owing to cost reductions promoted in the production division. In the ‘spec-in’ activities and greater focus on dealer development. residential-use market, the Group focused on its own specialty “PROSHOPs” and leveraged its proposal and installation capabilities, which are its Americas Region strengths, to expand sales mainly in the mid-range and high-end residential In the Americas, net sales increased year on year in the region as a whole market with the “New Life Multi Series,” residential multi-split type room air due to strong sales. Net sales of residential air-conditioning systems rose conditioners that propose a variety of lifestyles for customers. In the commer- year on year as a result of favorable weather in the first half and efforts to cial-use market, the Group expanded sales by carrying out model changes to expand the sales network. For light commercial equipment (commercial the mainstay “VRV-X” series, commercial multi-split type room air air-conditioning equipment for medium-sized buildings), Daikin has pushed Selling, General and Administrative Expenses (¥ billion) 500 400 300 200 100 0 0 Sales by Segment Segment Profit (¥ billion) 2,400 1,800 1,200 600 0 0 (¥ billion) 240 180 120 60 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Air conditioning Chemicals Other Air conditioning Chemicals Other 35 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 forward with sales policies by routes, and sales were above the previous • Other Operations fiscal year. In the market for Applied Systems, backed by a higher level of Overall sales of the “Others” segment fell by 2.9% year on year, to ¥51.8 demand than in the previous fiscal year, net sales grew year on year thanks billion. Operating income increased by 6.3% year on year, to ¥3.8 billion. to sales of Applied Systems, mainly rooftops equipped with inverters, in addi- Sales of oil hydraulic equipment for industrial machinery fell year on year tion to growth in the after-sales service business. due to the impact of stagnant demand in the Japanese market. • Chemicals Sales of oil hydraulic equipment for construction machinery and vehicles remained flat against the previous fiscal year due to the impact of produc- Overall sales of the Chemicals segment decreased by 3.4%, to ¥156.8 bil- tion volume adjustments by Chinese agricultural machinery manufacturers, lion, and operating income decreased by 11.2% year on year, to ¥18.3 bil- despite robust sales to key customers in Japan and the United States. lion. In the specialized machinery businesses, sales of home oxygen equipment Demand for fluoropolymers was robust for semiconductor-related applica- were strong, while sales of ammunition to Japan’s Ministry of Defense tions in Japan and elsewhere in Asia. However, overall sales of fluoropoly- decreased, resulting in a decline in net sales compared to the previous fiscal mers fell year on year. This was due to foreign exchange rate impact, price year. competition in the U.S. market from rival companies and products made in In the electronics system business, net sales were on a par with the China, and intensified competition in the LAN cable market. previous fiscal year, as sales especially of database systems for design Fluoroelastomers were affected significantly by foreign exchanges, and and development sectors expanded. sales fell year on year, despite robust demand in automotive fields in each region around the world. Currency Exchange Rates Sales of specialty chemicals were down, compared with the previous fiscal During the fiscal year, the yen appreciated against the U.S. dollar and the year. Net sales of oil and water repellents fell significantly year on year due euro. The average exchange rates for the yen were ¥108 to one U.S. dollar to delays in switchovers to new products as well as the impact of foreign and ¥119 to one euro. The impact of exchange rate fluctuations on Company exchange, among other factors. Sales of anti-fouling surface coating agents sales was minus ¥193.6 billion, and the effect on operating income was used in devices, such as touch panels, increased year on year, supported by minus ¥37.0 billion. strong demand in China. Sales of etchant for cleaning semiconductors increased year on year due to sales growth in Japan and elsewhere in Asia where related demand was favorable. As for fluorocarbon gas, overall sales of gas increased substantially year on year as a result of growth in sales for after-sales service in the Americas. Yen-U.S. dollar rate Yen-euro rate Fiscal 2016 Fiscal 2017 ¥120 ¥133 ¥108 ¥119 Cash Dividends per Share Total Assets Working Capital and Current Ratio (¥ billion) 2,400 1,800 1,200 600 0 0 (¥ billion) 600 400 200 0 (%) 240 160 80 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Working capital Current ratio (¥) 140 120 100 80 60 40 20 0 36 SG&A Expenses and Operating Income owners of the parent company and other factors. As a result, the sharehold- Selling, general and administrative expenses rose 1.3%, to ¥500.2 billion, ers’ equity ratio increased to 47.2%, from 46.3% at the end of the previous because of an increase in R&D expenses, and rose to 24.5% of net sales. fiscal year, and net assets per share increased to ¥3,802.10, from ¥3,473.54 Consolidated operating income rose 5.9%, to ¥230.8 billion, and the at the end of the previous fiscal year. operating income ratio increased 0.6 percentage point, to 11.3%. Cash Flows Assets, Liabilities, and Total Equity During the fiscal year under review, net cash provided by operating activities • Assets was ¥267.7 billion, an increase of ¥41.5 billion from the previous fiscal year, At the end of fiscal 2017, consolidated total assets amounted to ¥2,356.1 principally due to an increase in income before income taxes and a decrease billion, up ¥165.0 billion from the previous fiscal year-end. Current assets in income taxes paid. Net cash used in investing activities was ¥128.8 bil- were up ¥93.1 billion from the previous year-end, to ¥1,159.9 billion, lion, an increase of ¥23.3 billion from the previous fiscal year, primarily due because of an increase in cash and deposits. Noncurrent assets increased by to an increase in payment for acquisition of consolidated subsidiaries. Net ¥71.9 billion from the previous fiscal year-end, to ¥1,196.3 billion, due to an cash used in financing activities was ¥73.5 billion, a decrease of ¥11.9 bil- increase in buildings and structures, as well as other factors. lion from the previous fiscal year, mainly due to an increase in proceeds from long-term loans payable. After including the effect of foreign exchange rate • Assets, Liabilities, and Total Equity change to these results, cash and cash equivalents at the end of the fiscal Consolidated total liabilities increased by ¥66.9 billion from the end of the year under review amounted to ¥344.1 billion, an increase of ¥52.9 billion previous fiscal year and amounted to ¥1,220.5 billion at the end of fiscal from the previous fiscal year. 2017 because of an increase in notes and accounts payable and other factors. Capital Investment In addition, interest-bearing debt increased by ¥0.4 billion mainly due to Concentrating management assets in business fields that offer high profit- an increase in short-term loans payable and amounted to ¥609.4 billion at ability is the Daikin Group’s fundamental strategy. fiscal year-end. The interest-bearing debt ratio (interest-bearing debt divided In fiscal 2017, the Group made total capital investment of ¥90.3 billion, by total assets) decreased to 25.9%, compared with 27.8% at the end of largely in the air-conditioning/refrigeration equipment and chemicals busi- the previous fiscal year, as a result of an increase in total assets due to an ness fields. increase in cash and deposits. In the air-conditioning and refrigeration equipment field, Daikin invested Net assets increased by ¥98.1 billion from the previous fiscal year-end, to ¥9.1 billion, centered on the research and development and rationalization ¥1,135.6 billion, because of the recording of net income attributable to of room air conditioners and package air conditioners. At Goodman Global Total Share holders’ Equity and Shareholders’ Equity Ratio Free Cash Flow Capital Investment and Depreciation and Amortization (¥ billion) 1,200 900 600 300 0 (%) 48 36 24 12 0 (¥ billion) 150 100 50 0 -50 -100 -150 (¥ billion) 120 90 60 30 0 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Shareholders’ equity Shareholders’ equity ratio Capital investment Depreciation and amortization (excluding amortization of goodwill) 37 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Group, Inc., investments of ¥31.3 billion were made primarily to increase high-function materials and materials suitable for an environmentally friendly capacity. society. Furthermore, the Group is also enhancing the development functions In the chemicals field, the Group invested ¥7.4 billion, primarily to of its global locations, including in Europe and China, utilizing new technolo- increase capacity and for rationalization objectives. In addition, Daikin gies created by the Japanese domestic research and development depart- Fluorochemicals (China) Co., Ltd., made ¥2.5 billion in investments for ment in the development of products that suit local needs. Through these increasing capacity. efforts, Daikin will endeavor to substantially increase the efficiency and The main sources of funds for these investments were bank borrowings speed of research and development to produce differentiated products and retained earnings. Note that the Daikin Group did not make any major around the world. disacquisitions of equipment or facilities during the fiscal year under review. In fiscal 2017, R&D expenses included in cost of goods sold and SG&A expenses amounted to ¥53.9 billion. R&D Expenses In response to an increase in worldwide concern regarding global warming • Air-Conditioning and Refrigeration Equipment and energy issues, the Group is engaged in leading-edge research and devel- R&D expenses for air-conditioning and refrigeration equipment operations opment programs designed to proactively contribute to the resolution of totaled ¥45.9 billion. global environmental issues, while also expanding the Group’s business The wall-mounted-type Urusara 7, which is for residential use, demon- operations. In 2015, the Group established its Technology and Innovation strates its pleasant airflow control, which prevents direct flows to the people Center (TIC), which is the core facility for the technology and product devel- in the room (for cooling: circulation airflow; for heating: vertical direct airflow), opment of the Group. This center is designed to conduct research and devel- and has been well received. In addition to the above conventional features, opment on cutting-edge technologies and basic technologies and also to when cooling, whole room temperature irregularities have now been quickly develop and provide customers with new value-added and differentiated resolved without direct flows to people by employing a combination of the products by combining not only expertise within the Group but also the circulation and vertical direct airflows. With this airflow control and Daikin’s world’s wisdom, including that of industries, academia, and the government. original waterless humidifier system technology and cooling dehumidifying In addition to heat-pump and inverter technologies for air conditioning, the control that further enhance pleasant air-conditioning experiences, we have TIC has integrated energy-saving solutions business research centered on the created spaces enveloped in comfort. development and air conditioning of air-conditioning control systems, utiliz- In addition, we launched the UX Series, a wall-mounted indoor unit multi- ing green architecture/renewable energy areas, new product development in ple air-conditioning system for residential use. An industrial designer and processing material areas, and cutting-edge IT. The TIC has also gathered Daikin Europe employed a design that blends easily into walls and a curved together development on new applications for fluoride and development on front panel based on the concept of “harmony with the interior,” due to the ROE (%) 16 12 8 4 0 ROA (%) 8 6 4 2 0 Research and Development Expenses (¥ billion) 60 50 40 30 20 10 0 38 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 growing awareness over residential interior design. Furthermore, by connect- fluoride-based substances. Daikin is developing water and oil repellent tex- ing the UX Series and hydronic floor heating to multiple air-conditioning sys- tiles treatment materials as well as carpet treatment materials. Daikin is also tems, we have realized energy conservation and pleasant air-conditioning developing materials for LCD-related applications that draw on the function- experiences through interlocking control, in addition to