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Lifetime BrandsEnriching lives, in harmony with nature Kao is dedicated to filling consumers’ daily lives with smiles. The philosophy behind our product development and manufacturing has remained unchanged over the 120 years since Kao Sekken (Kao Soap) was introduced in 1890. With the business environment continuing to change on a global scale, what can Kao do as a leading manufacturer? We believe we can provide new value to people around the world through Yoki-Monozukuri,* pursued from an ecological perspective. Positioning ecology at the core of management, Kao is striving for the wholehearted satisfaction and enrichment of the lives of people globally in the fields of cleanliness, beauty and health. Going forward, the Kao Group will continue to enhance Yoki-Monozukuri and pursue true, sustainable enrichment made possible through the harmony of people and nature. * We define “Yoki-Monozukuri” as “a strong commitment by all members to provide products and brands of excellent value for consumer satisfaction.” In Japanese, “Yoki” literally means “good/excellent,” “Monozukuri” means “development/manufacturing of products.” Forward-Looking Statements Forward-looking statements such as earnings forecasts and other projections contained in this report are based on information available at the time of publication and assumptions that management believes to be reasonable. Actual results may differ materially from those expectations due to various factors. Contents Financial Highlights Segment Information A Message from Chairman of the Board of Directors Motoki Ozaki An Interview with New President and CEO Michitaka Sawada Kao at a Glance 2 4 6 8 14 Feature: Innovation That Satisfies Beauty Care Business Human Health Care Business Global Integrated Management Meeting Local Consumer Needs 16 18 Fabric and Home Care Business Chemical Business Offering Eco-Innovation Rapid Progress toward an Eco-Chemical Business 19 20 Kao’s Management Framework Directors, Corporate Auditors and Executive Officers Corporate Governance Compliance Financial Section 11-Year Summary Management Discussion and Analysis Consolidated Financial Statements Notes to Consolidated Financial Statements Independent Auditor’s Report Principal Subsidiaries and Affiliates Investor Information 22 24 26 28 30 40 46 67 68 69 Kao Annual Report 2012 1 Financial Highlights Outstanding Year-on-Year Performance Net Sales +2.5% ¥1,216.1 billion EVA* 106 (Year ended March 31, 2000=100) *EVA (Economic Value Added) is a registered trademark of Stern Stewart & Co. The fi gure is a comparison to the base year ended March 31, 2000. Operating Income +3.8% ¥108.6 billion Net Income +12.2% ¥52.4 billion EBITA +2.2% ¥142.2 billion Cash Dividends +¥2.00 per share ¥60.00 Kao Corporation and Consolidated Subsidiaries Years ended March 31, 2012, 2011 and 2010 Billions of yen 2012 2011 2010 Millions of U.S. dollars 2012 Change 2012/2011 For the year: Net sales ....................................................... Beauty Care Business ............................... Human Health Care Business .................... Fabric and Home Care Business ................ Consumer Products Business ................ Chemical Business .................................... Eliminations ............................................... Japan .......................................................... Asia & Oceania ........................................... North America ............................................ Europe ........................................................ Eliminations ................................................ EBITA ............................................................ Operating income .......................................... Net income .................................................... EBITDA .......................................................... At year-end: Total assets ................................................... Net worth ...................................................... ¥1,216.1 537.9 181.8 285.6 1,005.3 247.6 (36.9) ¥1,186.8 533.5 175.8 279.0 988.3 232.0 (33.4) ¥1,184.4 547.9 183.2 276.9 1,008.0 207.8 (31.5) 925.3 173.6 85.4 117.0 (85.2) 142.2 108.6 52.4 188.4 912.4 152.4 80.3 112.1 (70.4) 139.1 104.6 46.7 186.0 918.5 131.7 79.2 111.2 (56.2) 129.5 94.0 40.5 178.8 $14,796.2 6,545.1 2,211.4 3,475.4 12,231.9 3,013.0 (448.7) 11,258.5 2,112.0 1,039.0 1,423.6 (1,037.0) 1,729.9 1,321.2 638.0 2,292.2 991.3 538.0 1,022.8 528.9 1,065.8 565.1 12,060.7 6,546.2 2.5% 0.8 3.4 2.4 1.7 6.7 .– 1.4 13.9 6.3 4.4 .– 2.2 3.8 12.2 1.3 (3.1) 1.7 Per share: Net income .................................................... Cash dividends .............................................. Net worth ...................................................... Yen U.S. dollars Change ¥ 100.46 60.00 1,031.08 ¥ 87.69 58.00 1,013.05 ¥ 75.57 57.00 1,054.31 $ 1.22 0.73 12.55 14.6% 3.4 1.8 Notes: 1. The U.S. dollar amounts are translated, for convenience only, at the rate of ¥82.19=US$1, the approximate exchange rate at March 31, 2012. 2. Eliminations represent intersegment sales and interregion sales. Net sales of the Chemical Business include intersegment sales to the Beauty Care Business, the Human Health Care Business and the Fabric and Home Care Business. 3. Net sales by region are classified based on the location of Kao Group companies. 4. Yen and U.S. dollar amounts are rounded to the nearest whole number or decimal. 5. EBITA (Earnings before interest, taxes and amortization) is operating income before amortization of goodwill and other items related to acquisitions. 6. EBITDA (Earnings before interest, taxes, depreciation and amortization) is operating income before depreciation and amortization. 7. Net worth is equity, excluding minority interests and stock acquisition rights. 2 Kao Annual Report 2012 Net Sales and Operating Income Ratio (Billions of yen) 1,500 1,318.5 1,276.3 1,184.4 1,186.8 1,216.1 1,000 500 0 8.8 7.6 7.9 8.8 8.9 2008 2009 2010 2011 2012 Net Sales (Left) Operating Income Ratio (Right) Net Income and ROE* Net Income per Share (Years ended March 31) (%) 25 (Billions of yen) 80 (%) 20 (Yen) 150 20 15 10 5 0 60 40 20 0 66.6 64.5 11.7 11.5 52.4 9.8 46.7 8.5 40.5 7.3 2008 2009 2010 2011 2012 Net Income (Left) ROE* (Right) *In calculating ROE, equity excludes minority interests and stock acquisition rights. 15 10 5 0 100 50 0 122.53 120.25 100.46 87.69 75.57 2008 2009 2010 2011 2012 Cash Dividends and Payout Ratio Net Worth and DER* EBITDA 40 20 0 (Yen) 60 54.00 56.00 57.00 58.00 60.00 (%) 100 (Billions of yen) 600 574.0 545.2 565.1 528.9 538.0 75.4 66.1 59.7 46.6 44.1 80 60 40 20 400 200 0.5 0.5 0.3 0.3 0.2 184.3 178.8 186.0 188.4 (Times) 1.2 1.0 0.8 0.6 0.4 0.2 (Billions of yen) 250 209.7 200 150 100 50 2008 2009 2010 2011 2012 0 0 2008 2009 2010 2011 2012 0 0 2008 2009 2010 2011 2012 Cash Dividends (Left) Payout Ratio (Right) Net Worth (Left) DER* (Right) *DER (Debt to Equity Ratio)=Interest-bearing debt ÷ Equity, excluding minority interests and stock acquisition rights Capital Expenditures and Depreciation and Amortization R&D Expenses and Percentage of Net Sales Free Cash Flow* (Billions of yen) 150 127.9 128.1 (Billions of yen) 120 119.5 100 93.4 100 50 0 78.4 76.1 2008 2009 2010 2011 2012 *Free cash flow = Net cash provided by operating activities + Net cash used in investing activities 80 60 40 20 0 87.5 84.8 81.4 79.8 49.0 44.6 44.9 49.1 47.2 2008 2009 2010 2011 2012 Capital Expenditures Depreciation and Amortization (Billions of yen) 50 45.1 46.1 44.9 45.5 (%) 8 48.2 40 30 20 10 0 6 4 2 0 3.4 3.6 3.8 3.8 4.0 2008 2009 2010 2011 2012 R&D Expenses (Left) Percentage of Net Sales (Right) Kao Annual Report 2012 3 Segment Information Net Sales (Billions of yen) 1,500 1,318.5 1,276.3 Operating Income (Billions of yen) 120 116.3 104.6 108.6 (Years ended March 31) 1,184.4 1,186.8 1,216.1 96.8 94.0 1,000 500 0 2008 2009 2010 2011 2012 80 40 0 2008 2009 2010 2011 2012 (cid:129) (cid:129) Figures are rounded to the nearest whole number or decimal. Figures in the graph represent net sales to outside customers only. Beauty Care Business Human Health Care Business Fabric and Home Care Business Chemical Business Business Segment Sales (Year ended March 31, 2012) Chemical Business Breakdown by Region Japan Asia North America Europe Eliminations (Billions of yen) 210.8 125.5 89.2 35.9 55.7 (95.5) Chemical Business Oleo chemicals Performance chemicals Specialty chemicals ¥ ¥210.8 billion 17.3% Consumer Products Business Breakdown by Region Japan Asia & Oceania North America Europe Eliminations (Billions of yen) 1,005.3 832.3 87.4 49.6 61.5 (25.5) Beauty Care Business Prestige cosmetics Premium skin care products Premium hair care products Consolidated Net Sales ¥1,216.1 billion ¥537.9 billion 44.2% ¥285.6 billion 23.5% Fabric and Home Care Business Fabric care products Home care products ¥181.8 billion 15.0% 15.0% Human Health Care Business Food and beverage products Sanitary products Personal health products (cid:129) (cid:129) (cid:129) (cid:129) Figures are rounded to the nearest whole number or decimal. Figures in the graph represent net sales to outside customers only. Net sales by region are classified based on the location of Kao Group companies. Eliminations represent interregion sales. 4 Kao Annual Report 2012 Operating Income / EBITA* Operating Income Ratio (Years ended March 31) Net Sales (Billions of yen) 800 600 547.9 533.5 537.9 Beauty Care Business 400 200 0 (Billions of yen) 80 Operating Income (Left) EBITA* (Left) Operating Income Ratio (Right) 60 40 40.0 39.9 48.9 2.9 20 0.9 1.0 15.4 4.7 5.5 0 2010 2011 2012 2010 2011 2012 (Billions of yen) 300 (Billions of yen) 20 Operating Income (Left) Operating Income Ratio (Right) 200 183.2 175.8 181.8 Human Health Care Business 100 0 15.3 8.7 14.6 8.0 15 10 5 0 9.0 4.9 2010 2011 2012 2010 2011 2012 (Billions of yen) 400 (Billions of yen) 80 Operating Income (Left) Fabric and Home Care Business 300 200 100 0 276.9 279.0 285.6 60 Operating Income Ratio (Right) 60.7 59.7 55.5 30 40 21.9 21.4 19.4 20 0 2010 2011 2012 2010 2011 2012 * EBITA (Earnings before interest, taxes and amortization) is operating income before amortization of goodwill and other items related to acquisitions. (%) 5.0 4.0 3.0 2.0 1.0 0 (%) 20.0 16.0 12.0 8.0 4.0 0 (%) 40 Chemical Business (Billions of yen) 400 (Billions of yen) 40 Operating Income (Left) Operating Income Ratio (Right) 232.0 247.6 207.8 300 200 100 0 19.7 9.5 24.1 10.4 23.0 9.3 30 20 10 0 2010 2011 2012 2010 2011 2012 Note: Net sales include intersegment sales. s s e n i s u B s t c u d o r P r e m u s n o C s s e n i s u B l a c i m e h C 20 10 0 (%) 20 15 10 5 0 Kao Annual Report 2012 5 A Message from Chairman of the Board of Directors Motoki Ozaki After eight years as Kao’s president and chief executive officer, I am confident that the Company is in an excellent position to achieve profitable growth both in Japan and around the world as a result of structural evolution. Just as important, this growth will also be sustainable as a result of our commitment to reducing environmental impact and contributing to society. The market agrees, given Kao’s inclusion in socially responsible investment indexes and its selection as one of the world’s most ethical companies. Kao will continue to serve its stakeholders effectively and with integrity. 6 Kao Annual Report 2012 A key theme during my tenure as CEO was leveraging innovative technology to raise Kao’s competitive advantage in global markets and achieve profi table growth. In each of our businesses, we are using our unique capabilities and expertise to launch high-value-added products. We complemented product innovation with structural innovation and implemented a matrix management system that shifted the focus of our businesses from product categories to the consumer’s perspective. Structural reorganization has also helped Kao strategically and efficiently allocate resources to respond to changes in market structure and consumers. Integration of business operations across Asia has also supported profi table global growth. This initiative successfully enhanced communication among Asian countries to effi ciently develop high-value-added products that meet the needs of both particular countries and the broader market. We are now taking a similar approach by implementing matrix management in our North American and European operations. Over the past eight years we have deepened our commitment to the environment and in 2009 issued the Kao Environmental Statement. Our “eco together” concept is a key component of our approach, guiding us as we work together with stakeholders and consumers worldwide throughout the product lifecycle, from materials procurement and manufacturing, to distribution, sales, use and fi nal disposal. We have also maintained our longstanding emphasis on corporate social responsibility issues such as effective governance and corporate ethics. The Kao Group clarifi ed its deployment of free cash fl ow (net cash provided by operating activities plus net cash used in investing activities) during my tenure. We invested in future growth, as shown by the acquisition of Kanebo Cosmetics Inc. We also used free cash fl ow to increase cash dividends per share at a compound annual rate of nearly 7 percent over the past eight years. In addition, we reduced interest-bearing debt related to the acquisition while repurchasing shares totaling ¥135 billion. Our focus on efficiently putting our resources to work has created an organization that is well positioned to continue generating profitable growth and consistently strong shareholder returns. In my new role as Chairman of the Board of Directors, I plan to support the new company leadership and the sustainable growth of the Kao Group by focusing on corporate governance and risk management issues. Motoki Ozaki Chairman of the Board of Directors Kao Annual Report 2012 7 An Interview with New President and CEO Michitaka Sawada Michitaka Sawada President and Chief Executive Officer Michitaka Sawada joined Kao in 1981 after earning a Master of Engineering specialized in applied chemistry from Osaka University. Sawada’s career over more than thirty years in research and development at Kao spans both fundamental research and product development research, from the development of the polymer materials used in the iconic Bioré pore strips through to leadership on the re-engineering of Merries baby diapers after his appointment as Vice President of the Sanitary Products Research Laboratories in 2003. In 2006, Sawada became an Executive Officer of Kao and assumed broader responsibility across the entire R&D Division. He was the fi rst to lead the Human Health Care R&D Center following its establishment in 2007 and quickly progressed to appointment to the Board of Directors in 2008. Recognition of Sawada’s significant achievements in leading R&D teams in diverse fields, as well as his dynamism, energy and wide-ranging insights on global growth, all contributed to his appointment as Representative Director, President and Chief Executive Officer of Kao on June 28, 2012. Sawada has been an active member of the Japan Chief Technology Officer Forum, Japan Management Association and the Japan Association for Chemical Innovation, where he has contributed to the development of industry policies and strategies. He was recently appointed as Vice Chairman of the Japan Soap and Detergent Association, a leading industry body. Sawada was born on December 20, 1955 in Osaka Prefecture, Japan. He and his wife have two daughters. LEADERSHIP 8 Kao Annual Report 2012 CONTINUOUS INNOVATION What is your core theme for the Kao Group as you lead it into the future? “Yoki-Monozukuri” is one of the Kao Group’s core concepts. We defi ne it as “a strong commitment by all members to provide products and brands of excellent value for consumer satisfaction.” But this concept is not simply about producing high quality products – it also encompasses our commitment to enriching people’s lives, reducing environmental impact and resolving social issues arising from changing lifestyles. That requires fresh ideas and the will to make them realities, which is why we need innovation. But not just innovation. We need “continuous innovation.” The Kao Group is an exciting place because of its positive, innovative corporate culture, and I am proud that I have helped keep this spirit burning brightly. My career has focused on research and development, so I have seen fi rsthand that continuous innovation drives profi table growth. This concept of continuous innovation starts with breakthrough innovation; we need great new ideas for products that cause creative destruction. This kind of innovation changes the game. With its proven innovative capabilities, the Kao Group can take the lead in the markets that emerge. But we cannot stop there; we must follow up with step-by-step innovation. By this I mean a series of small but significant steps that keep The Key to Strategic Success Continuous innovation is the key, and has two phases: Breakthrough innovation: great new ideas for products that cause creative destruction Step-by-step innovation: a series of small but significant steps that keep our brands fresh in the marketplace The Kao Group’s Mid-Term Growth Strategies Use the Kao Group’s innovative technology to raise its competitive advantage in the global market and achieve profitable growth Consumer Products Business Further reinforcement of business in Japan, the Kao Group’s profit base Accelerated globalization Mature markets: Achieve further growth driven by high-value-added products Growth markets: Invest management resources to strengthen focal strategic brands Establish corporate identity Chemical Business Rapid progress toward an eco-chemical business Kao Annual Report 2012 9 our brands fresh in the marketplace. This involves incremental additions to value over time. After all, a product is not innovative if nobody uses it, and we are not in the business of creating fads. This cycle is essential for Kao. For example, we created the compact detergent market in Japan with breakthrough innovation, and have been the leader in this market for 25 years using step-by-step innovation. Kao is serious about nurturing its product concepts over the long term. Continuous innovation adapts products and approaches to evolving market and consumer needs, so that our innovative products remain relevant and at the forefront of consumer consciousness. It means constant improvement of what we make and do. And it requires persistence – we cannot afford to become complacent. We must continuously come up with new ideas that maintain our product leadership as competitors will inevitably try to replicate our innovations. I also want to make the most of our organizational strengths while making sure that we are not doing research for its own sake, but research that is creating value. That is how we will meet challenges successfully to keep sales and earnings on an upward vector over the medium and long term. VALUE How is Kao responding to the increasing maturity of the Japanese market? The Kao Group adapts. We remain open to new ideas as our markets change. This is what sustains us as we turn challenges like market maturity into opportunities. We absolutely want to create value that consumers appreciate. As markets in Japan have matured, we have expanded the spectrum of value we offer through our products. We have always focused on functional value, creating products that consumers love because they work really well and make life better. Then we complemented the focus on functional value by emphasizing emotional value, such as more appealing fragrances and enhanced look and feel. Going forward, we also intend to strengthen our offering in terms of social value. This involves effectively meeting needs and wants in a social context, such as employing universal design to enhance ease of use for seniors, or making our offerings even more environmentally responsible. Our concept of continuous innovation is key to leveraging the maturity 10 Kao Annual Report 2012 of the market in order to sustain profitable growth in Japan. We are innovating every day and looking for additional opportunities to evolve beyond providing products alone to include suites of products and services that offer functional, emotional and social value, such as a health solution business that focuses on prevention and improvement of health issues for an aging society. In the future, the Kao Group will consider how to apply the know-how gained through this business in markets outside Japan. GLOBAL Japan is a large market for the Kao Group, while some countries outside Japan are growth drivers. How will you build the Kao Group’s global business? Overseas markets present many opportunities for global expansion. This is particularly true for growth markets with large populations such as China and Indonesia, which we see as fundamental to our future. Previously, we targeted upper-tier consumers with premium products in these markets, but now we are adding a strong emphasis on volume zones – categories with sizable markets such as laundry detergents, sanitary products and diapers targeting mid-tier consumers. We intend to make use of another Kao Group strength: our ability to deliver volume zone products that consistently connect with consumers because they are easy to understand and meet clearly identified needs. As in the premium products market, we need to be known as an innovative company through continuous innovation in volume zones. We are competing against huge global companies, and will not succeed if we use the same approaches they do. We will use consumer insights and continuous innovation to compete with truly differentiated products that are compelling, while making sure they are price competitive as well. Through this focus, we are generating meaningful results in China and elsewhere in Asia, giving us a great base for further expansion. Our initiative to integrate management of the Beauty Care Business in North America and Europe demonstrates another aspect of our approach to global expansion. Not simply an exercise in integration to raise efficiency, this is the next stage of our strategy for ultimately creating a strong, unified business worldwide through global integrated management of the Consumer Products Business. Kao Annual Report 2012 11 PRESENCE The Kao Group’s global identity is a strategic asset. How will you build it? I think of our global identity in terms of the word “presence.” Our presence is our standing among consumers, communities and other stakeholders. It means awareness of the Kao Group, its brands and its commitment to enriching lives, in harmony with nature. Our presence is the result of everything we do and achieve. We want markets to know and respect the Kao Group, because that drives profitable growth and creates a virtuous cycle in which earnings growth funds the innovation that supports more earnings growth. We want society to know and respect the Kao Group for its contribution as a corporate citizen, because that makes our employees and the communities we serve proud of the Kao Group. The key to building our presence will be to constantly renew ourselves as we embrace a commitment to change. Employees must have the desire to take on the challenges of innovation, and the courage to be creative. Enhancing our presence involves thinking about markets in which we have the best opportunities to sweep away the conventional and lead with the new. It also means continuous innovation that incrementally strengthens our brands and our ability to contribute to communities. Sustainability is a core Kao Group management focus. How is sustainability related to the overall objectives of the Kao Group? The Kao Group has embedded sustainability in its management, and we are deploying our unique ability to innovate to address environmental awareness. We have to be environmentally responsible in Japan and overseas. Companies that fail to do that will not succeed. They will simply become irrelevant. Our concept of Yoki-Monozukuri certainly includes ecologically conscious products, and was a core rationale for founding the Eco-Technology Research Center. It is a unique expression of what differentiates the Kao Group, a place where we are using eco-innovation research to link product creation and use to environmental responsibility. Continuous innovation drives sustainability. It drove the development of our “eco together” environmental statement, in which we work with consumers, business partners and society to reduce environmental impact throughout the entire product lifecycle. It drives our commitment to eco- innovation, which has resulted in products such as the Neo fabric care 12 Kao Annual Report 2012 series that conserves water, electricity and resources, as well as innovations that help us use less water in our operations. It also supports our drive to develop eco-chemical products for global markets. Since 2005, we have been participating in the United Nations Global Compact, a strategic policy initiative for businesses that are committed to aligning their operations and strategies with ten universally accepted principles in the areas of environment, human rights, labor and anti- corruption. We have also demonstrated our global commitment to social and environmental issues in ways such as participating in the Round Table on Sustainable Palm Oil since September 2010. Sustainability will certainly remain central to Kao Group management worldwide. How will the Kao Group continue to generate solid shareholder returns? Kao Corporation has raised dividends for 22 consecutive years and has repurchased nearly 138 million shares since 1999, and I will maintain this clear and consistent commitment to shareholder returns. How? The short answer is profitable growth. The Kao Group is focusing on effective use of free cash flow and other fundamentals that drive value and enable shareholder satisfaction, because we contribute to society and make ourselves an attractive investment when we grow profitably. We will maintain our emphasis on deploying free cash flow toward reinvesting earnings in capital expenditures, mergers and acquisitions that support profitable global growth. Use of Free Cash