Kao Corp.
Annual Report 2014

Plain-text annual report

PROFILE The Kao Group’s operations consist of the Consumer Products Business and the Chemical Business. The Consumer Products Business encompasses the Beauty Care Business, in which we offer prestige cosmetics, premium skin care products and hair care products; the Human Health Care Business, with products such as functional health beverages, sanitary products and personal health products; and the Fabric and Home Care Business, which includes laundry detergents and household cleaners. In the Chemical Business, we develop chemical products that meet the various needs of industry. FINANCIAL HIGHLIGHTS Net sales and profi ts* Cash dividends: ¥70 break previous records 25th consecutive period of increase * Net sales and net income broke the previous records, and operating income broke previous records for the second year in a row. (Years ended March 31, 2011 and 2012, period ended December 31, 2012 and years ended December 31, 2012 to 2014) Net Sales (Billions of yen) 1,500 1,186.8 1,216.1 1,220.4 1,000 1,012.6 1,401.7 1,315.2 500 0 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Net Sales (Left) Operating Income / Operating Income Ratio (Billions of yen) 150 100 50 0 133.3 124.7 104.6 108.6 101.6 111.8 8.8 8.9 10.0 9.2 9.5 9.5 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Operating Income (Left) Operating Income Ratio (Right) Net Income per Share (%) 25 (Yen) 180 20 15 10 5 0 120 60 0 156.46 126.03 100.46 101.12 101.77 87.69 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Notes: 1. Due to a change in the fi scal year end, the term of consolidation for the fi scal period ended December 31, 2012 consisted of the nine months from April to December for Kao Corporation and its subsidiaries whose fi scal year end was previously March 31 and the twelve months from January to December for subsidiaries whose fi scal year end was December 31. 2. December 2012 (Restated) represents fi gures for the year from January 1 to December 31, 2012 for Kao Group companies whose fi scal year end was previously March 31. 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. The Kao Way The Kao Way explains the essence of Kao’s unique corporate culture and spirit, which have been developed through our business activities since the founding of the company. Our mission is to strive for the wholehearted satisfaction and enrichment of the lives of people globally and to contribute to the sustainability of the world, with products and brands of excellent value that are created from the consumer’s and customer’s perspective. This commitment is embraced by all members of the Kao Group as we work together with passion to share joy with consumers and customers in our core domains of cleanliness, beauty, health and chemicals. * We defi ne Yoki-Monozukuri as “a strong commitment by all members to provide products and brands of excellent value for consumer satisfaction.” This core concept distinguishes Kao from all others. ** Genba literally means “actual spot.” At Kao, Genba-ism defi nes the importance of observing things “on-site,” in the actual location and environment, both internally and externally, in order to maximize our understanding of the business and optimize our performance. Further information is available at: http://www.kao.com/jp/en/corp_about/kaoway.html CONTENTS 2 Kao’s Strengths 4 Becoming a Company with a Global Presence 6 “Essential Research”: Offering Value for the Future That Helps to Resolve Social Issues 8 A Message from President and CEO Michitaka Sawada 16 Research and Development 18 Corporate Governance 22 Board of Directors and Audit & Supervisory Board Members, Executive Offi cers and Executive Fellows 25 Compliance 26 Risk Management 27 Sustainability 31 Financial Section 76 Principal Subsidiaries and Affi liates 77 Investor Information Kao Corporation Annual Report 2014 1 Kao’s Strengths For over 120 years, the Kao Group has been providing value to people by creating products that change their lives for the better. Taking advantage of the unique strengths that we have developed over this time, we continue to create value for the future that helps to resolve social issues. R&D Capabilities Kao works to create innovative products by combining fundamental technology research, which investigates cutting-edge science in various fi elds for future business creation, and product development research, which seeks to understand the lifestyles and needs of consumers worldwide to create products that provide comfort and satisfaction. Top Share of the Household and Personal Care Market* in Japan Kao has captured a high market share with value offerings that anticipate changes in people’s lifestyles. We provide strongly competitive products. *Source: INTAGE Inc. Jan. – Dec. 2014, value share in 79 categories in which Kao sells Our Strengths Synergy between the Chemical and Consumer Products Businesses Having diverse research domains that range from chemicals to consumer products leads to the development of innovative products. At the same time, having both businesses reduces Kao’s costs and creates high added value by broadly optimizing the total supply chain from chemicals to consumer products. Sales and Proposal Capabilities in Japan Kao’s proposal-oriented sales activities address consumers’ needs and retailers’ challenges with a unique sales structure that has sales company and logistics functions to enable better communication with retailers and consumers for true customer satisfaction. Breakdown of Business Segment Sales (Year ended December 31, 2014) Chemical Business ¥247.2 billion 17.6% Fabric and Home Care Business Human Health Care Business 2 Kao Corporation Annual Report 2014 ¥247.2 billion 17.6% Consolidated Net Sales ¥1,401.7 billion ¥324.5 billion 23.2% ¥589.9 billion 42.1% ¥240.1 billion 17.1% Consumer Products Business ¥1,154.5 billion 82.4% Beauty Care Business Note: Figures in the graph represent net sales to outside customers only. Segment Information Beauty Care Business Net Sales1 (Billions of yen) 800 Main Products Professional hair care products / Cosmetics / Skin care (mass products) / Hair care (mass products) Human Health Care Business Main Products Beverages / Oral care / Blood circulation enhancement products (incl. bath additives and thermal pads) / Sanitary products Fabric and Home Care Business (Billions of yen) 400 Main Products Laundry detergents and fabric treatments / Products for kitchen, bath, toilet and living room care Chemical Business Main Products Oleo chemicals / Performance chemicals / Specialty chemicals Operating Income1 / EBITA2 Operating Income Ratio1 (Billions of yen) 80 Operating Income (Left) EBITA (Left) Operating Income Ratio (Right) 57.3 54.0 4.8 4.9 45.9 4.2 21.8 23.9 28.4 60 40 20 0 570.3 589.9 444.4 600 400 200 0 Dec. 2012 Dec. 2013 Dec. 2014 Dec. 2012 Dec. 2013 Dec. 2014 (Billions of yen) 300 (Billions of yen) 30 Operating Income (Left) Operating Income Ratio (Right) 240.1 210.6 152.0 200 100 0 20 10 0 21.9 16.9 11.5 7.6 7.6 8.0 8.0 9.19.19.1 9.1 10 Dec. 2012 Dec. 2013 Dec. 2014 Dec. 2012 Dec. 2013 Dec. 2014 (Billions of yen) 80 Operating Income (Left) Operating Income Ratio (Right) 62.2 61.0 51.4 21.7 21.7 20.0 20.0 18.8 18.8 20 311.0 324.5 236.7 300 200 100 0 60 40 20 0 Dec. 2012 Dec. 2013 Dec. 2014 Dec. 2012 Dec. 2013 Dec. 2014 (Billions of yen) 400 (Billions of yen) 30 Operating Income (Left) Operating Income Ratio (Right) 288.0 261.2 208.1 300 200 100 0 21.5 22.1 16.8 8.1 8.1 8.2 8.2 7.7 7.7 20 10 0 Dec. 2012 Dec. 2013 Dec. 2014 Dec. 2012 Dec. 2013 Dec. 2014 Note: Net sales include intersegment sales. (%) 8 6 4 2 0 (%) 30 20 0 (%) 40 30 10 0 (%) 20 15 10 5 0 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 Notes: 1. Period ended December 31, 2012 and years ended December 31, 2013 and 2014 2. EBITA (Earnings before interest, taxes and amortization) is operating income before amortization of goodwill and other items related to acquisitions. Kao Corporation Annual Report 2014 3 Becoming a Company with a Global Presence The Kao Group’s mission is to strive for the wholehearted satisfaction and enrichment of the lives of people globally and to contribute to the sustainability of the world, with products and brands of excellent value that are created from the consumer’s and customer’s perspective. We aim to become a company with a global presence by offering value for the future that helps to resolve the social issues regarding the environment, health, the aging society and hygiene through our business activities. The Environment Health Global warming, insufficient water The number of health-conscious resources and other environmental people is rising rapidly. We will offer problems that significantly affect life value for the future that plays a role in are growing more serious each year. helping people improve their own Kao will offer value for the future to health. promote environmental conservation. 4 Kao Corporation Annual Report 2014 The Aging Society Hygiene With a focus on the aging society, we Infectious diseases and hygiene issues will offer value for the future that helps are numerous throughout the world. seniors remain healthy and active. We will offer value for the future that facilitates hygienic lives. Kao Corporation Annual Report 2014 5 “Essential Research”: Offering Value for the Future That Helps to Kao’s Research and Development Aims to Create Value That Will Be a Foundation of Society Decades from Now. The Aging Society Health Hygiene The Environment Kao aims to advance a wide range of cutting-edge science together with industry, government and academia. Research into humans and materials derived from this science gives rise to new discoveries and inventions for the evolution of Kao’s fundamental technology research. We then add new perspectives and design elements to deepen and combine our technologies to offer value that consumers and customers desire for the future. With operations consisting of the Consumer Products Business and the Chemical Business, Kao conducts “essential research” to offer value for the future that helps to resolve social issues regarding the environment, health, the aging society and hygiene. 6 Kao Corporation Annual Report 2014  Resolve Social Issues Representative Results of Essential Research The Aging Society 20013 2013 Goldwell Kerasilk The Environment 2014 2014 Algae research The world’s fi rst keratin treatment with no harmful substances that transforms unruly, frizzy hair into manageable hair that is smooth like silk. Expected to also apply to hair concerns that arise with aging. Health 2003 2003 Healthya Green Tea Healthya Green Tea, which contains high levels of tea catechin, is the fi rst tea product in Japan to receive permission from the Ministry of Health, Labour and Welfare to be labeled as Food for Specifi ed Health Use suitable for people concerned about body fat. As a global pioneer, Kao aims to acquire a natural raw material source of fats and oils that is not in competition with food resources. 1980 Toner and toner binder Kao is a global pioneer in the development of polyester resin, which is used for printer and copier toner with superior performance in low-temperature fusing (high-speed printing) and pigment dispersion (high image quality). Kao’s toner and toner binder substantially reduce electricity consumption, and are used for one out of every three copies and prints made worldwide. Hygiene 2011 2011 Attack Neo Antibacterial EX Power The only liquid laundry detergent formulated with bleaching agents. Suppresses odor-causing bacteria and deodorizes with each wash, while preventing mold and mildew in washing machine tubs and laundry. A single rinse saves water, electricity and time. Kao Corporation Annual Report 2014 7 A Message from President and CEO Michitaka Sawada Look forward to the Kao Group’s future growth as it makes its presence felt as a company that helps to resolve social issues. Michitaka Sawada President and Chief Executive Officer As stated in the “Kao Way,” which is our corporate philosophy, the mission of the Kao Group is to strive for the wholehearted satisfaction and enrichment of the lives of people globally and to contribute to the sustainability of the world. Under this mission, we have made numerous value offerings through our products and services since our founding. In the future, Kao intends to become a company with a global presence, exerting a substantial impact on the world by helping to resolve social issues while continuing to take on challenges. Maximizing the use of our assets, such as our human resources, R&D assets and brands, is important for achieving this objective. We will continue to create new value for the future and offer it to the world through “essential research.” Day in and day out, we will work diligently toward the realization of our goal of becoming a company with a global presence. 8 Kao Corporation Annual Report 2014 In 2014, under Kao Group Mid-term Plan 2015 (K15) we made great strides toward our vision for the Group’s future. We made progress in building the sustainable growth model we have targeted by maximizing the use of Kao Group assets to enhance our capabilities to increase profits. We drew up Kao Group Mid-term Plan 2015 (K15) in 2013, and 2015 is its final year. In 2014, not only were we able to achieve numerical targets, but we were also able to make structural changes toward the realization of K15. We had been offering consumers high-value-added products, which became more readily accepted by consumers as the market changed. Under these circumstances, we made substantial progress toward building the sustainable growth model I have been insisting on: a post-deflation growth model for transformation to a more profi table structure, with the capabilities to generate profits by maximizing the use of our assets. It is a virtuous cycle in which the profi ts we generate are proactively allocated to investments that lead to growth in market share and sales, which in turn provides profi t exceeding the amount of investment. For example, even if an unforeseen event occurs, we can overcome it and continue to generate profi ts that can be used for other investments for further growth. The Kao Group has many assets accumulated by our predecessors, in areas including research and development, human resources, goods, information and brands. To start with, we are making better use of our human resources. We have given all employees a sense of ownership and an awareness of maximizing the use of the assets they possess. As a result, among other factors, employee attitudes have changed. They are able to think and act on-site to make forward-looking proposals that utilize Targeted Sustainable Growth Model Profi table growth, creation of new assets Establish a post-defl ation growth model Proactive investment Increase profi ts Increase market share and sales Capabilities to generate profi ts (Transformation to a profi table structure) Maximize use of Kao Group assets Kao Corporation Annual Report 2014 9 their assets. In this way, we are gradually shifting to a structure that generates profits, or in other words, enhancing our capabilities to increase profits. As maximizing use of assets has taken root throughout the Kao Group, we have enhanced our capabilities to increase profits. The result has been progress in building our sustainable growth model. At the same time, we continuously invest in research and development, including “essential research.” Building the foundation for this sustainable growth model was our primary accomplishment in 2014. Capital expenditures were at the ¥50 billion level until fiscal 2012, but increased to the ¥60 billion level since K15 began. During 2014, we increased production capacity in Japan for baby diapers, which are growing in sales, and for the Fabric and Home Care Business, to reinforce this business. Outside Japan, we built our second consumer products plant in the growing market of Indonesia as part of the global expansion of the Consumer Products Business. Our efforts to strengthen the Chemical Business included the establishment of new plants in Indonesia and China. Moreover, we proactively increased investment in marketing new and improved high-value-added products, among other measures to respond to the last-minute surge in demand before the consumption tax rate increase in Japan in April 2014. As a result, the increase in profits from sales growth Growth Model for Exiting Deflation with Proactive Investment* Profitable growth Investment ¥310.0 billion Net sales ¥1,470.0 billion FY2015 Operating income ¥150.0 billion Investment ¥285.7 billion Net sales ¥1,401.7 billion FY2014 Operating income ¥133.3 billion Investment ¥269.4 billion Net sales ¥1,315.2 billion FY2013 Operating income ¥124.7 billion FY2014 actual year-on-year growth • Investment: • Net sales: (Billion yen) +16.3 +86.5 • Operating income: +8.6 10 Kao Corporation Annual Report 2014 * Investment = Capital expenditures + Marketing expenditures + Research and development expenditures A Message from President and CEO Michitaka Sawada exceeded the increase in investment. The Kao Group’s share of the household and personal care products market in Japan has increased compared with the previous year. This is a sign that we are shifting to the sustainable growth model that I am determined to establish. Regarding Kanebo Cosmetics brightening products containing the ingredient Rhododenol, the Kao Group continues to respond in a sincere manner. Kanebo Cosmetics has been making individual visits to people who have experienced vitiligo-like symptoms and offering support for their recovery and compensation. K15 Net Sales and Operating Income (Billions of yen) 1,500 1,270.0 1,315.2 1,220.4 (Billions of yen) 1,470.0 200 1,370.0 1,401.7 1,000 111.8 124.7 133.3 150.0 130.0 116.0 500 0 FY2012* FY2013 FY2014 FY2015 150 100 50 0 K15 net sales target ¥1.4 trillion K15 operating income target ¥150 billion Overseas sales ratio 26.8% 30.9% 33.1% 30% or more (Target) Net Sales (Actual) (Left) Operating Income (Actual) (Right) Net Sales (Forecast) (Left) Operating Income (Forecast) (Right) * Excludes the impact of the change in financial term in 2012. In 2015, we will build our foundation for the future. We are poised for a major leap to achieve the targets of K15, particularly the operating income target of ¥150 billion. K15 has reached its final year in 2015. The plan was drawn up by visualizing the Kao Group’s desired state, then looking backward to plot out the steps to get there. This will be a year of looking a decade or two into the future to establish a foundation for long-term application of the sustainable growth model we have been building. In 2015, as the final year of K15, it is imperative that we (1) break previous records for net sales and profits and (2) achieve the numerical management targets of ¥1.4 trillion in net sales, ¥150 billion in operating income and an overseas sales ratio of 30 percent or more. These key performance indicators have not changed since the initial announcement. Kao Corporation Annual Report 2014 11 Growth Strategies to Achieve K15 1. Expand the Consumer Products Business globally ■ Growth markets: Expand the business signifi cantly by proposing products in the domain of “cleanliness” including laundry detergents, baby diapers and sanitary napkins that target the growing middle-class consumer segments ■ Mature markets: Accelerate growth with high-value-added products 2. Further reinforce the Fabric and Home Care Business, and accelerate profi table growth in the Beauty Care and Human Health Care Businesses Fabric and Home Care Business ■ Maintain or capture the top share in each product category Beauty Care Business and Human Health Care Business ■ Move the cosmetics business to a phase of profi table growth ■ Propose products and services through new approaches focused on health and the aging society 3. Reinforce the Chemical Business ■ Promote higher added value ■ Strengthen synergy with the Consumer Products Business Profitable growth and the creation of new assets are priority themes for achieving these targets, with a sustainable growth model driven by making maximum use of the Kao Group’s assets and capabilities to generate profits. To reinforce our Consumer Products Business in Japan, we will proactively launch new and improved products and invest in marketing. We will also work to restore the cosmetics business through growth of the distinctive Sofina and Kanebo brands, and take measures to reinforce the Healthya brand of functional drinks. For further growth in the Consumer Products Business in Asia, we will enhance our efforts for the premium segment while proactively conducting business targeting the middle-class consumer segment. In the Consumer Products Business in the Americas and Europe, where we are facing challenges, we will improve profitability. In the Chemical Business, we will respond to changes in the global operating environment by proposing high-value-added products and further reinforcing oleo chemicals. We will focus on “essential research” with our sights set decades into the future to help resolve social issues globally. Setting its sights on the future, the Kao Group will focus efforts on the social issues where it can best maximize its assets: the environment, health and the aging society, to which we have added hygiene. 