design. As a result, ality of fluorocompounds, and has received an order for a project to develop Daikin was awarded the Energy Conservation Grand Prize for fiscal 2015 by intermediate materials for medical use. In these and a wide range of other the Energy Conservation Center, Japan. areas, Daikin engages in fluoride-related R&D. In the commercial-use air-conditioner business, we launched the VRV X In addition to the development of materials, as part of R&D in peripheral series, a multiple air-conditioning system for office buildings. Through review- areas to develop technologies and applications, Daikin is working on the ing the coolant circuit and enhancing running efficiency during low-load development of film process products, multilayered materials, and advanced operating periods, we have substantially reduced annual electric power costs. materials research related to the medical, optical, and environmental areas, In addition, for ceiling cassette type indoor units, we have employed the fun- probing the depths of fluoro-related research and applications. Especially in damentally reviewed “active circulation airflow” to realize warm and pleas- the energy field, Daikin is concentrating on developing such products as ant heating from the feet up. Furthermore, responding to the needs for the electrolyte solutions, additives, positive electrode binders, gaskets, and other simple adoption of air-conditioning systems that lack airflows, such as radi- components needed to increase the capacity and safety of lithium ion ant air-conditioning and built-in floor heating systems, we have added a secondary batteries. chilled water producing “chilled water unit” to our product lineup. In the refrigerant field, we accelerated R&D related to next-generation For applied equipment, in North America, in addition to cost reductions, refrigerants to cope with environmental regulations and developed the new we launched next-generation magnetic bearing turbo refrigerator equipment refrigerant R407H for freezers and refrigerators. R407H is a non-ozone that also conforms to the high requirements for lifts. In addition, we demon- depleting and non-flammable refrigerant and has approximately 62% lower strated an industry-leading level of full-load performance for high-efficiency global warming potential (GWP) than the commonly used R404A refrigerant. two-stage turbo refrigerator equipment with refrigeration capacities of Going forward, we will continue to engage in the development of even lower 1,500RT. In China, we developed module and turbo refrigeration equipment GWP refrigerants. To accelerate and promote R&D in these areas, the to meet the expected demand for the renewal and replacement of existing Chemicals Division is responsible for ensuring the implementation of new equipment. product development, and the TIC is exploring the next generation of themes Responding to environmental needs, we launched DC inverter cooling that will lead to the Chemicals business. dedicated chillers, high-efficiency air-cooled magnetic bearing chillers, and ultrahigh-efficiency heat-pump chillers. In Europe, we developed our inverter • Other Operations screw chillers, which demonstrate an industry-leading level of efficiency, and, R&D expenses for Other operations totaled ¥1.8 billion. for secondary side products, we progressed with simple selection and the In oil hydraulics, Daikin is commercializing a large-capacity series of prod- development of overwhelmingly highly efficient products, launching an ucts and developing new applications by leveraging the special characteris- air-handling unit aimed at hospitals and the hygiene market. tics of its hybrid oil hydraulic system technology that combines oil hydraulic For air-handling units, we developed a ceiling-embedded type to meet the technology and inverter technology to realize energy conservation and high needs for distributed ventilation. functionality that could not be attained with previously existing hydraulic • Chemicals systems. In the industrial press business, Daikin’s “Super Unit” has won high acclaim for its low electric power consumption and resulting energy conser- R&D expenses for Chemicals operations totaled ¥6.2 billion. vation. It also features low noise and lower heat emissions, and it contrib- Daikin conducts R&D for new products and new applications based on utes to the work environment through the use of a reduced-size oil tank, and rich experience in fluorine products and fluorochemical technology. In fluoro- reduces the burden on the environment. In addition, Daikin has launched a polymer resins and fluororubbers, using fluorochemicals’ good properties in large-scale extruder system that equals electric power as a motive force for heat resistance, low drug reactivity, and dielectric properties, Daikin is devel- its responsiveness and energy conservation. This system can handle multiple oping new differentiated products for automotive, semiconductor, wire and voltages and has other features needed in Asia and other regions where cable (IT field), and other applications. In coating materials development, adaptation to local conditions is needed. Daikin will expand this system’s Daikin makes use of the non-adhesive and chemical resistance properties of lineup, and it is being adopted in many locations where presses and other 39 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 machines are needed. Daikin is adapting its products to additional uses Amid this business environment, for this year (2017), we set “Integrate globally and will move forward with sales expansion. new power with our solid foundation to enhance our corporate value” as the Also, Daikin is proceeding with the development of an energy conserva- Group’s New Year’s slogan with the aim of generating results amid the tion system for use on special vehicles. One of these units, a hydraulic hybrid uncertain outlook in the global situation. We will refine our efforts to system for use on vehicles, has already been adopted. In addition to conven- strengthen our sales and marketing capabilities, improve product develop- tional hydraulic systems, Daikin is proceeding with the development of ment, production, procurement, and quality capabilities, and enhance our advanced environmentally responsive products that go beyond the existing human resources capabilities, which we have continued to implement, and frameworks and will find applications globally. further promote initiatives aimed at greater growth. In defense systems, Daikin conducts R&D related to artillery shell and We should work toward reinforcing our production system, global guided missile components mainly for Japan’s Ministry of Defense. research and development framework, and securing new technologies by making investments after ascertaining areas of common ground between Dividend Policy and Dividends Applicable to the Fiscal Year pursuing medium- to long-term growth under “FUSION 20,” the Group’s Daikin continues to make strategic investments and expand its business, strategic management plan, and securing short-term profit. while also proceeding with such structural reforms as those to promote com- For the fiscal year ending March 31, 2018, we forecast a 7.1% increase in prehensive cost reductions and strengthen its financial position. The aim of consolidated net sales, to ¥2,190 billion, with operating income rising 5.3%, these initiatives is to become a truly global excellent company and, at the to ¥243.0 billion, and net income attributable to owners of the parent com- same time, substantially augment corporate value. pany increasing 3.9%, to ¥160.0 billion. The estimated exchange rate for the Specifically, in accordance with its fundamental goal of providing a stable fiscal year ending March 31, 2018, is based on the assumption that US$1 and continuous return to shareholders, Daikin is striving to keep its consoli- equals ¥108 and 1 euro equals ¥118. dated ratio of dividends on equity (DOE) at levels of 3% or above while also seeking to increase its consolidated dividend payout ratio and thereby Principal Risks Associated further expand shareholder returns. with the Daikin Group’s Operations Internal reserves will be applied to strengthen the Daikin Group’s business Sharp changes in politico-economic conditions and financial position to accelerate the development of global businesses, or supply-demand relationships in principal markets further the development of environment-friendly products, and make strate- The Group develops, manufactures, sells, and procures goods and services gic investments to expand business activities and strengthen competitive- throughout the world, and there is a possibility that Group performance ness. could be impacted due to changes in the business environment in the mar- For the fiscal year ended March 31, 2017, Daikin increased its total cash kets or regions in which the Group operates, such as political or economic dividend by ¥10 per share, to ¥130 per share (comprising an interim divi- trends, the introduction of more-stringent environmental regulations, dend of ¥60 per share and a year-end dividend of ¥70 per share). For the increased competition from competitors, or sudden rises in the cost of raw current fiscal year ending March 31, 2018, the Company plans to distribute materials. In addition, Daikin is attempting to further expand its manufactur- a total annual dividend of ¥130 per share (comprising an interim dividend of ing and sales network and enhance Groupwide profitability through invest- ¥65 per share and a year-end dividend of ¥65 per share). ment such as the acquiring of air-conditioning equipment dealers or Outlook for Fiscal 2018 companies, such as the Goodman Global Group, Inc. (completed in 2012), and the establishment of manufacturing facilities. However, there is a possi- While the global economy is expected to steadily expand going forward, bility that the Group’s performance could be impacted, depending on the against the backdrop of the economic recovery in the United States and state of progress of such activities. robust Chinese, Indian, and ASEAN economies, the outlook is also uncertain due to factors such as political risks in the United States and Europe and geopolitical risks in the Middle East and Asia. 40 Cold summer weather and other unusual weather patterns innovations related to quality, costs, and product development speed. The accompanied by changes in demand for air conditioners Group also has purchased liability insurance to cover unexpected quality- Air-conditioning and refrigeration operations accounted for 89.8% of the related claims, but, in the case that a major quality claim situation were Daikin Group’s consolidated net sales in fiscal 2017. Therefore, the Group to occur, there is a possibility that it could have an impact on the Group’s strives to accurately monitor weather information and weather-related performance. demand trends in the world’s principal markets. It also employs flexible man- ufacturing methods and marketing policies designed to minimize the impact Major problems in manufacturing of those demand trends on its performance. However, depending on the The Group strives to implement thorough preventative maintenance mea- magnitude of demand changes resulting from cold summer weather or other sures at all its production facilities, regardless of whether they are in Japan unusual weather patterns, there is a possibility that the Group’s performance or overseas. In addition, particularly with respect to the Chemicals business, could be impacted. the Group is working to strengthen its facility safety audits, security manage- ment systems, and other related systems. Moreover, with respect to manufac- Large fluctuations in currency exchange rates turing problems, the Group has purchased insurance to cover facility damage Overseas sales accounted for 74.6% of the Daikin Group’s consolidated net and foregone earnings, but, in the case that a major problem were to occur sales in fiscal 2017. The acceleration of global business development going in manufacturing operations, there is a possibility that it could have an forward is expected to further elevate this overseas sales ratio. Consolidated impact on the Group’s performance. financial statements are prepared by translating local currency-denominated items for Group operations in each global region, including sales, expenses, Major changes in the market prices of securities and assets. Accordingly, depending on currency exchange rates at the time of and other assets the currency translation, there may be an impact on yen translation values The Group’s holdings of securities are primarily holdings designed to even when there has been no change in local currency-denominated figures. strengthen collaborative business expansion measures in cooperation with In addition, because the Group engages in foreign currency-denominated business