Flow* 1. Capital expenditures and M&A for future growth 2. Steady and continuous cash dividends Year ended March 31, 2012 Cash dividends per share: ¥60.00 59.7% Payout ratio: 3. Share repurchases and repayment of interest-bearing debt including borrowings t includi t including borrowings rest bearing debt * Free cash flow = Net cash provided by operating activities + Net cash used in investing activities We see that as a win-win approach that benefits the Kao Group and its stakeholders. I expect continuous innovation to ensure that Kao Corporation generates attractive returns for shareholders while upholding the ethical and community principles that are the basis for the Kao Group’s strong stakeholder support. Michitaka Sawada President and Chief Exective Officer Kao Annual Report 2012 13 Kao at a Glance Beauty Care Business Human Health Care Business Fabric and Home Care Business Chemical Business s s e n i s u B s t c u d o r P r e m u s n o C s s e n i s u B l a c i m e h C 14 Kao Annual Report 2012 Business Overview In order to allow all consumers to achieve their own unique beauty with leading technologies, the Kao Group offers a wide range of products including prestige cosmetics, premium skin care products such as facial and body cleansers, and premium hair care products such as shampoos and conditioners. The Kao Group offers products that help consumers live healthily and comfortably, including sanitary products created using proprietary technologies, functional health beverages that offer new performance values, and other products such as bath additives and toothpaste. The Kao Group offers products designed for quality, functionality, and ease of use in order to help consumers enjoy a clean, comfortable lifestyle, including fabric care products such as laundry detergents and fabric treatments, as well as dishwashing detergents, kitchen cleaners and other home care products. The Kao Group’s Chemical Business offers customers worldwide a range of chemical products designed to meet the diverse needs of global industry, including oleo chemicals manufactured from natural oil and fat raw materials, surfactants, toners and toner binders, and fragrances and aroma chemicals. Representative Products Mid-Term Strategies Accelerate growth through integrated global business operations. Attain profitable growth utilizing value- added technologies in targeted market segments. Achieve top-line growth in facial and body cleanser categories through differentiation in quality and cost. Promote expansion of sanitary products in Asia based on recognition of Japanese quality. In Japan, work to add value to existing products in response to market changes and create new markets. In Japan, further promote “eco together” with the growth of Attack Neo, which is effective even in small amounts and can conserve water and electricity as a single-rinse detergent. In China and other Asian countries where the liquid laundry detergent market is expanding, launch, nurture and strengthen new products with Kao’s unique technology to meet local needs and surpass market growth. Expand sales and develop markets in BRICs and other growing markets. Promote greater added value with a focus on ecology. Kao Annual Report 2012 15 Beauty Care Business Global Integrated Management Originally introduced as a facial cleanser, Bioré has established a solid position in the Japanese market as a leading brand in the Kao Group’s premium skin care portfolio. Since the start of our global expansion in 1982, Bioré products have been tailored to local markets, but the brand is now undergoing worldwide renewal driven by the Kao Group’s exclusive new Skin Purifying Technology. Feature: Innovation That Satisfies To succeed globally, it is important to pair technologies that are applicable worldwide with local insight to understand the different needs and characteristics of each market and respond appropriately. Moreover, to ensure that we fully convey the unique value of Bioré in markets around the world, the Kao Group is conducting strong rollouts at the local level with a thorough understanding of the needs of the target demographics in each country, based on the brand guidelines that support global development. The Kao Group is constantly exploring new science and technologies to create valuable products and offer them to consumers around the world. We seek to enhance our brand value with an approach that pairs a global perspective for developing world- class technology with local insights to tailor products to each market. Here we highlight some of our initiatives. 16 Kao Annual Report 2012 Cleansing ingredients (aggregation) Bioré Skin Care Facial Foam, which presented the concept of “cleansing skin care” to the market, uses the Kao Group’s Skin Purifying Technology to gently remove dirt and excess oil that can irritate the skin, leaving it feeling smooth. Skin We intend to enhance the brand value of Bioré by returning to the basics, centered on world-class cleansing technology. The various markets around the world differ in terms of consumer needs and competitive landscapes. In order for Bioré to build a strong global presence, the Kao Group must focus on its core value of “clean, healthy beautiful skin.” We have returned to the basics to better define Bioré’s strengths around its cleansing ability, and now we plan to begin our new offerings with facial cleanser, the product that best represents these core values. Our technology is what makes this possible. Even though the facial cleanser market is maturing, I believe that by adding new value to our products, we can further increase consumer satisfaction in every market. Global Rollout of New Bioré Taiwan United States Satoru Tanaka President, Premium Skin Care Business Group, Beauty Care Business Unit Bioré is a top-ranking brand in Taiwan. A high level of satisfaction with the facial cleanser, the core driver of Kao USA Inc. (formerly Kao Brands Company) launched the Bioré Restage Project in 2010 and set out to the brand’s image, can be expected to carry over to the restructure its brand strategy. To gain an advantage makeup remover and body cleanser lines as well. That in the highly competitive U.S. facial cleanser market, is why this is a critically important item. In restaging the the company identified the need to rethink its target facial cleanser with the introduction of Skin Purifying demographic, and decided to focus on women in their Technology in 2012, Kao (Taiwan) Corporation conducted twenties because of their outstanding brand loyalty. extensive surveys of consumers in their homes, and used these findings to effectively spotlight Bioré’s Based on extensive surveys of this target demographic, the company is carrying out a advanced functional value and to enhance its established communications strategy centered on digital marketing. brand image. Kao Annual Report 2012 17 Human Health Care Business Meeting Local Consumer Needs Laurier products are sold in nine countries and regions in Asia, and the Kao Group aims to make it Asia’s leading sanitary napkin brand. With the development and introduction of a groundbreaking new surface material, the Kao Group repositioned the brand and, in 2010, began a series of launches in Asia, where it has gained strong support from local women. By both strengthening standard global product functions with innovative technology and introducing products developed from a consumer- driven perspective in each local market, the Kao Group aims to be the closest to Asian consumers. Product Development Aimed at Creating a “Next-Generation Sanitary Napkin” Laurier has won steady support in the growing Asian market for feminine hygiene products, including the top market share in Singapore. However, with competition increasing, the Kao Group is targeting younger consumers by highlighting the functional and emotional appeal of Laurier, which uses a new surface material developed for superior absorbency, as a “next-generation sanitary napkin.” Taiwan Thailand “Magnetic Absorbency” is the Brand-Building Catch Phrase In Taiwan, aggressive promotion of the comfort and other features of Laurier Super Slim Guard in magazines and online has established a solid position for it as a high-value- added product. In August 2011, we launched the renewed Laurier Super Slim Guard with a new surface material, and created the catch phrase “magnetic absorbency” to evoke the product’s originality and unrivaled absorbency. As a result, it is gaining strong support from women in the target segment. Dealing with Two Different Markets In the sanitary napkin market in Thailand, it is necessary to win share in two different markets: urban areas, where the hypermarkets of global retailers and convenience stores are the dominant sales channels, and rural areas, where traditional outlets such as long- established family-run shops are prevalent. When we introduced the new product with stronger absorbency using a new surface material, we devised and aggressively implemented effective marketing strategies for each of these two markets. Innovation is the Key to Winning the Top Share In sales promotions for Laurier Soft & Safe, a brisk-selling new thin-type product, we focused on television commercials. Employing a well-known actress to increase trust, the commercials were designed based on extensive surveys of consumers’ real-life experiences to gain insight into their needs and help them identify with the product. For Laurier Super Slim Guard, on the other hand, we highlighted the product’s absorbency to appeal to active career women, and sales have been strong. We realize the importance of listening to consumers and constantly innovating. Kanwara Chingchit Category Manager, Marketing, Consumer Business, Kao Commercial Thailand Co., Ltd. 18 Kao Annual Report 2012 Fabric and Home Care Business Offering Eco-Innovation This year marks the 25th anniversary of the 1987 debut of Attack, the world’s fi rst compact laundry detergent. In 2009, after two years of development aimed at making single-rinse laundering possible, the Kao Group launched Attack Neo, which reduces washing time and saves water and electricity. The same technology used in Attack Neo was applied in Attack Instant Clean Liquid detergent, which was launched in China in 2010. Simultaneously Reducing Environmental Impact and Benefiting Consumers In developing Attack Neo, the Kao Group sought to create a product that was not just “eco-friendly” but would also use environmental technology to benefit consumers. Efforts focused on the water used in laundering. The toilet, bathing, cooking and laundry account for about 90 percent of daily water use in the average household. Researchers therefore looked to find a way to save water by making single-rinse laundering possible, and succeeded in developing a surfactant with strong cleaning performance and excellent rinsing properties. At the same time, the product was made much more concentrated, resulting in the creation of Attack Neo, a completely new, ultra-concentrated liquid detergent. The technology of Attack Neo has also been applied in China and Australia to create products tailored to laundry habits in those countries. Creating New Value with Attack Instant Clean Liquid When we were developing Attack Instant Clean Liquid detergent, which was launched in September 2010, we surveyed 850 average households in Chinese urban areas (Shanghai and Beijing) to see how they do their laundry. We found that most people use a combination of machine washing and hand washing, and that roughly 80 percent of the water used in laundering is consumed in rinsing. That led us to focus on the need for efficient rinsing, just as the Kao Group did in Japan. Through joint development with the Japanese team, we came up with a product that offers high cleaning performance and easy rinsing, both by machine and by hand washing, and also helps to reduce water consumption. From left: Wen Limeng, Ji Kan and Zhu Ye Research and development staff at Kao (China) Research & Development Center Co., Ltd. Kao Annual Report 2012 19 Chemical Business Rapid Progress toward an Eco-Chemical Business The Kao Group is taking steps to provide new value to customers while reducing its environmental footprint. The Eco-Technology Research Center, a base for development of next-generation environmental technologies, started operation in June 2011. With this new facility, the Kao Group will accelerate ecology- centered management by further blending technologies and exercising its creativity. Development of Toner and Toner Binder with Low-Temperature Fusing Eco-Innovation Research Laboratories The Eco-Innovation Research Laboratories established in the Eco-Technology Research Center centralizes research on the environment, which was previously dispersed across the organization. It will play a leading role in realizing Kao’s vision of ecology-centered management in actual development and manufacturing. The Kao Group has been providing toner and toner binder for laser printers and copiers globally since 1980. Looking for a way to reduce energy consumption, we focused on polyester resin ahead of our competitors. This led to the development of a product that easily fuses to paper even at low temperatures, enabling sharp printing quality. Today, the Kao Group accounts for more than 30 percent of the world’s total annual production volume of toner binder. In addition, our low-temperature fusing toner binder substantially reduces the impact on the environment, and lowering the fusing temperature by 10°C is expected to reduce CO2 emissions by approximately 10 percent. The Kao Group is further improving its toner binder to enable fusing at temperatures 30°C lower than conventional toner binders. Promoting Innovation by Blending Technologies from Different Fields In eco-innovation research, we have constructively integrated the various eco-research functions of the Kao Group’s research and development division. Our intention is to be a professional research institute that competes on the global stage by developing next- generation technologies around the theme of sustainability. We are aiming to develop environmental management indexes that will determine how good each product is for the environment as a whole, rather than determining whether or not a product is environmentally-conscious based solely on greenhouse gas emissions or water usage. We hope that the new technologies we create will contribute to the advancement of the Kao Group’s ecology-centered management and to a sustainable society. Naoki Katada Vice President, Eco-Innovation Research Laboratories 20 Kao Annual Report 2012 Kao’s Management Framework Directors, Corporate Auditors and Executive Officers Corporate Governance Compliance 22 24 26 Kao Annual Report 2012 21 Directors, Corporate Auditors and Executive Officers (As of June 28, 2012) Board of Directors * Holds the post of Executive Officer concurrently ** Outside Director Motoki Ozaki Michitaka Sawada* Hiroshi Kanda* Chairman of the Board of Directors President, The Kao Foundation for Arts and Sciences Representative Director Representative Director Tatsuo Takahashi* Representative Director Toshihide Saito* Ken Hashimoto* Hisao Mitsui* Teruhiko Ikeda** Advisor, Mizuho Trust & Banking Co., Ltd. Takuma Otoshi** Sonosuke Kadonaga** Senior Advisor, IBM Japan, Ltd. President, Intrinsics 22 Kao Annual Report 2012 Corporate Auditors *** Outside Corporate Auditor Masanori Sunaga Takayuki Ishige Full-time Corporate Auditor Full-time Corporate Auditor Tadashi Oe*** Corporate Auditor, Attorney-at-Law Teruo Suzuki*** Corporate Auditor, Certified Public Accountant Executive Officers Michitaka Sawada President and Chief Executive Officer Hiroshi Kanda Senior Managing Executive Officer President, Consumer Products, Global Responsible for Corporate Communications, and Kao Professional Services Co., Ltd. Tatsuo Takahashi Senior Managing Executive Officer Representative Director, President and Chief Executive Officer, Kao Customer Marketing Co., Ltd. Toshiharu Numata Senior Managing Executive Officer Masumi Natsusaka Managing Executive Officer Representative Director, President, Kanebo Cosmetics Inc. President, Beauty Care Business Unit, Global Katsuhiko Yoshida Managing Executive Officer President, Fabric and Home Care Business Unit, Global President, Consumer Products, Asia (except China) Yoshinori Takema Managing Executive Officer Senior Vice President, Research and Development, Global Responsible for Product Quality Management (except Export Regulations Service) President, Consumer Products and Chemical Business, China Chairman of the Board of Directors and Chief Executive Officer, Kao (China) Holding Co., Ltd. Chairman of the Board of Directors, Kao Commercial (Shanghai) Co., Ltd. Chairman of the Board of Directors, Kanebo Cosmetics (China) Co., Ltd. Masato Hirota Senior Vice President, Media Planning and Management, Global Shinichiro Hiramine Senior Vice President, Corporate Communications, Global Toshihide Saito Managing Executive Officer Shigeru Koshiba Vice President, Corporate Strategy, Global Shoji Kobayashi President, Chemical Business Unit, Global Chairman of the Board of Directors, Pilipinas Kao, Incorporated Chairman of the Board of Directors, Fatty Chemical (Malaysia) Sdn. Bhd. Chairman of the Board of Directors, Kao Chemicals Europe, S.L. Takuji Yasukawa President, Human Health Care Business Unit - Food and Beverage Business, Global Senior Vice President, Human Capital Development, Global Senior Vice President, Corporate Strategy, Global Responsible for Legal and Compliance Chairman of the Board of Directors, Kao USA Inc. President, Kao Group Corporate Pension Fund President, Kao Health Insurance Ken Hashimoto Managing Executive Officer Senior Vice President, Procurement, Global Responsible for Accounting and Finance, Information Systems and EVA Promotion Hisao Mitsui Managing Executive Officer Senior Vice President, Production and Engineering, Global Senior Vice President, Environment and Safety Management, Global Responsible for Chemical Business Unit, Logistics, and TCR Promotion Naohisa Kure Vice President, Research and Development – Beauty Care, Global Akira Yoshimatsu Vice President, Research and Development, Global Vice President, Research and Development - Fabric and Home Care, Global Vice President, Research and Development - Chemical, Global Hideko Aoki Senior Vice President, Product Quality Management, Global Minoru Utsumi Vice President, Production and Engineering - Beauty Care Supply Chain Management, Global Vice President, Supply Chain Management Strategy and Planning, Global Vice President, Plant Management, Tokyo Plant Yoshimichi Saita President, Human Health Care Business Unit, Global Muneki Hirao Vice President, Production and Engineering - Chemical Supply Chain Management, Global Vice President, Plant Management, Wakayama Plant Motohiro Morimura Vice President, Production and Engineering - Fabric and Home Care Supply Chain Management, Global Vice President, Plant Management, Wakayama Plant Kenji Miyawaki Senior Vice President, Marketing Research and Development, Global Kazuyoshi Aoki Senior Vice President, Accounting and Finance, Global Yasushi Aoki Senior Vice President, Human Resources and Administration, Kanebo Cosmetics Inc. Tadaaki Sugiyama Senior Vice President, Legal and Compliance, Global William J. Gentner Vice President, Corporate Strategy, Global President, Consumer Products, Americas and EMEA Toshiaki Takeuchi Representative Director, Senior Managing Executive Officer, Kao Customer Marketing Co., Ltd. Kao Annual Report 2012 23 Corporate Governance Kao considers corporate governance to be a key management task. The Company’s basic approach to corporate governance is to maintain the management structure and internal control system necessary to realize highly effi cient, sound and transparent management, with the aim of continuously increasing corporate value. Corporate Governance Structure Kao has introduced, within the framework of the Board of Directors, including Outside Directors, and the Board of Corporate Auditors including Outside Corporate Auditors, an Executive Officer system to separate supervision from execution. Following the conclusion of the Annual General Meeting of Shareholders and the subsequent meeting of the Board of Directors in June 2012, Kao has as part of continuing corporate governance improvements increased the number of Outside Directors from two to three, reduced the number of members of the Board of Directors from fifteen to ten (including the Chairman, who does not have executive authority), and reinforced the organization of Executive Officers by increasing the number from twenty-six to twenty-eight and by establishing four new Executive Officer positions, titled Senior Managing Executive Officer or Managing Executive Officer, without concurrent positions in the Board of Directors. Furthermore, Kao has four Corporate Auditors, including two Outside Corporate Auditors. All Outside Directors and Outside Corporate Auditors maintain their neutrality and independence from the Company’s management. Kao has established the Compensation Advisory Committee and the Committee for the Examination of the Nominees for the Chairman of the Board of Directors and the President, which fulfill functions similar to the compensation committee and nominating committee of a “company with committees.” In June 2011, a meeting of the Compensation Advisory Committee was held with all Outside Directors in attendance. It reported to the Board of Directors meeting in the same month its evaluation that the current compensation system and level of compensation for Members of the Board and Executive Officers were appropriate. Also, prior to the appointment of the Chairman and the President following the election of Members of the Board at the Annual General Meeting of Shareholders in June 2012, a meeting of the Committee for the Examination of the Nominees for the Chairman of the Board of Directors and the President was held by all Outside Directors and Outside Corporate Auditors. The committee subsequently submitted to the Board its opinion that each candidate was qualified and appropriate. In order to improve the effectiveness of audits and strengthen auditing functions, the four Corporate Auditors, including the two Outside Corporate Auditors, exchange opinions with Representative Directors on regularly scheduled occasions, attend meetings of the Board of Directors and Management Committee as well as other important meetings, and participate in regular conferences by corporate auditors of domestic Kao Group companies. They also share auditing information with the internal auditing division and the Company’s accounting auditor, and conduct interviews of internal divisions and subsidiaries regularly or as necessary. Functions of Committees Compensation Advisory Committee This committee is composed of all Representative Directors, the Chairman of the Board of Directors and all Outside Directors. The Committee meets at least once a year during the compensation review period for Members of the Board and Executive Officers. At this meeting, the committee obtains and examines opinions on the compensation system and the level of compensation for the Members of the Board and Executive Officers. The results of that examination are reported at a meeting of the Board of Directors. Committee for the Examination of the Nominees for the Chairman of the Board of Directors and the President Composed of all Outside Directors and all Outside Corporate Auditors, this committee examines the nominees prior to the appointment or reappointment of the Chairman of the Board of Directors and/or the President, and submits its evaluation of the nominees’ qualifications to the Board of Directors. Ensuring the Independence of Outside Directors/Corporate Auditors In February 2010, Kao established and announced the Standards for Independence of Outside Directors/Corporate Auditors of Kao Corporation. All of the current Outside Directors and Outside Corporate Auditors meet these standards, and are registered with the Tokyo Stock Exchange as independent directors/corporate auditors. Outside Directors are expected to utilize their considerable experience and expertise as managers or people of relevant knowledge and experience to fulfill a checking function from a neutral position, independent of the Company’s management, to ensure that management decisions of the Company are not disproportionately biased by the views of Company insiders. In addition, the Company believes that thorough discussion at Board of Directors meetings is vital to corporate governance. Therefore, the Secretariat of the Board of Directors provides Outside Directors with adequate explanations of the background, purpose and content of agenda items prior to each meeting of the Board of Directors. Furthermore, administrative divisions such as Global Accounting and Finance, Global Internal Audit and Global Legal and Compliance are available to assist Outside Corporate Auditors at the Outside Corporate Auditors’ request. The average attendance rate of Outside Directors and Outside Corporate Auditors at the 14 Board of Directors meetings held in the fiscal year ended March 31, 2012 was 92.9 percent and 92.9 percent, respectively. The average attendance rate of Outside Corporate Auditors at the 7 Corporate Auditors meetings during the same period was 92.9 percent. 