12 Kao Corporation Annual Report 2014 A Message from President and CEO Michitaka Sawada In the area of the environment, for example, Eco-Technology Research Center in Wakayama Prefecture in Japan, has been conducting research on algae as a next- generation energy source. In the area of health, we have already begun developing health promotion solutions including health-related products and measuring instruments. For the aging society, we have been conducting a business that provides a wide range of products for active seniors, not only incontinence products, employing universal design and other measures. For hygiene, the new area on our list, we intend to use the technologies we have accumulated in Japan to make a contribution to consumers worldwide. Moreover, to achieve our vision of becoming a company with a global presence, we will refine our current strategies to set the direction of our mid-term growth strategies following K15. There are still countries where the Kao Group does not do business, and we want to enter those markets with all due speed to accelerate the global expansion of the Consumer Products Business. Growth in Japan will be indispensable for this expansion. Japan’s low birthrate and aging society are said to be causing the market to contract, but I believe we can generate growth by anticipating changes in lifestyles and making value offerings that are a half-step ahead of those changes. Consumer spending is improving, and we should be able to grow by further enhancing the market positions we have already established. In Japan, we are facing the social issues of a low birthrate and an aging society ahead of other countries. By successfully dealing with these issues and accumulating expertise under these conditions in Japan, we will be equipped to tackle them on a global scale. We also intend to quickly return the cosmetics business to a growth path. In the Chemical Business, we aim to achieve sales expansion and stable profitability. I recognize that these strategies will require the training of expert personnel and continuous investment in “essential research.” By expert personnel, I mean employees who can link related parts of our functions: research with operations, technologies with business, local sites with the head office, and so on. The key will be to train expert personnel who can generate comprehensive value by bringing together other employees who display value in specialized fields. We are already conducting measures for this purpose within the Kao Group, such as the Innovation Creation Project and the Global Expansion Project. In addition, “essential research” is the most important element in creating value for the future. Without a doubt, the Kao Group’s lifestyle proposals to date have originated from this research. It is one of the strengths we must maximize for future growth, and we will continue to prioritize investment in it to develop our ability to create value for the future. Kao Corporation Annual Report 2014 13 In 2014, we made substantial changes to our corporate governance structure to attain our initial objectives: enhancing discussions of strategies from a global perspective by the Board of Directors, speedy decision-making and separation of supervision and execution. To continue sustainable development, the Kao Group has been working to enhance its corporate governance through innovation.* Our new structure has been in operation since March 2014. We have reinforced the outside perspective of the Board of Directors with an equal number of inside and outside members, and an Independent Outside Director as chairman. Moreover, two of the Outside Directors are Independent Directors. We have also accelerated decision-making, further clarified the division of roles between supervision and execution, and delegated authority. Receiving valuable opinions from the diverse perspectives of the Outside Directors and Outside Audit & Supervisory Board Members has deepened discussions of the Kao Group’s future direction and other matters. It also leads to engagement with our investors from a long-term perspective, which in turn increases our corporate value. * “Innovation” is one of the values of the Kao Way. Look forward to Kao’s growth decades into the future. The targeted sustainable growth model based on maximizing the use of the Kao Group’s assets and our capabilities to generate profits has begun to function, and we are now able to invest for our future growth. We will continue to prioritize the uses of the cash flow we generate each year as we have in the past. Moreover, the Kao Group was the first in Japan to introduce Economic Value Added (EVA)* as a management indicator to increase corporate value. We believe EVA management generates and improves “true” profit that exceeds the cost of capital. We will work to increase corporate value by continuously improving EVA through profitable growth. Furthermore, because EVA management keeps us aware of the cost of capital at all times, it improves ROE. *EVA (Economic Value Added) is a registered trademark of Stern Stewart & Co. Direction of Mid-term Growth Strategies (3 to 5 Years) after K15 ■ Accelerate global expansion of the Consumer Products Business ■ High-value-added offerings that resolve social issues including the environment, health, the aging society and hygiene ■ Return the cosmetics business to a growth path ■ Achieve sales expansion and stable profi tability in the Chemical Business 14 Kao Corporation Annual Report 2014 A Message from President and CEO Michitaka Sawada The Kao Group will voluntarily implement International Financial Reporting Standards from 2016 based on its judgment that standardizing accounting within the Group will help to improve the quality of Group management. The implementation will enable management based on standardized frameworks and information in each Kao Group company and business, thus strengthening our management foundation to improve our corporate value as a global company. The Kao Group will increase its corporate value by creating value for the future from the perspective of consumers and working to help resolve social issues, primarily in the areas of the environment, health, the aging society and hygiene. By increasing value for our customers, employees and shareholders in a balanced fashion, we aim to achieve profitable growth and contribute to a sustainable society. The Kao Group is in the process of building its sustainable growth model to drive future growth. Our shareholders can look forward to Kao’s growth as we set our sights decades into the future. Use of Cash Flow* and Shareholder Returns Use steadily generated cash fl ow effectively in order of priority shown below from an EVA standpoint toward further growth. 1 2 3 Investment for future growth (capital expenditures, M&A, etc.) Steady and continuous cash dividends Share repurchases and early repayment of interest-bearing debt including borrowings * Net cash provided by operating activities EVA (Year ended March 31, 2000 = 100) (Year ended December 31, 2011 = 100) 200 150 100 50 0 163 154 142 132 134 125 113 120 100 106 95 91 67 165 138 112 100 200 150 100 50 0 Mar. 2000 Mar. 2001 Mar. 2002 Mar. 2003 Mar. 2004 Mar. 2005 Mar. 2006 Mar. 2007 Mar. 2008 Mar. 2009 Mar. 2010 Mar. 2011 Mar. 2012 Dec. 2011 Dec. 2012 Dec. 2013 Dec. 2014 Note: Due to the change in the fiscal year end, EVA has been restated on a calendar year basis for periods ended December 31, 2011 and 2012. Kao Corporation Annual Report 2014 15 Research and Development Basic Policy understanding of the various cultures and needs of Kao’s mission is to strive for the wholehearted consumers in diverse countries and regions to develop satisfaction and enrichment of the lives of people innovative products and technologies that create new globally and to contribute to the sustainability of the value and new markets. world, with products and brands of excellent value that Approximately 2,800 Kao Group personnel conduct are created from the consumer’s and customer’s research and development. R&D expenditures for the perspective. Based on this mission, Kao’s research and entire Kao Group in 2014 were ¥51.7 billion, equivalent development division combines original ideas with an to 3.7% of net sales. Topics Thomson Reuters Names Kao One of the 2014 Top 100 Global Innovators Kao regards its patents and other intellectual property companies are selected (IP) rights as important management resources, and in using metrics such as 2014 it was selected for the fourth time by Thomson overall patent volume, Reuters as one of the “2014 Top 100 Global Innovators.” patent grant success The award is given to innovative companies recognized rate, global reach of the for having developed inventions with a global impact and portfolio and patent for working to protect their IP rights. Based on Thomson influence as evidenced Reuters’ patent database, IP search and analysis platform by citations. and criteria established by its IP solutions business, Receiving an award as one of the “2014 Top 100 Global Innovators” Topics In Research on Algae, Kao Finds Some Strains That Produce Medium Chain Fatty Acids, and Identifi es an Enzyme That Plays an Important Role in the Biosynthesis Pathway Kao has succeeded in fi nding an enzyme that can produce a Through research on biotechnologies that evolved from large number of medium chain fatty acids, which are the technologies for enzymes for detergents, Kao found some main components of natural fats and oils (such as palm strains that contained a large number of C12 medium chain kernel oils and coconut oils) used as raw materials for fatty acids among C12 to 14 medium chain fatty acids. surfactants in detergents, shampoos, and other related Additionally, as a fi rst in the fi eld of algae, we identifi ed a products. This fi nding presents a strong possibility that Kao could become a world pioneer in acquiring a natural raw novel acyl-ACP thioesterase with high specifi city to medium chain fatty acids from the genus Nannochloropsis. We material source of fats and oils that is not in competition expect that these fi ndings will dramatically accelerate the with food resources. breeding development of algae for large-scale production of Reportedly, the potential for algae to produce fats and oils medium chain fatty acids. is more than ten times that of natural resources such as palm. In recent years, many research cases to acquire new raw materials for fuels (biofuels) to replace fossil fuels have reported on the production of fats and oils that contain C16 to 18 fatty acids as a main component. However, surfactants in detergents and the base substances of various raw materials are C12 to 14 medium chain fatty acids. Therefore, there have been virtually no examples of relevant research within the conventional scope of research on algae. Algae research 16 Kao Corporation Annual Report 2014 Beauty Care Business Kao conducts research for a deep understanding of the true nature of the skin and hair of people around the world and develops materials and formulations that give rise to new functions. By doing so, we aim to help consumers achieve healthy, beautiful skin and hair and to offer beauty proposals tailored to diverse lifestyles. To maximize the use of the Kao Group’s assets and reinforce the cosmetics category of the Beauty Care Business, we integrated our research organizations for Kao Sofi na and Kanebo Cosmetics. We have reorganized the Kanebo Cosmetics Laboratories in Odawara, Japan as the Kao Odawara Research Laboratories, which will conduct full-scale research as the Kao Group’s comprehensive R&D facility for cosmetics. In hair care, we renewed the Essential hair care brand in Japan, Taiwan, Singapore and Hong Kong. Using fi ne cuticle care technology for uniform adsorption of hair care ingredients (lanolin fatty acids that repair, moisturize and preserve) that include 18-methyleicosanoic acid, the improved shampoos and conditioners reduce hair friction to enhance the smoothness of fi ngers running through the hair and make washing, drying and setting easier. R&D expenditures in the Beauty Care Business totaled ¥22.3 billion. Human Health Care Business Kao researches the body and mind to improve the quality of life by making the most of people’s natural vitality. In sanitary products, we launched an improved version of Laurier Super Absorbent Guard from the Laurier brand of sanitary napkins in Japan. Using a new technology for an absorbent pad with localized blocking properties both reduces unpleasant stiffness and makes it comfortable to wear while also increasing absorbency. In Thailand, we Fabric and Home Care Business launched Laurier Super Gentle Plus, which uses a topsheet material with a gentle touch and reduces the surface area in direct contact with the skin to one-third that of conventional products, thus reducing chafi ng, the primary cause of irritation. R&D expenditures in the Human Health Care Business totaled ¥12.1 billion. Kao’s research and development spans a wide range of fi elds from household products that meet the diverse needs of consumers to products for professional use where a high level of cleanliness and hygiene is required. In home care, we launched an improved version of CuCute dishwashing detergent. Kao’s original hybrid wash formulation, which combines two types of surfactant, creates thick suds from the start of washing to rapidly remove tough, congealed grease and fat and rinses off immediately, thus saving water. R&D expenditures in the Fabric and Home Care Business totaled ¥7.4 billion. Chemical Business In this business, Kao’s research and development strives for more substantive R&D results in areas including oils and fats, surfactants and polymers to produce chemical products distinguished by their ability to meet diverse needs in a wide range of industries. Kao conducts research on forward-looking environmental technologies, centering on advanced use of biomass. In our research on algae, we have succeeded in fi nding an enzyme that can produce a large number of medium chain fatty acids. We are pursuing technological development with the aim of large-scale production of fats and oils from algae as a natural raw material source of fats and oils that is not in competition with food resources. In performance chemicals, we are developing value- added products with a reduced environmental burden. In collaboration with Bridgestone Corporation, we have developed a sustainable dispersion improving agent that distributes silica more evenly in rubber. This enables the addition of more silica to the rubber raw material than in conventional tires, thus improving fuel economy and wet grip performance. In specialty chemicals, development efforts include raising the ratio of bio-ingredients in our toner binder. R&D expenditures in the Chemical Business totaled ¥9.9 billion. 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 Kao Corporation Annual Report 2014 17 Corporate Governance Basic Policy and Structure In accordance with this position, Kao works to improve For Kao, the basis of corporate governance is separating governance as a company with an Audit & Supervisory the functions of supervision and execution to strengthen Board by strengthening the supervisory function of the supervision of execution and transferring authority to the Board of Directors and the auditing function of the Audit Executive Offi cers to strengthen and accelerate execution & Supervisory Board. An overview of Kao’s governance with the aim of continuously enhancing corporate value. structure is given in the following chart. Corporate Governance Structure Shareholders Meeting Monitoring Audit & Supervisory Board Audit Board of Directors Committee for the Examination of the Nominees for the Members of the Board of Directors and Executive Officers Compensation Advisory Committee Audit s r o t i d u A g n i t n u o c c A Audit Audit Supervision Management Committee Sustainability Committee Eco-Strategy Committee Internal Control Committee Disclosure Committee Compliance Committee Information Security Committee Risk Management Committee Committee for Responsible Care Promotion Quality Assurance Committee e c n a i l p m o C e n i l t o H n o i t a t l u s n o C s r e y w a L e d s t u O i Corporate Audit Services Internal Audit Executive Officer Responsible for each Division 　 ● Business Divisions 　 ● Functional Divisions Executing Divisions Audit Investigation (Attendance) Accounting Auditors Certified Public Accountants Audit Conference by Audit & Supervisory Board Members of Domestic Group Companies (Attendance) Subsidiaries/Affiliates Audit Audit & Supervisory Board Members Note: Our policy is to ask lawyers and other experts, as necessary, when making business decisions concerning business management and daily operations. 18 Kao Corporation Annual Report 2014 Board of Directors Audit & Supervisory Board The Board of Directors ensures diversity, independence The Audit & Supervisory Board ensures the effectiveness and lively discussions by inviting people from outside the of its audits through the collaboration of the Full-time Company with diverse experiences and knowledge and by Audit & Supervisory Board Members with the Outside having a committee structure with an appropriate and Audit & Supervisory Board Members, a majority of whom equal number of inside and outside members. have qualifi cations such as attorney-at-law or certifi ed Number of Members 6 Outside Directors Included in Above 3 (50%) Independence The Company has reported two of the three Outside Directors to the Tokyo Stock Exchange as Independent Outside Directors who have met the qualifi cations for independence in the Standards for Independence of Outside Directors/ Audit & Supervisory Board Members of Kao Corporation (the “Standards”). The Standards, which have been established with reference to the Independence Tests of the New York Stock Exchange, can be found at: http://www.kao.com/jp/en/corp_ imgs/corp_info/governance_002.pdf Chairman Independent Outside Director Term of Offi ce 1 year (voluntarily shorter than the statutory period) Number of Meetings 15 times/year Average Attendance Rate of Outside Directors 95% public accountant, who maintain independence and expertise as outside parties. Number of Members 5 Outside Audit & Supervisory Board Members Included in Above 3 (60%) Independence Chairman Term of Offi ce The Company has reported all three Outside Audit & Supervisory Board Members to the Tokyo Stock Exchange as Independent Outside Audit & Supervisory Board Members who have met the qualifi cations in the Standards. Full-time Audit & Supervisory Board Member 4 years (statutory period: prohibited by the law to shorten the period) Number of Meetings 10 times/year Average Attendance Rate of Outside Audit & Supervisory Board Members Board of Directors Meetings: 100% Audit & Supervisory Board Meetings: 98% Meetings to exchange opinions with Representative Directors: 100% (3 times/year) Committee for the Examination of the Nominees for the Members of the Board of Directors and Executive Officers Compensation Advisory Committee This committee examines the compensation system and remuneration levels for Directors and Executive Offi cers This committee examines the nominees prior to election and submits the results of its examinations to the Board or re-election as Representative Director, Director, of Directors. Executive Officer and title of Executive Officer as proposed to the General Meeting of Shareholders and Number of Members 9 the Board of Directors, and submits its evaluation of the nominees’ qualifi cations to the Board of Directors. Number of Members 6 Composition Chairman All Outside Directors and all Outside Audit & Supervisory Board Members Chosen by committee members. The chairman was the President and Chief Executive Offi cer in 2014. Number of Meetings Held for each election or re-election. Held once in 2014. Attendance Rate 100% Composition Chairman All Representative Directors, all Outside Directors and all Outside Audit & Supervisory Board Members Chosen by committee members. The chairman was the President and Chief Executive Offi cer in 2014. Number of Meetings Held once in 2014. Compensation System See next page Kao Corporation Annual Report 2014 19 Support System for Outside Directors and Outside Audit & Supervisory Board Members To allow for active discussions at meetings of the Board of Directors, the Board of Directors Secretariat provides Outside Directors with suffi cient explanations on matters Type of Remuneration Composition1 Base salary Short-term incentive2 (bonus) Long-term incentive (remuneration-type stock options) 60 – 70% 20% 10 – 20% such as the background, purposes and content of the Notes: 1. Composition is the percentage allocated in estimated annual standard remuneration. 2. Short-term incentive is set to fl uctuate between 0% and 200% depending on the achievement of targets for EVA, net sales and operating income. 3. The Company has no retirement bonus system for Directors. 