partners and to strengthen relationships with business partners. transactions in raw materials and component procurement and in the sale of However, in the case of large fluctuations in securities markets, bankruptcies goods and services, there is a possibility that changes in currency exchange of business partners, and similar situations, there is a possibility that it could rates could impact manufacturing costs and sales performance. To avoid such have an impact on the Group’s performance. currency exchange rate-related risks, the Group undertakes short-term risk hedging via forward exchange contracts and similar instruments. Daikin Impairment of long-lived assets also undertakes medium- to long-term measures to continuously adjust In connection with its business assets, goodwill generated on the occasion procurement and manufacturing operations and optimize them for changing of corporate acquisitions, and similar items, the Group records various types currency exchange-rate trends, and to balance imports and exports in each of tangible and intangible long-lived assets. With respect to these assets, in currency. Through this, the Group works to realize a business structure that cases going forward when such factors as performance trends and market is not greatly impacted by changes in currency exchange rates. However, price drops prevent the generation of expected cash flows, there may be currency exchange rate-related risks cannot be completely avoided. cases in which the assets in question may require impairment treatment. In the case of such impairment of long-lived assets, there is a possibility Major product quality claims that it could have an impact on the Group’s performance. The Group strives to ensure thorough quality management for all its prod- ucts, regardless of whether they are manufactured in Japan or overseas. With Natural disasters respect to new product development, all four related elements—design, In the case that such natural disasters as major earthquakes and typhoons production technology, and purchasing units and suppliers—work in an occur and exert an impact on the Group’s manufacturing, marketing, and integrated manner to concurrently move ahead with the collaborative distribution bases, there is a possibility that it could have an impact on the development of process innovation measures, aiming to implement Group’s performance. 41 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017Consolidated Balance Sheet Daikin Industries, Ltd. and Consolidated Subsidiaries March 31, 2017 ASSETS Current assets: Cash and cash equivalents (Notes 9 and 17) Trade receivables (Notes 8, 9 and 17): Notes Accounts Allowance for doubtful receivables Inventories (Note 3) Deferred tax assets (Note 13) Prepaid expenses and other current assets Total current assets Property, plant and equipment: Land Buildings and structures Machinery and equipment Furniture and fixtures Lease assets (Note 16) Construction in progress Total Accumulated depreciation Net property, plant and equipment Investments and other assets: Investment securities (Notes 6, 9 and 17) Investments in and advances to unconsolidated subsidiaries and associated companies Goodwill (Note 7) Customer relationships Other intangible assets Deferred tax assets (Note 13) Assets for retirement benefits (Note 10) Other assets Total investments and other assets Total See notes to consolidated financial statements. 42 Millions of Yen 2017 2016 ¥ 344,094 ¥ 291,206 51,154 317,907 (8,216) 358,303 35,786 60,857 50,730 304,917 (6,279) 333,652 33,987 58,556 1,159,885 1,066,769 37,589 335,654 515,027 167,119 4,610 29,592 36,364 280,346 495,660 163,060 5,692 50,132 1,089,591 1,031,254 (665,064) 424,527 (646,154) 385,100 179,206 20,260 330,876 135,774 70,314 5,048 13,034 17,225 170,487 19,100 329,753 124,672 64,436 3,475 11,540 15,773 771,737 739,236 ¥2,356,149 ¥2,191,105 LIABILITIES AND EQUITY Current liabilities: Short-term borrowings (Notes 9 and 17) Current portion of long-term debt (Notes 9 and 17) Current portion of long-term lease obligations (Note 16) Trade payables (Note 17): Notes Accounts Income taxes payable (Note 17) Deferred tax liabilities (Note 13) Provision for product warranties Accrued expenses (Note 8) Other current liabilities (Note 8) Total current liabilities Long-term liabilities: Long-term debt (Notes 9 and 17) Long-term lease obligations (Note 16) Liabilities for retirement benefits (Note 10) Deferred tax liabilities (Note 13) Other long-term liabilities Total long-term liabilities Commitments and contingent liabilities (Notes 16 and 18) Equity (Notes 11, 12 and 22): Common stock—authorized, 500,000,000 shares; issued 293,113,973 shares in 2017 and 2016 Capital surplus Stock acquisition rights Retained earnings Treasury stock, at cost: 739,660 shares in 2017 and 1,075,356 shares in 2016 Accumulated other comprehensive income (loss): Unrealized gain on available-for-sale securities Deferred loss on derivatives under hedge accounting Foreign currency translation adjustments Remeasurements of defined benefit plans Subtotal Noncontrolling interests Total equity Total Millions of Yen 2017 2016 ¥ 57,699 ¥ 54,675 77,178 1,798 8,971 164,176 27,770 23,769 49,751 108,279 107,286 626,677 72,941 1,943 7,959 148,079 11,511 24,581 46,567 98,801 96,670 563,727 463,292 477,492 9,463 11,940 87,994 21,174 1,930 10,982 78,029 21,475 593,863 589,908 85,032 84,545 1,080 837,968 (3,160) 53,042 (120) 61,037 (6,708) 85,032 83,585 1,119 720,548 (4,598) 46,320 (2,124) 93,798 (8,152) 1,112,716 1,015,528 22,893 21,942 1,135,609 1,037,470 ¥2,356,149 ¥2,191,105 43 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Consolidated Statement of Income Daikin Industries, Ltd. and Consolidated Subsidiaries Year Ended March 31, 2017 Net sales (Note 8) Cost of sales (Note 15) Gross profit Selling, general and administrative expenses (Notes 7, 8 and 15) Operating income Other (expenses) income: Interest and dividend income Interest expense Exchange gains (losses) Gain on sales of land Losses on disposals of property, plant and equipment and other intangible assets Losses on impairment of long-lived assets (Note 4) Gains on sales of investment securities (Note 6) Impairment losses on investment securities (Notes 6 and 17) Gains on reversal of stock acquisition rights Loss on restructuring of subsidiaries Other—net Other (expenses) income—net Income before income taxes Income taxes (Note 13): Current Deferred Total income taxes Net income Net income attributable to noncontrolling interests Net income attributable to owners of parent Amounts per common share (Note 20): Basic net income Diluted net income Cash dividends applicable to the year See notes to consolidated financial statements. 44 Millions of Yen 2017 2016 ¥2,043,969 ¥2,043,691 1,313,034 1,332,115 730,935 500,166 230,769 10,431 (9,910) 330 452 (927) 25 (561) (160) 230,609 70,217 471 70,688 159,921 (5,982) 711,576 493,704 217,872 10,637 (8,495) (11,279) (1,078) (491) 112 (605) 4 (1,294) 800 (11,689) 206,183 59,389 4,702 64,091 142,092 (5,105) ¥ 153,939 ¥ 136,987 Yen ¥526.81 526.43 130.00 ¥469.23 468.84 120.00 Consolidated Statement of Comprehensive Income Daikin Industries, Ltd. and Consolidated Subsidiaries Year Ended March 31, 2017 Net income Other comprehensive loss (Note 19): Unrealized gains (losses) on available-for-sale securities Deferred gains (losses) on derivatives under hedge accounting Foreign currency translation adjustments Remeasurements of defined benefit plans Share of other comprehensive loss in affiliates accounted for using the equity method Total other comprehensive loss Millions of Yen 2017 2016 ¥159,921 ¥142,092 6,721 2,004 (32,609) 1,448 (1,142) (23,578) (21,498) (1,659) (86,963) (5,573) (809) (116,502) Comprehensive income ¥136,343 ¥ 25,590 Total comprehensive income attributable to: Owners of parent Noncontrolling interests See notes to consolidated financial statements. ¥131,348 ¥ 22,489 4,995 3,101 Consolidated Statement of Changes in Equity Daikin Industries, Ltd. and Consolidated Subsidiaries Year Ended March 31, 2017 Outstanding Number of Common Shares Issued Common Stock Capital Surplus Stock Acquisition Rights Retained Earnings Treasury Stock Millions of Yen Accumulated Other Comprehensive Income (Loss) Unrealized Gain on Available- for-Sale Securities Deferred Loss on Derivatives under Hedge Accounting Foreign Currency Translation Adjustments Remeasure- ments of Defined Benefit Plans Total Noncontrol- ling Interests Total Equity Balance, April 1, 2015 291,833,321 ¥85,032 ¥83,444 ¥ 993 ¥617,129 ¥(5,221) ¥67,819 ¥ (464) ¥179,566 ¥(2,580) ¥1,025,718 ¥22,594 ¥1,048,312 Net income Cash dividends, ¥120 per share Repurchase of treasury stock (53,704) Disposal of treasury stock 259,000 Change in parent’s ownership interest due to transactions with noncontrolling interests Net change in the year 183 (42) 136,987 (33,568) (479) 1,102 136,987 (33,568) (479) 1,285 136,987 (33,568) (479) 1,285 (42) (42) 126 (21,499) (1,660) (85,768) (5,572) (114,373) (652) (115,025) Balance, March 31, 2016 292,038,617 85,032 83,585 1,119 720,548 (4,598) 46,320 (2,124) 93,798 (8,152) 1,015,528 21,942 1,037,470 Net income Cash dividends, ¥130 per share Repurchase of treasury stock Disposal of treasury stock Net change in the year 153,939 (36,519) (304) 336,000 960 (3) 1,441 153,939 (36,519) (3) 2,401 153,939 (36,519) (3) 2,401 (39) 6,722 2,004 (32,761) 1,444 (22,630) 951 (21,679) Balance, March 31, 2017 292,374,313 ¥85,032 ¥84,545 ¥1,080 ¥837,968 ¥(3,160) ¥53,042 ¥ (120) ¥ 61,037 ¥(6,708) ¥1,112,716 ¥22,893 ¥1,135,609 See notes to consolidated financial statements. 45 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Consolidated Statement of Cash Flows Daikin Industries, Ltd. and Consolidated Subsidiaries Year Ended March 31, 2017 Operating activities: Income before income taxes Adjustments for: Income taxes—paid Depreciation and amortization Losses on impairment of long-lived assets Gains on sales of investment securities Impairment losses on investment securities Losses on disposals of property, plant and equipment and other intangible assets Equity in (earnings) losses of unconsolidated subsidiaries and associated companies Changes in assets and liabilities, net of effects of the purchase of subsidiaries: Trade notes and accounts receivable Inventories Other current assets Assets for retirement benefits Trade notes and accounts payable Accrued expenses Other current liabilities Liabilities for retirement benefits Other—net Total adjustments Net cash provided by operating activities Investing activities: Payments for purchases of property, plant and equipment Proceeds from sales of property, plant and equipment Payments for acquisition of newly consolidated subsidiaries, net of cash and cash equivalents acquired (Note 14) Proceed from sales of shares of subsidiary resulting in change in the scope of consolidation Payment for acquisition of shares of an associated company Payments for transfer of business Proceed from transfer of business Payments for acquisition of investment securities Proceeds from sales of investment securities (Note 6) Other—net Net cash used in investing activities Financing activities: Net decrease in short-term borrowings Proceeds from long-term debt Repayments of long-term debt (Note 14) Cash dividends paid to owners of parent Cash dividends paid to noncontrolling interests Proceeds from issuance of shares to noncontrolling interests Other—net Net cash used in financing activities Effect of exchange rate changes on cash and cash equivalents Net increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year See notes to consolidated financial statements. 46 Millions of Yen 2017 2016 ¥230,609 ¥206,183 (55,253) 85,029 (25) 927 (920) (13,440) (23,384) 364 (1,333) 14,406 8,940 16,432 1,289 4,022 37,054 267,663 (88,335) 2,253 (32,998) 705 (1,870) (165) 46 (8,459) (128,823) (1,243) 60,295 (91,263) (36,519) (4,265) 233 (782) (73,544) (12,408) 52,888 291,206 ¥344,094 (72,930) 84,203 491 (112) 605 1,078 83 (19,940) 1,494 (2,869) 7,998 10,318 7,733 10,166 708 (9,023) 20,003 226,186 (96,697) 992 (1,311) (358) (3,182) 121 (2,587) 193 (2,664) (105,493) (2,839) (40,076) (33,568) (6,529) (2,410) (85,422) (31,015) 4,256 286,950 ¥291,206 Notes to Consolidated Financial Statements Daikin Industries, Ltd. and Consolidated Subsidiaries Year Ended March 31, 2017 1. BASIS OF PRESENTATION OF CONSOLIDATED FINANCIAL STATEMENTS The accompanying consolidated financial statements of Daikin Industries, Ltd. (the “Company”) have been prepared in accordance with the provisions set forth in the Japanese Financial Instruments and Exchange Act and its related accounting regulations and in accordance with accounting principles generally accepted in Japan (“Japanese GAAP”), which are different in certain respects as to the application and disclosure requirements of International Financial Reporting Standards (IFRSs). In preparing these consolidated financial statements, certain reclassifications and rearrangements have been made to the Company’s consolidated financial statements issued domestically in order to present them in a form which is more familiar to readers outside Japan. In addition, certain reclassifications have been made in the 2016 consolidated financial statements to conform to the classification used in 2017. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a. Principles of Consolidation and Accounting for Investments in Unconsolidated Subsidiaries and Associated Companies - The accompanying consolidated financial statements include the accounts of the Company and its significant subsidiaries (collectively, the “Group”). Under the control and influence concepts, those companies in which the Company, directly or indirectly, is able to exercise control are fully consolidated, and those companies over which the Group has the ability to exercise significant influence are accounted for by the equity method. The Group applies the equity method of accounting for investments in unconsolidated subsidiaries and associated companies except for certain insignificant companies. Investments in such insignificant companies are stated at cost, except investments for which the value has been permanently impaired, for which appropriate write-downs are recorded. If these subsidiaries and associated companies had been consolidated or accounted for using the equity method, respectively, the effect on the accompanying consolidated financial statements would not have been material. All significant intercompany balances and transactions have been eliminated in consolidation. All material unrealized profit included in assets resulting from transactions within the Group is eliminated. b. Unification of Accounting Policies Applied to Foreign Subsidiaries for the Consolidated Financial Statements - In accordance with the Accounting Standards Board of Japan (“ASBJ”) Practical Issues Task Force (“PITF”) No. 18, “Practical Solution on Unification of Accounting Policies Applied to Foreign Subsidiaries for the Consolidated Financial Statements,” the accounting policies and procedures applied to a parent company and its subsidiaries for similar transactions and events under similar circumstances should, in principle, be unified for the preparation of the consolidated financial statements. However, financial statements prepared by foreign subsidiaries in accordance with either IFRSs or generally accepted accounting principles in the United States of America (Financial Accounting Standards Board Accounting Standards Codification—”FASB ASC”) tentatively may be used for the consolidation process, except for the following items which should be adjusted in the consolidation process so that net income is accounted for in accordance with Japanese GAAP, unless they are not material: (a) amortization of goodwill; (b) scheduled amortization of actuarial gain or loss of pensions that has been recorded in equity through other comprehensive income; (c) expensing capitalized development costs of research and development; and (d) cancellation of the fair value model of accounting for property, plant and equipment and investment properties and incorporation of the cost model of accounting. c. Unification of Accounting Policies Applied to Foreign Associated Companies for the Equity Method - In accordance with ASBJ Statement No. 16, “Accounting Standard for Equity Method of Accounting for Investments,” adjustments are to be made to conform the associate’s accounting policies for similar transactions and events under similar circumstances to those of the parent company when the associate’s financial statements are used in applying the equity method unless it is impracticable to determine such adjustments. In addition, financial statements prepared by foreign associated companies in accordance with either IFRSs or generally accepted accounting principles in the United States of America (“U.S. GAAP”) tentatively may be used in applying the equity method if the following items are adjusted so that net income is accounted for in accordance with Japanese GAAP, unless they are not material: (a) amortization of goodwill; (b) scheduled amortization of actuarial gain or loss of pensions that has been recorded in equity through other comprehensive income; (c) expensing capitalized development costs of research and development; and (d) cancellation of the fair value model of accounting for property, plant and equipment and investment properties and incorporation of the cost model of accounting. 47 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 d. Business Combinations - Business combinations are accounted for using the purchase method. Acquisition-related costs, such as advisory fees or professional fees, are accounted for as expenses in the periods in which the costs are incurred. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the business combination occurs, an acquirer shall report in its financial statements provisional amounts for the items for which the accounting is incomplete. During the measurement period, which shall not exceed one year from the acquisition, the acquirer shall retrospectively adjust the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date and that would have affected the measurement of the amounts recognized as of that date. Such adjustments shall be recognized as if the accounting for the business combination had been completed at the acquisition date. A parent’s ownership interest in a subsidiary might change if the parent purchases or sells ownership interests in its subsidiary. The carrying amount of noncontrolling interest is adjusted to reflect the change in the parent’s ownership interest in its subsidiary while the parent retains its controlling interest in its subsidiary. Any difference between the fair value of the consideration received or paid and the amount by which the noncontrolling interest is adjusted is accounted for as capital surplus as long as the parent retains control over its subsidiary. The Group acquired 100% of the equity interest of Flanders Holdings LLC on April 27, 2016 and accounted for this acquisition by the purchase method of accounting (see Note 5). e. Cash Equivalents - Cash equivalents are short-term investments that are readily convertible into cash and exposed to insignificant risk of changes in value. Cash equivalents include time deposits, which mature within three months of the date of acquisition. Time deposits that mature in more than three months, but within a year of the date of acquisition, are recorded as short-term investments. The Group had no short-term investments at March 31, 2017 and 2016. f. Allowance for Doubtful Accounts - The allowance for doubtful accounts is stated in amounts considered to be appropriate based on the past credit loss experience and an evaluation of potential losses in receivables outstanding. g. Inventories - Inventories of the Company and its consolidated domestic subsidiaries are stated at the lower of cost, principally determined by the average method, or net selling value. Inventories of consolidated foreign subsidiaries are stated at the lower of cost, principally determined by the average method, or market. h. Property, Plant and Equipment - Property, plant and equipment are stated at cost. Depreciation of property, plant and equipment of the Company and its consolidated subsidiaries is principally computed by the straight-line method based on the estimated useful lives of the assets. The range of useful lives is from 15 to 50 years for buildings and structures, and from 5 to 15 years for machinery and equipment. The useful lives for lease assets are the terms of the respective leases. i. Asset Retirement Obligations - An asset retirement obligation is recorded for a legal obligation imposed either by law or contract that results from the acquisition, construction, development and normal operation of a tangible fixed asset and is associated with the retirement of such tangible fixed asset. The asset retirement obligation is recognized as the sum of the discounted cash flows required for the future asset retirement and is recorded in the period in which the obligation is incurred if a reasonable estimate can be made. If a reasonable estimate of the asset retirement obligation cannot be made in the period the asset retirement obligation is incurred, the liability should be recognized when a reasonable estimate of the asset retirement obligation can be made. Upon initial recognition of a liability for an asset retirement obligation, an asset retirement cost is capitalized by increasing the carrying amount of the related fixed asset by the amount of the liability. The asset retirement cost is subsequently allocated to expense through depreciation over the remaining useful life of the asset. Over time, the liability is accreted to its present value each period. Any subsequent revisions to the timing or the amount of the original estimate of undiscounted cash flows are reflected as an adjustment to the carrying amount of the liability and the capitalized amount of the related asset retirement cost. j. Long-Lived Assets - The Group reviews its long-lived assets for impairment whenever events or changes in circumstance indicate the carrying amount of an asset or asset group may not be recoverable. An impairment loss is recognized if the carrying amount of an asset or asset group exceeds the sum of the undiscounted future cash flows expected to result from the continued use and eventual disposition of the asset or asset group. The impairment loss would be measured as the amount by which the carrying amount of the asset exceeds its recoverable amount, which is the higher of the discounted cash flows from the continued use and eventual disposition of the asset or the net selling price at disposition. k. Leases - Finance lease transactions are capitalized by recognizing lease assets and lease obligations in the balance sheet. In March 2007, the ASBJ issued ASBJ Statement No. 13, “Accounting Standard for Lease Transactions,” which revised the previous accounting standard for lease transactions. The revised accounting standard permits leases that existed at the transition date and do not transfer ownership of the leased property to the lessee to continue to be accounted for as operating lease transactions. 48 The Company and its consolidated domestic subsidiaries applied the revised accounting standard effective April 1, 2008. In addition, the Company and its consolidated domestic subsidiaries continue to account for leases that existed at the transition date and that do not transfer ownership of the leased property to the lessee as operating lease transactions. All other leases are accounted for as operating leases. l. Investment Securities - All marketable securities held by the Group are classified as available-for-sale securities and are reported at fair value, with unrealized gains and losses, net of applicable taxes, reported in a separate component of equity. The cost of securities sold is principally determined based on the moving-average method. Non-marketable available-for-sale securities are stated at cost principally determined by the moving-average method. For other-than-temporary declines in fair value, available-for-sale securities are reduced to net realizable value by charging such losses to income. m. Goodwill and Intangible Assets - Goodwill and intangible assets arise principally from business combinations. Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired. Goodwill is amortized over a period of 9 to 20 years. Intangible assets primarily include customer relationships. Customer relationships are amortized using the straight-line method over the estimated useful lives (mainly 30 years). n. Provision for Product Warranties - The Group repairs or exchanges certain products without charge under specific circumstances. The provision for product warranties is stated in amounts considered to be appropriate based on the past experience and an evaluation of potential losses on the product warranties. o. Employees’ Retirement Benefits - The Company and its consolidated domestic subsidiaries have non-contributory funded pension plans covering substantially all of their employees. Certain consolidated foreign subsidiaries have pension plans. The Company accounts for the liability for retirement benefits based on the projected benefit obligations and plan assets at the balance sheet date. The projected benefit obligations are attributed to periods on a benefit formula basis. Actuarial gains and losses and past service costs that are yet to be recognized in profit or loss are recognized within equity (accumulated other comprehensive income), after adjusting for tax effects and are recognized in profit or loss over certain periods (mainly 10 years) no longer than the expected average remaining service period of the employees. The discount rate is determined using a single weighted-average discount rate reflecting the estimated timing and amount of benefit payment. p. Stock Options - The Company measures the cost of employee stock options based on the fair value at the date of grant and recognized as compensation expense over the vesting period as consideration for receiving goods or services. The Company accounts for stock options granted to nonemployees based on the fair value of either the stock options of the goods or services received. In the consolidated balance sheet, the stock options are presented as a stock acquisition right as a separate component of equity until exercised. q. Foreign Currency Transactions - All short-term and long-term monetary receivables and payables denominated in foreign currencies are translated into Japanese yen at the exchange rates at the consolidated balance sheet date. The foreign exchange gains and losses from translation are recognized in the consolidated statement of income to the extent that they are not hedged by forward exchange contracts. r. Foreign Currency Financial Statements - The balance sheet accounts of the consolidated foreign subsidiaries are translated into Japanese yen at the current exchange rate as of the balance sheet date except for equity, which is translated at the historical rate. Revenue and expense accounts of the consolidated foreign subsidiaries are translated into Japanese yen at the average exchange rate. Differences arising from such translations are shown as “foreign currency translation adjustments” under accumulated other comprehensive income in a separate component of equity. s. Bonuses to Directors and Audit & Supervisory Board Members - Bonuses to Directors and Audit & Supervisory Board Members are accrued at the year-end to which such bonuses are attributable. Accrued bonuses are included in accrued expenses. t. Income Taxes - The provision for current income taxes is computed based on income before income taxes included in the consolidated statement of income. The asset and liability approach is used to recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred taxes are measured by applying currently enacted tax laws to the temporary differences. The Company applied ASBJ Guidance No. 26, “Guidance on Recoverability of Deferred Tax Assets,” effective April 1, 2016. There was no impact from this for the year ended March 31, 2017. 49 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017u. Derivative Financial Instruments - The Group uses foreign exchange forward contracts, currency swaps and currency options to manage foreign exchange risk associated with certain assets and liabilities denominated in foreign currencies. The Group uses mainly interest rate swaps and interest rate options to manage its exposure to fluctuations in interest rates. The Group uses commodity futures contracts to manage the risk of fluctuation of commodity prices for materials. The Group does not enter into derivatives for trading or speculative purposes. Derivative financial instruments are classified and accounted for as follows: (1) derivatives are principally recognized as either assets or liabilities and measured at fair value, and gains or losses on derivative transactions are recognized in the consolidated statement of income and (2) for derivatives used for hedging purposes, if such derivatives qualify for hedge accounting because of high correlation and effectiveness between the hedging instruments and the hedged items, gains or losses are deferred until maturity of the hedged transactions. The interest rate swaps that qualify for hedge accounting and meet specific matching criteria are not remeasured at market value but the differential paid or received under the swap agreements is recognized and included in interest expense or income. v. Amounts Per Common Share - Basic net income per common share is computed by dividing net income attributable to common shareholders by the weighted-average number of common shares outstanding for the period, retroactively adjusted for stock splits. Diluted net EPS of common stock assumes full exercise of the outstanding stock options which have a dilutive effect at the beginning of year (or at the time of issuance). Cash dividends per share presented in the accompanying consolidated statement of income are dividends applicable to the respective fiscal years including dividends to be paid after the end of the year. w. New Accounting Pronouncements Leases - On January 13, 2016, the International Accounting Standards Board issued IFRS 16 Leases. On February 25, 2016, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2016-02 Leases (Topic 842). These standards require lessees to recognize most leases on the balance sheet thereby resulting in the recognition of lease assets and liabilities. The Company expects to apply IFRS 16 for annual periods beginning on or after January 1, 2019. The Company expects to apply ASU 2016-02 for annual periods beginning after December 15, 2019 and for the first quarter within annual periods beginning after December 15, 2020. The Group is currently assessing the impact that these new standards will have on the consolidated financial statements. 3. INVENTORIES Inventories at March 31, 2017 and 2016 consisted of the following: Finished products and merchandise Semifinished products and work in process Raw materials and supplies Total Millions of Yen 2017 2016 ¥249,487 ¥232,018 42,250 66,566 40,028 61,606 ¥358,303 ¥333,652 50 4. LONG-LIVED ASSETS The Group reviewed its long-lived assets for impairment for the years ended March 31, 2017 and 2016. Impairment losses recognized were mainly as follows: March 31, 2016 Use Location Asset Category Millions of Yen Held for use Settsu City, Osaka Prefecture Machinery and equipment ¥450 The Group recognized impairment losses recorded in other expenses for those assets as the profitability of oil hydraulics business for industrial machinery is expected to decline due to economic downturn and sluggish demand in the Chinese market. The carrying amounts of the related assets were written down to the recoverable amount. The recoverable amounts of these assets were measured at value in use and the discount rate used for computation of the present value of future cash flows was 5%. No impairment loss was recognized for the year ended March 31, 2017. 5. BUSINESS COMBINATIONS Acquisition of an Entity during the Year Ended March 31, 2017 1. Outline of the business combination: (1) Name and business contents of the acquiree: Flanders Holdings LLC Name: Business contents: Manufacture and sale of air filters and other related products (2) Main reason for the business combination: With this acquisition, Flanders Holdings LLC (hereinafter, “Flanders”) will be integrated into American Air Filter Company, Inc. (hereinafter, “AAF”), enabling AAF to leverage its global sales network to market cleanroom equipment and high-end air filter products, which are the main products of Flanders. In addition to making AAF the leading manufacturer in the United States, which is reportedly the largest air filter market in the world, this integration will also position AAF as a leading company in the global market. (3) Date of the business combination: April 27, 2016 (4) Legal form of the business combination: Acquisition of equity interests for cash considerations (5) Name of the acquiree after business combination: Flanders Holdings LLC (6) Ratio of equity interests acquired: 100% (7) Basis for determination of the acquirer: AAF, a subsidiary of the Company, is regarded as the acquiring company since AAF acquired all equity interests of Flanders for cash consideration. 2. Period of operating results of the acquiree included in the consolidated financial statements: From April 27, 2016, to March 31, 2017 3. Amount and breakdown of the acquisition costs: Payment for acquisition of equity interests: Cash US$209 million (¥23,287 million) 4. Amount and breakdown of the main acquisition related costs: Expenses related directly to the acquisition, including mainly advisory expenses: US$6 million (¥719 million) 5. Amount of goodwill recognized, reason for recognition, and method and period for amortization of goodwill: (1) Amount of goodwill recognized: US$171 million (¥18,990 million) (2) Reason for recognition: Future business activities are expected to generate excess profitability. (3) Method and period for amortization of goodwill: Straight-line method over 13 years 51 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 20176. Amount and breakdown of the assets acquired and the liabilities assumed at the acquisition date: Current assets Fixed assets Total assets Current liabilities Long-term liabilities Total liabilities Millions of USD $107 418 $525 $222 93 $315 Millions of Yen ¥11,880 46,492 ¥58,372 ¥24,703 10,382 ¥35,085 7. Amount of identifiable intangible assets other than goodwill, its details and major weighted-average useful life: Customer relationships Trademarks Technologies Total Millions of USD $130 18 2 $150 Millions of Yen ¥14,466 2,003 256 ¥16,725 Weighted Average Useful Life 15 Non-amortizable 11 8. Even if this business combination had been completed as of April 1, 2016, the beginning of the fiscal year ended March 31, 2017, the Company believes the effect of consolidating this entity on the financial statements would be minor. Therefore, the pro forma financial information is omitted. 6. MARKETABLE AND INVESTMENT SECURITIES The acquisition costs and aggregate fair values of marketable available-for-sale securities included in investment securities at March 31, 2017 and 2016 were as follows: Securities classified as available-for-sale: Equity securities Debt securities Total Securities classified as available-for-sale: Equity securities Debt securities Total Millions of Yen 2017 Cost Unrealized Gains Unrealized Losses Fair Value ¥99,121 ¥71,961 ¥(2,300) ¥168,782 325 1 326 ¥99,446 ¥71,962 ¥(2,300) ¥169,108 Millions of Yen 2016 Cost Unrealized Gains Unrealized Losses Fair Value ¥98,754 ¥63,907 ¥(2,975) ¥159,686 350 1 351 ¥99,104 ¥63,908 ¥(2,975) ¥160,037 52 Available-for-sale securities that were sold during the years ended March 31, 2017 and 2016 were as follows: March 31, 2017 Available-for-sale: Equity securities March 31, 2016 Available-for-sale: Equity securities Millions of Yen Proceeds Realized Gains Realized Losses ¥40 ¥25 Millions of Yen Proceeds Realized Gains Realized Losses ¥168 ¥98 The impairment loss on marketable available-for-sale securities for the year ended March 31, 2016 was ¥0.1 million. No impairment loss was recognized for the year ended March 31, 2017. 7. GOODWILL Amortization expenses for goodwill were ¥25,735 million and ¥26,282 million for the years ended March 31, 2017 and 2016, respectively, which were included in selling, general and administrative expenses. 8. RELATED PARTY TRANSACTIONS Material transactions and balances with related parties for the years ended March 31, 2017 and 2016 were as follows: (1) 2017 (a) The Company Name Description of Post Ownership of the Company (%) Chiyono Terada External Director/Chief 0.00 Executive Officer (CEO) and President of Art Corporation (b) The Company’s consolidated subsidiaries Name Description of Post Ownership of the Company (%) Chiyono Terada External Director/CEO 0.00 and President of Art Corporation Millions of Yen Transactions Resulting Account Balances Description of Transaction Commissions for moving business and delivery business 2017 ¥488 Account Accrued expenses and other current liabilities 2017 ¥47 Millions of Yen Transactions Resulting Account Balances Description of Transaction Commissions for moving business and delivery business 2017 ¥ 56 Account Accrued expenses and other current liabilities 2017 ¥ 5 Sales of products 143 Accounts receivable 22 The terms and conditions applicable to the above-mentioned transactions have been determined on an arm’s-length basis and by reference to the normal market price. 53 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017(2) 2016 (a) The Company Name Description of Post Ownership of the Company (%) Chiyono Terada External Director/Chief 0.00 Executive Officer (CEO) and President of Art Corporation (b) The Company’s consolidated subsidiaries Name Description of Post Ownership of the Company (%) Chiyono Terada External Director/CEO 0.00 and President of Art Corporation Millions of Yen Transactions Resulting Account Balances Description of Transaction 2016 Account Commission for moving business and delivery business ¥535 Accrued expenses and other current liabilities 2016 ¥76 Millions of Yen Transactions Resulting Account Balances Description of Transaction 2016 Account Commission for moving business and delivery business ¥ 55 Accrued expenses and other current liabilities 2016 ¥ 5 Sales of products 119 Accounts receivable 16 The terms and conditions applicable to the above-mentioned transactions have been determined on an arm’s-length basis and by reference to the normal market price. 