24 Kao Annual Report 2012 Internal Control System and Risk Management System Internal Control System Kao formulated its Policies regarding the Development of the Internal Control System in May 2006, and revises them as necessary after confirming the level of compliance each year. In accordance with these policies, the Internal Control Committee, chaired by the Representative Director, President and Chief Executive Officer of Kao, discusses and determines plans for the maintenance and operation of the internal control system. The committee also evaluates these plans on a regular basis and makes improvements as necessary. Six committees have been placed under the Internal Control Committee. Each of these subcommittees assesses the state of internal controls and makes improvements as Risk Management Among the various risks related to overall business activities, risks related to management strategies that affect business opportunities are evaluated by the relevant divisions and countermeasures are developed. When necessary, the Management Committee and Board of Directors check and oversee these countermeasures. Management of operational risks is based on the order of priority specified in the Kao Risk Management Policy (1. Protection of human life; 2. Environmental conservation; 3. Continuation of operations; and 4. Protection of assets). The Risk Management Committee, chaired by the Member of the Board in charge of risk management, needed by employing the PDCA (Plan, Do, Check and Act) cycle. The subcommittees have begun activities for global management integration in their respective business areas. Six Committees under the Internal Control Committee: Number of Times Convened during the Year Ended March 31, 2012 Disclosure Committee Compliance Committee Information Security Committee Risk Management Committee Committee for Responsible Care Promotion Quality Assurance Committee 6 times 2 times 8 times 12 times 2 times 4 times promotes risk management throughout the Company. In the event of a serious crisis, a task force headed by the Representative Director, President & CEO is set up to respond to the situation. Objectives of Activities to Properly Manage Risk 1. Identify at the global level risks that could affect 1. Identify at the global level risks that could affect Yoki-Monozukuri and the continuation of Yoki-Monozukuri and the continuation of operations, and strengthen countermeasures operations, and strengthen countermeasures i 2. Strengthen the emergency response system 2. Strengthen the emergency response system 3. Maintain and enhance the business continuity plan (BCP) 3. Maintain and enhance the business continuity plan (BCP) Measures to Maintain and Enhance the Business Continuity Plan Some of the Kao Group’s manufacturing, research, distribution and sales bases were damaged to a greater or lesser extent in the Great East Japan Earthquake, but the Group pulled together to restore normal operations to fulfill its mission as a manufacturer of daily necessities. We are reflecting the issues brought to light on that occasion in our business continuity plan (BCP) and other aspects of our operations. For procurement of raw materials, the Kao Group is purchasing from multiple vendors and standardizing specifications to enable flexible purchasing according to conditions. To strengthen our manufacturing system, we have taken measures such as seismic strengthening and liquefaction countermeasures to make factories more disaster resistant. In addition, we are restructuring our manufacturing bases from a global perspective to accommodate priority products. Another new issue we are aware of is the possibility that an earthquake with an epicenter in Tokyo or other disaster could damage the head office and interrupt its functions. Therefore, we are studying how to maintain head office functions by considering duty assignments and ways of continuing operations under emergency conditions. In 2012, we will work to establish a stronger business continuity framework by swiftly dealing with the issues we have been studying in order to improve the effectiveness of the BCP. Kao Annual Report 2012 25 Compliance Measures to Promote and Establish Compliance The principle of integrity, passed down from Kao’s founder, and revision of Kao’s Business Conduct Guidelines (BCG), is a core value of the Company’s corporate philosophy, The (2) implementation of educational activities to promote each Kao Way. Integrity means behaving lawfully and ethically employee’s understanding of the BCG (employees sign an and conducting fair and honest business activities. Kao acknowledgement of their understanding), and (3) regards integrity as the starting point of compliance and a establishment and operation of compliance hotlines to resolve guiding principle to follow so that it may continue to earn employees’ questions and give them support to take the respect and trust of all stakeholders. responsible action in a timely and appropriate manner. To practice integrity in our daily business activities, we Compliance-related activities are conducted throughout the have defined three compliance priorities: (1) establishment entire Kao Group, primarily through the Compliance Committee. Main Activities in the Year Ended March 31, 2012 (cid:129) Revised BCG and conducted e-learning in domestic Kao Group companies and annual review (cid:129) Conducted Integrity Workshops (total number of attendees from October 1, 2008 to March 31, 2012): Asia/Oceania North America and Europe Japan Total 4 times / 110 people 192 times / 4,520 people 62 times / 1,262 people 258 times / 5,892 people (cid:129) Established and began operation of compliance hotlines for reporting and consultation (cid:129) Conducted regular monitoring: Annual departmental self- assessment, supplier satisfaction survey, and self-check during training Note: Besides the Integrity Workshops, Kao has conducted other BCG seminars since 2003 and has secured acknowledgements of understanding from all employees of domestic Kao Group companies. Kao Named One of the World’s Most Ethical Companies for Sixth Consecutive Year In March 2011, Kao was named one of the World’s Most Ethical Companies 2012 by Ethisphere Institute, a U.S. think tank. Since the first listing in 2007, Kao is the only Japanese company, and also the only consumer products company and chemical company in the world to be included in the list for six consecutive years. This year’s record number of surveyed companies came from over 100 countries, and 145 companies from more than 36 industries made the list. Companies are evaluated in five categories: Ethics and Compliance Program; Reputation, Leadership and Innovation; Corporate Citizenship and Responsibility; Governance; and Culture of Ethics. Among these categories, Kao received particular recognition for its measures to promote ethics and compliance. These include establishing and revising the BCG, conducting Integrity Workshops to instill a commitment to integrity in all Kao Group employees, and setting up hotlines at all Kao Group companies for employees to report or consult on possible legal or ethical violations. The hotlines resolve employees’ questions and give them support to take responsible action. In addition to these measures, Kao also received praise for enhancing environmental initiatives under its policy of ecology-centered management, including the June 2011 opening of a new research facility, the Eco-Technology Research Center. Further information is available on the Kao CSR webpage at http://www.kao.com/jp/en/corp_csr/csr.html 26 Kao Annual Report 2012 Financial Section 11-Year Summary Management Discussion and Analysis Consolidated Financial Statements 28 30 40 Notes to Consolidated Financial Statements 46 Independent Auditor’s Report 67 Kao Annual Report 2012 27 11-Year Summary Kao Corporation and Consolidated Subsidiaries Years ended March 31 For the year: Net sales ................................................................ Segments Millions of yen 2012 2011 2010 2009 ¥1,216,096 ¥1,186,831 ¥1,184,385 ¥1,276,316 Beauty Care Business ..................................... Human Health Care Business .......................... Fabric and Home Care Business ...................... Consumer Products Business ...................... Chemical Business .......................................... Eliminations ..................................................... 537,938 181,758 285,645 1,005,341 247,635 (36,880) Former Segments Consumer Products ......................................... Prestige Cosmetics ......................................... Chemical Products .......................................... Eliminations ..................................................... Region Japan .............................................................. Asia and Oceania ............................................. North America ................................................. Europe ............................................................ Eliminations ..................................................... Operating income .................................................. Net income ............................................................ Capital expenditures .............................................. Depreciation and amortization ................................ Cash flows ............................................................. Research and development expenditures............... (% of sales) ............................................................ Advertising expenditures ....................................... (% of sales) ............................................................ At year-end: Total assets ........................................................... Net worth .............................................................. — — — — 925,339 173,588 85,397 117,005 (85,233) 108,590 52,435 47,178 79,798 101,960 48,171 4.0% 82,209 6.8% 991,272 538,029 533,514 175,761 279,008 988,283 231,997 (33,449) — — — — 912,443 152,361 80,328 112,123 (70,424) 104,591 46,738 49,101 81,380 97,028 45,516 3.8% 81,082 6.8% 547,944 183,151 276,918 1,008,013 207,834 (31,462) 588,330 191,319 274,202 1,053,851 262,058 (39,593) — — — — 918,499 131,699 79,200 111,158 (56,171) 94,034 40,507 44,868 84,778 95,269 44,911 3.8% 86,359 7.3% — — — — 953,369 161,927 98,999 140,623 (78,602) 96,800 64,463 44,624 87,463 122,441 46,126 3.6% 90,258 7.1% 1,022,799 528,895 1,065,751 565,133 1,119,676 545,230 Number of employees............................................ 34,069 34,743 34,913 33,745 Per share: Net income ............................................................ Cash dividends ....................................................... Net worth .............................................................. Weighted average number of shares Yen ¥ 100.46 60.00 1,031.08 ¥ 87.69 58.00 1,013.05 ¥ 75.57 57.00 1,054.31 ¥ 120.25 56.00 1,017.19 outstanding during the period (in thousands) ........ 521,936 532,980 536,009 536,085 Key financial ratios: Return on sales ...................................................... Return on equity .................................................... Net worth ratio ....................................................... % 4.3% 9.8 54.3 3.9% 8.5 51.7 3.4% 7.3 53.0 5.1% 11.5 48.7 Notes: 1. Kao reorganized its operations effective April 2007 by integrating the former consumer products business and prestige cosmetics business into the Consumer Products Business, which is divided into three businesses (the Beauty Care Business, the Human Health Care Business and the Fabric and Home Care Business). Together with the Chemical Business, Kao’s business operations now consist of four segments. Figures for 2007 have been restated to reflect the change. 2. Net sales by segment include intersegment sales. Under the former segments, net sales of Chemical Products include intersegment sales to Consumer Products and Prestige Cosmetics. Under the current segments, net sales of the Chemical Business include intersegment sales to the Beauty Care Business, the Human Health Care Business and the Fabric and Home Care Business. 3. Kanebo Cosmetics Inc. and its consolidated subsidiaries are included in the consolidated statements of income from the year ended March 31, 2007, and in the consolidated balance sheets as of March 31, 2006. The results of Kanebo Cosmetics Inc., which had a fiscal year ended December 31, are included for the eleven months starting in February 2006, after the company was added to the Kao Group. 28 Kao Annual Report 2012 2008 2007 2006 2005 2004 2003 2002 ¥1,318,514 ¥1,231,808 ¥ 971,230 ¥936,851 ¥902,628 ¥865,247 ¥839,026 627,914 191,300 274,657 1,093,871 258,674 (34,031) 584,284 183,608 269,519 1,037,411 223,609 (29,212) — — — — 968,594 158,295 111,017 154,648 (74,040) 116,253 66,562 49,045 93,444 131,114 45,070 3.4% 99,176 7.5% 744,748 292,663 223,609 (29,212) 924,196 125,989 106,731 135,918 (61,026) 120,858 70,528 70,143 92,171 134,906 44,389 3.6% 96,892 7.9% — — — — — — 704,034 85,247 208,890 (26,941) 708,056 110,898 95,168 109,486 (52,378) 120,135 71,140 203,595 60,758 107,943 40,262 4.1% 83,770 8.6% 1,232,601 574,038 1,247,797 564,532 1,220,564 509,676 32,900 32,175 29,908 ¥ 122.53 54.00 1,070.67 ¥ 129.41 52.00 1,035.66 ¥130.58 50.00 935.11 — — — — — — 690,007 78,294 196,989 (28,439) 703,085 100,282 83,638 93,804 (43,958) 121,379 72,180 54,318 56,794 109,704 39,764 4.2% 84,157 9.0% 688,974 448,249 19,143 ¥131.16 38.00 821.47 — — — — — — 670,438 77,648 181,621 (27,079) 673,657 101,452 79,907 84,899 (37,287) 119,706 65,359 51,823 58,166 106,430 38,506 4.3% 82,773 9.2% 723,891 427,757 19,330 ¥119.06 32.00 782.14 — — — — — — 646,413 75,833 170,935 (27,934) 654,595 101,555 75,796 67,845 (34,544) 114,915 62,462 84,544 58,310 104,436 37,713 4.4% 74,277 8.6% 720,849 417,031 19,807 ¥108.05 30.00 744.56 — — — — — — 626,047 74,176 162,802 (23,999) 648,188 93,499 70,274 57,625 (30,560) 111,728 60,275 49,537 58,484 103,657 37,543 4.5% 66,069 7.9% 772,145 459,731 19,923 ¥100.43 26.00 779.44 543,228 544,996 544,127 549,626 547,865 576,770 600,150 5.0% 11.7 46.6 5.7% 13.1 45.2 7.3% 14.9 41.8 7.7% 16.5 65.1 7.2% 15.5 59.1 7.2% 14.2 57.9 7.2% 13.1 59.5 4. Net sales by region including interregion sales are classified based on the location of Kao Group companies. 5. Cash flows are defined as net income plus depreciation and amortization minus cash dividends. 6. Net income per share is computed based on the weighted average number of shares outstanding during the respective years. From the year ended March 31, 2003, the portion of net income unavailable to common shareholders, such as preferred dividends, which should be included in the appropriation of retained earnings, is deducted from net income for the calculation of net income per share. The same method is applied to the calculation of net worth per share. 7. Cash dividends per share are the amounts applicable to the respective years, including dividends to be paid after the end of the year. 8. Net worth is equity, excluding minority interests and stock acquisition rights. 9. In calculating return on equity, equity excludes minority interests and stock acquisition rights. Kao Annual Report 2012 29 Management Discussion and Analysis Overview of Consolidated Results As a result, net sales increased 2.5 percent compared with the previous fiscal year to ¥1,216.1 billion (US$14,796.2 During the fiscal year ended March 31, 2012, the global million). Excluding the effect of currency translation, net sales economy recovered overall, albeit weakly, despite the impact would have increased 4.0 percent. In the Beauty Care of the European financial crisis. In Asia, economic expansion Business, sales of prestige cosmetics grew in Japan, and continued, but at a slower pace. In Japan, there were signs of premium hair care products performed well outside Japan. a gradual recovery, although conditions remained severe due Sales increased in the Human Health Care Business and the to the effects of the Great East Japan Earthquake (the Fabric and Home Care Business. In the Chemical Business, “Earthquake”) in March 2011 as well as deflation and the sales outside Japan increased as the Kao Group adjusted its appreciation of the yen. The household and personal care selling prices in response to fluctuations in raw material prices. products market in Japan, a key market for the Kao Group, Operating income increased 3.8 percent compared with the contracted 1 percent on a value basis as consumer purchase previous fiscal year to ¥108.6 billion (US$1,321.2 million) and net prices fell compared with the previous fiscal year with the income increased 12.2 percent to ¥52.4 billion (US$638.0 million). purchasing behavior of budget-strapped consumers. The cosmetics market in Japan continued to contract due to a shift in consumer preference to lower-priced products. * The Kao Group defines “Yoki-Monozukuri” as a strong commitment by all members to provide products and brands of excellent value for consumer satisfaction. In Japanese, “Yoki” literally means “good/excellent,” and “Monozukuri” means “development/manufacturing of products.” Under these circumstances, the Kao Group made all-out Analysis of Income Statements efforts to ensure a stable supply of products after the Earthquake as the mission of a manufacturer of daily Net Sales and Operating Income necessities, and worked to launch and nurture products with Net sales increased 2.5 percent compared with the previous high added value based on its concept of Yoki-Monozukuri.* fiscal year to ¥1,216.1 billion (US$14,796.2 million). Excluding In addition, while aggressively investing for growth, including the effect of currency translation, net sales would have the completion of the Eco-Technology Research Center, which increased 4.0 percent. In the Beauty Care Business, sales of centralizes environmental research functions to accelerate prestige cosmetics expanded in Japan, while sales of eco-innovation research, the Kao Group also worked to rebuild premium hair care products were strong overseas. Sales also its prestige cosmetics business in Japan and promote cost increased in the Human Health Care Business and the Fabric reduction measures. and Home Care Business. In the Chemical Business, the Kao Net Sales / Gross Profit Ratio Net Sales (Left) Gross Profit Ratio (Right) Operating Income / Operating Income Ratio Operating Income (Left) Operating Income Ratio (Right) (Billions of yen) 1,500 1,318.5 1,276.3 1,184.4 1,186.8 1,216.1 1,000 58.0 56.2 58.4 58.0 56.8 500 0 2008 2009 2010 (Years ended March 31) 2011 2012 30 Kao Annual Report 2012 (%) 100 (Billions of yen) 150 (%) 20 80 60 40 20 0 116.3 8.8 2008 100 50 0 96.8 7.6 94.0 7.9 104.6 108.6 15 8.8 8.9 10 5 0 2012 2009 2010 (Years ended March 31) 2011 Costs, Expenses and Income as Percentages of Net Sales Years ended March 31, Cost of sales .................................................................................. 2012 43.2% 2011 42.0% Gross profit .................................................................................... 56.8 (–1.2) 58.0 (– 0.4) Selling, general and administrative expenses .............................................................. 47.9 (–1.3) 49.2 (– 1.3) Operating income .......................................................................... 8.9 (+0.1) 8.8 (+0.9) Income before income taxes and minority interests .................................................................. Net income .................................................................................... 8.7 (+0.6) 4.3 (+0.4) 8.1 (+1.1) 3.9 (+0.5) Note: Figures in parentheses represent changes in percentage points from the previous year. 2010 41.6% 58.4 50.5 7.9 7.0 3.4 Group adjusted selling prices in response to changes in raw In addition, loss related to the Earthquake decreased to ¥2.0 material prices, resulting in sales growth overseas. billion from ¥4.1 billion in the previous fiscal year, and the Prices of raw materials increased due to volatility in market effect of application of the accounting standard for asset prices, mainly of natural oils and fats and petrochemicals. retirement obligations, which totaled ¥1.6 billion in the However, in addition to the effect on profits of increased previous fiscal year, was absent in the fiscal year. sales, the Kao Group continued its efforts to reduce costs and As a result, income before income taxes and minority cut back expenses. As a result, operating income increased interests increased from ¥96.0 billion in the previous fiscal ¥4.0 billion from ¥104.6 billion in the previous fiscal year to year to ¥105.3 billion (US$1,280.7 million). Total income taxes ¥108.6 billion (US$1,321.2 million). increased from ¥48.2 billion in the previous fiscal year to ¥50.8 billion (US$617.8 million). The income tax rate after Other Expenses and Net Income application of tax effect accounting was 48.2 percent, a Net other expenses were ¥3.3 billion (US$40.5 million), decrease from 50.2 percent in the previous fiscal year. compared with net other expenses of ¥8.6 billion in the Net income increased ¥5.7 billion from ¥46.7 billion in the previous fiscal year. Interest expense decreased as the Kao previous fiscal year to ¥52.4 billion (US$638.0 million). Net Group refinanced debt and redeemed bonds, and foreign income per share was ¥100.46 (US$1.22), an increase of currency exchange loss decreased because the appreciation ¥12.77, or 14.6 percent, from ¥87.69 in the previous fiscal year. of the yen eased in comparison with the previous fiscal year. Net Income / Return on Sales (Billions of yen) 80 66.6 64.5 Net Income (Left) Return on Sales (Right) (%) 15 60 40 20 0 46.7 40.5 52.4 10 5.0 5.1 3.4 3.9 4.3 2008 2009 2010 (Years ended March 31) 2011 2012 5 0 Kao Annual Report 2012 31 Information by Segment Consumer Products Business (US$1,041.3 million). Although there was an impact from Sales increased 1.7 percent compared with the previous fiscal higher raw material prices, the Kao Group curtailed expenses Operating income increased ¥5.1 billion to ¥85.6 billion year to ¥1,005.3 billion (US$12,231.9 million). Excluding the effect and took steps to reduce costs. of currency translation, sales would have increased 2.8 percent. In Japan, sales increased 1.8 percent to ¥832.3 billion Beauty Care Business (US$10,126.2 million). Although sales were impacted by the Sales increased 0.8 percent compared with the previous fiscal Earthquake, intensified market competition and deflation, the year to ¥537.9 billion (US$6,545.1 million). Excluding the effect of Kao Group took measures including proposing environmentally currency translation, sales would have increased 2.4 percent. conscious products, launching new products in response to Sales of prestige cosmetics, which consist of self-selection changing consumer lifestyles and enhancing proposal-based and counseling cosmetics, increased 2.2 percent to ¥260.0 sales and in-store merchandising activities. billion (US$3,163.2 million) with the launch of new products, In Asia and Oceania, sales increased 6.6 percent to ¥87.4 although the downtrend continued in Japan’s cosmetics market billion (US$1,063.8 million). Excluding the effect of currency with the impact of the Earthquake in addition to the shift in translation, sales would have increased 11.8 percent. Although consumer preference toward lower-priced products. In Japan, market competition intensified, the Kao Group carried out the Kao Group launched new products and enhanced in-store aggressive measures including collaborations with retailers and merchandising for self-selection brands such as KATE makeup introduction of new products amid continued market growth. and EVITA total cosmetics. In counseling cosmetics, the Kao In North America, sales decreased 2.7 percent to ¥49.6 Group nurtured and strengthened its megabrands with annual billion (US$603.9 million). Excluding the effect of currency sales of more than ¥10 billion, including making improvements to translation, sales would have increased 6.6 percent. The the BLANCHIR SUPERIOR whitening skin care and SOFINA market was firm, and new products contributed to sales, but beauté skin care brands, and adding a new product line for the appreciation of the yen exerted an impact on results. SOFINA Primavista base makeup. In addition, the Kao Group In Europe, sales increased 1.3 percent to ¥61.5 billion carried out reform of sales methods including optimization of (US$748.4 million). Excluding the effect of currency marketing activities and counseling in response to changes in translation, sales would have increased 5.1 percent. The consumer needs and increased its share in a contracting market. market recovered, albeit gradually, and new products launched Sales outside Japan expanded steadily. in 2010 performed well. Consumer Products Business Net Sales / Operating Income (Billions of yen) 1,093.9 1,053.9 96.5 1,200 1,000 800 600 400 200 0 32 Kao Annual Report 2012 32 Kao Annual Report 2012 Net Sales (Left) Operating Income (Right) Beauty Care Business Net Sales / Operating Income (Billions of yen) 150 (Billions of yen) 750 Net Sales (Left) Operating Income (Right) (Billions of yen) 50 1,008.0 988.3 1,005.3 627.9 588.3 547.9 533.5 537.9 79.6 74.4 80.5 85.6 100 500 27.3 50 0 2012 250 17.6 4.7 5.5 0 2008 2009 2010 (Years ended March 31) 2011 15.4 2012 2008 2009 2010 (Years ended March 31) 2011 40 30 20 10 0 Sales of premium skin care products grew in Japan as the Kao Human Health Care Business Group launched products from the Bioré facial cleanser and Bioré U Sales increased 3.4 percent compared with the previous fiscal body cleanser brands that use new cleansing technology (Skin year to ¥181.8 billion (US$2,211.4 million). Excluding the effect of Purifying Technology) to wash away dirt with the least possible currency translation, sales would have increased 4.0 percent. damage to the skin, and continued to make proposals for dry and In food and beverage products, the Healthya brand of sensitive skin with the Curél brand. Sales in Asia increased, with functional drinks that promote body fat utilization gained support product improvements contributing to strong performance by from consumers and sales were firm. Bioré in Hong Kong, Taiwan and Indonesia. In North America, Sales of sanitary products were essentially flat compared Jergens performed well in the hand and body lotion category. with the previous fiscal year. Sales of sanitary napkins grew Sales of premium hair care products decreased in Japan. steadily in Japan, aided by the launch of improved Laurier F, and Sales of Merit shampoo and conditioner were steady, but sales also increased in Asian countries. Sales of baby diapers were of hair coloring products were weak due to market contraction impacted by market contraction and competition in Japan, and intensifying competition. Sales in Asia increased, with although market share grew. In Taiwan, China and Russia, baby strong performance by Liese foam hair color in Hong Kong, diapers performed strongly. Taiwan and Thailand. In North America and Europe, strong sales Sales of personal health products increased, as toothpastes of foam hair color, hair styling products and other new John