4. Compensation for Outside Directors, who are independent of the Company’s operations, consists of base salary and stock options only. 5. Compensation of Audit & Supervisory Board Members consists of base salary only. respective agenda items prior to each meeting of the Board of Directors. Furthermore, under this support system, in addition to support staff nominees, administrative divisions such as Global Internal Audit, the Legal and Compliance Department and the Accounting and Finance Department provide Outside Audit & Supervisory Board Members with assistance upon request. Compensation System for Officers The Company’s fundamental position on remuneration of Directors, Audit & Supervisory Board Members and Executive Offi cers is (1) a compensation system that attracts diverse and excellent candidates to establish and improve competitive advantages; (2) a compensation system that promotes continuous improvement of corporate value and shares interests with shareholders; and (3) an objective and transparent decision-making process regarding compensation. Based on data from an outside research institution on Directors’ and Executive Offi cers’ remuneration, the Company decides on compensation by setting a benchmark each year with other well-known manufacturing companies of a similar business size and in a similar business category as companies of the same rank, and comparing their remuneration systems and levels of remuneration with those of the Company. The composition of remuneration of Inside Directors and Executive Offi cers is as shown above right, and remuneration is determined based on their roles as Directors and Executive Offi cers and positions concurrently held. 20 Kao Corporation Annual Report 2014 Corporate Governance Comment from Chairman of the Board of Directors Sonosuke Kadonaga (Independent Outside Director) As chairman of the Board of Directors, I am pleased that the effects of changes to the Board have gradually become apparent. I intend to ensure that Kao continues working to enhance its corporate governance. In March 2014, Kao made substantial changes to its Board of Directors to enhance its corporate governance structure. The number of Directors changed from seven Inside Directors and three Outside Directors to a total of six Directors, consisting of an equal number of Inside and Outside Directors, two of whom are Independent Directors. In addition, as an Independent Outside Director, I assumed the position of chairman of the Board of Directors. Now that about a year has passed, I feel we are attaining our initial objectives, including enhancing discussions of strategies from global Sonosuke Kadonaga Chairman of the Board of Directors Independent Outside Director perspectives, speedy decision-making and separation of supervision and audits, including checks by Outside supervision and execution. Directors and Outside Audit & Supervisory Board The Board of Directors conducts lively discussions, as Members of the periodic reports made by the Executive the three Outside Directors with rich overseas working Officers to the Board of Directors on the status of experience offer opinions from multifaceted execution. Moreover, granting a wide range of authority perspectives that make the most of their respective to Executive Officers has accelerated decision-making experiences and knowledge. The team of Audit & for faster execution and management. Supervisory Board Members, including members from Of course, our efforts to enhance corporate outside with many years of corporate experience as an governance are by no means finished with the current attorney-at-law or certified public accountant, adds to structure. Appropriately dealing with the rapid changes these discussions from specialist perspectives. The in our business environment in recent years requires Board of Directors mainly decides the direction of constant innovation, including innovation of the matters such as long-term business strategies and corporate governance structure. I believe more active organizational structure, and entrusts their execution to management discussion by the Board of Directors will the Executive Officers. In addition, the separation of be vital in setting the course for our management and supervision and execution is promoted by enhanced businesses from holistic and long-term perspectives. Kao Corporation Annual Report 2014 21 Board of Directors and Audit & Supervisory Board Members (As of April 1, 2015) Board of Directors Michitaka Sawada1 Representative Director Apr. 1981 Joined the Company Jun. 2006 Executive Officer Jun. 2008 Member of the Board, Executive Officer Jun. 2012 Representative Director, President and Chief Executive Officer (current) Jan. 2014 Responsible for Product Quality Management Katsuhiko Yoshida1 Representative Director Apr. 1979 Joined the Company Apr. 2007 President, Human Health Care Business Unit Jun. 2007 Executive Officer Apr. 2010 President, Fabric and Home Care Business Unit Jun. 2012 Managing Executive Officer (current) Mar. 2014 Member of the Board, Representative Director, President, Consumer Products; Responsible for Kao Professional Services Co., Ltd. (current) Toshiaki Takeuchi1 Representative Director Apr. 1981 Joined the Company Mar. 2009 Vice President, Corporate Planning, Kao Customer Marketing Co., Ltd. Mar. 2010 Member of the Board, Executive Officer, Kao Customer Marketing Co., Ltd. May 2011 Member of the Board, Senior Managing Executive Officer, Kao Customer Marketing Co., Ltd. May 2012 Representative Director, Senior Managing Executive Officer, Kao Customer Marketing Co., Ltd. Jun. 2012 Executive Officer Apr. 2013 Representative Director, Executive Vice President, Kao Customer Marketing Co., Ltd. Mar. 2014 Member of the Board, Representative Director, Managing Executive Officer, President and Chief Executive Officer, Kao Customer Marketing Co., Ltd. (current) 22 Kao Corporation Annual Report 2014 Sonosuke Kadonaga2 Independent 4 President, Intrinsics Apr. 1976 Joined Chiyoda Corporation Jun. 1981 Master of Science in Chemical Engineering, Massachusetts Institute of Technology, School of Engineering, U.S.A. Aug. 1986 Joined McKinsey & Company, Inc., Japan Jul. 2009 President, Intrinsics (current) Jun. 2012 Member of the Board, Kao Corporation (current) Mar. 2014 Chairman of the Board of Directors Toru Nagashima2 Independent 4 Senior Advisor, Teijin Limited Apr. 1965 Joined Teijin Limited Jul. 1974 Courses taken in the MBA Program, University of Utah, U.S.A. Oct. 1975 Seconded to Polynova S.A., Mexico Jun. 2000 Member of the Board, and CESHO (Chief Environment, Safety & Health Officer), Teijin Limited Apr. 2001 Member of the Board, CMO (Chief Marketing Officer) and General Manager of Corporate Strategy & Planning Office, Teijin Limited Jun. 2001 Managing Director, CMO (Chief Marketing Officer) and General Manager of Corporate Strategy & Planning Office, Teijin Limited Nov. 2001 President & Representative Director, COO, Teijin Limited Jun. 2002 President & Representative Director, CEO, Teijin Limited Jun. 2008 Chairman of the Board, Teijin Limited Mar. 2013 Member of the Board, Kao Corporation (current) Apr. 2013 Senior Advisor, Member of the Board, Teijin Limited Jun. 2013 Senior Advisor, Teijin Limited (current) Masayuki Oku2 Chairman of the Board, Sumitomo Mitsui Financial Group, Inc. Apr. 1968 Joined Sumitomo Bank May 1975 LL.M., University of Michigan Law School, U.S.A. Jan. 1991 Branch Manager, Chicago Branch, Sumitomo Bank Jun. 1994 Director, Sumitomo Bank Nov. 1998 Managing Director, Sumitomo Bank Jun. 1999 Managing Director and Managing Executive Officer, Sumitomo Bank Jan. 2001 Senior Managing Director and Senior Managing Executive Officer, Sumitomo Bank Apr. 2001 Senior Managing Director and Senior Managing Executive Officer, Sumitomo Mitsui Banking Corporation Dec. 2002 Senior Managing Director, Sumitomo Mitsui Financial Group, Inc. Jun. 2003 Deputy President and Executive Officer, Sumitomo Mitsui Banking Corporation Jun. 2005 Chairman of the Board, Sumitomo Mitsui Financial Group, Inc. (current), and President and Chief Executive Officer, Sumitomo Mitsui Banking Corporation Mar. 2014 Member of the Board, Kao Corporation (current) Board of Directors and Audit & Supervisory Board Members Audit & Supervisory Board Members Shoji Kobayashi Full-time Audit & Supervisory Board Member Apr. 1979 Joined the Company Jun. 2006 Executive Officer Apr. 2007 Vice President, Chemical Business Unit Jun. 2010 President, Chemical Business Unit Mar. 2013 Full-time Audit & Supervisory Board Member (current) Teruo Suzuki3 Independent 5 Audit & Supervisory Board Member, Certified Public Accountant Aug. 1978 Registered as Certified Public Accountant Jan. 2004 Partner, KPMG AZSA LLC Jun. 2012 Audit & Supervisory Board Member, Kao Corporation (current) Toshiharu Numata Full-time Audit & Supervisory Board Member Apr. 1989 Joined the Company Jun. 2005 Executive Officer Jun. 2006 Member of the Board, Executive Officer; and Senior Vice President, Research and Development Jun. 2008 Member of the Board, Executive Vice President; Senior Vice President, Research and Development; and Responsible for Chemical Business, Product Quality Management; and TCR Promotion May 2012 Member of the Board, Managing Executive Officer; Senior Vice President, Research and Development; and Responsible for Chemical Business Unit, Product Quality Management; TCR Promotion; and China Business Jun. 2012 Senior Managing Executive Officer; President, Consumer Products and Chemical Business, China; Chairman of the Board and Chief Executive Officer, Kao (China) Holding Co., Ltd.; Chairman of the Board, Kao Commercial (Shanghai) Co., Ltd.; and Chairman of the Board, Kanebo Cosmetics (China) Co., Ltd. Mar. 2015 Full-time Audit & Supervisory Board Member (current) Notes: 1. Holds the post of Executive Officer concurrently 2. Outside Director 3. Outside Audit & Supervisory Board Member 4. Reported to Tokyo Stock Exchange, Inc. as Independent Director as set forth in the Regulations of Tokyo Stock Exchange, Inc. 5. Reported to Tokyo Stock Exchange, Inc. as Independent Audit & Supervisory Board Member as set forth in the Regulations of Tokyo Stock Exchange, Inc. Norio Igarashi3 Independent 5 Audit & Supervisory Board Member, Certified Public Accountant, Professor, Yokohama National University Apr. 1977 Registered as Certified Public Accountant Jul. 1988 Partner, Aoyama Audit Corporation and Price Waterhouse Apr. 2007 Professor, Graduate School of International Social Sciences, Yokohama National University (current) Mar. 2013 Audit & Supervisory Board Member, Kao Corporation (current) Yumiko Waseda3 Independent 5 Audit & Supervisory Board Member Attorney-at-Law Apr. 1985 Registered as an attorney-at-law Joined Masayuki Matsuda Law & Patent Offices (now Mori Hamada & Matsumoto, a law firm) Apr. 2013 Joined Tokyo Roppongi Law & Patent Offices Jan. 2014 Partner, Tokyo Roppongi Law & Patent Offices (current) Mar. 2014 Audit & Supervisory Board Member, Kao Corporation (current) Kao Corporation Annual Report 2014 23 Executive Fellows Corporate Executive Fellows who are treated as the same as the Company’s Executive Offi cers will engage in activities to deepen the cooperation with outside parties by utilizing their expertise and outside network. Yoshinori Takema Corporate Executive Fellow 1 Takuji Yasukawa Corporate Executive Fellow 2 Minoru Utsumi Corporate Executive Fellow 2 Notes: 1. Individual treated the same as the Company’s Managing Executive Offi cers 2. Individual treated the same as the Company’s Executive Offi cers Executive Officers and Executive Fellows Executive Officers Michitaka Sawada President and Chief Executive Offi cer Katsuhiko Yoshida Senior Managing Executive Offi cer President, Consumer Products Responsible for Kao Professional Services Co., Ltd. Toshiaki Takeuchi Managing Executive Offi cer Representative Director, President and Chief Executive Offi cer, Kao Customer Marketing Co., Ltd. Masumi Natsusaka Managing Executive Offi cer Kozo Saito President, Consumer Products – International Business Management Chairman of the Board, Kao USA Inc. Hideki Tanaka Senior Vice President, Procurement Takehiko Shinto Representative Director, President, Kanebo Cosmetics Sales Inc. Jun Shida Vice President, Research and Development – Development Research – Health Care and Household Responsible for Beauty Care Business President, Beauty Care – Cosmetics Business Unit Representative Director, President, Kanebo Cosmetics Inc. Yasushi Wada Vice President, Supply Chain Management – Demand and Supply Planning Center Motohiro Morimura Managing Executive Offi cer Senior Vice President, Supply Chain Management Senior Vice President, Environment and Safety Management Responsible for TCR Promotion Yasushi Aoki Managing Executive Offi cer Senior Vice President, Human Capital Development Representative Director, Chairman of the Board, Kanebo Cosmetics Inc. Member of the Board and Senior Executive Offi cer, Senior Vice President, Human Resources and Administration, Kanebo Cosmetics Inc. President, Kao Group Corporate Pension Fund Hideko Aoki Managing Executive Offi cer Senior Vice President, Product Quality Management Yoshimichi Saita Senior Vice President, Media Planning and Management Kenji Miyawaki Senior Vice President, Marketing Research and Development Kazuyoshi Aoki Senior Vice President, Accounting and Finance Tadaaki Sugiyama Senior Vice President, Legal and Compliance Masakazu Negoro President, Chemical Business Unit Chairman of the Board, Fatty Chemical (Malaysia) Sdn, Bhd. Chairman of the Board, Pilipinas Kao, Incorporated Presidente, Kao Chemicals Europe, S.L. Tomoharu Matsuda President, Beauty Care – Skin Care and Hair Care Business Unit Yoshihiro Hasebe Senior Vice President, Research and Development Masayuki Abe Senior Vice President, Information Systems Naoki Komoda President, Fabric and Home Care Business Unit Hitoshi Hosokawa Vice President, Research and Development – Development Research – Skin Care, Hair Care and Cosmetics Hiroyuki Yamashita Vice President, Supply Chain Management – Technology Development Center Vice President, Supply Chain Management – Demand and Supply Planning Center – Human Health Care Minoru Nakanishi Regional Executive Offi cer, President, Consumer Products, Greater China Chairman of the Board and President, Kao (China) Holding Co., Ltd. Chairman of the Board, Kao Commercial (Shanghai) Co., Ltd. Chairman of the Board, Kanebo Cosmetics (China) Co., Ltd. Akemi Ishiwata Senior Vice President, Corporate Communications Satoru Tanaka President, Human Health Care Business Unit 24 Kao Corporation Annual Report 2014 Compliance Basic Policy Preventing Bribery Kao upholds the principle of integrity, passed down from its founder, as one of the “Values” of its corporate philosophy, the Kao Way. “Integrity” means to behave lawfully and ethically and conduct fair and honest business activities. Kao regards integrity as the starting point of compliance and promotes it as a foundation for earning the respect and trust of all stakeholders. Structure Kao has established a Compliance Committee, chaired by a Managing Executive Officer and comprised of representatives of relevant divisions and affiliates. Once every six months, the committee (1) discusses the establishment and revision of Kao’s code of conduct, the Kao Business Conduct Guidelines (BCG), and other internal compliance-related guidelines; (2) implements educational activities to promote the spread and establishment of corporate ethics both in Japan and overseas; and (3) monitors the operation of and responses to the compliance hotlines. The committee then reports important matters, provides an overview of activities and makes proposals to the Board of Directors as appropriate. In the BCG, Kao has made clear its strong stance against bribery by specifying that bribes shall not be given to or received from any third party, including government officials, private companies and individuals. Furthermore, the BCG prohibits “facilitation payments,” which are small payments to government officials to speed up routine non-discretionary government actions. To present this stance in a more specific form, the Kao Group has introduced its Anti-Bribery Guidelines, which includes detailed anti-bribery rules applicable Group-wide as well as operating procedures for the giving and receiving of entertainment and gifts, and for other matters geared to the business, country or region. Verifying the Validity and Appropriateness of Compliance Activities Based on its medium-to-long-term and annual action plans, Kao conducts compliance promotion activities including regular revision of the BCG, maintenance and operation of compliance hotlines, and Integrity Workshops. To confirm the validity and appropriateness of the activities being conducted so that they lead to more effective compliance activities, Kao has decided to ask the opinions of compliance promoters and general staff in all departments within the Company and obtain verification from a consulting firm outside the Company early in 2015 in order to establish action plans for subsequent years. PDCA Cycle for Compliance Activities The Kao Group’s Compliance Activities (New activities planned are in red) Plan • Plan introduction and/or revision of BCG and compliance-related guidelines • Plan establishment of Kao Group compliance hotlines (in new entities) • Plan new educational measures • Plan new measures based on employee opinions and third-party evaluation Do • Introduce and revise BCG and compliance-related guidelines • Establish and operate Kao Group compliance hotlines • Implement training based on plans • Implement new educational measures based on employee opinions I • Implement training based on execution of new measures planned in line with third-party evaluation m Proactive investment Act • Address issues that require improvement based on division self-diagnoses and third-party evaluation Check • Self-check of activities (Division self-diagnoses, audit by Global Internal Audit, etc.) • Ask employee opinions • Third-party evaluation Kao Corporation Annual Report 2014 25 Risk Management Basic Policy and Structure Kao visualizes the various risks pertaining to achieving the Kao Group’s targets and its business activities and implements measures to reduce their frequency and influence. In addition, we make preparations and conduct necessary drills to minimize damages and loss in the event that such risk becomes a reality. With regard to risks involved in business strategies, a responsible division reviews the progress of short-term and medium-to-long-term business plans, including business conditions, which form the basis of such strategies, and further identifies risks and considers and implements necessary countermeasures, in cooperation with related divisions. With regard to operational risks, the Risk Management Committee, chaired by the Executive Officer in charge of Risk Management, verifies the furtherance of Group-wide risk management and establishes basic policies for the activities to be carried out upon each occurrence of disasters/accidents, product quality problems and other emergency situations, as well as preparation and operating plans of specific countermeasures, in accordance with the “Kao Risk Management Policy.” In addition, in each division we appoint a member responsible for promoting risk management, who identifies, evaluates and considers measures to avoid or deal with operational risks on a regular basis. In addition to the enhancement of operational risk Priority Themes 1. Identification of Risks That Could Seriously Affect Achievement of Management Targets and Business Activities and Strengthening of Countermeasures Kao works to respond appropriately to strategic risks by having top management and responsible persons in each division review the progress of short-term plans and the Kao Group Mid-term Plan 2015 (K15), including the business conditions on which they are based, identifying risks and implementing necessary countermeasures. With regard to operational risks, Kao will conduct risk surveys at key divisions in Japan as well as at Kao Group companies outside Japan to identify events that could seriously affect Kao Group business activities, factors in their occurrence, current countermeasures and issues. In addition, Kao will establish policies based on the results of these surveys and have the divisions responsible for the relevant risks formulate responses as a priority measure to reduce the impact on business activities. 2. Development and Strengthening of the Emergency Response System As our business becomes more global, emergency situations that require our response broaden in scope to encompass accidents and disasters, political and social unrest and labor disputes. The impact on the business when such emergency situations occur is increasing in terms of both the scale and speed. We are developing and strengthening our emergency response system to be able to respond to these kinds of situations in Japan and overseas. management that it has conducted up to now, Risk 3. Strengthening the Business Continuity Plan Management, Corporate Strategy will enhance overall risk management by visualizing and formulating countermeasures for risks involved in business strategies that must be dealt with by the entire Kao Group. In the event of an emergency, an emergency response organization will be established to respond to such a situation, centered on the responsible divisions and, depending on the graveness of the impact on the Kao Group as a whole, an emergency response headquarters will further be established in order to direct a prompt We will fulfill our responsibility to ensure the delivery of products that our customers need by formulating and continuously improving a business continuity plan that hypothesizes various events and their main causes that could have a serious negative impact on the continuity of our business activities, such as an operational stoppage due to a large-scale earthquake or an epidemic. Topics Changes in “Business Risks and Other Risks” response to the situation with the President and Chief Kao has changed and revised the presentation of “Business Executive Officer or another appropriate person acting as the head thereof. The management status of the above-described business strategy and operational risks will be reported and discussed at the meeting of the Board of Directors or at the Executive Committee on a regular basis, and also in a timely manner whenever necessary. Risks and Other Risks” based on its identifi cation of serious strategic and operational risks that could have a negative impact on achievement of its management targets and its business activities. (For details, see “Business Risks and Other Risks” on page 41.) In 2015, Kao will work to evaluate and verify the status of management of these serious risks and further enhance its response. 