9. SHORT-TERM BORROWINGS AND LONG-TERM DEBT Short-term borrowings of the Group at March 31, 2017 and 2016 consisted of the following: Bank overdrafts and notes to banks Commercial paper Total Millions of Yen 2017 ¥57,699 ¥57,699 2016 ¥40,675 14,000 ¥54,675 Unused short-term bank credit lines were ¥178,048 million at March 31, 2017. The weighted-average interest rates of bank overdrafts and notes to banks at March 31, 2017 and 2016 were 2.51% and 1.00%, respectively. The weighted-average interest rate of commercial paper at March 31, 2016 was 0.00%. 54 Long-term debt at March 31, 2017 and 2016 consisted of the following: 1.42% unsecured bonds, due 2016 0.46% unsecured bonds, due 2017 1.86% unsecured bonds, due 2019 0.72% unsecured bonds, due 2019 0.38% unsecured bonds, due 2021 1.20% unsecured bonds, due 2022 0.68% unsecured bonds, due 2024 0.21% unsecured bonds, due 2026 Unsecured loans from government-sponsored banks, with interest of 1.75%, due through 2019 Millions of Yen 2017 ¥ 10,000 40,000 10,000 10,000 30,000 10,000 10,000 20,000 2016 ¥ 30,000 10,000 40,000 10,000 10,000 30,000 10,000 20,000 Unsecured loans from banks and others, payable in foreign currencies, with interest ranging from 0.00% to 4.00% (2017) and from 0.90% to 4.00% (2016), due through 2026 171,256 140,816 Unsecured loans from banks and others with interest ranging from 0.11% to 3.60% (2017) and from 0.15% to 3.62% (2016), due through 2023 Total Less current portion 229,214 540,470 (77,178) 249,617 550,433 (72,941) Long-term debt, less current portion ¥463,292 ¥477,492 Annual maturities of long-term debt outstanding at March 31, 2017 were as follows: Year Ending March 31 2018 2019 2020 2021 2022 2023 and thereafter Total Millions of Yen ¥ 77,178 78,208 92,442 94,625 63,605 134,412 ¥540,470 At March 31, 2017, investment securities with book values of ¥800 million, time deposit with a book value of ¥193 million and note receivables with book values of ¥399 million were pledged as collateral without corresponding borrowings. As is customary in Japan, additional securities must be provided if requested by a lending bank. Certain banks have the right to offset cash deposited against any debt or obligation that becomes due, or, in case of default and certain other specified events, against all other debt payable to them. To date, none of the lenders have ever exercised these rights with respect to debt of the Group. 55 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 10. SEVERANCE INDEMNITIES AND PENSION PLANS Under the Group’s severance indemnities and pension plans, employees terminating their employment are, in most circumstances, entitled to severance and pension payments based on their average pay during their employment, length of service and certain other factors. The Group accounts for part of the defined benefit obligations and benefit costs for retirement lump-sum payment using the simplified method. 1. Defined benefit plans (1) The changes in defined benefit obligations for the years ended March 31, 2017 and 2016 were as follows (excluding the benefit plans for which the simplified method was applied): Balance at beginning of year Service cost Interest cost Net actuarial losses Past service cost Benefits paid Effect of changes in the scope of consolidation Foreign currency translation adjustments Others Balance at end of year Millions of Yen 2017 ¥95,395 4,751 1,164 4,647 (3,752) 165 (3,205) (6) 2016 ¥91,059 5,229 1,913 3,688 150 (4,072) 266 (3,018) 180 ¥99,159 ¥95,395 (2) The changes in plan assets for the years ended March 31, 2017 and 2016 were as follows (excluding the benefit plan for which the simplified method was applied): Balance at beginning of year Expected return on plan assets Net actuarial gains (losses) Contributions from the employer Benefits paid Effect of changes in the scope of consolidation Foreign currency translation adjustments Others Balance at end of year Millions of Yen 2017 2016 ¥ 98,679 ¥102,450 3,269 4,257 3,068 (3,342) (231) (2,726) (17) 3,796 (4,690) 3,186 (3,576) (2,488) 1 ¥102,957 ¥ 98,679 (3) The changes in defined benefit obligation for the years ended March 31, 2017 and 2016 using the simplified method were as follows: Balance at beginning of year Periodic benefit cost Benefits paid Balance at end of year Millions of Yen 2017 ¥2,726 1,196 (1,219) ¥2,703 2016 ¥2,674 1,046 (994) ¥2,726 56 (4) Reconciliations between the liabilities recorded in the consolidated balance sheet and the balances of defined benefit obligation and plan assets at March 31, 2017 and 2016 were as follows (including the benefit plan for which the simplified method was applied): Funded defined benefit obligation Plan assets Total Unfunded defined benefit obligation Millions of Yen 2017 ¥ (95,868) 102,957 7,089 (5,994) 2016 ¥(92,760) 98,679 5,919 (5,361) Net amount of liabilities and assets recorded in the consolidated balance sheet ¥ 1,095 ¥ 558 Liabilities for retirement benefits Assets for retirement benefits Net amount of liabilities and assets recorded in the consolidated balance sheet ¥ (11,939) 13,034 ¥ 1,095 ¥(10,982) 11,540 ¥ 558 (5) The components of net periodic benefit costs for the years ended March 31, 2017 and 2016 were as follows: Service cost Interest cost Expected return on plan assets Recognized net actuarial losses (gains) Amortization of past service cost Periodic benefit cost calculated by the simplified method Others Subtotal (net periodic benefit costs) Total Millions of Yen 2017 ¥4,751 1,163 (3,269) 2,039 (144) 1,196 (4) 5,732 ¥5,732 2016 ¥5,229 1,913 (3,796) (103) (218) 1,046 255 4,326 ¥4,326 (6) Amounts recognized in other comprehensive income (before income tax effect) in respect of defined benefit plans for the years ended March 31, 2017 and 2016 were as follows: Past service cost Net actuarial (losses) gains Total Millions of Yen 2017 ¥ 432 (2,826) ¥(2,394) 2016 ¥ 205 7,887 ¥8,092 (7) Amounts recognized in accumulated other comprehensive income (before income tax effect) in respect of defined benefit plans for the years ended March 31, 2017 and 2016 were as follows: Unrecognized past service cost Unrecognized net actuarial losses Total Millions of Yen 2017 ¥ (680) 9,617 ¥8,937 2016 ¥ (1,112) 12,443 ¥11,331 57 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017(8) Plan assets (a) Components of plan assets Plan assets at March 31, 2017 and 2016, consisted of the following: Domestic debt securities Domestic equity securities Foreign debt securities Foreign equity securities Insurance assets (general account) Cash and deposits Alternative investments Total 2017 6% 8 22 20 17 1 26 2016 6% 8 25 18 17 1 25 100% 100% (b) Method of determining the expected rate of return on plan assets To determine the expected long-term rate of return on plan assets, we consider current and target asset allocations, as well as historical and expected returns on various categories of plan assets. (9) Assumptions used for the years ended March 31, 2017 and 2016 were as follows: Discount rate Expected rate of return on plan assets Expected rate of future salary increases 2017 Mainly 0.3% Mainly 2.5% Mainly 3.5% 2016 Mainly 0.3% Mainly 2.5% Mainly 3.5% 2. Defined contribution plan The amounts of contribution required for the defined contribution plan paid by the Company and its subsidiaries were ¥4,965 million and ¥4,742 million for the years ended March 31, 2017 and 2016, respectively. 11. EQUITY Japanese companies are subject to the Companies Act of Japan (the “Companies Act”). The significant provisions in the Companies Act that affect financial and accounting matters are summarized below: (a) Dividends Under the Companies Act, companies can pay dividends at any time during the fiscal year in addition to the year-end dividend upon resolution at the shareholders’ meeting. For companies that meet certain criteria including (1) having a Board of Directors, (2) having independent auditors, (3) having an Audit & Supervisory Board, and (4) the term of service of the directors being prescribed as one year rather than the normal two-year term by its articles of incorporation, the Board of Directors may declare dividends (except for dividends-in-kind) at any time during the fiscal year if the company has prescribed so in its articles of incorporation. However, the Company cannot do so because it does not meet all the above criteria. The Companies Act permits companies to distribute dividends-in-kind (non-cash assets) to shareholders subject to a certain limitation and additional requirements. Semiannual interim dividends may also be paid once a year upon resolution by the Board of Directors if the articles of incorporation of the Company so stipulate. The Companies Act provides certain limitations on the amounts available for dividends or the purchase of treasury stock. The limitation is defined as the amount available for distribution to the shareholders, but the amount of net assets after dividends must be maintained at no less than ¥3 million. (b) Increases/Decreases and Transfer of Common Stock, Reserve and Surplus The Companies Act requires that an amount equal to 10% of dividends must be appropriated as a legal reserve (a component of retained earnings) or as additional paid-in capital (a component of capital surplus), depending on the equity account that was charged upon the payment of such dividends, until the aggregate amount of legal reserve and additional paid-in capital equals 25% of the common stock. Under the Companies Act, the total amount of additional paid-in capital and legal reserve may be reversed without limitation. The Companies Act also provides that common stock, legal reserve, additional paid-in capital, other capital surplus and retained earnings can be transferred among the accounts within equity under certain conditions upon resolution of the shareholders. 58 (c) Treasury Stock and Treasury Stock Acquisition Rights The Companies Act also provides for companies to purchase treasury stock and dispose of such treasury stock by resolution of the Board of Directors. The amount of treasury stock purchased cannot exceed the amount available for distribution to the shareholders which is determined by a specific formula. Under the Companies Act, stock acquisition rights are presented as a separate component of equity. The Companies Act also provides that companies can purchase both treasury stock acquisition rights and treasury stock. Such treasury stock acquisition rights are presented as a separate component of equity or deducted directly from stock acquisition rights. 12. STOCK OPTIONS The stock options outstanding at March 31, 2017, were as follows: Number of Options Granted 290,000 shares Date of Grant Exercise Price Exercise Period 2010.7.14 ¥3,050 Stock Option 2010 Stock Option 2011 Stock Option 2012 Stock Option 2013 Stock Option 2014 Stock Option 2015 Stock Option 2016 Stock Option Persons Granted 8 directors 41 employees 10 directors 39 employees 10 directors 41 employees 10 directors 38 employees 9 directors 45 employees 9 directors 46 employees 8 directors 53 employees 296,000 shares 2011.7.14 ¥2,970 300,000 shares 2012.7.13 ¥2,186 286,000 shares 2013.7.12 ¥4,500 310,000 shares 2014.7.14 ¥6,715 53,200 shares 2015.7.13 ¥ 1 58,100 shares 2016.7.14 ¥ 1 From July 15, 2012 to July 14, 2016 From July 15, 2013 to July 14, 2017 From July 14, 2014 to July 13, 2018 From July 13, 2015 to July 12, 2019 From July 15, 2016 to July 14, 2020 From July 14, 2018 to July 13, 2030 From July 15, 2019 to July 14, 2031 59 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 The stock option activity was as follows: 2009 Stock Option 2010 Stock Option 2011 Stock Option 2012 Stock Option 2013 Stock Option 2014 Stock Option 2015 Stock Option 2016 Stock Option Shares Year Ended March 31, 2016 Vested April 1, 2015—Outstanding 8,000 16,000 36,000 87,000 286,000 310,000 Granted Exercised Canceled March 31, 2016—Outstanding Year Ended March 31, 2017 Vested (4,000) (10,000) (16,000) (51,000) (178,000) (4,000) 6,000 20,000 36,000 108,000 310,000 53,200 53,200 April 1, 2016—Outstanding 6,000 20,000 36,000 108,000 310,000 53,200 Granted Exercised Canceled (6,000) (20,000) (19,000) (76,000) (215,000) 58,100 March 31, 2017—Outstanding Exercise price Average stock price at exercise ¥3,250 ¥8,486 ¥3,050 ¥ 2,970 ¥ 2,186 ¥8,817 ¥10,512 ¥10,270 17,000 32,000 ¥4,500 ¥9,391 95,000 ¥6,715 ¥9,708 53,200 ¥ 1 58,100 ¥ 1 Fair value price at grant date ¥ 899 ¥1,113 ¥ 935 ¥ 676 ¥1,220 ¥1,697 ¥7,726 ¥7,859 The assumptions used to measure the fair value of 2016 Stock Option Estimate method: Black-Scholes option-pricing model Volatility of stock price: 39.9% Estimated remaining outstanding period: 9 years Estimated dividend: Risk-free interest rate: ¥120 per share 0.3% 60 13. INCOME TAXES The Company and its