Frieda and Bub bath additives performed well. products drove substantial sales growth. Operating income decreased ¥0.7 billion to ¥14.6 billion Operating income increased ¥9.9 billion to ¥15.4 billion (US$178.0 million) with the impact of increased raw material (US$187.5 million) due to ongoing efforts to rebuild the prestige prices and market competition, despite the Kao Group’s cost cosmetics business in Japan and other factors, even though the reduction activities in addition to the impact of increased sales. Kao Group invested aggressively in advertising expenses for new products in North America and Europe. Operating income before Fabric and Home Care Business amortization of goodwill and other items related to acquisitions Sales increased 2.4 percent compared with the previous fiscal (EBITA) increased ¥9.0 billion to ¥48.9 billion (US$594.9 million), year to ¥285.6 billion (US$3,475.4 million). Excluding the effect which is equivalent to 9.1 percent of sales. of currency translation, sales would have increased 2.9 percent. Sales of fabric care products increased. In Japan, the Kao Group worked to highlight the reduced laundry time and Human Health Care Business Net Sales / Operating Income Net Sales (Left) Operating Income (Right) Fabric and Home Care Business Net Sales / Operating Income Net Sales (Left) Operating Income (Right) (Billions of yen) 191.3 200 191.3 183.2 175.8 (Billions of yen) 20 181.8 (Billions of yen) 300 274.7 274.2 276.9 279.0 (Billions of yen) 80 285.6 150 100 50 0 15.3 14.6 13.2 13.0 9.0 2008 2009 2010 (Years ended March 31) 2011 2012 16 12 8 4 0 200 100 0 56.1 49.1 60.7 59.7 55.5 2008 2009 2010 (Years ended March 31) 2011 2012 60 40 20 0 Kao Annual Report 2012 33 Kao Annual Report 2012 33 environmental appeal of conserving water, electricity and increased 10.0 percent. resources with the Neo series, and strengthened the product In oleo chemicals, the Kao Group made efforts to adjust line by additionally launching Attack Neo Antibacterial EX selling prices in response to fluctuations in prices of natural Power ultra-concentrated liquid laundry detergent, which oils and fats and petrochemicals. In performance chemicals, suppresses odor-causing bacteria in laundry. Wide Haiter EX the Kao Group worked to develop and expand sales of high- Power fabric bleach for color garments and new Flair value-added products with reduced environmental impact. Fragrance fabric softener performed strongly. In Asia, Sales of specialty chemicals, primarily toner and toner binder consumer support led to increased sales of Attack Instant for copiers and printers, were firm. Clean Liquid laundry detergent in China and Attack Easy Operating income decreased ¥1.1 billion to ¥23.0 billion laundry detergent in Indonesia and other countries. (US$279.9 million) due to the impact of the appreciation of the In home care products in Japan, there was a steady increase yen and decreased demand from customer industries, despite in sales of CuCute dishwashing detergent, Toilet Quickle efforts to adjust selling prices and cost reduction activities. cleaning wipes, Quickle Wiper dust mop kits following a product renewal, and Resesh Aroma Charge fabric and air freshener. Financial Structure Operating income decreased ¥4.1 billion to ¥55.5 billion (US$675.8 million) with the impact of increased raw material Total assets decreased ¥31.5 billion from the previous fiscal prices, although the Kao Group conducted cost reduction year-end to ¥991.3 billion (US$12,060.7 million). The principal activities and other measures. increases in assets were a ¥20.1 billion increase in notes and accounts receivable – trade, an ¥11.8 billion increase in short- Chemical Business term investments and a ¥9.2 billion increase in finished In the Chemical Business, while sales in Japan were affected goods. The principal decreases in assets were a ¥25.3 billion by decreased demand in customer industries due to the decrease in cash and time deposits, an ¥11.5 billion decrease Earthquake, the appreciation of the yen, flooding in Thailand in short-term and long-term deferred tax assets, and a ¥35.5 and other factors, sales grew substantially outside Japan. As a billion decrease in intangible assets due to the progress of result, sales increased 6.7 percent compared with the amortization of trademarks and other intellectual property previous fiscal year to ¥247.6 billion (US$3,013.0 million). rights and goodwill. Excluding the effect of currency translation, sales would have Total liabilities decreased ¥41.7 billion from the previous Chemical Business Net Sales / Operating Income (Billions of yen) 300 258.7 262.1 Net Sales (Left) Operating Income (Right) Total Assets / Net Worth* Total Assets Net Worth (Billions of yen) 40 (Billions of yen) 1,500 247.6 232.0 207.8 24.1 23.0 200 100 0 19.7 19.7 17.2 2008 2009 Note: Net sales include intersegment sales. 2010 2011 2012 (Years ended March 31) 34 Kao Annual Report 2012 30 20 10 0 1,000 500 0 1,232.6 1,119.7 1,065.8 1,022.8 991.3 574.0 545.2 565.1 528.9 538.0 2008 2009 2010 2011 2012 * Net worth is equity, excluding minority interests and stock acquisition rights. (As of March 31) fiscal year-end to ¥441.6 billion (US$5,372.5 million). The income before income taxes and minority interests of ¥105.3 principal increase in liabilities was a ¥5.9 billion increase in billion (US$1,280.7 million), depreciation and amortization of notes and accounts payable – trade. The principal decrease in ¥79.8 billion (US$970.9 million) and change in trade payables liabilities was a ¥50.0 billion decrease in the current portion of of ¥9.0 billion (US$109.5 million). The principal decreases long-term debt due to redemption of bonds. were income taxes paid of ¥38.3 billion (US$466.5 million), Total equity increased ¥10.1 billion from the previous fiscal change in trade receivables of ¥26.5 billion (US$322.6 million) year-end to ¥549.7 billion (US$6,688.2 million). The principal and change in inventories of ¥14.9 billion (US$181.7 million). increase in equity was net income totaling ¥52.4 billion. The principal decreases in equity were a ¥30.3 billion decrease Cash Flows from Investing Activities due to recognition of cash dividends and an ¥11.7 billion Net cash used in investing activities totaled ¥49.0 billion change in foreign currency translation adjustments. In May (US$595.6 million). This primarily consisted of purchase of 2011, Kao Corporation retired 13.9 million shares of treasury property, plant and equipment of ¥41.7 billion. stock worth ¥32.5 billion. As a result, the net worth ratio, defined as net worth Cash Flows from Financing Activities divided by total assets, was 54.3 percent, compared with 51.7 Net cash used in financing activities totaled ¥86.2 billion percent at the end of the previous fiscal year. (US$1,048.3 million). This primarily consisted of ¥50.0 billion Cash Flows for redemption of bonds and ¥30.8 billion for payments of cash dividends, including to minority shareholders. Taking advantage of low market interest rates, the Kao Group also The balance of cash and cash equivalents at March 31, 2012 refinanced ¥20.0 billion in long-term debt in September 2011 decreased ¥13.4 billion compared with the end of the and used refinancing to shift ¥30.0 billion in current portion of previous fiscal year to ¥129.7 billion (US$1,578.5 million). long-term debt into long-term debt in March 2012. Cash Flows from Operating Activities Net cash provided by operating activities totaled ¥125.0 billion (US$1,521.3 million), compared with ¥151.3 billion in the previous fiscal year. The principal increases in net cash were Cash Flows*/ Capital Expenditures (Billions of yen) 200 Cash Flows Capital Expenditures Cash Dividends / Payout Ratio Cash Dividends (Left) Payout Ratio (Right) (Yen) 60 54.00 56.00 57.00 58.00 60.00 (%) 100 150 100 50 0 131.1 122.4 95.3 97.0 102.0 49.0 44.6 44.9 49.1 47.2 2008 2009 2010 2011 2012 * Cash flows are defined as net income plus depreciation and amortization minus cash dividends. (Years ended March 31) 40 20 0 75.4 66.1 59.7 44.1 46.6 2008 2009 2010 (Years ended March 31) 2011 2012 75 50 25 0 Kao Annual Report 2012 35 Planned Change in Fiscal Year End Corporation plans to pay total cash dividends of ¥62.00 per share, an increase of ¥2.00 per share compared with the Due to a planned change in the fiscal year end from March 31 previous fiscal year. Although consolidated group companies to December 31, the fiscal year ending December 31, 2012 with a fiscal year end in March will only report a nine-month will be the nine-month period from April through December period due to the change in the fiscal year end, this plan is in for Kao Corporation and its subsidiaries with a fiscal year end accordance with the Company’s basic policies regarding in March, and the twelve-month period from January through distribution of profits, and free cash flow and other factors December for subsidiaries with a fiscal year end in December. have also been taken into consideration. As a result, the projected consolidated payout ratio will be 53.9 percent. Basic Policies Regarding Distribution of Profits and Dividends for the Period EVA In order to achieve profitable growth, Kao Corporation secures Economic Value Added (EVA®) is the Kao Group’s main an internal reserve for capital investment and acquisitions management metric, defined as net operating profit after tax from a medium-to-long-term management perspective and (NOPAT) less a charge for the cost of invested capital in the places priority on providing shareholders with steady and business. We believe EVA indicates “true” profit. Continuously continuous dividends. In addition, the Company flexibly increasing EVA raises corporate value, which is consistent considers the repurchase and retirement of shares from the with the long-term interest of not only shareholders but other standpoint of improving capital efficiency. stakeholders as well. The Kao Group aims to conduct In accordance with these policies, and in light of the business activities that expand the scale of its business while increase in net income compared with the previous fiscal also increasing EVA, and uses EVA for business performance year, Kao Corporation announced a year-end dividend for the evaluation, performance-based compensation and strategic fiscal year ended March 31, 2012 of ¥31.00 (US$0.38) per decision-making. During the fiscal year ended March 31, 2012, share, an increase of ¥2.00 per share from the previous due to an increase in NOPAT and a decrease in invested fiscal year. Consequently, cash dividends for the fiscal year capital, EVA increased to 106 from 95 for the previous fiscal increased ¥2.00 per share compared with the previous fiscal year, expressed as an index with the year ended March 31, year, resulting in a total of ¥60.00 (US$0.73) per share and a 2000 as 100. The Kao Group conducted the following EVA- consolidated payout ratio of 59.7 percent. related activities during the fiscal year. For the fiscal year ending December 31, 2012, Kao EVA* (EVA for the the year ended March 31, 2000 = 100) (Billions of yen) 154 163 142 132 134 125 113 120 100 106 95 91 67 200 150 100 50 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 *EVA (Economic Value Added) is a registered trademark of Stewart & Co. 36 Kao Annual Report 2012 Investing for Growth: During the fiscal year ended March 31, market conditions. During the fiscal year, the Kao Group 2012, the Kao Group invested aggressively for future growth. In redeemed bonds totaling ¥50.0 billion (US$608.3 million). The the growth market of China, a new factory is under construction Kao Group also took advantage of low market interest rates to and is scheduled to begin production of baby diapers at the end refinance ¥50.0 billion (US$608.3 million) in debt. of December 2012. To raise its competitiveness in global * Free cash flow: Net cash provided by operating activities + Net cash used in investing activities markets and achieve profitable growth, the Kao Group built the Eco-Technology Research Center in Wakayama, Japan, which started operation in June 2011. This centralizes and combines the Kao Group’s environmental research functions and accelerates the development of next-generation environmental technologies, particularly eco-innovation research and technologies, in order to embody ecology-centered management in the development and manufacture of products. Research and development expenditures, which increased ¥2.7 billion compared with the previous fiscal year to ¥48.2 billion (US$586.1 million), were the equivalent of 4.0 percent of net sales, compared with 3.8 percent in the previous fiscal year. Increasing Profit: During the fiscal year ended March 31, 2012, NOPAT increased due to an increase in sales volume from strong performance by the Chemical Business outside Japan and steady results from rebuilding the prestige cosmetics business in Japan. Moreover, ongoing total cost reduction activities cut costs by ¥9.0 billion year on year. Business Risks and Other Risks Various risks arise in the course of a company’s business. The Kao Group takes reasonable measures to mitigate risks by preventing the occurrence of, diversifying and hedging them. However, unanticipated situations may occur that exert a significant impact on the Kao Group’s business results and financial condition. The risks described below are not a comprehensive list of risks the Kao Group faces. Other risks exist and may have an impact on investment decisions. Any statements below concerning the future are judgments made by Kao Corporation as of the submission of its securities report to the Ministry of Finance on June 28, 2012. (1) Market and Consumer Demand The Japanese consumer products market, the foundation of the Kao Group’s operations, has been sluggish in recent years, due to economic stagnation as well as changes in the Kao Financial Improvement: Free cash flow* totaled ¥76.1 billion Group’s customer base as a consequence of the declining birth (US$925.7 million) for the year ended March 31, 2011, a rate and aging society. Utilizing the changes in the values of its decrease of ¥43.4 billion compared with the previous fiscal customer base, the Kao Group aims to respond to consumers’ year due to an increase in capital expenditures and an needs by applying its comprehensive Yoki-Monozukuri (see increase in notes and accounts receivable because the fiscal note on page 30) capabilities and working to develop value- year end was on a weekend. The Kao Group has set priorities added products to maintain and improve its brand values. for how it will deploy this free cash flow. Investments for However, a number of factors could cause uncertainties in the mergers and acquisitions and additional capital expenditures Kao Group’s business activities, delaying an adequate response for future growth are the top priorities in deploying free cash to these changes. This could have a gradual impact on the Kao flow, followed by stable and continuous dividends. Kao Group’s business results and financial condition. Corporation increased cash dividends per share for the fiscal year by ¥2.00 to ¥60.00 (US$0.73) for the 22nd consecutive (2) Prestige Cosmetics Business year of growth in cash dividends. Moreover, the Kao Group The Kao Group operates the prestige cosmetics business, uses the remaining free cash flow for the repurchase of where it is difficult to attain significant results using the shares as a payout measure and for repayment of interest- business model it has developed to date, due to intensifying bearing debt, considering its investment plans and financial competition in Japan and overseas from competitors in the Kao Annual Report 2012 37 same industries and the entrance of new companies from However, results may not meet the initial intentions due to other industries, as well as changes in consumer purchasing reasons including a lack of consumer acceptance of new attitudes accompanied by substantial changes in retail products’ environmental technologies or a lack of distinct channels. The Kao Group is rebuilding its prestige cosmetics advantage over other companies’ products. This could have an business in Japan through initiatives including brand and impact on the Kao Group’s business results and financial marketing reform. However, a delay in appropriate response condition. could have an impact on the Kao Group’s business results and financial condition. (6) Raw Material Prices Market prices for fats and oils used as raw materials for (3) Distributors and Retailers products of the Kao Group and petroleum-related raw The Kao Group is highly dependent on the Japanese market. materials may change for various reasons including Particularly in the consumer products business in Japan, the geopolitical risks, the balance between supply and demand, progress of new groups of retailers due to merger and abnormal weather and exchange rate fluctuations. The Kao integration, changes in sales channels and the appearance of Group has moved to reduce the effect of increases in raw new distributors in response to changes in consumer activity material prices through measures including cost reductions could affect the Kao Group’s sales activities. The Kao Group is and passing on increases in raw material costs into product offering proposals and conducting activities that correspond to prices. However, unexpectedly radical changes in market these changes in the retail environment. Nevertheless, a delay conditions and pricing could have an impact on the Kao in appropriate response could have an impact on the Kao Group’s business results and financial condition. Group’s business results and financial condition. (7) Product Quality (4) Overseas Operations The Kao Group designs and manufactures products from the As one of its growth strategies, the Kao Group is conducting viewpoint of consumers, in compliance with related laws and operations in markets in Asia, North America and Europe, with regulations and voluntary standards. In the development a particular emphasis on strengthening its operations in stage prior to market launch, the Kao Group conducts countries where higher economic growth rates and market thorough safety testing and survey research to confirm the expansion are forecast. However, in the course of business, safety of products. After market launch, the Kao Group works factors such as competition, pricing, cost management, to further improve quality by incorporating the opinions and distribution, and relationships with vendors may not go as desires of consumers through its consumer communication planned. This could have an impact on the Kao Group’s centers. However, the unanticipated occurrence of a serious business results and financial condition. quality problem or concerns about product safety or reliability resulting from new scientific knowledge would not only cause (5) Environmental Activities difficulties for the relevant brand, but would also have a major The Kao Group works for both business growth and “eco- impact on the reputation of all of the Kao Group’s products. innovation” by developing products with high environmental This could cause a decrease in sales, which could impact the value that conserve water and other resources, as well as Kao Group’s business results and financial condition. focusing on using raw materials that are low in greenhouse gas emission volumes or recyclable, conserving energy in (8) Earthquakes and Other Incidents production and distribution, and employing renewable energy, The Kao Group has implemented earthquake resistance in addition to their original product quality and performance. diagnoses, seismic retrofitting, emergency drills simulating 38 Kao Annual Report 2012 crisis situations, and systems to confirm employee safety at (10) Impairment all of its production facilities and primary offices in Japan, and The Kao Group records various tangible and intangible fixed has promoted the formulation of a business continuity plan assets and deferred tax assets including assets used in the (BCP). The Kao Group is currently planning to strengthen its course of business and goodwill incurred in corporate disaster countermeasures, including reviewing its measures acquisitions. Impairment of or increase in valuation allowance to respond to risks and reinforcing its BCP. In spite of these for these assets may be required if cash flow does not meet measures, however, in the event of an earthquake on a scale expectations due to trends in future business results, decline beyond our assumptions and the consequent damage, the in market value or other factors. This accounting treatment Kao Group’s ability to secure raw materials, maintain could have an impact on the Kao Group’s business results and production, or supply products to the market may be financial condition. disrupted, or demand trends could change significantly due to a worsening economic environment, which could have a (11) Human Resources serious impact on the Kao Group’s business results and Securing capable human resources is indispensable to achieve financial condition. Furthermore, impediments to continuing the Kao Group’s business goals. Hiring, developing and production, securing raw materials, or supplying products to retaining human resources with advanced expertise to markets due to factors including a fire or explosion at implement R&D, production of technologies, market planning production facilities, information system malfunction, and sales activities are necessary to the Yoki-Monozukuri (see problems at a supplier of raw materials, dysfunction of social note on page 30) that consumers consistently support. infrastructures such as electric power and water, However, an inability to secure superior human resources due environmental pollution from radioactive materials or other to changes in employment conditions or other factors could harmful substances, terrorism, political change, riots and have an impact on the Kao Group’s business results and other incidents could have a serious impact on the Kao financial condition. Group’s business results and financial condition. (12) Legal and Regulatory Issues (9) Currency Exchange Rate Fluctuations In the course of its business activities, the Kao Group must Foreign currency-denominated transactions are affected by comply with a variety of laws and regulations concerning changes in currency exchange rates. The Kao Group hedges areas such as standards for product quality and safety, the foreign exchange risk through various measures such as environment and chemical substances, as well as accounting settlement of transactions through foreign currency accounts, standards, tax law and regulations related to labor and foreign exchange contracts, and currency swaps to mitigate transactions. The Kao Group has constructed a compliance the effect on business results. The Kao Group does not system and strives to comply with all related laws and engage in derivative transactions for the purpose of regulations. However, a serious legal violation, change in speculation. However, items denominated in local currencies, current laws and regulations, or new laws and regulations including the sales, expenses and assets of overseas could restrict the Kao Group’s business activities, require consolidated subsidiaries, are translated into Japanese yen for investment for compliance, or otherwise affect the Kao preparation of the consolidated financial statements. If the Group. This could have an impact on the Kao Group’s business exchange rate at the time of conversion differs substantially results and financial condition. from the expected rate, the value after translation into yen will change significantly, which will have an impact on the Kao Group’s business results and financial condition. Kao Annual Report 2012 39 Consolidated Balance Sheets Kao Corporation and Consolidated Subsidiaries March 31, 2012 and 2011 Assets Current assets: Cash and time deposits (Notes 3 and 16) .................................................. Short-term investments (Notes 3, 4 and 16) .............................................. Notes and accounts receivable (Note 16): Trade (Note 5) ........................................................................................ Nonconsolidated subsidiaries and affiliates ............................................ Other ...................................................................................................... Inventories: Finished goods ....................................................................................... Work in process and raw materials ........................................................ Deferred tax assets (Note 6) ...................................................................... Other current assets .................................................................................. Allowance for doubtful receivables (Note 16) ............................................. Total current assets ............................................................................ Millions of yen 2012 2011 Thousands of U.S. dollars (Note 2) 2012 ¥ 85,483 48,798 ¥ 110,762 37,028 $ 1,040,066 593,722 140,352 3,349 2,670 82,393 38,313 17,736 14,970 (1,115) 432,949 120,297 1,610 3,066 73,190 36,148 21,854 13,959 (1,081) 416,833 1 1,707,653 2,912 40,747 6,101 32,486 82,581 1,002,470 42,4,170 466,151 22,3,222 215,793 15,905 182,138 (2,36) (13,566) 4351,025 5,267,660 6887 788,369 330 3,931,585 775 8,440,905 —18 145,200 9,,880 122,996 1,190 13,429,055 (83) (10,501,959) 234 2,927,096 Property, plant and equipment (Note 5): Land........................................................................................................... Buildings and structures ............................................................................ Machinery, equipment and other ............................................................... Lease assets .............................................................................................. Construction in progress ............................................................................ Total .................................................................................................... Accumulated depreciation ......................................................................... Net property, plant and equipment ..................................................... 