26 Kao Corporation Annual Report 2014 Sustainability Basic Policy Based on its corporate philosophy, the Kao Way, the Kao Group contributes to realizing a sustainable society by working to find solutions to social issues through Yoki-Monozukuri tailored to the needs of the times and the community. On July 1, 2013, we announced the Kao Sustainability Kao Sustainability Statement Three Key Areas Statement to share with stakeholders inside and outside Conservation the Kao Group our policy for achieving both corporate growth and a sustainable society as our business expands globally. With this statement as our point of reference, the Kao Group proactively seeks the trust and support of its stakeholders, aiming to enhance its contributions to a sustainable society. Community Culture Day-to-day Work / Basic Activities Three Key Areas and Target Fields To grow its business responsibly and sustainably, the chosen for their compatibility with the mid-term plan Kao Group will focus its efforts on the three key areas and the Kao Group’s corporate resources as well as of Conservation, Community and Culture. These were their importance for resolving social issues. Conservation Community Reducing environmental impacts of our business activities Engaging with communities through business Culture Integrity Fields Environmental activities in partnership with stakeholders Engaging with local communities through partnerships Diversity and Inclusion SRI 1 Indexes and External CSR 2 Evaluations SRI indexes for which Kao has been selected CSR-related evaluations from external organizations Kao Corporation also received Gold Class 2015 and Industry Mover 2015 Notes: 1. SRI: Socially Responsible Investment 2. CSR: Corporate Social Responsibility Kao Corporation Annual Report 2014 27 Environment Basic Policy In a society confronted with a range of global environmental challenges, such as the depletion of natural resources and global warming, Kao has adopted the mission of striving for the enrichment of the lives of people globally. In 2009, we announced the Kao Environmental Statement and medium- term objectives for 2020. The entire Kao Group will focus on manufacturing that reduces environmental impact and on ecology-centered management as it continue meeting its responsibilities as a user of chemicals. We recognize CO2, water, chemical substances and biodiversity as four priority areas for taking action. Changes in Water Consumption during Product Use1 (%) 0 -20 -40 (Millions m3) 0 3,000 2,500 2,000 1,500 1,000 500 0 -20 -20 -21 -21 Target -30 1,805 1,877 1,900 1,916 1,992 2005 2011 2012 2013 2014 2020 Water Consumed in the Use of Kao Products (Left) Per Unit Reduction Rate (Right) In addition, we conduct “eco together” activities to promote cooperation with our diverse stakeholders, including Notes: 1. Water consumption during product use is defined as the amount of water used during the lifecycle of an individual consumer product in Japan, multiplied by annual unit sales. consumers, business partners and society, throughout the 2. Some data for 2005 have been retroactively modified. product lifecycle, from raw material procurement to production, logistics, sales, use and disposal. Outside Japan, we promote nationwide cleanliness and water-saving activities in China jointly with the Center for Environmental Education and Communications of the Ministry of Environmental Protection of China. Activities have the theme of “aiming to save 10,000 liters annually per household.” Initiatives for Water Reducing Water Consumption during Product Use For household laundering, which consumes a large amount of water, Kao launched the concentrated liquid laundry detergent Attack Neo in 2009. The use of ultra-concentration technology that requires only one laundry rinse cycle saves not only water but also electricity and time. In August 2013, we launched Ultra Attack Neo, which uses a new cleaning ingredient for high-performance, speedy laundering that For dishwashing, another activity that consumes a large amount of water, in August 2014 we launched an improved version of CuCute dishwashing detergent with higher cleaning power and faster rinsing. Since 2010, our Merit Shampoo employs a component allowing swift rinsing of lather. The shampoo cuts rinse water by approximately 20 percent compared with the original version. Initiatives at Plants and in Offi ces Each of Kao’s plants uses water as a product ingredient, as well as to clean and cool equipment. To reduce use, Pilipinas Kao, Inc. closely monitors the amount of water it uses. As a measure to reuse water, the Sumida Complex in Japan, Fatty Chemical (Malaysia) Sdn. Bhd. and other sites collect rainwater and use it to water green spaces. powerfully removes dirt and odors with just five minutes of Moreover, we promote measures to recycle water by washing time. We have also introduced water-saving laundry cleaning and reusing water used in certain processes. detergents in China and Australia. 2020 Medium-term Objectives CO2 Water Consumer products: 35% reduction (across product lifecycle, per unit sales in Japan, relative to FY2005) Water consumption during product use: 30% reduction (per unit sales in Japan, relative to FY2005) Chemical substances Active implementation of the Strategic Approach to International Chemicals Management (SAICM) to promote sound chemical management Biodiversity Implementation of measures to protect biodiversity through responsible raw material procurement and other measures Notes: 1. With regard to commercial/industrial products, CO2 reduction and resource conservation measures will be undertaken jointly with customers. 2. These medium-term objectives represent a fi rst step in ongoing environmental activities that will continue to be expanded in the future. 28 Kao Corporation Annual Report 2014 Sustainability Supply Chain Basic Policy Kao is further enhancing its competitiveness in global Specific activities are as follows. markets with the aim of becoming a company with a global presence. For that purpose, we conduct procurement with fairness, legal compliance and the highest ethics. In order to achieve a sustainable society, we give full consideration to preservation of natural resources, conservation, safety and human rights, striving to fulfill our corporate social responsibilities. Initiatives Sustainable Procurement of Raw Materials In recognition of the risks to sustainable development from scarcity of resources, degradation of biodiversity, climate change and other environmental problems, as well as human rights issues, Kao strives for sustainable procurement of raw materials. These initiatives require comprehensive engagement of the supply chain. In particular, we work toward climate change mitigation by participating in the CDP Supply Chain Project1 while requiring major suppliers to disclose and reduce greenhouse gas emissions. In addition, in cooperation with our suppliers, we are streamlining distribution and reducing the environmental impact of procured products. In particular, recognizing the dependence of its businesses 1. Procurement of Sustainable Raw Materials Under procurement guidelines that were revised in 2014, Kao declared its goal of switching to procurement of sustainable raw materials for palm oil, paper and pulp by 2020 as an initiative toward zero deforestation. Kao has joined the Roundtable on Sustainable Palm Oil and received supply chain certification at its related plants for procurement of certified palm oil and palm kernel oil. By 2020, Kao aims to purchase only sustainable palm oil and palm kernel oil that is traceable to the plantation. As for procurement of paper and pulp, by 2020 Kao aims to purchase only recycled paper or sustainably sourced paper and pulp for use in its consumer products, packaging and office paper. In particular, by 2020 Kao aims to purchase only pulp for raw materials that is traceable to the source. 2. Sustainable Sourcing of Plant Resources In recognition of the problems of the scarcity of plant resources and plunder of resources, Kao purchases plant resources in consideration of access and benefit sharing (ABS),2 and continues initiatives to diversify sourcing routes and to convert from natural to cultivated plants, considering the natural environment and local communities at their source. on natural capital, Kao is committed to zero deforestation at 3. Initiatives to Reduce Dependence on Petrochemical the source in its procurement of raw materials including Resources in Packaging palm oil and paper. Over the medium-to-long term, Kao strives to reduce its use of natural capital by reducing the amount of raw materials used in its business and shifting to alternative raw materials such as algae or other non-edible biomass sources, in addition to working toward sustainable procurement that also takes into account ethical issues that have emerged due to globalization. Kao continues efforts to reduce total volume of plastics used through minimization of container size and development of refill containers, while promoting use of biomass materials such as plant-based polyethylene in containers and packaging. Notes: 1. CDP refers to cooperation between institutional investors and major corporations in climate change initiatives and promotion of disclosure of greenhouse gas emissions. The Supply Chain Project refers to cooperation between the CDP and corporations, with corporations requesting their suppliers to disclose information regarding climate change; this project affects the entire supply chain. 2. Access to genetic resources and the fair and equitable sharing of benefits arising from their utilization, as defined by the Convention on Biological Diversity Kao Corporation Annual Report 2014 29 Sustainability Diversity & Inclusion Basic Policy Expanding the Number of Female Managers Based on the recognition that the vitality generated by Evaluating and promoting female employees based on diversity supports business development, we aim to their ambition and abilities and not attributes such as realize an organization in which each individual’s diverse gender leads to expanded roles for female employees. In skills, personality and values are included and mobilized to 2010, a woman was appointed Managing Executive Officer enhance the company’s collective strength with the aim of in charge of quality assurance and continues to hold this becoming a company with a global presence. position today. As we work to open up appropriate paths to Kao’s percentage of female employees continues to employees with motivation and ability, we are also rise and reached 27.6 percent as of December 2014 for continuing our awareness efforts, with the goal of the Kao Group. The percentage of female managers in achieving a corporate culture that allows a diverse range the Kao Group in Japan is 10.1 percent. The current of employees to flourish. percentages of female employees and female managers Development of Diverse Human Resources Kao works to fairly evaluate and promote each individual Policy for the Future in the Kao Group are shown below. employee, and to develop those with motivation and We will further promote the advancement of diverse ability into global leaders, regardless of gender, nationality, personnel to leadership positions as we make detailed or other factors. The Global Leadership Development enhancements to support measures from an on-site Program (GLDP) is a global program in which members perspective, build mechanisms to support women’s selected from companies in the Kao Group study Kao career formation and increase options for ways of management issues from a broader perspective and make working. In addition, we will steadily work to increase the proposals to executive management. Half of the participants number of female managers (toward a short-term of the GLDP, which has been held since 2010, are employees milestone of 30 percent globally and 15 percent in Japan) of subsidiaries and affiliates outside Japan and engage in by striving to raise awareness of different ways of vigorous discussions. working and change the workplace environment. Composition of Kao Group Employees and Managers (As of December 31, 2014) Change in Percentage of Female Managers Employees Japan 24,013 Asia (excluding Japan) Americas and Europe 8,975 4,242 Total 37,230 Female employees (%) 13,815 (57.5%) 4,532 (50.5%) 2,108 (49.7%) 20,455 (54.9%) Managers 2,539 954 1,168 4,661 Female managers (%) 257 (10.1%) 463 (48.5%) 566 (48.5%) 1,286 (27.6%) (%) 30 25 20 15 10 5 0 30 Kao Corporation Annual Report 2014 27.7 27.6 22.2 23.2 23.6 2010 2011 2012 2013 2014 Financial Section 11-Year Summary 32 Management Discussion and Analysis 34 Consolidated Financial Statements 44 Notes to Consolidated Financial Statements Independent Auditor’s Report 50 75 Kao Corporation Annual Report 2014 31 11-Year Summary Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2014 to 2012, period ended December 31, 2012, and years ended March 31, 2012 to 2005. For the year: Net sales ............................................................................... Business Segments Beauty Care Business .................................................... Human Health Care Business ......................................... Fabric and Home Care Business ..................................... Consumer Products Business ..................................... Chemical Business ......................................................... Eliminations .................................................................... Former Segments Consumer Products ........................................................ Prestige Cosmetics ........................................................ Chemical Products ......................................................... Eliminations .................................................................... Geographic Area Japan ............................................................................. Asia ................................................................................ Asia and Oceania ............................................................ Americas ........................................................................ 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 ............................................................................. Dec. 2014 Millions of yen Dec. 2013 Dec. 2012 (Restated) Dec. 2012 ¥1,401,707 ¥1,315,217 ¥1,220,359 ¥1,012,595 589,907 240,077 324,505 1,154,489 288,022 (40,804) 570,268 210,628 311,023 1,091,919 261,192 (37,894) 537,814 189,614 291,988 1,019,416 236,473 (35,530) 444,425 151,977 236,748 833,150 208,071 (28,626) — — — — 720,789 159,857 — 89,998 — 110,519 (68,568) 101,567 52,765 41,929 59,788 80,200 37,493 3.7% 67,045 6.6% 1,030,347 582,699 33,350 — — — — 997,309 244,903 — 124,216 — 152,056 (116,777) 133,270 79,590 68,484 79,660 125,436 51,739 3.7% 92,410 6.6% — — — — 959,405 199,655 — 108,599 — 134,168 (86,610) 124,656 64,764 63,687 77,297 109,497 49,650 3.8% 86,406 6.6% 1,198,233 658,232 1,133,276 628,709 — — — — 933,767 160,005 — 89,998 — 110,519 (73,930) 111,791 53,107 — — — — — — — — — — Number of employees........................................................... 32,707 33,054 Per share: Net income ........................................................................... Cash dividends ...................................................................... Net worth ............................................................................. Weighted average number of shares Yen ¥ 156.46 70.00 1,313.63 ¥ 126.03 64.00 1,227.54 ¥101.77 — — ¥ 101.12 62.00 1,116.61 outstanding during the period (in thousands) ........................ 508,687 513,880 — 521,824 Key financial ratios: Return on sales ..................................................................... Return on equity ................................................................... Net worth ratio ...................................................................... 5.7% 12.4 54.9 4.9% 10.7 55.5 4.4% 9.5 — 5.2% 9.4 56.6 % Notes: 1. Due to a change in the fiscal year end, the term of consolidation for the fiscal period ended December 31, 2012 consists of the nine months from April to December for Kao Corporation and its subsidiaries whose fiscal year end was previously March 31 and the twelve months from January to December for subsidiaries whose fiscal year end was December 31. 2. December 2012 (Restated) represents figures for the year from January 1 to December 31, 2012, for Kao Group companies whose fiscal year end was previously March 31. 3. As of January 2014, certain changes have been made in inter-company transactions among subsidiaries in the Consumer Products Business in the Americas and Europe. 4. Australia and New Zealand, which had been included in Asia and Oceania until the fiscal year ended March 31, 2012, have been reclassified under Americas from the fiscal period ended December 31, 2012. 5. 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 March 2007 have been restated to reflect the change. 6. 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. 32 Kao Corporation Annual Report 2014 Mar. 2012 Mar. 2011 Mar. 2010 Mar. 2009 Mar. 2008 Mar. 2007 Mar. 2006 Mar. 2005 Millions of yen ¥1,216,096 ¥1,186,831 ¥1,184,385 ¥1,276,316 ¥1,318,514 ¥1,231,808 ¥ 971,230 ¥936,851 537,938 181,758 285,645 1,005,341 247,635 (36,880) 533,514 175,761 279,008 988,283 231,997 (33,449) 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) 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) — — — — — — 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% — — — — — — 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 — — — — 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% — — — — 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% — — — — 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% — — — — 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% 991,272 538,030 34,069 1,022,799 528,895 1,065,751 565,133 1,119,676 545,230 1,232,601 574,038 1,247,797 564,532 1,220,564 509,676 34,743 34,913 33,745 32,900 32,175 29,908 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 ¥ 122.53 54.00 1,070.67 ¥ 129.41 52.00 1,035.66 ¥ 130.58 50.00 935.11 ¥ 131.16 38.00 821.47 521,936 532,980 536,009 536,085 543,228 544,996 544,127 549,626 % 4.3% 9.8 54.3 3.9% 8.5 51.7 3.4% 7.3 53.0 5.1% 11.5 48.7 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. 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. 8. Net sales by geographic area including interregion sales are classified based on the location of Kao Group companies. 9. Cash flows are defined as net income plus depreciation and amortization minus cash dividends. 10. Net income per share is computed based on the weighted average number of shares outstanding during the respective years. 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. 11. Cash dividends per share are the amounts applicable to the respective years, including dividends to be paid after the end of the year. 12. Net worth is equity, excluding minority interests and stock acquisition rights. 13. In calculating return on equity, equity excludes minority interests and stock acquisition rights. Kao Corporation Annual Report 2014 33 Management Discussion and Analysis Overview of Consolidated Results fiscal year to ¥1,401.7 billion (US$11,725.8 million). Operating income increased ¥8.6 billion compared with the During the fiscal year ended December 31, 2014, the global previous fiscal year to ¥133.3 billion (US$1,114.9 million) and net economy showed weakness in some sectors but recovered income increased ¥14.8 billion compared with the previous moderately. In the Japanese economy, although weakness was fiscal year to ¥79.6 billion (US$665.8 million). apparent in personal consumption and elsewhere, a moderate recovery trend continued. The household and personal care products market in Japan, a key market for the Kao Group, grew by 2 percent on a value basis and consumer purchase prices * 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.” increased, both compared with the previous fiscal year. In Analysis of Income Statement addition, the cosmetics market in Japan was flat compared with the previous fiscal year. Net sales increased 6.6 percent compared with the previous Under these circumstances, the Kao Group worked to launch fiscal year to ¥1,401.7 billion (US$11,725.8 million). Excluding and nurture products with high added value in response to changes in consumer needs based on its concept of Yoki- Monozukuri,* which emphasizes research and development the effect of currency translation, net sales would have increased 4.7 percent. In the Consumer Products Business, sales and market share both grew in Japan due to the launch geared to customers and consumers. The Kao Group also of numerous high-value-added products and proactive sales worked to the utmost to supply products responding to the last- activities, although there was an impact from adverse weather minute surge in demand associated with the consumption tax conditions during the summer. Sales in Asia also continued to rate increase in Japan in April 2014, and strove to stimulate the grow steadily. Sales in the Chemical Business increased as market by launching numerous new and improved products after the Kao Group worked to adjust selling prices in connection the consumption tax rate increase. with higher prices for natural fats and oils used as raw Regarding Kanebo Cosmetics brightening products materials and to increase sales volume. containing the ingredient Rhododenol, for which a voluntary Despite aggressively increased marketing and other expenses recall was announced on July 4, 2013, the Kao Group has been for new and improved products and the impact of higher prices for wholeheartedly supporting the recovery and compensation of raw materials, operating income increased ¥8.6 billion compared people who have experienced vitiligo-like symptoms and is with the previous fiscal year to ¥133.3 billion (US$1,114.9 million) working to prevent a recurrence. due to the effect of increased sales of the Consumer Products Net sales increased 6.6 percent compared with the previous Business in Japan and Asia and the Chemical Business. (Years ended March 31, 2011 and 2012, period ended December 31, 2012 and years ended December 31, 2012 to 2014) 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 1,186.8 1,216.1 1,220.4 1,000 1,012.6 58.0 56.8 56.3 1,401.7 1,315.2 56.5 54.9 500 0 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 (%) 100 80 60 40 20 0 Note: The gross profit ratio has not been disclosed for the year ended December 31, 2012. 34 Kao Corporation Annual Report 2014 (Billions of yen) 150 133.3 124.7 111.8 (%) 20 15 9.2 9.5 9.5 10 104.6 108.6 8.8 8.9 101.6 10.0 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 5 0 100 50 0 Costs, Expenses and Income as Percentages of Net Sales Years ended December 31, 2014 and 2013, and period ended December 31, 2012 Cost of sales .................................................................................. Gross profit .................................................................................... Selling, general and administrative expenses ................................ Operating income .......................................................................... Income before income taxes and minority interests ..................... Net income .................................................................................... Dec. 2014 45.1% 54.9 45.4 9.5 9.0 5.7 Dec. 2013 43.5% 56.5 47.0 9.5 8.7 4.9 Dec. 2012 43.7% 56.3 46.3 10.0 10.1 5.2 Net income increased ¥14.8 billion compared with the and hygiene, and enhanced proposal-based sales, among other previous fiscal year to ¥79.6 billion (US$665.8 million). The measures, while working to supply products responding to the Kao Group recorded ¥8.9 billion (US$74.4 million) in last-minute surge in demand associated with the consumption compensation-related and other expenses in connection with tax rate increase and striving to stimulate the market by brightening products containing Rhododenol. launching numerous new and improved products after the Net income per share was ¥156.46 (US$1.31), an increase of consumption tax rate increase. ¥30.43, or 24.1 percent, from ¥126.03 in the previous fiscal year. In Asia, sales increased 20.7 percent to ¥140.5 billion Information by Segment Consumer Products Business (US$1,175.3 million). Excluding the effect of currency translation, sales would have increased 16.1 percent. Sales continued to grow as the Kao Group worked in areas such as launching and nurturing products targeting the middle-class consumer segment, collaborating with retailers, utilizing Sales increased 5.7 percent compared with the previous fiscal wholesale channels and expanding sales regions. year to ¥1,154.5 billion (US$9,657.8 million). Excluding the effect In the Americas, sales increased 15.9 percent to ¥79.9 billion of currency translation, sales would have increased 4.3 percent. (US$668.0 million). Excluding the effect of currency translation, In Japan, sales increased 3.9 percent to ¥900.0 billion sales would have increased 7.8 percent. Sales based on the (US$7,529.1 million). Sales and market share both grew as the same inter-company transaction method used in the previous Kao Group responded to changing consumer lifestyles and fiscal year would have increased 7.5 percent (an increase of social issues such as the environment, health, the aging society 0.1 percent excluding the effect of currency translation). (Years ended March 31, 2011 and 2012, period ended December 31, 2012 and years ended December 31, 2012 to 2014) Net Income / Return on Sales Net Income (Left) Return on Sales (Right) Net Income per Share (Billions of yen) 80 79.6 64.8 60 40 20 0 52.4 52.8 53.1 46.7 3.9 4.3 5.2 4.4 4.9 5.7 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 (%) 15 10 5 0 (Yen) 160 120 80 40 00 156.46 126.03 100.46 101.12 101.77 87.69 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Kao Corporation Annual Report 2014 35 Excluding the effect of currency translation, sales of skin care with the previous fiscal year, due in part to adverse weather products increased and sales of hair care products decreased conditions during the summer and a delayed recovery from compared with the previous fiscal year. the pullback following the consumption tax rate increase. The In Europe, sales increased 16.7 percent to ¥84.2 billion (US$704.6 million). Excluding the effect of currency translation, sales would have increased 7.9 percent. Sales based on the same inter-company transaction method used in the previous fiscal year would have increased 9.1 percent (an increase of 0.8 Kao Group continued to work to reinforce focal brands and expanded sales of SOFINA Primavista base makeup, ALBLANC skin care products and the new DEW beauté aging care line in counseling cosmetics, as well as renewed KATE TOKYO makeup in self-selection cosmetics. Outside Japan, percent excluding the effect of currency translation). Excluding sales increased compared with the previous fiscal year, the effect of currency translation, sales of cosmetics increased and sales of hair care products decreased compared with the excluding the effect of currency translation, due in part to growth in sales from the renewal of Molton Brown, a prestige previous fiscal year. brand from the United Kingdom. Operating income increased ¥8.3 billion compared with the Sales of skin care products increased compared with the previous fiscal year to ¥111.3 billion (US$930.8 million) due to the effect of increased sales in Japan and Asia associated with aggressively increased marketing and other expenses for new and improved products, despite the impact of higher prices for raw materials. previous fiscal year. In Japan, sales increased with strong performance by Bioré facial cleanser, Bioré U body cleanser and Curél derma care products, including new and improved products. In Asia, Bioré performed steadily and sales grew. In the Americas, sales excluding the effect of currency translation Note: The Kao Group’s Consumer Products Business consists of the Beauty Care Business, the Human Health Care Business, and the Fabric and Home Care Business. increased compared with the previous fiscal year, due in part to the launch of improved Jergens hand and body lotion products. Beauty Care Business Sales of hair care products were flat compared with the previous fiscal year. In Japan, although hair coloring products Sales increased 3.4 percent compared with the previous fiscal were impacted by market contraction, sales increased with year to ¥589.9 billion (US$4,934.8 million). Excluding the effect of currency translation, sales would have increased 1.3 percent. strong performance by shampoos, conditioners and hair styling products, including the contribution from Essential and Sales of cosmetics increased 1.4 percent compared with other new and improved products. In Asia, sales decreased the previous fiscal year to ¥260.6 billion (US$2,180.4 million). compared with the previous fiscal year due to narrowing down Excluding the effect of currency translation, sales would have increased 0.3 percent. In Japan, sales were flat compared the brands. In the Americas and Europe, the Kao Group launched an improved styling product line from John Frieda, (Years ended March 31, 2011 and 2012, period ended December 31, 2012 and years ended December 31, 2012 to 2014) Consumer Products Business Net Sales / Operating Income (Billions of yen) 1,200 1,000 988.3 1,005.3 Net Sales (Left) Operating Income (Right) Beauty Care Business Net Sales / Operating Income (Billions of yen) 150 1,154.5 (Billions of yen) 750 1,091.9 1,019.4 833.2 80.5 85.6 84.7 93.4 111.3 103.0 100 500 533.5 537.9 537.8 Net Sales (Left) Operating Income (Right) (Billions of yen) 50 570.3 589.9 40 800 600 400 200 0 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 50 0 250 0 36 Kao Corporation Annual Report 2014 444.4 28.4 30 21.8 20.1 23.9 15.4 5.5 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 20 10 0 Management Discussion and Analysis but sales excluding the effect of currency translation Merries baby diapers continued to sell strongly in Japan, decreased compared with the previous fiscal year in the where the Kao Group increased production capacity, and sales severe competitive environment. also grew in China and Russia. Regarding locally produced Operating income increased ¥4.5 billion compared with the products targeting the middle-class consumer segment, the previous fiscal year to ¥28.4 billion (US$237.9 million) due to Kao Group worked to expand sales of products launched in the effect of increased sales and other factors. Operating China in 2013 and began sales in Indonesia in September 2014. income before amortization of goodwill and other items Sales of personal health products increased compared with related to acquisitions (EBITA) increased ¥3.2 billion compared the previous fiscal year. Sales of oral care products were flat, with the previous fiscal year to ¥57.3 billion (US$478.9 million), although the Kao Group launched improved products and which is equivalent to 9.7 percent of sales. nurtured high-value-added products. Sales of bath additives Human Health Care Business were flat, due in part to stiff competition, but sales of MegRhythm steam thermo power pads increased substantially. Sales increased 14.0 percent compared with the previous fiscal Operating income increased ¥5.0 billion compared with the year to ¥240.1 billion (US$2,008.3 million). Excluding the effect previous fiscal year to ¥21.9 billion (US$183.0 million) due to of currency translation, sales would have increased 12.8 percent. the effect of increased sales and cost reduction activities, Sales of food and beverage products decreased compared although higher raw material prices had an impact. with the previous fiscal year in a severe market environment, despite efforts in green tea to strengthen promotion of the Fabric and Home Care Business function of tea catechins in increasing the body’s fat-burning Sales increased 4.3 percent compared with the previous fiscal ability and the launch of an improved coffee drink with enhanced flavor, both under the Healthya brand of functional drinks that year to ¥324.5 billion (US$2,714.6 million). Excluding the effect of currency translation, sales would have increased 4.1 percent. promote body fat utilization. Sales of fabric care products increased compared with the Sales of sanitary products increased substantially compared with the previous fiscal year. The Laurier brand of sanitary napkins increased its market share in Japan due to growth in sales of high-value-added products such as Laurier F, which protects skin from dampness and chafing, and Laurier Slim Guard, which offers both high absorbency and comfort. Laurier sales also increased steadily in Asia. previous fiscal year. In Japan, the Kao Group’s efforts to highlight the environmental appeal of conserving water, electricity and resources with the Neo series included promotion of the reduced laundry time resulting from the strong cleaning power of Ultra Attack Neo ultra-concentrated liquid laundry detergent and an improved version of Attack Neo Antibacterial EX W Power ultra-concentrated liquid (Years ended March 31, 2011 and 2012, period ended December 31, 2012 and years ended December 31, 2012 to 2014) Human Health Care Business Net Sales / Operating Income Net Sales (Left) Operating Income (Right) Fabric and Home Care Business Net Sales / Operating Income (Billions of yen) 250 (Billions of yen) 240.1 30 (Billions of yen) 350 279.0 59.7 285.6 292.0 59.6 55.5 236.7 51.4 200 150 100 50 0 175.8 181.8 15.3 14.6 210.6 189.6 21.9 152.0 16.9 13.6 11.5 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 300 250 200 150 100 50 0 20 10 0 Net Sales (Left) Operating Income (Right) (Billions of yen) 80 324.5 311.0 62.2 61.0 60 40 20 0 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Kao Corporation Annual Report 2014 37 laundry detergent containing more of an anti-mold agent, which was launched in May 2014. For Attack Reset Power Operating income decreased ¥1.2 billion compared with the previous fiscal year to ¥61.0 billion (US$509.9 million) due powder laundry detergent, the Kao Group stimulated the in part to aggressively increased marketing and other powder laundry detergent market with the launch of a refill expenses for new and improved products and the impact of product that reduces environmental impact. Due in part to higher raw material prices, despite the effect of increased these activities, sales of laundry detergent increased despite sales and other factors. the impact of adverse weather conditions during the summer. In fabric softeners, the Kao Group launched Humming Fine Chemical Business with a deodorant effect that lasts for 24 hours, and both it and Flair Fragrance performed firmly. Wide Haiter EX Power, a Sales increased 10.3 percent compared with the previous fiscal year to ¥288.0 billion (US$2,409.4 million). Excluding the effect fabric bleach for color garments with strengthened of currency translation, sales would have increased 6.7 percent. deodorizing and antibacterial functions, performed well. In Amid overall weakness in customer industries in Japan, Asia, sales increased compared with the previous fiscal year. For Attack laundry detergent, sales increased in Indonesia due in part to the launch of Attack Jaz1, a powder detergent for demand increased in certain customer industries, including export-related industries due to the depreciation of the yen and those related to reconstruction following the Great East hand washing targeting the middle-class consumer segment, Japan Earthquake in March 2011. Conditions remained firm and in Taiwan and Hong Kong, where liquid laundry detergent in the Americas, and a moderate recovery became apparent with a strengthened antibacterial function that was launched in Europe. in 2013 performed well. In oleo chemicals, the Kao Group worked to increase sales Sales of home care products increased compared with the volume of fatty alcohols, for which it expanded its facilities in previous fiscal year. In Japan, the Kao Group launched an improved version of CuCute dishwashing detergent with an 2013, and to adjust selling prices in connection with higher prices for natural fats and oils used as raw materials. In innovative washing formulation for significantly higher performance chemicals, sales were firm as the Kao Group cleaning power as well as both long-lasting suds and easy worked to develop and expand sales of high-value-added rinsing, and it performed well. Sales of household cleaners increased due in part to contributions from Bath Magiclean Antibacterial Deodorizer Plus bathroom cleaner and new Magiclean Brightening Sheets home cleaner. In addition, sales of Quickle Wiper household mop kits and sheets also grew. products with reduced environmental impact. Sales of specialty chemicals were flat compared with the previous fiscal year despite structural changes in the personal computer market, as the Kao Group worked to offer products adapted to customer needs. (Years ended March 31, 2011 and 2012, period ended December 31, 2012 and years ended December 31, 2012 to 2014) (Years ended March 31, 2011 and 2012, period ended December 31, 2012 and years ended December 31, 2013 and 2014) Chemical Business Net Sales / Operating Income (Billions of yen) 300 Net Sales (Left) Operating Income (Right) Total Assets / Net Worth* Total Assets Net Worth (Billions of yen) 288.0 40 (Billions of yen) 1,500 200 100 0 247.6 232.0 208.1 24.1 23.0 261.2 236.5 21.5 22.1 16.8 18.1 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2012 (Restated) Dec. 2013 Dec. 2014 Note: Net sales include intersegment sales. 38 Kao Corporation Annual Report 2014 30 20 10 0 1,022.8 991.3 1,030.3 1,000 1,133.3 1,198.2 528.9 538.0 582.7 628.7 658.2 500 0 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2013 Dec. 2014　 * Net worth is equity, excluding minority interests and stock acquisition rights. Management Discussion and Analysis Operating income increased ¥0.6 billion compared with the were a ¥4.2 billion decrease in income taxes payable and a previous fiscal year to ¥22.1 billion (US$184.5 million), despite ¥6.4 billion decrease in liability for retirement benefits. the impact of higher prices for natural fats and oils used as Total equity increased ¥29.8 billion from the end of the raw materials, due to the effect of increased sales resulting previous fiscal year to ¥672.4 billion (US$5,624.8 million). The from selling price adjustments and growth in sales volume, as principal increases in equity were net income totaling ¥79.6 well as cost reduction activities. billion, foreign currency translation adjustments of ¥23.6 Financial Structure billion and remeasurements of defined benefit plans totaling ¥8.2 billion (post retirement liability adjustments for foreign consolidated subsidiaries at the end of the previous fiscal year). The principal decreases in equity were a ¥50.0 billion Total assets increased ¥65.0 billion from the end of the decrease due to purchase of treasury stock and payments of previous fiscal year to ¥1,198.2 billion (US$10,023.7 million). dividends from retained earnings totaling ¥33.8 billion. In The principal increases in assets were a ¥22.8 billion increase December 2014, Kao Corporation retired treasury stock. in notes and accounts receivable – trade, a ¥22.0 billion As a result, the net worth ratio (defined as net worth increase in short-term investments, a ¥12.4 billion increase in divided by total assets) was 54.9 percent compared with 55.5 finished goods, a ¥6.3 billion increase in work in process and percent at the end of the previous fiscal year. raw materials, a ¥30.3 billion increase in property, plant and equipment, and a ¥9.7 billion increase in asset for retirement benefits. The principal decreases in assets were an ¥18.9 Cash Flows billion decrease in cash and time deposits and a ¥24.7 billion decrease in intangible assets due to the progress of amortization The balance of cash and cash equivalents at December 31, of trademarks and other intellectual property rights and goodwill. 2014 increased ¥1.1 billion compared with the end of the Total liabilities increased ¥35.2 billion from the end of the previous fiscal year to ¥228.7 billion (US$1,912.8 million). previous fiscal year to ¥525.8 billion (US$4,398.9 million). The principal increases in liabilities were a ¥12.0 billion increase in Cash Flows from Operating Activities notes and accounts payable – trade, a ¥10.4 billion increase in Net cash provided by operating activities totaled ¥145.1 billion notes and accounts payable – other, a ¥3.6 billion increase in (US$1,214.0 million). The principal increases in net cash were accrued expenses and a ¥6.9 billion increase in liability for income before income taxes and minority interests of ¥126.8 loss related to cosmetics. The principal decreases in liabilities billion, depreciation and amortization of ¥79.7 billion and (Years ended March 31, 2011 and 2012, period ended December 31, 2012 and years ended December 31, 2013 and 2014) Cash Flows Capital Expenditures Cash Dividends per Share / Payout Ratio Cash Dividends per Share (Left) Payout Ratio (Right) Cash Flows* / Capital Expenditures (Billions of yen) 150 100 97.0 102.0 125.4 109.5 80.2 63.7 68.5 50 0 49.1 47.2 41.9 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2013 Dec. 2014 * Cash flows are defined as net income plus depreciation and amortization minus cash dividends. (Yen) 80 60 40 20 0 58.00 66.1 60.00 62.00 64.00 70.00 59.7 61.3 50.8 44.7 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2013 Dec. 2014 (%) 100 75 50 25 0 Kao Corporation Annual Report 2014 39 change in trade payables of ¥6.7 billion. The principal Company’s basic policies regarding distribution of profits, and decreases in net cash were change in trade receivables of free cash flow and other factors have also been taken into ¥11.0 billion, change in inventories of ¥12.4 billion and income consideration. As a result, the projected consolidated payout ratio taxes paid of ¥49.3 billion. is 43.8 percent. Cash Flows from Investing Activities Net cash used in investing activities totaled ¥63.8 billion EVA (US$533.8 million). This primarily consisted of ¥51.2 billion for purchase of property, plant and equipment and ¥4.5 billion for Economic Value Added (EVA®) is the Kao Group’s main purchase of intangible assets. management metric, defined as net operating profit after tax (NOPAT) less a charge for the cost of capital employed in the Cash Flows from Financing Activities business. We believe EVA indicates “true” profit. Continuously Net cash used in financing activities totaled ¥85.0 billion increasing EVA raises corporate value, which is consistent (US$711.2 million). This primarily consisted of ¥50.0 billion for with the long-term interest of not only shareholders but other purchase of treasury stock and ¥35.0 billion for payments of stakeholders as well. The Kao Group aims to conduct business cash dividends, including to minority shareholders. In activities that expand the scale of its business while also September 2014, Kao Corporation repaid ¥20.0 billion in increasing EVA, and uses EVA for business performance borrowings and borrowed the same amount in the same evaluation, performance-based compensation and strategic month to maintain an appropriate capital cost ratio and to decision-making. During the fiscal year ended December 31, enhance its financial base for investment in growth. 2014, EVA increased to 165 from 138 in the previous year due Basic Policies Regarding Distribution of Profits and Dividends for the Period In order to achieve profitable growth, Kao Corporation (the to an increase in net operating profit after tax (NOPAT) and measures to reduce capital charges, including stock repurchases. EVA is expressed as an index with the year ended December 31, 2011 as 100. The Kao Group conducted the following EVA-related activities during the fiscal year. Company) secures an internal reserve for capital investment Investing for Growth: During the fiscal year ended December and acquisitions from a medium-to-long-term management 31, 2014, the Kao Group invested aggressively for future perspective and places priority on providing shareholders with growth. In Japan, a new plant within the Sakata Plant complex steady and continuous dividends. In addition, the Company in Sakata, Yamagata Prefecture, started operation in April flexibly considers share repurchase and retirement of treasury stock from the standpoint of improving capital efficiency. 2014. Built to reinforce the Kao Group’s stable supply structure to address the rapid increase in demand for Merries In accordance with these policies, the Company announced baby diapers inside and outside Japan, the plant contributed a year-end dividend for the fiscal year ended December 31, to the business by increasing supply. Outside Japan, the Kao 2014 of ¥36.00 (US$0.31) per share, an increase of ¥4.00 per share compared with the previous fiscal year. Consequently, Group’s second consumer products plant in Indonesia started operation and sales of Merries baby diapers targeting the cash dividends for the fiscal year increased ¥6.00 per share middle-class consumer segment began. In the Fabric and compared with the previous fiscal year, resulting in a total of Home Care Business, the Kao Group enhanced facilities to ¥70.00 (US$0.59) per share. The consolidated payout ratio will reinforce the business foundation. In the Chemical Business, be 44.7 percent. the Kao Group continued construction of a new plant in China For the fiscal year ending December 31, 2015, the and expanded production facilities for surfactants as well as Company plans to pay total cash dividends of ¥76.00 per streamlining, maintaining and renewing facilities in Indonesia. share, an increase of ¥6.00 per share compared with the Research and development expenditures were ¥51.7 billion fiscal year ended December 31, 2014. Although the operating (US$432.8 million), the equivalent of 3.7 percent of net sales. environment is challenging, this plan is in accordance with the 40 Kao Corporation Annual Report 2014 Management Discussion and Analysis Increasing Profit: During the fiscal year ended December 31, (1) Consumer Products Business 2014, the Kao Group launched more new and improved 1. Response to Changes in Consumer Needs products than usual in the Consumer Products Business to The Kao Group’s Consumer Products Business is affected by respond to the last-minute surge in demand associated with business cycles and changes in consumers’ values in the the consumption tax rate increase in Japan, and to stimulate market of each country. The Consumer Products Business the market after the increase. maintains and improves brand value by understanding Growth in sales outpaced the market, and contributed to changes in consumer needs and using the comprehensive an increase in profit. In addition, continuing growth in sales of Merries baby diapers in Japan, China and Russia contributed to improvement of NOPAT. The Chemical Business was impacted by a surge in prices of oils and fats used as raw materials, but NOPAT improved due to growth in sales volume. Financial Improvement: Free cash flow* totaled ¥813.8 billion (US$680.2 million) for the fiscal year ended December 31, 2014. The Kao Group has set priorities for how it will deploy this free cash flow. Investments for mergers and acquisitions and additional capital expenditures for future growth are the top priorities, followed by stable and continuous dividends. During the fiscal year, Kao Corporation worked to reduce invested capital with the repurchase of ¥50.0 billion of its stock from the market. The repurchased shares have been retired. Kao Corporation increased cash dividends per share for the fiscal year by ¥6.00 to ¥70.00 (US$0.59) for the 25th consecutive year of growth in cash dividends. * Free cash flow = Net cash provided by operating activities + Net cash used in investing activities Business Risks and Other Risks strength of the Kao Group’s product development and manufacturing in working to create high-value-added products and provide services through approaches in areas including the environment, health, the aging society and hygiene. However, as a consequence of uncertainties in these business activities due to various factors, the Consumer Products Business may be unable to provide products and services that respond to changes in consumer needs and brand value could decrease. This could have an impact on the Kao Group’s business results and financial condition. 