domestic subsidiaries are subject to Japanese national and local income taxes that, in the aggregate, resulted in normal effective statutory tax rates of approximately 30.8% and 33.0% for the years ended March 31, 2017 and 2016, respectively. The tax effects of significant temporary differences and tax loss carryforwards that resulted in deferred tax assets and liabilities at March 31, 2017 and 2016 were as follows: Deferred tax assets: Provision for product warranties Inventories Investment securities Tax loss carryforwards Deferred revenue Software and other intangible assets Accrued bonus Liabilities for retirement benefits Allowance for doubtful receivables Foreign income tax credit Other Less valuation allowance Total deferred tax assets Deferred tax liabilities: Intangible assets Undistributed earnings of consolidated subsidiaries Unrealized gain on available-for-sale securities Assets for retirement benefits Deferred gains on sales of property Other Total deferred tax liabilities Net deferred tax liabilities Millions of Yen 2017 2016 ¥ 14,696 14,552 ¥ 14,946 14,293 6,911 9,908 6,485 6,012 3,973 2,487 1,747 184 6,774 5,641 5,505 5,345 3,529 2,246 1,425 733 20,614 (16,728) 17,664 (16,669) ¥ 70,841 ¥ 61,432 ¥ 69,574 ¥ 64,087 33,483 16,727 4,216 1,375 16,395 33,019 14,694 3,574 1,187 10,019 ¥141,770 ¥ (70,929) ¥126,580 ¥ (65,148) A reconciliation between the normal effective statutory tax rates and the actual effective tax rates reflected in the accompanying consolidated statement of income for the year ended March 31, 2016 was as follows: Normal effective statutory income tax rate Differences in foreign subsidiaries’ tax rates Amortization of goodwill Taxes and tax effects on dividends from foreign subsidiaries Valuation allowance Permanently non-taxable income, such as dividend income Tax credit for research and development Permanently non-deductible expenses, such as entertainment expenses Other - net Actual effective income tax rate 2016 33.0% (6.5) 4.0 3.7 (1.4) (1.2) (1.1) 0.5 0.1 31.1% 61 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 A reconciliation of the difference between the normal effective statutory tax rates and the actual effective tax rates is not disclosed since the difference is less than 5% of the normal effective statutory income tax rate for the year ended March 31, 2017. On November 18, 2016, the Tax Reform Act was enacted in Japan to change the normal effective statutory tax rate used in the calculation of deferred tax assets and deferred tax liabilities for the year ended March 31, 2017, from the figures used for the year ended March 31, 2016. It resulted in a change in the deferred tax liabilities (net of deferred tax assets) and income taxes—deferred recorded in the year ended March 31, 2017. The effect of this change on the consolidated financial statements is not material. At March 31, 2017, the Company and certain consolidated subsidiaries had tax loss carryforwards aggregating ¥30,698 million, which are available to be offset against taxable income of the Company and such subsidiaries in future years. These tax loss carryforwards, if not utilized, will expire as follows: Year Ending March 31 2018 2019 2020 2021 2022 2023 and thereafter Total Millions of Yen ¥ 1,292 315 696 825 573 26,997 ¥30,698 14. SUPPLEMENTAL CASH FLOW INFORMATION The Group acquired Flanders Holdings LLC and its subsidiaries during the year ended March 31, 2017. Reconciliation between cash paid for the equity interest of Flanders Holdings LLC and payment for the acquisition of these newly consolidated subsidiaries, net of cash and cash equivalents acquired, was as follows: Current assets Fixed assets Goodwill Current liabilities Long-term liabilities Cash paid for the equity interest Cash and cash equivalents of consolidated subsidiaries Payment for acquisition of equity interest of newly consolidated subsidiaries, net of cash and cash equivalents acquired Millions of Yen 2017 ¥11,880 27,501 18,991 (24,703) (10,382) 23,287 (834) ¥22,453 Repayments of long-term debt included ¥18,336 million for repayments of long-term debt by Flanders Holdings LLC and the other companies which the Group acquired for the year ended March 31, 2017. 15. RESEARCH AND DEVELOPMENT COSTS Research and development costs included in cost of sales and selling, general and administrative expenses were ¥53,870 million and ¥46,138 million for the years ended March 31, 2017 and 2016, respectively. 62 16. LEASES The Group leases certain computer equipment and other assets. Obligations under finance leases and future minimum payments under noncancelable operating leases at March 31, 2017 were as follows: Due within one year Due after one year Total 17. FINANCIAL INSTRUMENTS AND RELATED DISCLOSURES Millions of Yen Finance Leases ¥ 1,798 9,463 ¥11,261 Operating Leases ¥17,091 39,719 ¥56,810 Group policy for financial instruments The Group uses financial instruments, mainly bank loans and bonds, based on its capital financing plan. Short-term bank loans and commercial paper are used to fund the Group’s ongoing operations, and cash surpluses are invested in low-risk financial assets. Derivatives are not used for speculative purposes, but to manage exposure to financial risks as described below. Nature and extent of risks arising from financial instruments and risk management for financial instruments Receivables, such as trade notes and trade accounts, are exposed to customer credit risk. The Group manages its credit risk from receivables based on the internal policies, which include monitoring of payment terms and balances of major customers to identify the default risk of the customers. Payment terms of payables, such as trade notes and trade accounts, are less than one year. Although receivables and payables in foreign currencies are exposed to the market risk of fluctuation in foreign currency exchange rates, the net position of receivables and payables in each foreign currency is hedged by using mainly forward foreign currency contracts and currency swaps. In addition, receivables and payables in foreign currencies which are expected from forecasted transactions are hedged by using forward foreign currency contracts and currency swaps. Investment securities, mainly equity instruments of customers and suppliers of the Group, are exposed to the risk of market price fluctuations. Investment securities are periodically managed by monitoring market values and financial position of issuers. Short-term bank loans and commercial paper are mainly used to fund the Group’s ongoing operations. Long-term bank loans and bonds are used mainly for capital expenditures. Although the payables such as trade notes and trade accounts, bank loans and bonds are exposed to liquidity risk, the Group manages the liquidity risk through adequate financial planning by the corporate finance department. In addition, the Group has short-term bank credit lines. Some long-term bank loans are exposed to market risks from changes in interest rates, which are hedged by mainly using interest rate swaps. Derivatives mainly include forward foreign currency contracts, interest rate swaps and commodity futures contracts, which are used to manage exposure to market risks from changes in foreign currency exchange rates of receivables and payables, interest rates of bank loans, and market value fluctuation of raw materials. Derivative transactions entered into by the Group have been made in accordance with internal policies which regulate the authorization and credit limit amount. Because the counterparties to these derivatives are limited to financial institutions with high creditworthiness, the Group does not anticipate any losses arising from credit risk. 63 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Fair values of financial instruments The carrying amounts, fair values and unrealized loss of significant financial instruments were as follows. Fair values of financial instruments are based on quoted price in active markets. If a quoted price is not available, another rational valuation technique is used instead. Instruments whose fair values cannot be readily determined are not included in the following. Cash and cash equivalents Trade notes and accounts receivable Investment securities Total Trade notes and accounts payable Short-term borrowings Income taxes payable Long-term debt Total Derivatives Cash and cash equivalents Trade notes and accounts receivable Investment securities Total Trade notes and accounts payable Short-term borrowings Income taxes payable Long-term debt Total Derivatives Millions of Yen March 31, 2017 Carrying Amount Fair Value Unrealized Loss ¥344,094 ¥344,094 369,061 169,108 ¥882,263 ¥173,147 57,699 27,770 540,470 ¥799,086 369,061 169,108 ¥882,263 ¥173,147 57,699 27,770 546,631 ¥805,247 ¥ (1,363) ¥ (1,363) Millions of Yen March 31, 2016 ¥6,161 ¥6,161 Carrying Amount Fair Value Unrealized Loss ¥291,206 ¥291,206 355,647 160,037 ¥806,890 ¥156,038 54,675 11,511 550,433 ¥772,657 ¥ (3,444) 355,647 160,037 ¥806,890 ¥156,038 54,675 11,511 560,212 ¥782,436 ¥ (3,444) ¥9,779 ¥9,779 Assets Cash and cash equivalents The carrying values of cash and cash equivalents approximate fair value because of their short maturities. Trade notes and accounts receivable The carrying values of trade notes and accounts receivable approximate fair value because of their short maturities. Investment securities The fair values of equity securities are measured at the quoted market prices of the stock exchange for the equity instruments, and the fair values of debt securities are measured at the amounts to be received through maturity discounted at the Group’s assumed corporate discount rate. Fair value information for investment securities by classification is included in Note 6. 64 Liabilities Trade notes and accounts payable, short-term borrowings and income taxes payable The carrying values of trade notes and accounts payable, short-term borrowings and income taxes payable approximate fair value because of their short maturities. Long-term debt The fair values of bonds are determined at the quoted market prices of the over-the-counter market for the corporate bonds, and the fair values of long-term loans are determined by discounting the cash flows related to the loans at the Group’s assumed corporate borrowing rate. The fair values of long-term loans with floating interest rates, which are hedged by the interest rate swaps that qualify for hedge accounting and meet specific matching criteria, are determined by discounting the cash flows related to the loans and the interest rate swaps at the Group’s assumed corporate borrowing rate. Derivatives The fair values of derivatives are measured at the quoted price obtained from the financial institution. The contracts or notional amounts of derivatives that are shown in the table below do not represent the amounts exchanged by the parties and do not measure the Group’s exposure to credit or market risk. Derivative transactions to which hedge accounting is not applied Forward exchange contracts: Selling: GBP EUR USD AUD ZAR CZK HKD SGD MYR TRY IDR INR Buying: CNY Commodity futures contracts: Buying: Metal Millions of Yen March 31, 2017 Contract Amount Due after One Year Fair Value Unrealized Gain (Loss) ¥ (31) ¥ (31) 158 431 21 6 27 24 16 (3) 2 (8) (37) 16 158 431 21 6 27 24 16 (3) 2 (8) (37) 16 Contract Amount ¥ 4,777 32,805 39,742 7,263 731 2,769 1,041 1,445 744 1,757 3,163 1,458 1,140 ¥ 2,699 ¥ 2 ¥ 2 65 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Forward exchange contracts: Selling: GBP EUR USD AUD ZAR CZK HKD PLN SGD MYR TRY BRL IDR INR Buying: CNY MYR Commodity futures contracts: Buying: Metal Derivative transactions to which hedge accounting is applied Forward exchange contracts: Selling: GBP EUR USD ZAR CZK PLN TRY Buying: CNY Interest rate swaps: Millions of Yen March 31, 2016 Contract Amount Due after One Year Fair Value Unrealized Gain (Loss) ¥ 65 (49) 103 (281) (15) 7 23 (0) (55) (58) (48) (3) (59) (6) (67) ¥ 65 (49) 103 (281) (15) 7 23 (0) (55) (58) (48) (3) (59) (6) (67) 411 411 Contract Amount ¥ 5,535 42,015 18,385 5,869 655 1,813 1,261 188 2,027 985 8,214 18 2,947 676 1,391 9,353 ¥ 688 ¥ (39) ¥ (39) Millions of Yen March 31, 2017 Contract Amount Due after One Year Fair Value ¥ (5) (276) 20 (10) 53 (30) 24 9 Hedged Item Receivables Receivables Receivables Receivables Receivables Receivables Receivables Payables Contract Amount ¥ 5,701 37,769 6,340 1,138 6,743 1,220 2,310 5,702 Fixed-rate payment, floating-rate receipt Long-term debt ¥184,898 ¥171,996 ¥(1,773) Fixed-rate payment, floating-rate receipt* Long-term debt 129,200 98,000 66 Forward exchange contracts: Selling: GBP EUR USD ZAR CZK PLN TRY Buying: CNY Interest rate swaps: Millions of Yen March 31, 2016 Contract Amount Due after One Year Fair Value ¥ 291 (212) 73 6 (259) (21) (64) (131) Hedged Item Receivables Receivables Receivables Receivables Receivables Receivables