64,796 323,137 693,758 11,934 10,109 1,103,734 (863,156) 240,578 62,873 321,040 694,261 12,147 8,321 1,098,642 (853,918) 244,724 Intangible assets: Goodwill .................................................................................................... Trademarks ................................................................................................ Other intangible assets .............................................................................. Total intangible assets ........................................................................ 165,614 53,583 18,266 237,463 179,225 71,176 22,557 272,958 2387 2,015,014 1255 651,941 375 222,241 4047 2,889,196 Investments and other assets: Investment securities (Notes 4 and 16) ..................................................... Investments in and advances to nonconsolidated subsidiaries and affiliates ....................................................................... Deferred tax assets (Note 6) ...................................................................... Other assets (Note 8) ................................................................................ Total investments and other assets .................................................... See Notes to Consolidated Financial Statements. 7,516 7,023 04 91,447 6,927 42,554 23,285 80,282 ¥ 991,272 5,590 49,966 25,705 88,284 ¥ 1,022,799 287 84,280 4,029 517,752 438 283,306 ,108 976,785 x8,514 $12,060,737 40 Kao Annual Report 2012 Liabilities and Equity Current liabilities: Short-term debt (Notes 5 and 16) ................................................................... Current portion of long-term debt (Notes 5 and 16) ........................................ Notes and accounts payable (Note 16): Trade ........................................................................................................... Nonconsolidated subsidiaries and affiliates ................................................. Other ........................................................................................................... Income taxes payable (Note 16) ..................................................................... Accrued expenses .......................................................................................... Liability for loss related to the Great East Japan Earthquake .......................... Other current liabilities (Notes 5 and 6) .......................................................... Total current liabilities .............................................................................. Long-term liabilities: Long-term debt (Notes 5 and 16) .................................................................... Liability for retirement benefits (Note 8) ......................................................... Other (Notes 5 and 6) ..................................................................................... Total long-term liabilities .......................................................................... Commitments and contingent liabilities (Notes 7, 9 and 17) Equity (Notes 10 and 11): Common stock: Authorized — 1,000,000,000 shares in 2012 and 2011 Issued — 526,212,501 shares in 2012 and 540,143,701 shares in 2011 .... Capital surplus ................................................................................................. Stock acquisition rights ................................................................................... Retained earnings ........................................................................................... Treasury stock, at cost Millions of yen 2012 2011 Thousands of U.S. dollars (Note 2) 2012 ¥ 2,060 811 ¥ 6,776 80,795 986 $ 25,064 28 9,867 108,081 5,493 44,778 18,306 73,388 33 21,960 274,910 106,565 45,026 15,067 166,658 102,206 5,133 43,689 18,785 68,267 2,658 19,886 348,195 77,451 42,317 15,272 135,040 668 1,315,014 33 66,833 ,251 544,811 74 222,728 8546 892,907 401 79 267,186 95 3,344,811 04 1,296,569 ,497 547,828 218 183,319 3,519 2,027,716 85,424 109,561 1,238 447,619 85,424 109,561 1,143 457,918 632 1,039,348 52 1,333,021 41 15,063 426795 5,446,149 (4,402,474 shares in 2012 and 18,063,790 shares in 2011) .......................... (9,064) (40,977) (110,281) 379) Accumulated other comprehensive income Unrealized gain on available-for-sale securities ........................................... Deferred gain (loss) on derivatives under hedge accounting ...................... Foreign currency translation adjustments ................................................... Post retirement liability adjustments for foreign consolidated subsidiaries ... Total ......................................................................................................... Minority interests ............................................................................................ Total equity .............................................................................................. See notes to consolidated financial statements. 2,283 (3) (96,094) (1,697) 539,267 10,437 549,704 ¥991,272 1,861 (2) (84,430) (461) 530,037 9,527 539,564 ¥1,022,799 387 27,777 22) (37) (77) (1,169,169) 43) (20,647) 86 6,561,224 ,714 126,986 500 6,688,210 ,514 $12,060,737 Kao Annual Report 2012 41 Consolidated Statements of Income Kao Corporation and Consolidated Subsidiaries Years ended March 31, 2012 and 2011 Millions of yen 2012 2011 Thousands of U.S. dollars (Note 2) 2012 Net sales (Note 13) ............................................................................................ ¥1,216,096 ¥1,186,831 139 $14,796,155 Cost of sales ..................................................................................................... Gross profit ..................................................................................................... Selling, general and administrative expenses (Note 14) ............................... Operating income (Note 13) ............................................................................ Other income (expenses): Interest and dividend income .......................................................................... Interest expense ............................................................................................ Foreign currency exchange gain (loss) ............................................................ Equity in earnings (losses) of nonconsolidated subsidiaries and affiliates ...... Other, net (Note 15) ........................................................................................ Other income (expenses), net ..................................................................... 525,012 691,084 582,494 108,590 1,068 (2,204) (621) 1,658 (3,233) (3,332) 498,970 687,861 583,270 104,591 990 (3,342) (2,233) 973 (4,960) (8,572) 04 6,387,784 35 8,408,371 093 7,087,164 1,321,207 12,994 2) (26,816) ) (7,555) 86 20,173 ) (39,336) (40,540) Income before income taxes and minority interests ..................................... 105,258 96,019 6,710 1,280,667 Income taxes (Note 6): Current ............................................................................................................ Deferred .......................................................................................................... Total income taxes ...................................................................................... 38,653 12,120 50,773 38,996 9,182 48,178 470,289 147,463 26,570 617,752 Income before minority interests .................................................................... 54,485 47,841 662,915 Minority interests in earnings of consolidated subsidiaries ............................ 2,050 1,103 24,942 Net income ........................................................................................................ ¥ 52,435 ¥ 46,738 $ 637,973 Per share of common stock (Notes 1.t and 18): Basic net income ............................................................................................ Diluted net income .......................................................................................... Cash dividends applicable to the year ............................................................. Yen U.S. dollars (Note 2) ¥100.46 100.43 60.00 ¥87.69 87.67 58.00 $1.22 1.22 0.73 See Notes to Consolidated Financial Statements. 42 Kao Annual Report 2012 Consolidated Statements of Comprehensive Income Kao Corporation and Consolidated Subsidiaries Years ended March 31, 2012 and 2011 Millions of yen 2012 2011 Thousands of U.S. dollars (Note 2) 2012 Income before minority interests ....................................................................... ¥ 54,485 ¥ 47,841 $ 662,915 Other comprehensive income (Note 12) Unrealized gain (loss) on available-for-sale securities ......................................... Foreign currency translation adjustments .......................................................... Share of other comprehensive income in affiliates ............................................ Post retirement liability adjustments for foreign consolidated subsidiaries ....... Total other comprehensive income ................................................................ 487 (12,169) (172) (1,236) (13,090) (480) (21,865) 77 (15) (22,283) 5,925 (148,059) (2,093) (15,038) (159,265) Comprehensive income ...................................................................................... ¥ 41,395 ¥ 25,558 $ 503,650 Comprehensive income attributable to: Shareholders of Kao Corporation ....................................................................... Minority interests ............................................................................................... ¥39,956 1,439 ¥24,853 705 $486,142 17,508 See Notes to Consolidated Financial Statements. Kao Annual Report 2012 43 Consolidated Statements of Changes in Equity Kao Corporation and Consolidated Subsidiaries Years ended March 31, 2012 and 2011 Millions of yen Thousands of U.S. dollars (Note 2) 2012 2011 2012 Millions of yen Thousands of U.S. dollars (Note 2) 2012 2011 2012 Common stock Total Balance at beginning of year ....... Net income .............................. Cash dividends ........................ Purchase of treasury stock ...... Disposal of treasury stock ....... Retirement of treasury stock ... Net change in the year ............ Balance at end of year ................. ¥530,037 52,435 (30,273) (628) 80 — (12,384) 539,267 ¥566,155 46,738 (31,090) (30,093) 91 — (21,764) 530,037 $6,448,923 637,973 (368,329) (7,641) 973 — (150,675) 6,561,224 Minority interests Balance at beginning of year ....... Net change in the year ............ Balance at end of year ................. 9,527 910 10,437 9,139 388 9,527 115,914 11,072 126,986 Total equity Balance at beginning of year ....... Net income .............................. Cash dividends ........................ Purchase of treasury stock ...... Disposal of treasury stock ....... Retirement of treasury stock ... Net change in the year ............ Balance at end of year ................ 539,564 52,435 (30,273) (628) 80 — (11,474) ¥549,704 575,294 46,738 (31,090) (30,093) 91 — (21,376) ¥539,564 6,564,837 637,973 (368,329) (7,641) 973 — (139,603) $6,688,210 Cash dividends per share .............. Yen 2012 ¥58.00 2011 ¥58.00 U.S. dollars (Note 2) 2012 $0.71 Thousands 2012 2011 2011 Outstanding number of shares of common stock Balance at beginning of year ....... Purchase of treasury stock ...... Disposal of treasury stock ....... Balance at end of year ................. 522,080 (305) 35 521,810 536,021 (13,974) 33 522,080 See Notes to Consolidated Financial Statements. Balance at beginning of year ....... Balance at end of year ................ ¥ 85,424 85,424 ¥ 85,424 85,424 $ 1,039,348 1,039,348 Capital surplus Balance at beginning of year ....... Balance at end of year ................ 109,561 109,561 109,561 109,561 1,333,021 1,333,021 Stock acquisition rights Balance at beginning of year ....... Net change in the year ............ Balance at end of year ................ Retained earnings Balance at beginning of year ....... Net income .............................. Cash dividends ........................ Disposal of treasury stock ....... Retirement of treasury stock ... Balance at end of year ................ Treasury stock, at cost Balance at beginning of year ....... Purchase of treasury stock ...... Disposal of treasury stock ....... Retirement of treasury stock ... Balance at end of year ................ Accumulated other comprehensive income Unrealized gain on available-for-sale securities 1,143 95 1,238 1,022 121 1,143 13,907 1,156 15,063 457,918 52,435 (30,273) (1) (32,460) 447,619 442,273 46,738 (31,090) (3) — 457,918 5,571,456 637,973 (368,329) (12) (394,939) 5,446,149 (40,977) (628) 81 32,460 (9,064) (10,978) (30,093) 94 — (40,977) (498,564) (7,641) 985 394,939 (110,281) Balance at beginning of year ....... Net change in the year ............ Balance at end of year ................ 1,861 422 2,283 2,292 (431) 1,861 22,643 5,134 27,777 Deferred gain (loss) on derivatives under hedge accounting Balance at beginning of year ....... Net change in the year ............ Balance at end of year ................ Foreign currency translation adjustments Balance at beginning of year ....... Net change in the year ............ Balance at end of year ................ (2) (1) (3) (0) (2) (2) (25) (12) (37) (84,430) (11,664) (96,094) (62,993) (21,437) (84,430) (1,027,254) (141,915) (1,169,169) Post retirement liability adjustments for foreign consolidated subsidiaries Balance at beginning of year ....... Net change in the year ............ Balance at end of year ................ (461) (1,236) ¥ (1,697) (446) (15) ¥ (461) (5,609) (15,038) $ (20,647) 44 Kao Annual Report 2012 Consolidated Statements of Cash Flows Kao Corporation and Consolidated Subsidiaries Years ended March 31, 2012 and 2011 Operating activities: Income before income taxes and minority interests ...................................... ¥105,258 ¥ 96,019 $ 1,280,667 Millions of yen 2012 2011 Thousands of U.S. dollars (Note 2) 2012 Adjustments for: Income taxes paid ....................................................................................... Depreciation and amortization ..................................................................... Loss on sales or disposals of property, plant and equipment, net .............. Equity in (earnings) losses of nonconsolidated subsidiaries and affiliates .. Unrealized foreign currency exchange (gain) loss ....................................... Change in trade receivables ........................................................................ Change in inventories .................................................................................. Change in prepaid pension cost .................................................................. Change in trade payables ............................................................................ Change in liability for retirement benefits ................................................... Other, net .................................................................................................... Net cash provided by operating activities ................................................ Investing activities: Purchase of property, plant and equipment .................................................... Proceeds from sales of property, plant and equipment .................................. Purchase of intangible assets ......................................................................... Proceeds from the redemption and sales of investment securities ............... Increase in investments in and advances to nonconsolidated subsidiaries and affiliates .............................................................................. Proceeds from cancellation of derivatives ...................................................... Other, net ........................................................................................................ Net cash used in investing activities ........................................................ Financing activities: Increase (decrease) in short-term debt ........................................................... Proceeds from long-term loans ....................................................................... Repayments of long-term loans ..................................................................... Redemption of bonds .................................................................................... Purchase of treasury stock ............................................................................. Payments of cash dividends ........................................................................... Other, net ........................................................................................................ Net cash used in financing activities ........................................................ Translation adjustments on cash and cash equivalents ............................... Net increase (decrease) in cash and cash equivalents .................................. Cash and cash equivalents, beginning of year (Note 3) ................................. Cash and cash equivalents of newly consolidated subsidiaries, increase .. Cash and cash equivalents, end of year (Note 3) ........................................... See Notes to Consolidated Financial Statements. (38,339) 79,798 2,202 (1,658) 159 (26,513) (14,937) 906 8,997 3,056 6,103 125,032 (41,684) 746 (3,375) 1 (1,221) — (3,419) (48,952) (4,610) 50,013 (50,012) (50,000) (10) (30,776) (768) (86,163) (3,323) (13,406) 143,143 — ¥129,737 (40,888) 81,380 1,334 (973) 455 (642) (7,566) (73) 7,794 4,596 9,863 151,299 (27,725) 2,410 (4,001) 594 (153) 4,297 (7,200) (31,778) 12 17 (24,960) — (30,093) (31,427) (872) (87,323) (6,401) 25,797 117,180 166 ¥143,143 (466,468) 970,897 26,792 (20,173) 1,935 (322,582) (181,737) 11,023 109,466 37,182 74,254 1,521,256 (507,166) 9,076 (41,063) 12 (14,856) — (41,599) (595,596) (56,089) 608,505 (608,493) (608,347) (122) (374,449) (9,344) (1,048,339) (40,431) (163,110) 1,741,611 — $ 1,578,501 Kao Annual Report 2012 45 Notes to Consolidated Financial Statements Kao Corporation and Consolidated Subsidiaries Years ended March 31, 2012 and 2011 1 Summary of Significant Accounting Policies a) Basis of presenting consolidated financial statements The accompanying consolidated financial statements have been prepared in accordance with the provisions set forth in the Japanese Financial Instruments and Exchange Law and its related accounting regulations, and in conformity with accounting principles generally accepted in Japan (“Japanese GAAP”), which are different in certain respects as to application and disclosure requirements of International Financial Reporting Standards. In preparing the consolidated financial statements, certain reclassifications and rearrangements have been made to the consolidated financial statements issued in Japan in order to present them in a form that is more familiar to readers outside Japan. Certain 2011 financial statement items were reclassified to conform to the presentation for 2012. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. b) Consolidation and accounting for investments in nonconsolidated subsidiaries and affiliates The accompanying consolidated financial statements include the accounts of Kao Corporation (the “Company”) and its significant subsidiaries (collectively, the “Companies”). Investments in most of the nonconsolidated subsidiaries and affiliates over which the Companies have the ability to exercise significant influence (mainly 20-50 percent owned companies) are accounted for using the equity method. Under the control or influence concept, companies in which the parent company and/or its consolidated subsidiaries, directly or indirectly, are able to exercise control over operations are fully consolidated, and other companies over which the Company and/or its consolidated subsidiaries have the ability to exercise significant influence are accounted for using the equity method. Investments in the remaining subsidiaries and affiliates are stated at cost except for write-downs recorded for the value of investments that have been permanently impaired. If the equity method of accounting had been applied to these investments, the effect on the accompanying consolidated financial statements would not be material. All significant intercompany balances and transactions have been eliminated in consolidation. All material unrealized profit included in assets resulting from transactions within the Companies is eliminated. The excess of cost of investments in the subsidiaries and affiliates over the fair value of the net assets of the acquired subsidiary and affiliate at the dates of acquisition, consolidation goodwill, is being amortized over an estimated period not exceeding 20 years, or 5 years in situations in which the useful lives cannot be estimated. c) Unification of accounting policies applied to foreign subsidiaries for the consolidated financial statements The accounting standard for unification of accounting policies applied to foreign subsidiaries for the consolidated financial statements requires: (1) 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, (2) financial statements prepared by foreign subsidiaries in accordance with either International Financial Reporting Standards or the generally accepted 46 Kao Annual Report 2012 accounting principles in the United States of America tentatively may be used for the consolidation process, (3) however, the following items should be adjusted in the consolidation process so that net income is accounted for in accordance with Japanese GAAP unless they are not material: 1) Amortization of goodwill 2) Scheduled amortization of actuarial gain or loss of pensions that has been directly recorded in equity 3) Expensing capitalized development costs of R&D 4) Cancellation of the fair value model accounting for property, plant, and equipment and investment properties and incorporation of the cost model accounting 5) Exclusion of minority interests from net income, if contained d) Unification of accounting policies applied to foreign affiliated companies for the equity method The accounting standard requires adjustments to be made to conform the affiliate’s accounting policies for similar transactions and events under similar circumstances to those of the parent company when the affiliate’s financial statements are used in applying the equity method unless it is impracticable to determine adjustments. In addition, financial statements prepared by foreign affiliated companies in accordance with either International Financial Reporting Standards or the generally accepted accounting principles in the United States 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: 1) Amortization of goodwill 2) Scheduled amortization of actuarial gain or loss on pensions that has been directly recorded in equity 3) Expensing capitalized development costs of R&D 4) Cancellation of the fair value model accounting for property, plant, and equipment and investment properties and incorporation of the cost model accounting 5) Exclusion of minority interests from net income, if contained e) Business combinations The accounting standard for business combinations requires companies to account for in accordance with following policies: 1) Business combinations should be accounted for by the purchase method except combinations of entities under common control and joint ventures. 2) In-process research and development (IPR&D) acquired in the business combination should be capitalized as an intangible asset. 