2. Response to Changes in Retailing The Kao Group’s Consumer Products Business is affected by changes in the structure of retailing, including progress in the creation of new corporate groups through retail industry mergers and integration in the market and the emergence of new retail channels. The Consumer Products Business conducts sales activities and makes new offerings that respond to these structural changes. However, as a consequence of uncertainties in these business activities due to various factors, the Consumer Products Business may be unable to conduct sales activities or make new offerings that respond to these structural changes. This could have an impact on the Kao Group’s business results and financial condition. Various risks arise in the course of a company’s business. The Kao Group takes reasonable measures to mitigate risks by (2) Chemical Business preventing the occurrence of, diversifying and hedging them. The Kao Group’s Chemical Business is affected by factors However, unanticipated situations may occur that exert a including trends in customer demand and fluctuations in raw significant impact on the Kao Group’s business results and material prices. The Chemical Business promotes creation of financial condition. The risks described below are not a high-value added products that match customer needs, conducts comprehensive list of risks the Kao Group faces. Other risks research and development of products in consideration of the exist and may have an impact on investment decisions. Any environment, and provides such products while working to statements below concerning the future are judgments made reduce costs and deal with product prices. However, as a by Kao Corporation as of the submission of its securities consequence of uncertainties in these business activities due to report to the Ministry of Finance on March 25, 2015. various factors, the Chemical Business may be unable to provide products that match customer needs or respond to matters such as fluctuations in raw material prices. This could have an impact on the Kao Group’s business results and financial condition. Kao Corporation Annual Report 2014 41 (3) Business Acquisitions, Business Alliances and Mergers (6) Product Quality The Kao Group may implement business acquisitions, The Kao Group designs and manufactures products from the business alliances, mergers or other such measures. When viewpoint of consumers, in compliance with related laws and implementing them, the Kao Group makes decisions after regulations and voluntary standards. In the development thoroughly assessing economic value and its partner stage prior to market launch, the Kao Group conducts companies. However, due to various unforeseeable thorough safety testing and survey research to confirm the uncertainties in its business activities, the Kao Group may be safety of products. After market launch, the Kao Group works unable to produce the results it initially expected. This could to further improve quality by incorporating the opinions and have an impact on the Kao Group’s business results and desires of consumers through its consumer communication financial condition. centers. However, the unanticipated occurrence of a serious quality problem or concerns about product safety or reliability (4) Overseas Business Expansion resulting from new scientific knowledge would not only cause As one of its growth strategies, the Kao Group is conducting difficulties for the relevant brand, but would also have a major operations in markets in Asia, the Americas, Europe and impact on the reputation of all of the Kao Group’s products. elsewhere, with a particular emphasis on strengthening its This could have an impact on the Kao Group’s business operations in countries where higher economic growth rates results and financial condition. and market expansion are forecast. However, the Kao Group may be unable to strengthen its operations as a consequence (7) Response to Natural Disasters, Accidents and of uncertainties due to various factors in the course of Other Incidents business including the occurrence of a slowdown in economic To deal with earthquakes and other natural disasters, the Kao growth or uncertain political or social conditions, intensifying Group has formulated disaster countermeasures for its competition, the inability to conduct sufficient cost production facilities and primary offices and a business management or the emergence of problems in relationships continuity plan (BCP), and will continue to strengthen and with retail outlets, sales agents or other trading partners. This reinforce them in the future. However, the occurrence and could have an impact on the Kao Group’s business results and consequent damage of an earthquake on a scale exceeding financial condition. assumptions that hinder the supply of products to the market due to problems in areas such as securing raw materials and (5) Procurement of Raw Materials maintaining production, among other impediments, could Market prices for natural fats and oils and petroleum-related have a serious impact on the Kao Group’s business results materials used as raw materials for products of the Kao Group and financial condition. In addition, the emergence of major are affected by factors including geopolitical risks, the balance changes in demand trends due to a worsening economic between supply and demand, abnormal weather and environment associated with the earthquake could have a exchange rate fluctuations. The Kao Group has moved to serious impact on the Kao Group’s business results and reduce the effect of increases in raw material prices through financial condition. measures including cost reductions and passing on increases Furthermore, the occurrence of an explosion or fire at in raw material costs into product prices. In addition, the Kao production facilities, information system malfunction, Group is conducting development of substitute raw materials problems at a supplier of raw materials, dysfunction of social for natural fats and oils through research into advanced infrastructures such as electric power and water, effective utilization of non-edible raw materials. However, environmental pollution from harmful substances, the spread unexpectedly radical changes in market conditions and pricing of infectious disease, terrorism, political change, riots and could have an impact on the Kao Group’s business results and other incidents could hinder the supply of products to the financial condition. market. This could have a serious impact on the Kao Group’s reputation, business results and financial condition. 42 Kao Corporation Annual Report 2014 Management Discussion and Analysis (8) Currency Exchange Rate Fluctuations transactions. The Kao Group has constructed a compliance Foreign currency-denominated transactions are affected by system and strives to comply with all related laws and changes in currency exchange rates. The Kao Group hedges regulations. However, a serious legal violation by the Kao foreign exchange risk through various measures such as Group or by a consignee or other party could have an impact settlement of transactions through foreign currency accounts, on the Kao Group’s reputation, business results and financial foreign exchange contracts, and currency swaps to mitigate condition. Moreover, a change in current laws and regulations, the effect on business results. The Kao Group does not or new laws and regulations could restrict the Kao Group’s engage in derivative transactions for the purpose of business activities, require investment for compliance, or speculation. However, because items on the financial otherwise affect the Kao Group. This could have an impact on statements of overseas consolidated subsidiaries are the Kao Group’s business results and financial condition. translated into Japanese yen, substantial variance in the exchange rate from the expected rate at the time of (12) Information Management conversion will have an impact on the Kao Group’s business The Kao Group possesses confidential information related to results and financial condition. matters including research and development, production, marketing and sales, as well as the personal information of (9) Impact of Deferred Tax Assets and Impairment numerous customers used for product development, sales The Kao Group records various tangible and intangible fixed promotion and other purposes. The Kao Group conducts assets and deferred tax assets including assets used in the thorough information management using guidelines for course of business and goodwill incurred in corporate handling information and implements appropriate security acquisitions. The Kao Group may not generate the expected measures for its information systems, including both hardware cash flow due to divergence from planned future business and software. However, a leak of confidential or personal results, a decline in market value or other factors. This could information held by the Kao Group resulting from an attack on have an impact on the Kao Group’s business results and its server, unlawful access, a computer virus or other factor financial condition. (10) Securing Human Resources that exceeds expectations could have an impact on the Kao Group’s reputation, business results and financial condition. The Kao Group strives to secure diverse, superior human (13) Litigation resources to achieve its business goals globally. Human The Kao Group conducts diverse businesses globally, and resources with advanced expertise in areas such as research various types of litigation may be brought against it. The result of such litigation could have an impact on the Kao Group’s business results and financial condition. and development, production technologies, marketing and sales activities are indispensable in aiming for the Yoki- Monozukuri (see note on page 34) that consumers support. However, an inability to secure the necessary human resources due to changes in employment conditions or other factors could have an impact on the Kao Group’s business results and financial condition. (11) Compliance with Laws and Regulations In the course of its business activities, the Kao Group must comply with a variety of laws and regulations concerning areas such as standards for product quality and safety, the environment and chemical substances, as well as accounting standards, tax law and regulations related to labor and Kao Corporation Annual Report 2014 43 Consolidated Balance Sheet Kao Corporation and Consolidated Subsidiaries December 31, 2014 and 2013 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 ...................................................................................................... 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 Dec. 2014 Dec. 2013 Thousands of U.S. dollars (Note 2) Dec. 2014 ¥ 107,412 123,639 ¥ 126,314 101,645 $ 898,544 1,034,290 203,396 1,835 7,604 111,831 45,956 20,232 21,477 (1,648) 641,734 180,603 2,372 4,011 99,453 39,655 22,736 18,845 (1,669) 593,965 1,701,489 15,351 63,610 935,511 384,440 169,249 179,663 (13,786) 5,368,361 580,935 3,021,775 6,548,386 94,203 229,053 10,474,352 (7,901,029) 2,573,323 Property, plant and equipment: Land........................................................................................................... Buildings and structures ............................................................................ Machinery, equipment and other ............................................................... Lease assets (Note 7) ................................................................................ Construction in progress ............................................................................ Total .................................................................................................... Accumulated depreciation ......................................................................... Net property, plant and equipment ..................................................... 69,445 361,223 782,794 11,261 27,381 1,252,104 (944,489) 307,615 64,900 354,012 747,947 12,049 22,945 1,201,853 (924,569) 277,284 Intangible assets: Goodwill .................................................................................................... Trademarks ................................................................................................ Other intangible assets .............................................................................. Total intangible assets ........................................................................ 139,941 15,145 12,844 167,930 152,286 28,498 11,834 192,618 1,170,663 126,694 107,445 1,404,802 Investments and other assets: Investment securities (Notes 4 and 16) ..................................................... Investments in and advances to nonconsolidated subsidiaries and affiliates ....................................................................... Deferred tax assets (Note 6) ...................................................................... Asset for retirement benefits (Note 8) ....................................................... Other assets (Note 8) ................................................................................ Total investments and other assets ................................................... See Notes to Consolidated Financial Statements. 11,655 10,776 97,499 9,329 20,630 9,692 29,648 80,954 7,275 23,985 — 27,373 69,409 78,041 172,578 81,077 248,018 677,213 ¥1,198,233 ¥1,133,276 $10,023,699 44 Kao Corporation Annual Report 2014 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 cosmetics (Note 15) .............................................. 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 long-term liabilities (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 Dec. 2014 and Dec. 2013 Issued — 504,000,000 shares in Dec. 2014 and 516,000,000 shares in Dec. 2013 ... Capital surplus ................................................................................................. Stock acquisition rights ................................................................................... Retained earnings ........................................................................................... Treasury stock, at cost Millions of yen Dec. 2014 Dec. 2013 Thousands of U.S. dollars (Note 2) Dec. 2014 ¥ 1,137 20,776 ¥ 1,278 21,256 $ 9,511 173,800 124,979 8,433 61,766 28,108 94,584 8,220 32,533 380,536 84,152 42,414 18,738 145,304 112,972 6,596 51,322 32,322 91,006 1,350 20,212 338,314 84,916 48,847 18,559 152,322 1,045,499 70,545 516,698 235,135 791,233 68,764 272,151 3,183,336 703,965 354,810 156,751 1,215,526 85,424 109,561 944 468,684 85,424 109,561 1,120 471,383 714,606 916,522 7,897 3,920,729 (2,921,992 shares in Dec. 2014 and 3,829,950 shares in Dec. 2013) ........... (9,719) (9,397) (81,303) 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 ... Remeasurements of defined benefit plans ................................................. Total ......................................................................................................... Minority interests ............................................................................................ Total equity .............................................................................................. 5,507 8 (4,853) — 3,619 659,175 13,218 672,393 4,733 12 (28,416) (4,590) — 629,830 12,810 642,640 46,068 67 (40,597) — 30,274 5,514,263 110,574 5,624,837 ¥1,198,233 ¥1,133,276 $10,023,699 Kao Corporation Annual Report 2014 45 Consolidated Statement of Income Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2014 and 2013 Millions of yen Dec. 2014 Dec. 2013 Thousands of U.S. dollars (Note 2) Dec. 2014 Net sales (Note 13) ............................................................................................ ¥1,401,707 ¥1,315,217 $11,725,841 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 ..................................................................... 632,205 769,502 636,232 133,270 1,014 (1,295) 1,171 2,225 (9,624) (6,509) 572,769 742,448 617,792 124,656 1,133 (1,213) (320) 2,272 (11,589) (9,717) 5,288,648 6,437,193 5,322,336 1,114,857 8,483 (10,833) 9,796 18,613 (80,509) (54,450) Income before income taxes and minority interests ..................................... 126,761 114,939 1,060,407 Income taxes (Note 6): Current ............................................................................................................ Deferred .......................................................................................................... Total income taxes ...................................................................................... 44,316 2,023 46,339 50,752 (1,619) 49,133 370,722 16,923 387,645 Income before minority interests .................................................................... 80,422 65,806 672,762 Minority interests in earnings of consolidated subsidiaries ............................ 832 1,042 6,960 Net income ........................................................................................................ ¥ 79,590 ¥ 64,764 $ 665,802 Per share of common stock (Notes 1.v and 18): Basic net income ............................................................................................ Diluted net income .......................................................................................... Cash dividends applicable to the year ............................................................. Yen ¥156.46 156.24 70.00 ¥126.03 125.89 64.00 U.S. dollars (Note 2) $1.31 1.31 0.59 See Notes to Consolidated Financial Statements. 46 Kao Corporation Annual Report 2014 Consolidated Statement of Comprehensive Income Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2014 and 2013 Millions of yen Dec. 2014 Dec. 2013 Thousands of U.S. dollars (Note 2) Dec. 2014 Income before minority interests ....................................................................... ¥ 80,422 ¥ 65,806 $672,762 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 ....... Remeasurements of defined benefit plans ........................................................ Total other comprehensive income ................................................................ 639 24,709 222 — (3,725) 21,845 2,044 44,201 335 (2,759) — 43,821 5,345 206,701 1,857 — (31,161) 182,742 Comprehensive income ...................................................................................... ¥102,267 ¥109,627 $855,504 Comprehensive income attributable to: Shareholders of Kao Corporation ....................................................................... Minority interests ............................................................................................... ¥100,250 2,017 ¥107,823 1,804 $838,631 16,873 See Notes to Consolidated Financial Statements. Kao Corporation Annual Report 2014 47 Consolidated Statement of Changes in Equity Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2014 and 2013 Thousands Outstanding number of shares of common stock Common stock Capital surplus Stock acquisition rights Retained earnings Treasury stock, at cost Millions of yen 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 Remeasurements of defined benefit plans Total Minority interests Total equity 521,844 ¥85,424 ¥109,561 ¥1,294 ¥468,019 ¥ (8,985) ¥2,447 ¥ 6 ¥(71,872) ¥(1,901) ¥ — ¥583,993 ¥12,090 ¥596,083 (9,999) 325 (19) 64,764 (32,564) (30,038) (79) 888 (28,738) 28,738 (174) 2,286 512,170 85,424 109,561 1,120 (11,527) 435 (9,397) 4,733 471,383 79,590 (33,814) (50,041) (79) 1,323 (48,396) 48,396 6 12 43,456 (2,689) (28,416) (4,590) (176) 774 (4) 23,563 4,590 3,619 (19) 64,764 (32,564) (30,038) 809 — 42,885 629,830 79,590 (33,814) (50,041) 1,244 — 32,366 720 12,810 408 (19) 64,764 (32,564) (30,038) 809 — 43,605 642,640 79,590 (33,814) (50,041) 1,244 — 32,774 501,078 ¥85,424 ¥109,561 ¥ 944 ¥468,684 ¥ (9,719) ¥5,507 ¥ 8 ¥ (4,853) ¥ — ¥3,619 ¥659,175 ¥13,218 ¥672,393 Thousands Outstanding number of shares of common stock Common stock Capital surplus Stock acquisition rights Retained earnings Treasury stock, at cost Thousands of U.S. dollars (Note 2) 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 512,170 $714,606 $916,522 $ 9,369 $3,943,308 $ (78,610) $39,593 $100 $(237,711) $(38,397) (11,527) 435 665,802 (282,868) (418,613) (661) 11,068 (404,852) 404,852 Remeasurements of defined benefit plans Total Minority interests Total equity $ — $5,268,780 $107,161 $5,375,941 665,802 665,802 (282,868) (418,613) 10,407 — 270,755 (282,868) (418,613) 10,407 — 274,168 3,413 (1,472) 6,475 (33) 197,114 38,397 30,274 501,078 $714,606 $916,522 $ 7,897 $3,920,729 $ (81,303) $46,068 $67 $(40,597) $ — $30,274 $5,514,263 $110,574 $5,624,837 Balance at January 1, 2013 .............. Adjustment of retained earnings for newly consolidated subsidiaries .................. Net income ..................... Cash dividends, ¥63.00 per share .......... Purchase of treasury stock ............... Disposal of treasury stock ............... Retirement of treasury stock .................. Net change in the year ... Balance at December 31, 2013 ........ Net income ..................... Cash dividends, ¥66.00 per share .......... Purchase of treasury stock ............... Disposal of treasury stock ............... Retirement of treasury stock ............... Net change in the year ... Balance at December 31, 2014 ........ Balance at December 31, 2013 ........ Net income ..................... Cash dividends, US$0.55 per share ....... Purchase of treasury stock ............... Disposal of treasury stock ............... Retirement of treasury stock ................ Net change in the year ... Balance at December 31, 2014 .......... See Notes to Consolidated Financial Statements. 48 Kao Corporation Annual Report 2014 Consolidated Statement of Cash Flows Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2014 and 2013 Millions of yen Dec. 2014 Dec. 2013 Thousands of U.S. dollars (Note 2) Dec. 2014 Operating activities: Income before income taxes and minority interests ...................................... ¥126,761 ¥114,939 $1,060,407 Adjustments for: Income taxes paid ....................................................................................... Depreciation and amortization ..................................................................... ( Gain) loss on sales or disposals of property, plant and equipment, and intangible assets, net ......................................................................... (Gain) loss on transfer of business .............................................................. Equity in (earnings) losses of nonconsolidated subsidiaries and affiliates .... Unrealized foreign currency exchange (gain) loss ....................................... Change in trade receivables ........................................................................ Change in inventories .................................................................................. Change in trade payables ............................................................................ Change in notes and accounts payable - other and accrued expenses ....... Other, net .................................................................................................... Net cash provided by operating activities ................................................ Investing activities: Payments into time deposits .......................................................................... Proceeds from withdrawal of time deposits ................................................... Purchase of short-term investments .............................................................. Proceeds from redemption and sales of short-term investments .................. Purchase of property, plant and equipment .................................................... Purchase of intangible assets ......................................................................... Increase in investments in and advances to nonconsolidated subsidiaries and affiliates .............................................................................. Payment for purchase of newly consolidated subsidiaries, net of cash acquired ................................................................. 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 ...................................................................... Proceeds from issuance of bonds .................................................................. Redemption of bonds ..................................................................................... Purchase of treasury stock ............................................................................. Payments of cash dividends ........................................................................... Other, net ........................................................................................................ Net cash used in financing activities ........................................................ (49,294) 79,660 (29,829) 77,297 (412,364) 666,388 2,706 — (2,225) (1,220) (10,953) (12,397) 6,715 2,048 3,317 145,118 2,644 (350) (2,272) 381 (2,415) (5,405) 3,505 16,819 3,431 178,745 (2,125) 88 — — (51,151) (4,507) (4,802) 7,190 (7,998) 13,000 (55,672) (4,882) 22,637 — (18,613) (10,206) (91,626) (103,706) 56,174 17,132 27,747 1,213,970 (17,776) 736 — — (427,899) (37,703) (1,358) (1) (11,360) — (4,755) (63,808) (273) 20,001 (20,009) — — (50,044) (34,963) 266 (85,022) (891) (3,722) (57,778) (2,311) 19 (9) 50,000 (50,000) (30,039) (34,985) (134) (67,459) — (39,777) (533,779) (2,284) 167,316 (167,383) — — (418,638) (292,480) 2,226 (711,243) 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) ........................................... 4,776 1,064 227,598 — ¥228,662 13,032 66,540 160,435 623 ¥227,598 39,953 8,901 1,903,948 — $1,912,849 See Notes to Consolidated Financial Statements. Kao Corporation Annual Report 2014 49 Notes to Consolidated Financial Statements Kao Corporation and Consolidated Subsidiaries Years ended December 31, 2014 and 2013 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 accordance 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 financial statement items of the previous fiscal year were reclassified to conform to the presentation for the current fiscal year. The preparation of financial statements in accordance 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 and influence concepts, 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. 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 50 Kao Corporation Annual Report 2014 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 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 of accounting 5) Exclusion of minority interests from net income, if contained in net income 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 such 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 of accounting 5) Exclusion of minority interests from net income, if contained in net income e) Business combinations The accounting standard for business combinations requires companies to account for business combinations in accordance with the 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 a 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. j) Property, plant and equipment Property, plant and equipment are stated at cost. Depreciation of property, plant and equipment is computed under the straight-line method over the estimated useful lives, principally ranging from 21 to 35 years for buildings and structures and 7 or 9 years for machinery and equipment. k) Intangible assets Goodwill and trademarks are amortized on a straight-line basis over 15 or 20 years, and 10 years, respectively. f) Cash equivalents For purposes of the consolidated statement 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) Allowance for doubtful receivables To provide for potential loss on trade receivables, loans and other receivables, the Company and its domestic consolidated subsidiaries provide an allowance for the expected amount of unrecoverable receivables. Allowances for ordinary debt are computed based on the historical rate of default. For specified receivables, such as those where recovery is doubtful, the Company and its domestic consolidated subsidiaries consider the likelihood of recovery on an individual basis and record an allowance for the amount of debt expected to be unrecoverable. Foreign consolidated subsidiaries mainly record an allowance for the amount of specified receivables expected to be unrecoverable. h) 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. i) 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. l) 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. m) Liability for loss related to cosmetics To provide for payment of compensation-related and other expenses, the estimated substantive amount of actual loss related to cosmetics as of the end of the fiscal year is recorded. n) 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 employees who retire early. 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 statement of income. In May 2012, the Accounting Standards Board of Japan (the ASBJ) issued ASBJ Statement No. 26, “Accounting Standard for Retirement Benefits” and ASBJ Guidance No. 25, “Guidance on Accounting Standard for Retirement Benefits”, which replaced Kao Corporation Annual Report 2014 51 the accounting standard for retirement benefits that had been issued by the Business Accounting Council in 1998 with an effective date of April 1, 2000, and the other related practical guidance, and were followed by partial amendments from time to time through 2009. Major changes are as follows: (a) Under the revised accounting standard, actuarial gains and losses and past service costs that are yet to be recognized in profit or loss are recognized within equity (accumulated other comprehensive income), after adjusting for tax effects, and any resulting deficit or surplus is recognized as a liability (liability for retirement benefits) or asset (asset for retirement benefits). (b) The revised accounting standard does not change how to recognize actuarial gains and losses and past service costs in profit or loss. Those amounts are recognized in profit or loss over a certain period no longer than the expected average remaining service period of the employees. However, actuarial gains and losses and past service costs that arose in the current period and have not yet been recognized in profit or loss are included in other comprehensive income and actuarial gains and losses and past service costs that were recognized in other comprehensive income in prior periods and then recognized in profit or loss in the current period shall be treated as reclassification adjustments. (c) The revised accounting standard also made certain amendments relating to the method of attributing expected benefit to periods and relating to the discount rate and expected future salary increases. The revised accounting standard and guidance for (a) and (b) above are effective for the end of annual periods beginning on or after April 1, 2013, and for (c) above are effective for the beginning of annual periods beginning on or after April 1, 2014, or for the beginning of annual periods beginning on or after April 1, 2015, subject to certain disclosure in March 2015, both with earlier application being permitted from the beginning of annual periods beginning on or after April 1, 2013. However, no retrospective application of this accounting standard to consolidated financial statements in prior periods is required. The Company applied the revised accounting standard and the guidance for (a) and (b) above from the fiscal year ended December 31, 2014. As a result, asset for retirement benefits of ¥9,692 million (US$81,077 thousand) and liability for retirement benefits of ¥42,414 million (US$354,810 thousand) were recorded as of December 31, 2014. In addition, accumulated other comprehensive income for the year ended December 31, 2014 increased by ¥11,882 million (US$99,398 thousand). Net worth per share increased by ¥23.71 (US$0.20). o) 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 52 Kao Corporation Annual Report 2014 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. p) 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. q) 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. r) Income taxes The Companies provide for income taxes applicable to all items included in the consolidated statement 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. The Company and certain subsidiaries file tax returns under the consolidated taxation system, which allows tax payments to be based on the consolidated profits or losses. s) 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 statement of income to the extent that they are not hedged by foreign exchange derivatives. t) 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, Notes to Consolidated Financial Statements 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. 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. u) 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 statement 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 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. v) 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 statement of income are dividends applicable to the respective years including dividends to be paid after the end of the year. w) 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 following revision of an accounting standard, the new policy is applied retrospectively unless the revised accounting standard includes specific transitional provisions in which case the entity shall comply with the specific transitional provisions. 2) Changes in Presentation When the presentation of financial statements is changed, prior period financial statements are reclassified in accordance with the new presentation. 4) Corrections of Prior Period Errors When an error in prior period financial statements is discovered, those statements are restated. x) Changes in presentation “Liability for loss related to cosmetics”, which was included in “Other” under “Current liabilities” in the previous fiscal year, is presented separately from the fiscal year ended December 31, 2014 due to its increased materiality. The consolidated financial statements for the previous fiscal year have been reclassified to reflect the change in presentation. As a result, ¥1,350 million included in “Other” under “Current liabilities” on the consolidated balance sheet for the previous fiscal year has been reclassified as “Liability for loss related to cosmetics”. y) New accounting pronouncements Accounting Standard for Retirement Benefits On May 17, 2012, the ASBJ issued ASBJ Statement No. 26, “Accounting Standard for Retirement Benefits” and ASBJ Guidance No. 25, “Guidance on Accounting Standard for Retirement Benefits”, which replaced the Accounting Standard for Retirement Benefits that had been issued by the Business Accounting Council in 1998 with an effective date of April 1, 2000, and other related practical guidance, and were followed by partial amendments from time to time through 2009. Major changes are as follows: (a) Treatment in the balance sheet Under the current requirements, actuarial gains and losses and past service costs that are yet to be recognized in profit or loss are not recognized in the balance sheet, and the difference between retirement benefit obligations and plan assets (hereinafter, “deficit or surplus”), adjusted by such unrecognized amounts, is recognized as a liability or asset. Under the revised accounting standard, actuarial gains and losses and past service costs that are yet to be recognized in profit or loss shall be recognized within equity (accumulated other comprehensive income), after adjusting for tax effects, and any resulting deficit or surplus shall be recognized as a liability (liability for retirement benefits) or asset (asset for retirement benefits). (b) Treatment in the statement of income and the statement of comprehensive income The revised accounting standard does not change how to recognize actuarial gains and losses and past service costs in profit or loss. Those amounts would be recognized in profit or loss over a certain period no longer than the expected average remaining service period of the employees. However, actuarial gains and losses and past service costs that arose in the current period and have not yet been recognized in profit or loss shall be included in other comprehensive income and actuarial gains and losses and past service costs that were recognized in other comprehensive income in prior periods and then recognized in profit or loss in the current period shall be treated as reclassification adjustments. Kao Corporation Annual Report 2014 53  (c) Amendments relating to the method of attributing expected benefit to periods and relating to the discount rate and expected future salary increases The revised accounting standard also made certain amendments relating to the method of attributing expected benefit to periods and relating to the discount rate and expected future salary increases. The revised accounting standard and guidance for (a) and (b) above are effective for the end of annual periods beginning on or after April 1, 2013, and for (c) above are effective for the beginning of annual periods beginning on or after April 1, 2014, or for the beginning of annual periods beginning on or after April 1, 2015, subject to certain disclosure in March 2015, both with earlier application being permitted from the beginning of annual periods beginning on or after April 1, 2013. However, no retrospective application of this accounting standard to consolidated financial statements in prior periods is required. The Company applied the revised accounting standard and guidance for (a) and (b) above from the end of the fiscal year ended December 31, 2014, and will apply (c) above from the beginning of the fiscal year beginning January 1, 2015, and is in the process of measuring the effects of applying the revised accounting standard for (c) above in future applicable periods. 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 December 31, 2014 of ¥119.54=US$1, solely for convenience. The translations should not be construed as representations that Japanese yen amounts have been, could have been, or could in the future be, converted into United States dollars at that or any other rate. 3 Cash and Cash Equivalents Cash and cash equivalents at December 31, 2014 and 2013 consisted of the following: Cash and time deposits ............................................................................................ Short-term investments ............................................................................................ Less: time deposits and short-term investments which mature or become due over three months after the date of acquisition ....................................... Cash and cash equivalents ....................................................................................... Millions of yen Dec. 2014 ¥107,412 123,639 Dec. 2013 ¥126,314 101,645 Thousands of U.S. dollars Dec. 2014 $ 898,544 1,034,290 (2,389) ¥228,662 (361) ¥227,598 (19,985) $1,912,849 4 Short-Term Investments and Investment Securities Short-term investments and investment securities as of December 31, 2014 and 2013 consisted of the following: Millions of yen Dec. 2014 Dec. 2013 Short-term investments: Investment trust funds and other ..................................................................... Total .............................................................................................................. ¥123,639 ¥123,639 ¥101,645 ¥101,645 Investment securities: Marketable equity securities ............................................................................ Investment trust funds and other ..................................................................... Total .............................................................................................................. ¥ 10,473 1,182 ¥ 11,655 ¥ 9,595 1,181 ¥ 10,776 Thousands of U.S. dollars Dec. 2014 $1,034,290 $1,034,290 $ 87,611 9,888 $ 97,499 54 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements The carrying amount and aggregate fair value of the securities classified as available-for-sale and held-to-maturity at December 31, 2014 and 2013 were as follows: Millions of yen Dec. 2014 Cost Unrealized gains Unrealized losses Fair value Securities classified as: Available-for-sale: Equity securities ................................................................... Debt securities and other ...................................................... ¥ 2,641 47,644 ¥7,853 — ¥(21) — ¥10,473 47,644 Held-to-maturity: Debt securities and other ...................................................... 75,995 — — 75,995 Millions of yen Dec. 2013 Cost Unrealized gains Unrealized losses Fair value Securities classified as: Available-for-sale: Equity securities ................................................................... Debt securities and other ...................................................... ¥ 2,666 41,651 ¥6,966 — Held-to-maturity: Debt securities and other ...................................................... 59,994 — ¥37 — — ¥ 9,595 41,651 59,994 Thousands of U.S. dollars Dec. 2014 Cost Unrealized gains Unrealized losses Fair value Securities classified as: Available-for-sale: Equity securities ................................................................... Debt securities and other ...................................................... $ 22,093 398,561 $65,693 — $(176) — $ 87,611 398,561 Held-to-maturity: Debt securities and other ...................................................... 635,729 — — 635,729 Available-for-sale securities whose fair values are not readily determinable as of December 31, 2014 and 2013 were as follows: Available-for-sale: Equity securities ....................................................................................... Total ...................................................................................................... ¥1,182 ¥1,182 Dec. 2014 Dec. 2013 ¥1,181 ¥1,181 Carrying amount Millions of yen Thousands of U.S. dollars Dec. 2014 $9,888 $9,888 Proceeds from sales of available-for-sale securities for the years ended December 31, 2014 and 2013 were ¥47 million (US$393 thousand) and ¥9 million, respectively. Gross realized gains and losses on these sales, computed on the moving-average cost basis, for the year ended December 31, 2014 were ¥18 million (US$151 thousand) and ¥1 million (US$8 thousand), respectively. And gross realized gains for the year ended 2013 were ¥3 million. The carrying values of debt securities by contractual maturities for securities classified as held-to-maturity at December 31, 2014 are included in Note 16. Kao Corporation Annual Report 2014 55 5 Short-Term and Long-Term Debt Short-term debt at December 31, 2014 and 2013 consisted of the following: Unsecured loans principally from financial institutions ............................................. Total .................................................................................................................. Millions of yen Dec. 2014 ¥1,137 ¥1,137 Dec. 2013 ¥1,278 ¥1,278 Thousands of U.S. dollars Dec. 2014 $9,511 $9,511 The weighted average interest rates applicable to the above loans were 1.49% and 1.37% at December 31, 2014 and 2013, respectively. In addition to the above short-term debt, deposits payable to affiliates, included in other current liabilities, were ¥9,074 million (US$75,908 thousand) and ¥4,273 million at December 31, 2014 and 2013, respectively, and the applicable interest rates were 0.48% and 0.56% at December 31, 2014 and 2013, respectively. Long-term debt at December 31, 2014 and 2013 consisted of the following: Unsecured bonds due 2018, 0.39% ......................................................................... Unsecured bonds due 2020, 0.62% ......................................................................... Unsecured loans principally from financial institutions, weighted average rate of 0.31% in Dec. 2014, 0.56% in Dec. 2013 .................... Lease obligations ...................................................................................................... Less current portion .............................................................................................. Total .................................................................................................................. Millions of yen Dec. 2014 ¥ 25,000 25,000 50,096 4,832 ¥104,928 (20,776) ¥ 84,152 Dec. 2013 ¥ 25,000 25,000 50,103 6,069 ¥106,172 (21,256) ¥ 84,916 Thousands of U.S. dollars Dec. 2014 $ 209,135 209,135 419,073 40,422 $ 877,765 (173,800) $ 703,965 In addition to the above long-term debt, deposits payable to customers, included in other long-term liabilities, were ¥6,066 million (US$50,745 thousand) and ¥6,008 million at December 31, 2014 and 2013, respectively, and the applicable interest rate was 0.11% at December 31, 2014 and 2013. The aggregate annual maturities of long-term debt as of December 31, 2014 were as follows: Years ending December 31 2015 ............................................................................................................................................ 