Receivables Payables Contract Amount ¥ 7,378 41,319 2,455 885 7,596 1,156 3,528 4,521 Fixed-rate payment, floating-rate receipt Long-term debt ¥174,601 ¥162,776 ¥(3,057) Fixed-rate payment, floating-rate receipt* Long-term debt 149,600 129,200 * The above interest rate swaps that qualify for hedge accounting and meet specific matching criterion are not remeasured at market value, but the differential paid or received under the swap agreements is recognized and included in interest expense or income. In addition, the fair values of such interest rate swaps are included in long- term debt. Financial instruments whose fair values cannot be readily determinable Nonlisted equity securities Investments in limited partnerships and other investments Total Millions of Yen Carrying Amount 2017 2016 ¥ 9,413 ¥ 9,565 685 885 ¥10,098 ¥10,450 The impairment losses on nonlisted equity securities for the year ended March 31, 2016 were ¥605 million. Maturity analysis for financial assets and securities with contractual maturities Cash and cash equivalents Trade notes and accounts receivable Investment securities: Millions of Yen March 31, 2017 Due in One Year or Less ¥344,094 369,032 Due after One Year through Five Years ¥29 Due after Five Years through Ten Years Due after Ten Years Available-for-sale securities with contractual maturities (corporate bonds) 25 Total ¥713,151 ¥29 Cash and cash equivalents Trade notes and accounts receivable Investment securities: Due in One Year or Less ¥291,206 355,599 Available-for-sale securities with contractual maturities (corporate bonds) 25 Total ¥646,830 Please see Note 9 for annual maturities of long-term debt. Millions of Yen March 31, 2016 Due after One Year through Five Years Due after Five Years through Ten Years ¥48 25 ¥73 ¥300 ¥300 Due after Ten Years ¥300 ¥300 67 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 18. COMMITMENTS AND CONTINGENT LIABILITIES Commitments for capital expenditures outstanding at March 31, 2017 totaled approximately ¥7,922 million. At March 31, 2017, contingent liabilities for trade notes endorsed and repurchase obligation for liquidation of notes receivables totaled ¥4,118 million and ¥221 million, respectively. 19. COMPREHENSIVE INCOME The components of other comprehensive loss for the years ended March 31, 2017 and 2016 were as follows: Unrealized gains (losses) on available-for-sale securities: Gains (losses) arising during the year Reclassification adjustments to profit or loss Amount before income tax effect Income tax effect Total Deferred gains (losses) on derivatives under hedge accounting: Gains (losses) arising during the year Reclassification adjustments to profit or loss Amount before income tax effect Income tax effect Total Foreign currency translation adjustments: Adjustments arising during the year Reclassification adjustments to profit or loss Amount before income tax effect Total Remeasurements of defined benefit plans: Adjustments arising during the year Reclassification adjustments to profit or loss Amount before income tax effect Income tax effect Total Share of other comprehensive income in affiliates accounted for using the equity method: Adjustments arising during the year Total other comprehensive loss Millions of Yen 2017 2016 ¥ 8,780 ¥ (31,523) (25) 8,755 (2,034) (98) (31,621) 10,123 ¥ 6,721 ¥ (21,498) ¥ 3,487 ¥ (3,786) (395) 3,092 (1,088) 1,278 (2,508) 849 ¥ 2,004 ¥ (1,659) ¥(32,921) ¥ (86,950) 312 (32,609) ¥(32,609) (13) (86,963) ¥ (86,963) ¥ 502 ¥ (7,771) 1,892 2,394 (946) (321) (8,092) 2,519 ¥ 1,448 ¥ (5,573) ¥ (1,142) ¥ (809) ¥(23,578) ¥(116,502) 68 20. NET INCOME PER SHARE Reconciliations of the differences between basic and diluted net income per share (EPS) for the years ended March 31, 2017 and 2016 were as follows: Year Ended March 31, 2017 Basic EPS: Millions of Yen Thousands of Shares Net Income Weighted- Average Shares Yen EPS Net income available to common shareholders ¥153,939 292,208 ¥526.81 Effect of dilutive securities: Stock options Diluted EPS: 214 Net income for computation ¥153,939 292,422 ¥526.43 Year Ended March 31, 2016 Basic EPS: Millions of Yen Thousands of Shares Net Income Weighted- Average Shares Yen EPS Net income available to common shareholders ¥136,987 291,942 ¥469.23 Effect of dilutive securities: Stock options Diluted EPS: 239 Net income for computation ¥136,987 292,181 ¥468.84 21. SEGMENT INFORMATION Under ASBJ Statement No. 17, “Accounting Standard for Segment Information Disclosures,” and ASBJ Guidance No. 20, “Guidance on Accounting Standard for Segment Information Disclosures,” an entity is required to report financial and descriptive information about its reportable segments. Reportable segments are operating segments or aggregations of operating segments that meet specified criteria. Operating segments are components of an entity about which separate financial information is available and such information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Generally, segment information is required to be reported on the same basis as is used internally for evaluating operating segment performance and deciding how to allocate resources to operating segments. 1. Description of reportable segments The Group’s reportable segments are those for which separate financial information is available and regularly evaluated by the Company’s Board of Directors in order to decide how resources are allocated among the Group. Therefore, the Group’s reportable segments consist of the Air Conditioning segment and the Chemicals segment. The Air Conditioning segment manufactures, distributes and installs air conditioning and refrigeration equipment. The Chemicals segment manufactures and distributes chemicals. 2. Methods of measurement for the amounts of sales, profit, assets and other items for each reportable segment The accounting policies of each reportable segment are generally consistent with those disclosed in Note 2, “Summary of Significant Accounting Policies.” 69 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017 Total Segment profit Segment assets Other: Depreciation 3. Information about sales, profit, assets and other items Millions of Yen March 31, 2017 Reportable Segment Air Conditioning Chemicals Total Other Total Reconciliations Consolidated Sales: Sales to external customers ¥1,835,377 ¥156,754 ¥1,992,131 ¥51,838 ¥2,043,969 ¥2,043,969 Intersegment sales 389 12,265 12,654 520 13,174 ¥ (13,174) 1,835,766 169,019 2,004,785 52,358 2,057,143 (13,174) 2,043,969 208,750 18,302 227,052 3,750 230,802 (33) 230,769 1,943,887 191,049 2,134,936 34,641 2,169,577 186,572 2,356,149 Amortization of goodwill 25,735 25,735 25,735 ¥ 46,057 ¥ 11,600 ¥ 57,657 ¥ 1,621 ¥ 59,278 ¥ 59,278 25,735 Investment balance in unconsolidated subsidiaries and associated companies accounted for using the equity method Investment in property, plant and equipment and intangible assets 11,596 6,709 18,305 18,305 18,305 76,389 12,552 88,941 1,404 90,345 90,345 Millions of Yen March 31, 2016 Reportable Segment Air Conditioning Chemicals Total Other Total Reconciliations Consolidated Sales: Sales to external customers ¥1,828,012 ¥162,286 ¥1,990,298 ¥53,393 ¥2,043,691 ¥2,043,691 Intersegment sales 614 10,295 10,909 500 11,409 ¥ (11,409) 1,828,626 172,581 2,001,207 53,893 2,055,100 (11,409) 2,043,691 193,786 20,621 214,407 3,529 217,936 (64) 217,872 1,798,333 189,508 1,987,841 35,370 2,023,211 167,894 2,191,105 Total Segment profit Segment assets Other: Depreciation Amortization of goodwill 26,183 99 26,282 26,282 ¥ 44,326 ¥ 12,055 ¥ 56,381 ¥ 1,527 ¥ 57,908 ¥ 57,908 26,282 Investment balance in unconsolidated subsidiaries and associated companies accounted for using the equity method Investment in property, plant and equipment and intangible assets 11,815 6,798 18,613 18,613 18,613 90,617 18,157 108,774 3,938 112,712 112,712 Notes: 1. The Other segment is the aggregation of other operating segments which are not included in the reportable segments and consists of the Oil Hydraulics segment, the Defense segment and the Electronics segment. 2. “Reconciliations” include unallocated items and intersegment eliminations. The unallocated corporate assets included in “Reconciliations” amounted to ¥190,001 million and ¥173,176 million at March 31, 2017 and 2016, respectively, which consisted mainly of the Company’s cash, time deposits and investment securities. 3. The aggregated amount of segment profit equals operating income in the consolidated statement of income. 4. Intersegment sales are recorded at values that approximate market prices. 70 4. Supplemental information (1) Information about geographical areas (a) Sales Japan USA China Millions of Yen March 31, 2017 Asia and Oceania Europe Other Consolidated ¥518,453 ¥503,489 ¥329,247 ¥303,417 ¥274,055 ¥115,308 ¥2,043,969 Japan USA China Millions of Yen March 31, 2016 Asia and Oceania Europe Other Consolidated ¥502,233 ¥484,951 ¥349,266 ¥304,626 ¥276,587 ¥126,028 ¥2,043,691 Note: Sales are classified by country or region based on the physical locations of customers. (b) Property, plant and equipment Japan USA China Millions of Yen March 31, 2017 Asia and Oceania Europe Other Consolidated ¥140,563 ¥128,484 ¥70,230 ¥43,093 ¥33,093 ¥9,064 ¥424,527 Japan USA China ¥140,641 ¥91,187 ¥77,981 Millions of Yen March 31, 2016 Asia and Oceania ¥34,957 Europe ¥31,379 Other ¥8,955 Consolidated ¥385,100 (2) Significant impairment losses on long-lived assets by reportable segment Impairment losses on long-lived assets Millions of Yen March 31, 2016 Air Conditioning ¥41 Chemicals Other ¥450 Eliminations and Corporate Consolidated ¥491 Note: The impairment losses reported in “Other” are related to the Oil Hydraulics segment. 71 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017(3) Information about goodwill (a) Balance of goodwill by reportable segment Goodwill for each reportable segment at March 31, 2017 and 2016 was as follows: Goodwill Goodwill Millions of Yen 2017 Chemicals Other Millions of Yen 2016 Chemicals Other Eliminations and Corporate Eliminations and Corporate Air Conditioning ¥330,876 Air Conditioning ¥329,753 Consolidated ¥330,876 Consolidated ¥329,753 22. SUBSEQUENT EVENTS Resolutions approved by the Company’s Board of Directors at the meeting held on May 10, 2017 are subject to approval at the general shareholders’ meeting planned to be held on June 29, 2017. Appropriations of Retained Earnings Payment of year-end cash dividends of ¥70 per share to shareholders at March 31, 2017, totaling ¥20,467 million is to be resolved. 72 Independent Auditors’ Report 73 DAIKIN INDUSTRIES, LTD. ANNUAL REPORT 2017Corporate Data (As of March 31, 2017) Company Name Head Office Tokyo Office Fiscal Year-End Date Date of Founding Date of Establishment Paid-in Capital Number of Shares of Common Stock Issued Daikin Industries, Ltd. Umeda Center Bldg., 2-4-12, Nakazaki-Nishi, Kita-ku, Osaka 530-8323, Japan Phone: 81-6-6373-4312 URL: http://www.daikin.com/ JR Shinagawa East Bldg., 2-18-1, Konan, Minato-ku, Tokyo 108-0075, Japan Phone: 81-3-6716-0111 March 31 on an annual basis October 25, 1924 February 11, 1934 ¥85,032 million 293,113 thousand Number of Shareholders 24,146 Major Shareholders Number of Subsidiaries and Affiliated Companies Number of Employees Stock Exchange Listing Advertising Method • The Master Trust Bank of Japan, Ltd. (Trust Account) • Japan Trustee Services Bank, Ltd. (Trust Account) • Sumitomo Mitsui Banking Corporation • Japan Trustee Services Bank, Ltd. (Trust Account 5) • Japan Trustee Services Bank, Ltd. Retirement Benefit Trust Account for The Norinchukin Bank • The Bank of Tokyo-Mitsubishi UFJ, Ltd. • CBNY-GOVERNMENT OF NORWAY • Japan Trustee Services Bank, Ltd. (Trust Account 4) • Trust & Custody Services Bank, Ltd. (Securities Inv. Trust Account) • State Street Bank and Trust Company Subsidiaries: 245 Affiliates: 18 67,036 (Consolidated) Tokyo The Company uses the electronic advertising method, posting advertisements on its website (http:// www.daikin.co.jp/e-koukoku/). However, when electronic advertising is not possible due to technical problems or other circumstances, the Company will post advertisements in the Nikkei Shimbun. Shareholder Register Administrator Mitsubishi UFJ Trust and Banking Corporation 3-6-3, Fushimicho, Chuo-ku, Osaka 541-8502, Japan Ordinary General Meeting of Shareholders June Auditor Deloitte Touche Tohmatsu LLC Trends in Daikin’s Stock Price Daikin (¥) 12,000 12,000 9,000 9,000 6,000 6,000 3,000 3,000 0 0 TOPIX 4,000 4,000 3,000 3,000 2,000 2,000 1,000 1,000 0 0 Trading Volume (Thousands of shares) 80,000 80,000 4 4 7 7 10 10 1 1 4 4 7 7 10 10 1 1 4 4 7 7 10 10 1 1 4 4 7 7 10 10 1 1 4 4 7 7 10 10 1 1 4 4 7 7 10 10 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 74 60,000 60,000 40,000 40,000 20,000 20,000 0 0 1 1 3 3 2017 2017 A n n u a l R e p o r t 2 0 1 7 D A I K I N I N D U S T R I E S , L T D . 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