3) The acquirer should recognize the bargain purchase gain in profit or loss immediately on the acquisition date after reassessing and confirming that all of the assets acquired and all of the liabilities assumed have been identified after a review of the procedures used in the purchase allocation. Under the accounting standard for business separations, in a business separation where the interests of the investor no longer continue and the investment is settled, the difference between the fair value of the consideration received for the transferred business and the book value of net assets transferred to the separated business is recognized as a gain or loss on business separation in the statement of income. In a business separation where the interests of the investor continue and the investment is not settled, no such gain or loss on business separation is recognized. f) Cash equivalents For purposes of the statements of cash flows, cash equivalents are short-term investments that are readily convertible into cash and that are exposed to insignificant risk of changes in value. Cash equivalents include time deposits, commercial paper, investment trusts in bonds and receivables that are represented as short-term investments, all of which mature or become due within three months of the date of acquisition. g) Inventories The accounting standard for measurement of inventories requires that inventories held for sale in the ordinary course of business be measured at the lower of cost or net selling value, which is defined as the selling price less additional estimated manufacturing costs and estimated direct selling expenses. The replacement cost may be used in place of the net selling value, if appropriate. Cost of inventories is determined principally by the average method. The cost of inventories held by certain foreign consolidated subsidiaries is determined by the first-in, first-out method. h) Short-term investments and investment securities Short-term investments and investment securities are classified and accounted for, depending on management’s intent, as follows: i) held- to-maturity debt securities, which are expected to be held to maturity with the positive intent and ability to hold to maturity, are reported at amortized cost and ii) available-for-sale securities, which are not classified as the aforementioned securities, are reported at fair value, with unrealized gains and losses, net of applicable taxes, reported in a separate component of equity. Non-marketable available-for-sale securities are stated at cost determined by the moving-average method. For other than temporary declines in fair value, investment securities are reduced to net realizable value by a charge to income. i) Property, plant and equipment Property, plant and equipment are stated at cost. Depreciation of property, plant and equipment is computed under the declining- balance method for the assets located in Japan and principally under the straight-line method for the assets located outside Japan, using rates based upon the estimated useful lives, principally ranging from 21 to 35 years for buildings and structures and 7 or 9 years for machinery and equipment. j) Intangible assets Goodwill and trademarks are amortized on a straight-line basis over 15 or 20 years, and 10 years, respectively. k) Long-lived assets The Companies review their long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset or asset group may not be recoverable. An impairment loss would be 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. l) Retirement and pension plans The Company and most domestic consolidated subsidiaries have a cash balance plan and a defined contribution pension plan covering substantially all of their employees. The cash balance plan is linked to market interest rates and treated as a defined benefit plan. The pension plan also covers employees of certain nonconsolidated subsidiaries and affiliates in Japan. In addition, these companies may pay an early retirement allowance to early retired employees. Certain domestic consolidated subsidiaries have a defined benefit plan that provides for a lump-sum payment to terminated employees. The subsidiaries may pay an additional lump-sum payment that is not subject to actuarial calculations under the accounting standard for retirement benefits. Certain foreign subsidiaries have a defined contribution plan and/or a defined benefit plan. Some of these foreign subsidiaries apply the “corridor approach” in calculating actuarial gain or loss. Certain foreign subsidiaries also have local employees’ retirement benefit plans and provide for the amount to recognize the liability for these employees’ retirement benefits, primarily determined on an actuarial basis. The unrecognized transitional obligation, the unrecognized net actuarial gain or loss and the unrecognized prior service cost are being amortized over 15, 10 and 15 years, respectively. These amortizations are recognized in cost of sales and selling, general and administrative expenses in the consolidated statements of income. m) Asset retirement obligations The accounting standard for asset retirement obligations defines an asset retirement obligation as a legal obligation imposed either by law or contract that results from the acquisition, construction, development and the 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 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 increase or a decrease in the carrying amount of the liability and the capitalized amount of the related asset retirement cost. n) Stock options The accounting standard for stock options requires companies to recognize compensation expense for employee stock options based on the fair value at the date of grant and over the vesting period as consideration for receiving goods or services. The standard also requires companies to account for stock options granted to non- employees based on the fair value of either the stock option or the goods or services received. In the balance sheet, the stock option is presented as a stock acquisition right as a separate component of equity until exercised. The standard covers equity-settled, share-based payment transactions, but does not cover cash-settled, share-based payment transactions. In addition, the standard allows unlisted companies to measure options at their intrinsic value if they cannot reliably estimate fair value. Kao Annual Report 2012 47 o) Leases The accounting standard for lease transactions requires that all finance lease transactions should be capitalized to recognize lease assets and lease obligations in the balance sheet. In addition, the accounting standard permits leases which do not transfer ownership of the leased property to the lessee to be measured at the obligations under finance leases less interest expense and recorded as acquisition cost of lease assets. All other leases are accounted for as operating leases. p) Income taxes The Companies provide for income taxes applicable to all items included in the consolidated statements of income regardless of when such taxes are payable. Income taxes based on temporary differences between tax and financial reporting purposes are reflected as deferred income taxes in the consolidated financial statements using the asset and liability method. 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 balance sheet date. The foreign exchange gains and losses from translation are recognized in the consolidated statements of income to the extent that they are not hedged by foreign exchange derivatives. 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. Differences arising from such translation are shown as “Foreign currency translation adjustments” in a separate component of equity. Revenue and expense accounts of the consolidated foreign subsidiaries are translated into Japanese yen at the average exchange rate. s) Derivatives and hedging activities The Companies use derivative financial instruments to manage their exposures to fluctuations in foreign exchange and interest rates. Foreign exchange forward contracts, foreign currency swaps and interest rate swaps are utilized by the Companies to reduce foreign currency exchange and interest rate risks. The Companies do not enter into derivatives for trading purposes or speculative purposes. Derivative financial instruments and foreign currency transactions are classified and accounted for as follows: a) all derivatives are recognized as either assets or liabilities and measured at fair value, and gains or losses on derivative transactions are recognized in the consolidated statements of income, and b) for derivatives used for hedging purposes, if derivatives qualify for hedge accounting because of high correlation and effectiveness between the hedging instruments and the hedged items, gains or losses on derivatives are 2 Translation into United States Dollars The Companies’ accounts are maintained in or translated into Japanese yen. The United States dollar (US$) amounts included herein represent translations using the approximate exchange rate at March 31, 2012 of ¥82.19=US$1, solely for convenience. deferred until maturity of the hedged transactions. Short-term and long-term loan receivables denominated in foreign currencies, for which foreign exchange forward contracts or foreign currency swaps are used to hedge the foreign currency fluctuations, are translated at the contracted rate if the forward contracts or the swap contracts qualify for specific hedge accounting. The interest rate swaps which 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 are recognized and included in interest expense or income as incurred. t) Per share information Basic net income per share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period, retroactively adjusted for stock splits. Diluted net income per share of common stock reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised into common stock or resulted in the issuance of common stock. Cash dividends per share presented in the accompanying consolidated statements of income are dividends applicable to the respective years including dividends to be paid after the end of the year. u) Accounting changes and error corrections The accounting standard for accounting changes and error corrections requires the following; 1) Changes in Accounting Policies: When a new accounting policy is applied with revision of accounting standards, the new policy is applied retrospectively unless revised accounting standards include specific transitional provisions. When revised accounting standards include specific transitional provisions, an entity shall comply with the specific transitional provisions. 2) Changes in Presentations: When the presentation of financial statements is changed, prior period financial statements are reclassified in accordance with the new presentation. 3) Changes in Accounting Estimates: A change in an accounting estimate is accounted for in the period of the change if the change affects that period only, and is accounted for prospectively if the change affects both the period of the change and future periods. 4) Corrections of Prior Period Errors: When an error in prior period financial statements is discovered, those statements are restated. This accounting standard is applicable to accounting changes and corrections of prior period errors which are made from the beginning of the fiscal year that begins on or after April 1, 2011. The translations should not be construed as representations that Japanese yen have been, could have been, or could in the future be, converted into United States dollars at that or any other rate. 48 Kao Annual Report 2012 3 Cash and Cash Equivalents Cash and cash equivalents at March 31, 2012 and 2011 consisted of the following: Cash and time deposits ............................................................................................ Short-term investments ............................................................................................ Less: time deposits and short-term investments which mature or become Millions of yen 2012 ¥ 85,483 48,798 2011 ¥ 110,762 37,028 Thousands of U.S. dollars 2012 $1,040,066 593,722 due over three months after the date of acquisition ....................................... Cash and cash equivalents ....................................................................................... (4,544) ¥129,737 (4,647) ¥143,143 (55,287) $1,578,501 4 Short-Term Investments and Investment Securities Short-term investments and investment securities as of March 31, 2012 and 2011 consisted of the following: Millions of yen 2012 2011 Short-term investments: Government and corporate bonds ........................................................................ Investment trust funds and other ........................................................................ Total ................................................................................................................. Investment securities: Marketable equity securities ................................................................................. Investment trust funds and other ......................................................................... Total .................................................................................................................. ¥ — 48,798 ¥48,798 ¥ 6,335 1,181 ¥ 7,516 ¥ 6,270 30,758 ¥ 37,028 ¥ 5,828 1,195 ¥ 7,023 Thousands of U.S. dollars 2012 $ — 593,722 $593,722 $ 77,078 14,369 $ 91,447 The carrying amount and aggregate fair value of the securities classified as available-for-sale and held-to-maturity at March 31, 2012 and 2011 were as follows: Millions of yen 2012 Cost Unrealized gains Unrealized losses Fair value Securities classified as: Available-for-sale: Equity securities ....................................................................... Debt securities and other ......................................................... ¥ 2,785 38,799 ¥3,630 — Held-to-maturity: Debt securities and other ......................................................... 9,999 — ¥80 — — ¥ 6,335 38,799 9,999 Millions of yen 2011 Cost Unrealized gains Unrealized losses Fair value Securities classified as: Available-for-sale: Equity securities ....................................................................... Debt securities and other ......................................................... ¥ 2,765 27,029 ¥3,202 — Held-to-maturity: Debt securities and other ......................................................... 9,999 — ¥139 — — ¥ 5,828 27,029 9,999 Thousands of U.S. dollars 2012 Cost Unrealized gains Unrealized losses Fair value Securities classified as: Available-for-sale: Equity securities ....................................................................... Debt securities and other ......................................................... $ 33,885 472,065 $44,166 — Held-to-maturity: Debt securities and other ......................................................... 121,657 — $973 — — $ 77,078 472,065 121,657 Kao Annual Report 2012 49 Available-for-sale securities whose fair values are not readily determinable as of March 31, 2012 and 2011 were as follows: Carrying amount Millions of yen 2012 2011 Thousands of U.S. dollars 2012 Available-for-sale: Equity securities ........................................................................................... Total .......................................................................................................... ¥1,181 ¥1,181 ¥1,195 ¥1,195 $14,369 $14,369 Proceeds from sales of available-for-sale securities for the years ended March 31, 2012 and 2011 were ¥1 million (US$12 thousand) and ¥594 million, respectively. Gross realized gains and losses on these sales, computed on the moving-average cost basis, for the year ended March 31, 2012 were not recognized, and for the year ended March 31, 2011 were ¥186 million and ¥4 million, respectively. The carrying values of debt securities by contractual maturities for securities classified as held-to-maturity at March 31, 2012 are included in Note 16. 5 Short-Term and Long-Term Debt Short-term debt at March 31, 2012 and 2011 was comprised of the following: Secured loans principally from financial institutions ................................................. Unsecured loans principally from financial institutions ............................................. Total .................................................................................................................. Millions of yen 2012 ¥ 99 1,961 ¥2,060 2011 ¥ 69 6,707 ¥6,776 Thousands of U.S. dollars 2012 $ 1,205 23,859 $25,064 The weighted average interest rates applicable to the above loans were 2.00% and 3.90% at March 31, 2012 and 2011, respectively. In addition to the above short-term debt, deposits payable to affiliates, included in other current liabilities, were ¥6,527 million (US$79,414 thousand) and ¥5,058 million at March 31, 2012 and 2011, respectively, and the applicable interest rates were 0.44% and 0.44% at March 31, 2012 and 2011, respectively. The secured loans are collateralized by trade accounts receivable of ¥189 million (US$2,300 thousand) at March 31, 2012. Long-term debt at March 31, 2012 and 2011 consisted of the following: Unsecured bonds due 2011, 1.60% and due 2013, 1.91% .................................. Unsecured loans principally from financial institutions, weighted average rate 0.57% in 2012, 1.75% in 2011 ......................................... Lease obligations ...................................................................................................... Less current portion .............................................................................................. Total .................................................................................................................. Millions of yen 2012 2011 ¥ 49,999 ¥ 99,998 50,055 7,322 ¥107,376 (811) ¥106,565 50,056 8,192 ¥158,246 (80,795) ¥ 77,451 Thousands of U.S. dollars 2012 $ 608,334 609,016 89,086 $1,306,436 (9,867) $1,296,569 The current portion of long-term debt refinanced into long-term debt during the year ended March 31, 2012 was ¥30,000 million (US$365,008 thousand). The unsecured bonds redeemed during the year ended March 31, 2012 was ¥50,000 million (US$608,347 thousand). In addition to the above long-term debt, deposits payable to customers, included in other long-term liabilities, were ¥6,008 million (US$73,099 thousand) and ¥6,060 million at March 31, 2012 and 2011, respectively, and the applicable interest rates were 0.13% and 0.15% at March 31, 2012 and 2011, respectively. The aggregate annual maturities of long-term debt as of March 31, 2012 were as follows: Years ending March 31 2013 ................................................................................................................................................. 2014 ................................................................................................................................................. 2015 ................................................................................................................................................. 2016 ................................................................................................................................................. 2017 ................................................................................................................................................. 2018 and thereafter ......................................................................................................................... Total ............................................................................................................................................. Millions of yen ¥ 811 50,793 41,118 784 10,724 3,146 ¥107,376 Thousands of U.S. dollars $ 9,867 617,995 500,280 9,539 130,478 38,277 $1,306,436 50 Kao Annual Report 2012 6 Income Taxes The Company and its domestic subsidiaries are subject to Japanese national and local taxes based on income, which in the aggregate resulted in a normal statutory tax rate of approximately 41% for both 2012 and 2011. Foreign subsidiaries are subject to income taxes of the countries in which they operate. Tax effects of significant temporary differences and tax loss carryforwards that resulted in deferred tax assets or liabilities at March 31, 2012 and 2011 were as follows: Millions of yen 2012 2011 Deferred tax assets: Depreciation and amortization .............................................................................. Pension and severance costs ............................................................................... Accrued expenses ................................................................................................ Enterprise taxes .................................................................................................... Tax loss carryforwards .......................................................................................... Other ..................................................................................................................... Less valuation allowance ...................................................................................... Deferred tax assets .................................................................................................. Deferred tax liabilities: Unrealized gain on available-for-sale securities .................................................... Undistributed foreign earnings ............................................................................. Deferred gains on sales of property ..................................................................... Prepaid pension cost ............................................................................................ Other ..................................................................................................................... Deferred tax liabilities ............................................................................................... ¥ 18,221 16,323 10,791 1,327 46,854 13,283 (29,189) ¥ 77,610 ¥ (1,289) (6,007) (3,884) (1,218) (6,421) ¥(18,819) ¥ 21,552 16,362 11,720 1,487 63,157 15,981 (40,270) ¥ 89,989 ¥ (1,310) (5,893) (4,531) (1,042) (7,161) ¥(19,937) Thousands of U.S. dollars 2012 $ 221,694 198,601 131,293 16,146 570,069 161,613 (355,141) $ 944,275 $ (15,683) (73,087) (47,256) (14,819) (78,124) $(228,969) Net deferred tax assets ............................................................................................ ¥ 58,791 ¥ 70,052 $ 715,306 A reconciliation between the normal effective statutory tax rates and the actual effective tax rates reflected in the accompanying consolidated statements of income for the years ended March 31, 2012 and 2011 were as follows: Normal effective statutory tax rate ........................................................................... Tax credit for research and development costs and other .................................... Valuation allowance ............................................................................................... Expiration of tax loss carryforwards ..................................................................... Amortization expenses not deductible for income tax purposes .......................... Effect of tax rate reduction ................................................................................... Other – net ............................................................................................................ Actual effective tax rate ............................................................................................ 2012 40.5% (2.6) (6.4) 9.0 4.6 5.4 (2.3) 48.2% 2011 40.5% (2.7) 9.5 0.9 4.9 — (2.9) 50.2% On December 2, 2011, new tax reform laws were enacted in Japan, which will reduce the corporation tax rate and will impose special corporation tax for reconstruction of the Great East Japan Earthquake for fiscal years beginning on or after April 1, 2012. Consequently, the effective statutory tax rate used to measure deferred tax assets and liabilities changed from 40.54% to 38.01% for expected reversal of temporary differences during fiscal years beginning on or after April 1, 2012 until March 31, 2015. The rate will be changed to 35.64% for expected reversal of temporary differences during fiscal years beginning on or after April 1, 2015. As a result of these tax rate changes, net deferred tax assets after deducting deferred tax liabilities as of March 31, 2012 decreased ¥5,500 million (US$66,918 thousand), while deferred income taxes and unrealized gain on available-for-sale securities increased ¥5,676 million (US$69,059 thousand) and ¥176 million (US$2,141 thousand), respectively. Moreover, effective fiscal years beginning on or after April 1, 2012 the deferral period for tax loss carryforwards will be extended to nine years from seven years and the deduction will be limited to 80% of earnings prior to adjustment for tax loss carryforwards. Deferred tax assets increased ¥3,215 million (US$39,117 thousand) as a result. Deferred income taxes increased ¥2,461 million (US$29,943 thousand) because of the combined effect of the corporate tax rate changes, the deferral period extension and the limit on the deduction of tax loss carryforwards. Kao Annual Report 2012 51 7 Leases (a) Finance leases: The Companies lease certain buildings, machinery, computer equipment and other assets. (b) Operating leases: The minimum rental commitments under noncancellable operating leases as of March 31, 2012 and 2011 were as follows: Due within one year ................................................................................................... Due after one year ...................................................................................................... Total ........................................................................................................................ 8 Retirement Benefits Millions of yen 2012 ¥ 8,132 24,791 ¥32,923 2011 ¥ 8,624 30,826 ¥39,450 Thousands of U.S. dollars 2012 $ 98,941 301,631 $400,572 The Company and most domestic consolidated subsidiaries have a cash balance plan and a defined contribution pension plan. The cash balance plan is linked to market interest rates and treated as a defined benefit pension plan. These companies may pay an early retirement allowance to early retired employees. Certain domestic consolidated subsidiaries have a defined benefit plan that provides for a lump-sum payment to terminated employees. The subsidiaries may make an additional lump-sum payment that is not subject to actuarial calculations under the accounting standard for retirement benefits. Certain foreign consolidated subsidiaries have a contribution plan and/or a defined benefit plan. The liability for retirement benefits at March 31, 2012 and 2011 consisted of the following: Projected benefit obligation ...................................................................................... Fair value of plan assets ........................................................................................... Unrecognized prior service cost ............................................................................... Unrecognized actuarial loss ...................................................................................... Unrecognized transitional obligation ......................................................................... Prepaid pension cost ................................................................................................ Net liability for retirement benefits ....................................................................... ¥ 239,032 (196,235) 9,537 (2,009) (5,413) 114 ¥ 45,026 ¥ 231,540 (189,043) 14,128 (8,223) (7,213) 1,128 ¥ 42,317 Millions of yen 2012 2011 The components of net periodic benefit costs for the years ended March 31, 2012 and 2011 were as follows: Service cost .............................................................................................................. Interest cost ............................................................................................................. Expected return on plan assets ................................................................................ Amortization of prior service cost (credit) ................................................................. Recognized actuarial loss ......................................................................................... Amortization of transitional obligation ...................................................................... Net periodic benefit costs ..................................................................................... Millions of yen 2012 ¥ 8,694 5,177 (4,413) (3,261) 3,307 1,815 ¥11,319 2011 ¥ 8,399 5,147 (4,423) (3,603) 4,903 1,679 ¥12,102 Thousands of U.S. dollars 2012 $ 2,908,286 (2,387,578) 116,036 (24,443) (65,860) 1,387 $ 547,828 Thousands of U.S. dollars 2012 $105,779 62,988 (53,693) (39,676) 40,236 22,083 $137,717 Assumptions used for the years ended March 31, 2012 and 2011 were set forth as follows: Discount rate ................................................................................................................. Expected rate of return on plan assets .......................................................................... Amortization period of prior service cost ....................................................................... Recognition period of actuarial gain/loss ....................................................................... Amortization period of transitional obligation ................................................................ Primarily 2.0% Primarily 2.0% Primarily 15 years Primarily 10 years Primarily 15 years Primarily 2.0% Primarily 2.0% Primarily 15 years Primarily 10 years Primarily 15 years 2012 2011 In addition to the above net periodic benefit costs, the costs for other retirement and pension plans such as a defined contribution plan and for other supplemental retirement benefits were ¥2,772 million (US$ 33,727 thousand) and ¥2,358 million for the years ended March 31, 2012 and 2011, respectively. Certain foreign subsidiaries apply the “corridor approach” in calculating actuarial gain or loss. 52 Kao Annual Report 2012 9 Contingent Liabilities At March 31, 2012, the Companies had the following contingent liabilities: Trade notes discounted ....................................................................................................................... Guarantees of borrowings, principally of affiliates and employees ...................................................... ¥128 819 Millions of yen Thousands of U.S. dollars $ 1,557 9,965 The Companies are parties to pending litigation arising in the normal course of business. While it is not possible to predict the outcome of pending litigation, the Company believes, after consultation with counsel, that the results of such proceedings will not have a material adverse effect upon the Company's consolidated financial position and the results of its operations and its cash flows. 10 Equity Significant provisions in the Corporation Law of Japan (the “Corporation Law”) that affect financial and accounting matters are summarized below: (a) Dividends Under the Corporation Law, 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 such as having: (1) a board of directors, (2) independent auditors, (3) a board of corporate auditors, and (4) terms of service of directors prescribed as one year under the articles of incorporation rather than the normal term of two years, the boards of directors of such companies may declare dividends (except for dividends in kind) at any time during the fiscal year if the companies have prescribed so in their articles of incorporation. The Company's governance system on March 31, 2012 meets the first three criteria but the two-year service period of the members of the Board of Directors does not meet the fourth criterion. The Company pays the dividends semi-annually as a year- end dividend and an interim dividend. 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 Company pays semiannual interim dividends upon the resolution by the Board of Directors because the articles of incorporation of the Company so stipulate. The Corporation Law permits companies to distribute dividends- in-kind (non-cash assets) to shareholders subject to a certain limitation and additional requirements. The Corporation Law 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 Corporation Law 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 charged upon the payment of such dividends until the total of aggregate amount of legal reserve and additional paid-in capital equals 25% of the common stock. Under the Corporation Law, the total amount of additional paid-in capital and legal reserve may be reversed without limitation. The Corporation Law also provides that common stock, legal reserve, additional paid-in capital, other capital surplus and retained earnings can be transferred among the accounts under certain conditions upon resolution at the shareholders’ meeting. The Company’s legal reserve amount, which is included in retained earnings, totals ¥14,117 million (US$171,761 thousand) at both March 31, 2012 and 2011. The Company’s additional paid-in capital amount, which is included in capital surplus, totals ¥108,889 million (US$1,324,845 thousand) at both March 31, 2012 and 2011. The accompanying consolidated financial statements do not include any provision for the year-end dividend of ¥31.0 (US$0.38) per share, aggregating ¥16,193 million (US$197,019 thousand) which the Company will subsequently propose at the 106th Annual General Meeting of Shareholders to be held on June 28, 2012 as an appropriation of retained earnings in respect of the year ended March 31, 2012. (c) Treasury stock and treasury stock acquisition rights The Corporation Law also provides for companies to purchase own stock and retire treasury stock by resolution of the board of directors. The amount of own stock purchased cannot exceed the amount available for distribution to the shareholders which is determined by a specific formula. Under the Corporation Law, stock acquisition rights are presented as a separate component of equity. The Corporation Law also provides that companies can purchase both own stock and stock acquisition rights in their own companies. Such treasury stock is presented as a separate component of equity. Such stock acquisition rights are presented as a separate component of equity or deducted directly from stock acquisition rights. On May 20, 2011, the Company retired 13.9 million shares of treasury stock by the resolution of the Board of Directors at the meeting held on April 26, 2011. The Company purchased 0.3 million shares of its common stock from untraceable shareholders on September 21, at an aggregate cost of ¥619 million (US$7,531 thousand). Kao Annual Report 2012 53 11 Stock-Based Compensation Plans The stock options for the year ended March 31, 2012 were as follows: Name Persons originally granted Number of options originally granted Date of grant Exercise price Exercise price (U.S. dollars) (Yen) Stock option 2004 Stock option 2005 Stock option 2006 I 13 Directors of the Company 89 Employees of the Company 5 Directors of subsidiaries of the Company 13 Directors of the Company 90 Employees of the Company 5 Directors of subsidiaries of the Company 12 Executive Officers of the Company** 1,163,000 shares* July 8, 2004 ¥2,695 $32.79 1,167,000 shares* July 8, 2005 ¥2,685 $32.67 Stock option 2006 II 14 Directors of the Company 26,000 shares* September 29, 2006 12,000 shares* September 29, 2006 ¥1 ¥1 $0.01 $0.01 Stock option 2006 III 79 Employees of the Company 4 Directors of subsidiaries of the Company 437,000 shares* September 29, 2006 ¥3,211 $39.07 Stock option 2007 I 13 Directors of the Company 25,000 shares* August 31, 2007 Stock option 2007 II 14 Executive Officers of the Company*** 14,000 shares* August 31, 2007 ¥1 ¥1 $0.01 $0.01 Stock option 2007 III 78 Employees of the Company 4 Directors of subsidiaries of the Company 430,000 shares* August 31, 2007 ¥3,446 $41.93 Stock option 2008 I 14 Directors of the Company 24,000 shares* August 29, 2008 Stock option 2008 II 12 Executive Officers of the Company**** 12,000 shares* August 29, 2008 ¥1 ¥1 $0.01 $0.01 Stock option 2008 III 81 Employees of the Company 4 Directors of subsidiaries of the Company 447,000 shares* August 29, 2008 ¥3,100 $37.72 Stock option 2009 I 13 Directors of the Company 36,000 shares* August 28, 2009 Stock option 2009 II 12 Executive Officers of the Company***** 24,000 shares* August 28, 2009 ¥1 ¥1 $0.01 $0.01 Stock option 2009 III 74 Employees of the Company 8 Directors of subsidiaries of the Company 430,000 shares* August 28, 2009 ¥2,355 $28.65 Stock option 2010 I 14 Directors of the Company 38,000 shares* August 25, 2010 Stock option 2010 II 12 Executive Officers of the Company****** 24,000 shares* August 25, 2010 ¥1 ¥1 $0.01 $0.01 Stock option 2010 III 81 Employees of the Company 2 Directors of subsidiaries of the Company 435,000 shares* August 25, 2010 ¥2,190 $26.65 Stock option 2011 I 13 Directors of the Company 36,000 shares* August 25, 2011 Stock option 2011 II 13 Executive Officers of the Company******* 26,000 shares* August 25, 2011 ¥1 ¥1 $0.01 $0.01 Stock option 2011 III 81 Employees of the Company 1 Director of subsidiary of the Company 1 Employee of subsidiary of the Company 435,000 shares* August 25, 2011 ¥2,254 $27.42 * The number of options originally granted converts into number of shares of common stock. ** The 12 Executive Officers were not members of the Board of Directors of the Company at the date of grant. *** The 14 Executive Officers were not members of the Board of Directors of the Company at the date of grant. **** The 12 Executive Officers were not members of the Board of Directors of the Company at the date of grant. ***** The 12 Executive Officers were not members of the Board of Directors of the Company at the date of grant. ****** The 12 Executive Officers were not members of the Board of Directors of the Company at the date of grant. ******* The 13 Executive Officers were not members of the Board of Directors of the Company at the date of grant. 54 Kao Annual Report 2012 Exercise period July 1, 2006 through June 30, 2011 July 1, 2007 through June 29, 2012 July 1, 2008 through June 28, 2013 July 1, 2008 through June 28, 2013 July 1, 2008 through June 28, 2013 July 1, 2009 through June 30, 2014 July 1, 2009 through June 30, 2014 September 1, 2009 through August 29, 2014 July 1, 2010 through June 30, 2015 July 1, 2010 through June 30, 2015 September 1, 2010 through August 31, 2015 July 1, 2011 through June 30, 2016 July 1, 2011 through June 30, 2016 September 1, 2011 through August 30, 2016 July 1, 2012 through June 30, 2017 July 1, 2012 through June 30, 2017 September 1, 2012 through August 31, 2017 July 1, 2013 through June 29, 2018 July 1, 2013 through June 29, 2018 September 1, 2013 through August 31, 2018 The activity of stock options was as follows: (Number of shares) Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option 2007 I 2006 II 2006 III 2007 II 2007 III 2008 II 2008 III 2006 I 2008 I 2004 2005 For the year ended March 31, 2012 Non-vested Outstanding at March 31, 2011 ............................ Granted ...................................... Expired ....................................... Vested ........................................ Outstanding at March 31, 2012 ............................. Vested Outstanding at — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — March 31, 2011 .............................. Vested ........................................ Exercised .................................... Expired ....................................... 624,000 — — 624,000 807,000 — — 69,000 4,000 — 1,000 — 4,000 — — — 372,000 — — 35,000 6,000 — — — 6,000 — 1,000 — 391,000 — — 30,000 13,000 — 5,000 — 7,000 — 1,000 — 442,000 — — — Outstanding at March 31, 2012 .............................. — 738,000 3,000 4,000 337,000 6,000 5,000 361,000 8,000 6,000 442,000 Exercise price Yen ................................................. U.S. dollars ..................................... ¥2,695 $32.79 ¥2,685 $32.67 ¥1 $0.01 ¥1 $0.01 ¥3,211 $39.07 ¥1 $0.01 ¥1 $0.01 ¥3,446 $41.93 ¥1 $0.01 ¥1 $0.01 ¥3,100 $37.72 Average stock price at exercise Yen ................................................. U.S. dollars ..................................... Fair value price at grant date .............. Yen ................................................. U.S. dollars ..................................... — — — — — — — — ¥2,166 $26.35 — — — — — — ¥2,070 $25.19 — — ¥2,039 $24.81 ¥2,075 $25.25 — — ¥2,932 $35.67 ¥2,932 $35.67 ¥435 $5.29 ¥3,063 $37.27 ¥3,063 $37.27 ¥420 $5.11 ¥2,865 $34.86 ¥2,865 $34.86 ¥426 $5.18 Kao Annual Report 2012 55 Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option 2011 III 2010 II 2009 III 2010 III 2009 II 2011 II 2011 I 2009 I 2010 I (Number of shares) For the year ended March 31, 2012 Non-vested Outstanding at March 31, 2011 ............................ Granted ...................................... Expired ....................................... Vested ........................................ Outstanding at March 31, 2012 ............................. Vested Outstanding at — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — 36,000 — 36,000 — 26,000 — 26,000 — 435,000 — 435,000 — — — March 31, 2011 .............................. Vested ........................................ Exercised .................................... Expired ....................................... 36,000 — 16,000 — 24,000 — 9,000 — 430,000 — — — 38,000 — — — 24,000 — — — 435,000 — — — — 36,000 — — — 26,000 — — — 435,000 — — Outstanding at March 31, 2012 .............................. 20,000 15,000 430,000 38,000 24,000 435,000 36,000 26,000 435,000 Exercise price Yen ................................................. U.S. dollars ..................................... Average stock price at exercise ¥1 $0.01 ¥1 $0.01 ¥2,355 $28.65 ¥1 $0.01 ¥1 $0.01 ¥2,190 $26.65 ¥1 $0.01 ¥1 $0.01 ¥2,254 $27.42 Yen ................................................. U.S. dollars ..................................... Fair value price at grant date .............. Yen ................................................. U.S. dollars ..................................... ¥2,059 $25.05 ¥2,115 $25.73 ¥2,055 $25.00 — — — — — — — — — — — — — — ¥2,115 $25.73 ¥394 $4.79 ¥1,749 $21.28 ¥1,749 $21.28 ¥245 $2.98 ¥1,718 $20.90 ¥1,718 $20.90 ¥211 $2.57 The fair value prices for 2011 stock options were estimated using the Black-Scholes Option Pricing Model with the following assumptions: Stock option 2011 I Stock option 2011 II Stock option 2011III Volatility of stock price ........................................................................................... Estimated remaining outstanding period ............................................................... Estimated dividend per share 25.396% 4.5 years Yen ...................................................................................................................... U.S. dollars .......................................................................................................... Risk-free interest rate ............................................................................................ ¥58 $0.71 0.295% 25.396% 4.5 years ¥58 $0.71 0.295% 25.396% 4.5 years ¥58 $0.71 0.295% 56 Kao Annual Report 2012 12 Comprehensive Income Each component of other comprehensive income for the year ended March 31, 2012 was the following: Millions of yen 2012 Thousands of U.S. dollars 2012 Unrealized gain (loss) on available-for-sale securities: Gains 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 .................................................................................................... Income tax effect ............................................................................................................................. Total ................................................................................................................................................. Share of other comprehensive income in affiliates ¥ 517 12 529 (42) ¥ 487 ¥(12,169) — (12,169) — ¥(12,169) Gains arising during the year .......................................................................................................... Total ................................................................................................................................................. ¥ (172) ¥ (172) Post retirement liability adjustments for foreign consolidated subsidiaries Adjustments arising during the year ................................................................................................ Reclassification adjustments to profit or loss .................................................................................. Amount before income tax effect .................................................................................................... Income tax effect ............................................................................................................................. Total ................................................................................................................................................. ¥ (2,049) 87 (1,962) 726 ¥ (1,236) $ 6,290 146 6,436 (511) $ 5,925 $(148,059) — (148,059) — $(148,059) $ (2,093) $ (2,093) $ (24,930) 1,059 (23,871) 8,833 $ (15,038) Total other comprehensive income .............................................................................................. ¥(13,090) $(159,265) The corresponding information for the year ended March 31, 2011 was not required under the accounting standard for presentation of comprehensive income as an exemption for the first year of adopting that standard and not disclosed herein. 13 Segment Information (1) Description of reportable segments The Companies’ reportable segments are components for which separate financial information is available, and whose operating results are reviewed regularly by the chief operating decision maker in order to determine allocation of resources and assess segment performance. The Companies are organized into four business operating units, the Beauty Care Business, the Human Health Care Business and the Fabric and Home Care Business (collectively, the Consumer Products Business) and the Chemical Business. Each business operating unit plans comprehensive strategies for business in Japan and other countries, and conducts its own business activities. Therefore, the Companies have four reportable segments: the Beauty Care Business, the Human Health Care Business, the Fabric and Home Care Business and the Chemical Business. The Beauty Care Business segment manufactures and sells prestige cosmetics, premium skin care and premium hair care products. The Human Health Care Business segment manufactures and sells food and beverage, sanitary and personal health products. The Fabric and Home Care Business segment manufactures and sells fabric care and home care products. The Chemical Business segment manufactures and sells oleo chemicals, performance chemicals and specialty chemicals. (2) Methods of measurement for sales, profit (loss), assets, and other items for reportable segments The amount of segment profit corresponds to that of operating income. Intersegment sales and transfer prices are calculated mainly based on market value or manufacturing cost. Kao Annual Report 2012 57 Information by reportable segment of the Companies for the years ended March 31, 2012 and 2011 was as follows:: Millions of yen 2012 Reportable segment Consumer Products Business Human Health Fabric and Home Care Business Care Business Total ¥181,758 — 181,758 ¥ 14,630 ¥ 99,535 — 285,645 ¥285,645 ¥1,005,341 — 1,005,341 ¥ 55,544 ¥ 85,586 ¥128,858 ¥ 724,570 Beauty Care Business ¥537,938 — 537,938 ¥ 15,412 ¥496,177 Chemical Business ¥210,755 36,880 247,635 ¥ 23,001 ¥194,582 Reconciliations* ¥ — (36,880) (36,880) ¥ 3 ¥ 72,120 Consolidated ¥1,216,096 — 1,216,096 ¥ 108,590 ¥ 991,272 ¥ 37,766 ¥ 7,926 ¥ 9,794 ¥ 55,486 ¥ 11,648 ¥ — ¥ 67,134 1,780 1,083 1,239 4,102 1,661 13,106 11,520 12,219 36,845 10,333 — — 5,763 47,178 Sales to customers ........................... Intersegment sales ........................... Total sales ......................................... Segment profit (Operating income) ... Segment assets ................................ Other Depreciation and amortization** .... Investments in equity method affiliates ......................... Increase in property, plant and equipment and intangible assets .. * Reconciliation of segment profit includes elimination of intersegment transactions of inventory. Reconciliation of assets includes ¥78,742 million of the Company’s financial assets and negative ¥6,622 million elimination of receivables among reportable segments. **Depreciation and amortization excludes amortization of goodwill. Millions of yen 2011 Reportable segment Beauty Care Business ¥533,514 — 533,514 ¥ 5,536 ¥547,092 Consumer Products Business Human Health Fabric and Home Care Business Care Business ¥279,008 — 279,008 ¥ 59,659 ¥124,561 ¥175,761 — 175,761 ¥ 15,284 ¥ 87,127 Total ¥988,283 — 988,283 ¥ 80,479 ¥758,780 Chemical Business ¥198,548 33,449 231,997 ¥ 24,100 ¥186,704 Reconciliations* ¥ — (33,449) (33,449) ¥ 12 ¥ 77,315 Consolidated ¥1,186,831 — 1,186,831 ¥ 104,591 ¥1,022,799 ¥ 39,186 ¥ 7,902 ¥ 9,438 ¥ 56,526 ¥ 12,347 ¥ — ¥ 68,873 1,603 936 1,019 3,558 1,483 16,276 8,871 12,223 37,370 11,731 — — 5,041 49,101 Sales to customers ........................... Intersegment sales ........................... Total sales ......................................... Segment profit (Operating income) ... Segment assets ................................ Other Depreciation and amortization** .... Investments in equity method affiliates ......................... Increase in property, plant and equipment and intangible assets .. * Reconciliation of segment profit includes elimination of intersegment transactions of inventory. Reconciliation of assets includes ¥81,193 million of the Company’s financial assets and negative ¥3,878 million elimination of receivables among reportable segments. **Depreciation and amortization excludes amortization of goodwill. 58 Kao Annual Report 2012 Thousands of U.S. dollars 2012 Reportable segment Consumer Products Business Beauty Care Business Human Health Fabric and Home Care Business Care Business Total Sales to customers ........................... $6,545,054 $2,211,437 $3,475,423 $12,231,914 Intersegment sales ........................... — — Total sales ......................................... 3,475,423 12,231,914 6,545,054 Segment profit (Operating income) ... $ 187,517 $ 178,002 $ 675,800 $ 1,041,319 Segment assets ................................ $6,036,952 $1,211,035 $1,567,806 $ 8,815,793 — 2,211,437 — Chemical Business $2,564,241 448,716 3,012,957 $ 279,851 $2,367,466 Reconciliations* $ — (448,716) (448,716) $ 37 $ 877,478 Consolidated $14,796,155 — 14,796,155 $ 1,321,207 $12,060,737 Other Depreciation and amortization** .... $ 459,496 $ 96,435 $ 119,163 $ 675,094 $ 141,721 $ — $ 816,815 Investments in equity method affiliates ......................... Increase in property, plant and equipment and intangible assets .. 21,657 13,177 15,075 49,909 20,209 159,460 140,163 148,668 448,291 125,720 — — 70,118 574,011 * Reconciliation of segment profit includes elimination of intersegment transactions of inventory. Reconciliation of assets includes $958,048 thousand of the Company’s financial assets and negative $80,570 thousand elimination of receivables among reportable segments. **Depreciation and amortization excludes amortization of goodwill. (b) Information related to reportable segments Sales by geographic area for the years ended March 31, 2012 and 2011 were as follows: Sales to customers ...................................................... Japan ¥887,100 Asia/Oceania* ¥138,821 Sales to customers ...................................................... Japan ¥874,771 Asia/Oceania* ¥131,473 Millions of yen 2012 America** ¥87,289 Millions of yen 2011 America** ¥83,082 Europe*** ¥102,886 Consolidated ¥1,216,096 Europe*** ¥97,505 Consolidated ¥1,186,831 Sales to customers ...................................................... Japan $10,793,284 Asia/Oceania* $1,689,025 America** $1,062,039 Europe*** $1,251,807 Consolidated $14,796,155 Note: Sales are classified in countries or regions based on location of customers Thousands of U.S. dollars 2012 Kao Annual Report 2012 59 Property, plant and equipment by geographic area for the years ended March 31, 2012 and 2011 were as follows: Property, plant and equipment .................................... Japan ¥190,318 Asia/Oceania* ¥29,496 Property, plant and equipment .................................... Japan ¥190,878 Asia/Oceania* ¥29,956 Millions of yen 2012 America** ¥6,980 Millions of yen 2011 America** ¥8,123 Europe*** ¥13,785 Consolidated ¥240,579 Europe*** ¥15,767 Consolidated ¥244,724 Thousands of U.S. dollars 2012 Property, plant and equipment .................................... Japan $2,315,586 Asia/Oceania* $358,876 America** $84,925 Europe*** $167,721 Consolidated $2,927,108 * Asia/ Oceania: Asia and Oceania ** America: North America *** Europe: Europe and South Africa (c) Impairment losses by reportable segment Impairment losses by reportable segment for the years ended March 31, 2012 and 2011 were as follows: Millions of yen 2012 Impairment losses of assets .............. Reportable segment Beauty Care Business ¥193 Consumer Products Business Human Health Fabric and Home Care Business Care Business ¥90 ¥137 Total ¥420 Chemical Business ¥1 Reconciliations ¥— Consolidated ¥421 Impairment losses of assets .............. Reportable segment Beauty Care Business ¥63 Consumer Products Business Human Health Fabric and Home Care Business Care Business ¥32 ¥48 Total ¥143 Chemical Business ¥210 Reconciliations ¥ — Consolidated ¥353 Millions of yen 2011 Impairment losses of assets .............. Beauty Care Business $2,348 Consumer Products Business Human Health Fabric and Home Care Business Care Business $1,095 $1,667 Total $5,110 Chemical Business $12 Reconciliations $— Consolidated $5,122 Thousands of U.S. dollars 2012 Reportable segment 60 Kao Annual Report 2012 (d) Amortization and balance of goodwill by reportable segment Amortization and balance of goodwill by reportable segment for the years ended March 31, 2012 and 2011 were as follows: Millions of yen 2012 Reportable segment Amortization of goodwill .................... Goodwill at March 31, 2012 .............. Beauty Care Business ¥ 12,664 165,614 Consumer Products Business Human Health Fabric and Home Care Business Care Business ¥— — ¥— — Total ¥ 12,664 165,614 Chemical Business ¥— — Reconciliations ¥— — Consolidated ¥ 12,664 165,614 Millions of yen 2011 Reportable segment Amortization of goodwill .................... Goodwill at March 31, 2011 .............. Beauty Care Business ¥ 12,507 179,225 Consumer Products Business Human Health Fabric and Home Care Business Care Business ¥ — — ¥ — — Total ¥ 12,507 179,225 Chemical Business ¥ — — Reconciliations ¥ — — Consolidated ¥ 12,507 179,225 Thousands of U.S. dollars 2012 Reportable segment Beauty Care Business Amortization of goodwill .................... $ 154,082 Goodwill at March 31, 2012 .............. 2,015,014 Consumer Products Business Human Health Fabric and Home Care Business Care Business $— — $— — Total $ 154,082 2,015,014 Chemical Business $— — Reconciliations $— — Consolidated $ 154,082 2,015,014 14 Selling, General and Administrative Expenses Selling, general and administrative expenses principally consisted of the following: Advertising ................................................................................................................ Promotion ................................................................................................................. Research and development ...................................................................................... Salaries and bonuses ................................................................................................ Packing and delivery expenses ................................................................................. 15 Other Income (Expenses) “Other, net” consisted of the following: Gain on sales of investment securities ..................................................................... Loss related to the Great East Japan Earthquake .................................................... Effect of application of Accounting Standard for Asset Retirement Obligations ...... Loss on sales or disposals of property, plant and equipment, net ........................... Insurance .................................................................................................................. Other, net ................................................................................................................. Total ...................................................................................................................... Millions of yen 2012 ¥ 82,209 62,980 48,171 121,787 68,388 2011 ¥ 81,082 64,655 45,516 124,348 66,924 Millions of yen 2012 ¥ — (2,028) — (2,202) 39 958 ¥(3,233) 2011 ¥ 186 (4,129) (1,634) (1,334) — 1,951 ¥(4,960) Thousands of U.S. dollars 2012 $1,000,231 766,273 586,093 1,481,774 832,072 Thousands of U.S. dollars 2012 $ — (24,675) — (26,792) 475 11,656 $(39,336) Kao Annual Report 2012 61 16 Financial Instruments (1) Group policy for financial instruments The Companies position excess cash as standby funds until investing them in business activities, and manage them by investment only in short-term, low-risk financial instruments. The Companies have a policy to finance by debt from financial institutions and issuance of corporate bonds and other instruments in capital markets. The Companies use derivatives to hedge risk and do not use derivatives for the purposes of speculation. (2) Nature and extent of risks arising from financial instruments and risk management Receivables such as trade notes and trade accounts are exposed to customer credit risk. The Companies manage this risk by ensuring their internal deliberations and approval processes of reviewing customers’ credit standing before entering into transactions with new customers. In addition, the Companies secure guarantee deposits or collaterals as necessary. Furthermore, the Companies monitor due dates and manage balances of receivables by customer and periodically check the credit risk of key customers. Marketable securities, which consist of commercial papers of highly-rated companies and bond investment trusts including MMF and others, are highly safe and liquid financial instruments. Investment securities, which consist mainly of stock of business partners, are exposed to stock price volatility risk. The Companies periodically check the validity of their stockholdings. Payment terms of payables, such as trade notes and trade accounts, are mostly less than one year. Loans, principally from financial institutions, in short-term debt are mainly for financing related to operating activities. Bonds and loans principally from financial institutions in long-term debt are for financing related to M&A and investment in property, plant and equipment. Certain loans with floating interest rates are exposed to interest rate volatility risk. The Companies use interest rate swaps for the purpose of hedging the interest rate volatility risk by converting the floating rates into fixed rates. Derivative transactions entered into and managed by the Companies are made in accordance with internal policies that regulate objectives, credit limit amount, scope, organization and others. The Companies do not use derivatives for the purpose of speculation. All derivative transactions are entered into to meet requirements for hedging risk incorporated in the Companies’ business. The Companies limit the counterparties to these derivative transactions to major international financial institutions to reduce their credit risk. With regard to payables, such as trade notes, trade accounts and loans, the Companies monitor and manage liquidity risk by preparing monthly forecast statements of cash flows of each company. (3) Fair values of financial instruments Fair values of financial instruments are based on the quoted price in active markets. If a quoted price is not available, other rational valuation techniques are used. Also see Note 17 for details of the fair values of derivatives. The contract amounts of derivatives which are shown in Note 17 do not represent the amounts exchanged by the parties and do not measure the Companies’ exposure to credit or market risk. The carrying amount, fair value and unrealized gain or loss of financial instruments as of March 31, 2012 and 2011 consisted of the following: Cash and time deposits ........................................................................................ Short-term investments ....................................................................................... Notes and accounts receivable ............................................................................. Allowance for doubtful receivables ................................................................... Notes and accounts receivable, net .................................................................. Investment securities ........................................................................................... Total ................................................................................................................... Short-term debt .................................................................................................... Current portion of long-term debt ......................................................................... Notes and accounts payable ................................................................................. Income taxes payable ........................................................................................... Long-term debt ..................................................................................................... Total ................................................................................................................... Carrying amount ¥ 85,483 48,798 146,371 (1,020) 145,351 6,335 ¥285,967 ¥ 2,060 811 158,352 18,306 106,565 ¥286,094 Millions of yen 2012 Fair value ¥ 85,483 48,798 145,351 6,335 ¥285,967 ¥ 2,060 773 158,352 18,306 107,441 ¥286,932 Unrealized gain/(loss) ¥ — — — — ¥ — ¥ — 38 — — (876) ¥ (838) Derivatives ............................................................................................................ ¥ (340) ¥ (340) ¥ — 62 Kao Annual Report 2012 Cash and time deposits ........................................................................................ Short-term investments ....................................................................................... Notes and accounts receivable ............................................................................. Allowance for doubtful receivables ................................................................... Notes and accounts receivable, net .................................................................. Investment securities ........................................................................................... Total ................................................................................................................... Short-term debt .................................................................................................... Current portion of long-term debt ......................................................................... Notes and accounts payable ................................................................................. Income taxes payable ........................................................................................... Long-term debt ..................................................................................................... Total ................................................................................................................... Carrying amount ¥110,762 37,028 124,973 (1,002) 123,971 5,828 ¥277,589 ¥ 6,776 80,795 151,028 18,785 77,451 ¥334,835 Millions of yen 2011 Fair value ¥110,762 37,028 123,971 5,828 ¥277,589 ¥ 6,776 81,261 151,028 18,785 79,340 ¥337,190 Unrealized gain/(loss) ¥ — — — — ¥ — ¥ — (466) — — (1,889) ¥(2,355) Derivatives ............................................................................................................ ¥ 80 ¥ 80 ¥ — Cash and time deposits ........................................................................................ Short-term investments ....................................................................................... Notes and accounts receivable ............................................................................. Allowance for doubtful receivables ................................................................... Notes and accounts receivable, net .................................................................. Investment securities ........................................................................................... Total ................................................................................................................... Short-term debt .................................................................................................... Current portion of long-term debt ......................................................................... Notes and accounts payable ................................................................................. Income taxes payable ........................................................................................... Long-term debt ..................................................................................................... Total ................................................................................................................... Thousands of U.S. dollars 2012 Fair value $1,040,066 593,722 1,768,475 77,078 $3,479,341 $ 25,064 9,405 1,926,658 222,728 1,307,227 $3,491,082 Carrying amount $1,040,066 593,722 1,780,886 (12,411) 1,768,475 77,078 $3,479,341 $ 25,064 9,867 1,926,658 222,728 1,296,569 $3,480,886 Unrealized gain/(loss) $ — — — — $ — $ — 462 — — (10,658) $(10,196) Derivatives ............................................................................................................ $ (4,137) $ (4,137) $ — Cash and time deposits The carrying values of cash and time deposits approximate fair value because of their short maturities. Notes and accounts receivables The carrying values of notes and accounts receivable approximate fair value because of their short maturities. Short-term investments and investment securities The fair value of marketable equity securities is measured at the quoted market price of the stock exchange. The fair value of marketable debt securities is measured at the quoted market price of the stock exchange or at the quoted price obtained from the financial institutions if there is no quoted market price. The carrying value of other marketable securities, such as commercial papers, investment trust funds and other which consist of MMF and others, approximate fair value because of their short maturities. See Note 4 for information of the fair value of short-term investments and investment securities by classification. Short-term debt The carrying values of short-term debt approximate fair value because of their short maturities. Current portion of long-term debt The fair value of fixed interest loans is measured at the present value by discounting expected repayments of principal and interest in the remaining period using an assumed interest rate on an equivalent new loan. Kao Annual Report 2012 63 Notes and accounts payable The carrying values of notes and accounts payable approximate fair value because of their short maturities. Long-term debt The fair value of bonds issued by the Company is measured at the quoted market price. The fair value of fixed interest loans is measured at the present value by discounting expected repayments of principal and interest in the remaining period using an assumed interest rate on an equivalent new loan. The fair value of long-term loans subject to a special accounting method for interest rate swaps which qualify for hedge accounting and meet specific matching criteria is measured at the present value by discounting expected repayments of principal and interest together with the interest rate swaps in the remaining period using an assumed interest rate on an equivalent new loan. The fair value of lease obligations is measured at the present value by discounting expected repayments of lease obligations including interest in the remaining period using an assumed interest rate on equivalent new lease obligations. Derivatives Information on fair value of derivatives is included in Note 17. The carrying amount of financial instruments whose fair value cannot be reliably determined as of March 31, 2012 and 2011 consisted of the following: Investment securities that do not have a quoted market price in an active market ............................................................................ ¥1,181 ¥1,195 $14,369 Millions of yen 2012 2011 Thousands of U.S. dollars 2012 (4) Maturity analysis for financial assets and securities with contractual maturities The maturity analysis for financial assets and securities with contractual maturities as of March 31, 2012 was as follows: Due within one year Millions of yen Due after one year through five years Due after five years through ten years Cash and time deposits ............................................................................................ ¥ 85,483 Short-term investments and investment securities Held-to-maturity debt securities ........................................................................... 10,000 Available-for-sale other securities with contractual maturities ............................. 147 Notes and accounts receivable ................................................................................. 146,371 Total ...................................................................................................................... ¥242,001 ¥— — — — ¥— ¥— — — — ¥— Due within one year Thousands of U.S. dollars Due after one year through five years Due after five years through ten years Cash and time deposits ............................................................................................ $1,040,066 Short-term investments and investment securities Held-to-maturity debt securities ........................................................................... 121,668 Available-for-sale other securities with contractual maturities ............................. 1,789 Notes and accounts receivable ................................................................................. 1,780,886 Total ...................................................................................................................... $2,944,409 $— — — — $— $— — — — $— Please see Note 5 for annual maturities of long-term debt. Due after ten years ¥— — — — ¥— Due after ten years $— — — — $— 64 Kao Annual Report 2012 17 Derivatives (a) Derivative transactions to which hedge accounting is not applied The Companies had the following derivative contracts outstanding to which hedge accounting was not applied at March 31, 2012 and 2011: 2012 2011 Millions of yen Contract amount Contract amount due after one year Fair value Unrealized gain/(loss) Contract amount Foreign exchange forward contracts: Buying U.S. Dollar ............................................... ¥ 1,087 Buying Japanese Yen ......................................... 81 Buying British Pound .......................................... 774 Buying other currencies ...................................... 3 Selling U.S. Dollar ............................................... 11,082 Selling other currencies ...................................... 2,733 Foreign currency swaps: Selling put option British Pound ......................... ¥ 464 Option premium .......................................... — Buying call option U.S. Dollar ............................. 334 Option premium .......................................... — Buying call option Euro ...................................... 302 Option premium ........................................... — ¥ — — — — 714 — ¥ — — — — — — ¥ 9 2 28 0 (284) (96) ¥ (14) — 12 — 3 — ¥ 9 2 28 0 (284) (96) ¥ (14) — 12 — 3 — ¥1,010 49 806 233 7,301 3,863 ¥ — — — — — — Contract amount due after one year ¥ 331 — — — 1,569 — ¥ — — — — — — Fair value Unrealized gain/(loss) ¥ (42) 1 36 27 (52) 110 ¥ — — — — — — ¥ (42) 1 36 27 (52) 110 ¥ — — — — — — Thousands of U.S. dollars 2012 Contract amount Contract amount due after one year Fair value Unrealized gain/(loss) Foreign exchange forward contracts: Buying U.S. Dollar ............................................... $ 13,225 Buying Japanese Yen ......................................... 986 Buying British Pound .......................................... 9,417 Buying other currencies ...................................... 37 Selling U.S. Dollar ............................................... 134,834 Selling other currencies ...................................... 33,252 Foreign currency swaps: Selling put option British Pound ......................... $ 5,645 Option premium .......................................... — Buying call option U.S. Dollar ............................. 4,064 Option premium .......................................... — Buying call option Euro ...................................... 3,674 Option premium ........................................... — $ — — — — 8,687 — $ — — — — — — $ 110 24 341 0 (3,456) (1,169) $ 110 24 341 0 (3,456) (1,169) $ (170) $ (170) — 146 — 37 — — 146 — 37 — (b) Derivative transactions to which hedge accounting is applied The Companies had the following derivative contracts outstanding to which hedge accounting was applied at March 31, 2012: Hedged item Contract amount Millions of yen 2012 Contract amount due after one year Fair value Thousands of U.S. dollars 2012 Contract amount due after one year Fair value Contract amount Interest rate swaps: (Fixed rate payment, Floating rate receipt) .......... Long-term debt ¥40,000 ¥40,000 — $486,677 $486,677 — The interest rate swaps which qualify for hedge accounting and meet specific matching criteria are not remeasured at market value but the differentials paid or received under the swap agreements are recognized and included in interest expense or income. In addition, the fair value of the interest rate swaps is included in that of the hedged item, long-term debt, in Note 16. Kao Annual Report 2012 65 18 Net Income per Share A reconciliation of the differences between basic and diluted net income per share (“EPS”) for the years ended March 31, 2012 and 2011 was as follows: For the year ended March 31, 2012: Basic EPS Net income available to common shareholders ...................... Effect of dilutive securities Warrants ................................................................................. Diluted EPS Net income for computation ................................................... Millions of yen Net income Thousands of shares Weighted average shares Yen U.S. dollars EPS ¥52,435 521,936 ¥100.46 $1.22 — 183 ¥52,435 522,119 ¥100.43 $1.22 For the year ended March 31, 2011: Basic EPS Net income available to common shareholders ...................... Effect of dilutive securities Warrants ................................................................................. Diluted EPS Net income for computation ................................................... Millions of yen Net income Thousands of shares Weighted average shares Yen EPS ¥46,738 532,980 ¥87.69 — 151 ¥46,738 533,131 ¥87.67 Supplemental information Reorganization of Beauty Care Business in North America and Europe In order to conduct integrated management by unifying multiple managements of Beauty Care Business in each country in North America and Europe, the Company has been conducting a sequential reorganization within the Group since January 2012. As a result, major companies subject to reorganization and changes to their corporate names as of March 31, 2012 were as follows: Country Before Reorganization After Reorganization United States of America KPSS, Inc. Kao Brands Company KMS Global Marketing LLC Kao Brands Canada Inc. KPSS Canada Ltd. Canada Germany Kao USA Inc. Kao Canada Inc. KPSS – Kao Professional Salon Services GmbH Kao Germany GmbH United Kingdom Kao Brands Europe Limited Switzerland Netherlands Singapore KPSS AG KPSS Netherland B.V. Kao (Singapore) Private Limited KPSS Pte. Ltd. Kao (UK) Limited Kao Switzerland AG Kao Netherlands B.V. Kao Singapore Private Limited 66 Kao Annual Report 2012 Independent Auditor’s Report Kao Annual Report 2012 67 Principal Subsidiaries and Affiliates (As of June 28, 2012) Country/Area Business Company Country/Area Business Company ● ● Kao Customer Marketing Co., Ltd. Japan China Taiwan Vietnam Philippines Thailand Malaysia ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● Kanebo Cosmetics Inc. E'quipe, Ltd. Lissage Ltd. Kanebo Cosmillion Ltd. Nivea-Kao Co., Ltd. Ehime Sanitary Products Co., Ltd. Kao Professional Services Co., Ltd. Kao-Quaker Co., Ltd. Kao (China) Holding Co., Ltd. Kao Corporation Shanghai Kao Commercial (Shanghai) Co., Ltd. Kanebo Cosmetics (China) Co., Ltd. Shanghai Kanebo Cosmetics Co., Ltd. Kao Chemical Corporation Shanghai Switzerland Kao Trading Corporation Shanghai Kao (Hong Kong) Ltd. Spain ● Kao (Taiwan) Corporation ● ● Kao Vietnam Co., Ltd. Pilipinas Kao, Incorporated Kao Industrial (Thailand) Co., Ltd. Kao Commercial (Thailand) Co., Ltd. Kao Soap (Malaysia) Sdn. Bhd. Canada United States Mexico Germany Netherlands United Kingdom ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● Kao Canada Inc. Kao USA Inc. Kao America Inc. Kao Specialties Americas LLC Quimi-Kao, S.A. de C.V. Kao Germany GmbH Guhl Ikebana GmbH Kao Corporation GmbH ● Kao Chemicals GmbH Kao Netherlands B.V. Kao (UK) Limited KPSS (UK) Limited Kao Prestige Limited Molton Brown Limited Kao Switzerland AG Kanebo Cosmetics (Europe) Ltd. ● ● Kao Chemicals Europe, S.L. Kao Corporation S.A. Consumer Products Business ● Beauty Care Business ● Human Health Care Business ● Fabric and Home Care Business Chemical Business ● Chemical Business ● ● Kao (Malaysia) Sdn. Bhd. ● ● ● ● Fatty Chemical (Malaysia) Sdn. Bhd. Kao Plasticizer (Malaysia) Sdn. Bhd. Kao Oleochemical (Malaysia) Sdn. Bhd. Kao Singapore Private Limited P.T. Kao Indonesia ● P.T. Kao Indonesia Chemicals Singapore Indonesia ● ● ● ● ● ● 68 Kao Annual Report 2012 Investor Information (As of March 31, 2012) Kao Corporation Head Office 14-10, Nihonbashi Kayabacho 1-chome Chuo-ku, Tokyo 103-8210, Japan Telephone: 81-3-3660-7111 Founded June 19, 1887 Common Stock Authorized: 1,000,000,000 shares Issued: 526,212,501 shares Outstanding (excluding treasury stock): 522,366,519 shares Number of Shareholders: 54,622 Stock Listing Tokyo Stock Exchange Ticker Symbol Number 4452 Administrator of Shareholder Register Sumitomo Mitsui Trust Bank, Limited 8-4, Izumi 2-chome, Suginami-ku, Tokyo 168-0063, Japan Depositary and Registration for American Depositary Receipts (ADR Ticker Symbol: KCRPY) JPMorgan Chase Bank, N.A. 1 Chase Manhattan Plaza, Floor 58, New York, NY 10005, U.S.A. Top Ten Shareholders Name of Shareholders Number of Shares (thousand shares) Ratio of Shareholding* (percentage) Japan Trustee Services Bank, Ltd. (Trust Account) Northern Trust Co. (AVFC) Sub A/C American Clients The Master Trust Bank of Japan, Ltd. (Trust Account) State Street Bank and Trust Company Mellon Bank, N.A. as Agent for its Client Mellon Omnibus US Pension Northern Trust Co. AVFC Re U.S. Tax Exempted Pension Funds SSBT OD05 Omnibus Account – Treaty Clients Tokio Marine & Nichido Fire Insurance Co., Ltd. Kao Group Employee Shareholding Association State Street Bank and Trust Company 505225 * Ratio of shareholding is calculated based on the issued shares. 32,332 23,076 21,492 18,844 13,585 12,346 12,021 10,442 8,815 8,618 6.14 4.38 4.08 3.58 2.58 2.34 2.28 1.98 1.67 1.63 Composition of Shareholders Securities Companies 3.59% Other Japanese Companies 4.04% Individuals and Others 14.57% Financial Institutions 29.32% Treasury Stock 0.73% Companies and Individuals in Foreign Countries 47.75% For the Kao Sustainability Report and Kao Group Profile, please refer to the Kao Group website at http://www.kao.com/group/en/group/reports.html Investor Relations Telephone: 81-3-3660-7101 Facsimile: 81-3-3660-8978 e-mail: ir@kao.co.jp Web site: http://www.kao.com/jp/en/corp_ir/investors.html Stock Price Range and Trading Volume (Tokyo Stock Exchange) Stock Price Range (Yen) Common Stock Price Range Tokyo Price Index Close Monthly Trading Volume (Million Shares) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 120 100 80 60 40 20 0 2007 2008 2009 2010 2011 Note: Fiscal years beginning April and ending March the following calendar year Kao Annual Report 2012 69
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