2016 ............................................................................................................................................ 2017 ............................................................................................................................................ 2018 ............................................................................................................................................ 2019 ............................................................................................................................................ 2020 and thereafter…… .............................................................................................................. Total ........................................................................................................................................ Millions of yen ¥ 20,776 724 30,670 25,581 490 26,687 ¥104,928 Thousands of U.S. dollars $173,800 6,057 256,567 213,995 4,099 223,247 $877,765 56 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements 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 36% and 38% for the years ended December 31, 2014 and 2013, respectively. 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 December 31, 2014 and 2013 were as follows: Millions of yen Dec. 2014 Dec. 2013 Deferred tax assets: Depreciation and amortization .......................................................................... Pension and severance costs ........................................................................... Liability for retirement benefits ........................................................................ 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 ........................................................................................ Asset for retirement benefits ........................................................................... Other ................................................................................................................ Deferred tax liabilities ......................................................................................... ¥ 22,644 — 13,920 13,290 1,780 20,826 19,100 (21,096) ¥ 70,464 ¥ (2,765) (12,747) (3,495) — (5,133) (8,883) ¥(33,023) ¥ 20,634 16,272 — 10,649 1,928 33,021 17,650 (28,127) ¥ 72,027 ¥ (2,482) (11,524) (3,800) (1,461) — (8,707) ¥(27,974) Net deferred tax assets ....................................................................................... ¥ 37,441 ¥ 44,053 Thousands of U.S. dollars Dec. 2014 $ 189,426 — 116,446 111,176 14,890 174,218 159,780 (176,476) $ 589,460 $ (23,130) (106,634) (29,237) — (42,940) (74,310) $(276,251) $ 313,209 Reconciliation between the normal effective statutory tax rates and the actual effective tax rates reflected in the accompanying consolidated statement of income was 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 .......................... Other – net ............................................................................................................ Actual effective tax rate ............................................................................................ Dec. 2014 — — — — — — — Dec. 2013 38.0% (2.2) (3.7) 8.9 3.7 (1.9) 42.8% For the year ended December 31, 2014, the reconciliation is not disclosed because the difference is less than 5% of the normal effective statutory tax rate. Following the promulgation on March 31, 2014 of the “Act for Partial Amendment of the Income Tax Act, etc.” (Act No. 10 of 2014), the special reconstruction corporation tax is not imposed from fiscal years beginning on or after April 1, 2014. As a result, the effective statutory tax rate used for the calculation of deferred tax assets and deferred tax liabilities was changed from the former 36.23% to 35.64% for temporary differences expected to be eliminated during the fiscal year beginning on January 1, 2015. The effect of the change in the tax rate was immaterial. Kao Corporation Annual Report 2014 57 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 December 31, 2014 and 2013 were as follows: Due within one year ................................................................................................... Due after one year ..................................................................................................... Total ........................................................................................................................ Millions of yen Dec. 2014 ¥ 9,868 23,110 ¥32,978 Dec. 2013 ¥ 9,090 22,128 ¥31,218 Thousands of U.S. dollars Dec. 2014 $ 82,550 193,324 $275,874 8 Retirement Benefits 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 defined contribution plan and/or a defined benefit plan. For the year ended December 31, 2014 (1) Changes in defined benefit obligation The aggregate annual maturities of long-term debt as of December 31, 2014 were as follows: Balance at January 1 ....................................................................................................................... Current service cost .................................................................................................................... Interest cost ................................................................................................................................ Actuarial gain and loss ................................................................................................................. Benefits paid ............................................................................................................................... Past service cost ......................................................................................................................... Other ........................................................................................................................................... Balance at December 31 ................................................................................................................. (2) Changes in plan assets The changes in plan assets for the year ended December 31, 2014 were as follows: Balance at January 1 ....................................................................................................................... Expected return on plan assets ................................................................................................... Actuarial gain and loss ................................................................................................................. Contribution by the employer ...................................................................................................... Benefits paid ............................................................................................................................... Other ........................................................................................................................................... Balance at December 31 ................................................................................................................. Millions of yen Dec. 2014 ¥272,497 9,641 5,112 3,546 (10,421) (483) 3,780 ¥283,672 Millions of yen Dec. 2014 ¥230,352 5,329 12,681 10,551 (9,630) 1,667 ¥250,950 Thousands of U.S. dollars Dec. 2014 $2,279,547 80,651 42,764 29,664 (87,176) (4,040) 31,620 $2,373,030 Thousands of U.S. dollars Dec. 2014 $1,926,987 44,579 106,082 88,263 (80,559) 13,945 $2,099,297 58 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements (3) Reconciliation between the balances of defined benefit obligation and plan assets and liability and asset recorded on the consolidated balance sheet at December 31, 2014 Funded defined benefit obligation ................................................................................................... Plan assets ...................................................................................................................................... Unfunded defined benefit obligation ............................................................................................... Net liability for defined benefit obligation .................................................................................... Liability for retirement benefits ....................................................................................................... Asset for retirement benefits .......................................................................................................... Net liability for defined benefit obligation .................................................................................... (4) Benefit costs Components of net periodic benefit costs for the year ended December 31, 2014 were as follows: Current service cost ........................................................................................................................ Interest cost .................................................................................................................................... Expected return on plan assets ....................................................................................................... Amortization of actuarial gain and loss ............................................................................................ Amortization of past service cost .................................................................................................... Other .............................................................................................................................................. Net periodic benefit costs ........................................................................................................... Millions of yen Dec. 2014 ¥ 281,199 (250,950) 30,249 2,473 ¥ 32,722 Millions of yen Dec. 2014 ¥42,414 (9,692) ¥32,722 Millions of yen Dec. 2014 ¥ 9,641 5,112 (5,329) (892) (4,077) 1,651 ¥ 6,106 Thousands of U.S. dollars Dec. 2014 $ 2,352,342 (2,099,297) 253,045 20,688 $ 273,733 Thousands of U.S. dollars Dec. 2014 $354,810 (81,077) $273,733 Thousands of U.S. dollars Dec. 2014 $ 80,651 42,764 (44,579) (7,462) (34,106) 13,811 $ 51,079 In addition to the above net periodic benefit costs, the costs for the defined contribution plan were ¥3,382 million (US$28,292 thousand) for the year ended December 31, 2014. (5) Accumulated other comprehensive income on the defined benefit plan Components of accumulated other comprehensive income on the defined benefit plan before deduction of tax effects at December 31, 2014 were as follows: Unrecognized past service costs .................................................................................................... Unrecognized actuarial gain and loss .............................................................................................. Other .............................................................................................................................................. Total ............................................................................................................................................ Millions of yen Dec. 2014 ¥3,789 2,547 (454) ¥5,882 Thousands of U.S. dollars Dec. 2014 $31,697 21,307 (3,799) $49,205 Kao Corporation Annual Report 2014 59 (6) Plan assets Components of plan assets at December 31, 2014 were as follows: Debt securities ................................................................................................................................ Equity securities ............................................................................................................................. Cash and deposits ........................................................................................................................... Other .............................................................................................................................................. Total ............................................................................................................................................ Dec. 2014 77% 17 1 5 100% The expected rate of return on plan assets is determined considering components of plan assets, actual return on plan assets, policy on plan assets management, market trends and other factors. (7) Actuarial assumption Assumptions used for the year ended December 31, 2014 were as follows: Discount rate ................................................................................................................. Expected rate of return on plan assets .......................................................................... For the year ended December 31, 2013 The liability for retirement benefits at December 31, 2013 consisted of the following: Dec. 2014 Primarily 1.6% Primarily 2.0% Projected benefit obligation ............................................................................................................ Fair value of plan assets .................................................................................................................. Unrecognized prior service cost ...................................................................................................... Unrecognized actuarial gain (loss) ................................................................................................... Unrecognized transitional obligation ............................................................................................... Prepaid pension cost ....................................................................................................................... Net liability for retirement benefits .............................................................................................. Millions of yen Dec. 2013 ¥ 272,497 (230,352) 5,004 3,892 (2,240) 46 ¥ 48,847 The components of net periodic benefit costs for the year ended December 31, 2013 were as follows: Service cost .................................................................................................................................... Interest cost .................................................................................................................................... Expected return on plan assets ....................................................................................................... Amortization of prior service cost (credit) ........................................................................................ Recognized actuarial (gain) loss ...................................................................................................... Amortization of transitional obligation ............................................................................................. Net periodic benefit costs ............................................................................................................... Millions of yen Dec. 2013 ¥ 9,699 4,916 (4,734) (1,967) (19) 1,802 ¥ 9,697 Assumptions used for the year ended December 31, 2013 were 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 ................................................................ Dec. 2013 Primarily 1.6% Primarily 2.0% Primarily 15 years Primarily 10 years 15 years In addition to the above net periodic benefit costs, the costs for other retirement and pension plans such as the defined contribution plan and for other supplemental retirement benefits were ¥3,343 million for the year ended December 31, 2013. Certain foreign subsidiaries apply the “corridor approach” in calculating actuarial gain or loss. 60 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements 9 Contingent Liabilities At December 31, 2014, the Companies had the following contingent liabilities: Trade notes discounted ....................................................................................................................... Guarantees of borrowings, principally of affiliates and employees ...................................................... Millions of yen ¥ 21 181 Thousands of U.S. dollars $ 176 1,514 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) an audit & supervisory board, 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 meets all four criteria, but has not made the said prescription in its articles of incorporation. 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 own 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, totaled ¥14,117 million (US$118,094 thousand) at both December 31, 2014 and 2013. The Company’s additional paid-in capital amount, which is included in capital surplus, totaled ¥108,889 million (US$910,900 thousand) at both December 31, 2014 and 2013. The accompanying consolidated financial statements do not include any provision for the year-end dividend of ¥36.0 (US$0.30) per share, aggregating ¥18,059 million (US$151,071 thousand) which the Company will subsequently propose at the 109th Annual General Meeting of Shareholders to be held on March 25, 2015 as an appropriation of retained earnings in respect of the year ended December 31, 2014. (c) Treasury stock and treasury stock acquisition rights The Corporation Law also provides for companies to purchase their 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 their 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. The Company purchased 11.5 million shares of its common stock from the market during the year ended December 31, 2014, at an aggregate cost of ¥50,000 million (US$418,270 thousand). On December 10, 2014, the Company retired 12.0 million shares of treasury stock by the resolution of the Board of Directors at the meeting held on November 20, 2014. Kao Corporation Annual Report 2014 61 11 Stock-Based Compensation Plans The stock options for the year ended December 31, 2014 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 2007 I 13 Directors of the Company 25,000 shares* August 31, 2007 14,000 shares* August 31, 2007 ¥1 ¥1 $0.01 $0.01 Stock option 2007 II 14 Executive Officers of the Company** Stock option 2007 III Stock option 2008 I 78 Employees of the Company 4 Directors of subsidiaries of the Company 14 Directors of the Company Stock option 2008 II 12 Executive Officers of the Company*** Stock option 2008 III Stock option 2009 I 81 Employees of the Company 4 Directors of subsidiaries of the Company 13 Directors of the Company Stock option 2009 II 12 Executive Officers of the Company**** Stock option 2009 III Stock option 2010 I 74 Employees of the Company 8 Directors of subsidiaries of the Company 14 Directors of the Company Stock option 2010 II 12 Executive Officers of the Company***** Stock option 2010 III Stock option 2011 I 81 Employees of the Company 2 Directors of subsidiaries of the Company 13 Directors of the Company 430,000 shares* August 31, 2007 ¥3,446 $28.83 24,000 shares* August 29, 2008 12,000 shares* August 29, 2008 ¥1 ¥1 $0.01 $0.01 447,000 shares* August 29, 2008 ¥3,100 $25.93 36,000 shares* August 28, 2009 24,000 shares* August 28, 2009 ¥1 ¥1 $0.01 $0.01 430,000 shares* August 28, 2009 ¥2,355 $19.70 38,000 shares* August 25, 2010 24,000 shares* August 25, 2010 ¥1 ¥1 $0.01 $0.01 435,000 shares* August 25, 2010 ¥2,190 $18.32 36,000 shares* August 25, 2011 Stock option 2011 II 13 Executive Officers of the Company****** 26,000 shares* August 25, 2011 Stock option 2011 III Stock option 2012 I 81 Employees of the Company 1 Director of subsidiary of the Company 1 Employee of subsidiary of the Company 9 Directors of the Company 30,000 shares* August 23, 2012 435,000 shares* August 25, 2011 ¥2,254 $18.86 Stock option 2012 II 22 Executive Officers of the Company******* 49,000 shares* August 23, 2012 Stock option 2013 I 10 Directors of the Company 22,000 shares May 23, 2013 Stock option 2013 II 22 Executive Officers of the Company******** 27,000 shares May 23, 2013 Stock option 2014 I 6 Directors of the Company 12,000 shares May 22, 2014 Stock option 2014 II 23 Executive Officers of the Company********* 28,000 shares May 22, 2014 * The number of options originally granted converts into number of shares of common stock. ** 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. ******* The 22 Executive Officers were not members of the Board of Directors of the Company at the date of grant. ******** The 22 Executive Officers were not members of the Board of Directors of the Company at the date of grant. ********* The 23 Executive Officers were not members of the Board of Directors of the Company at the date of grant. 62 Kao Corporation Annual Report 2014 ¥1 ¥1 $0.01 $0.01 ¥1 ¥1 ¥1 ¥1 ¥1 ¥1 $0.01 $0.01 $0.01 $0.01 $0.01 $0.01 Exercise period 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 31, 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 July 1, 2014 through June 28, 2019 July 1, 2014 through June 28, 2019 July 1, 2015 through June 30, 2020 July 1, 2015 through June 30, 2020 July 1, 2016 through June 30, 2021 July 1, 2016 through June 30, 2021 Notes to Consolidated Financial Statements 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 2007 II 2007 III 2008 I 2008 II 2008 III 2009 I 2009 II 2009 III 2010 I 2010 II For the year ended December 31, 2014 Non-vested Outstanding at December 31, 2013 ... Granted ...................................... Expired ....................................... Vested ........................................ Outstanding at December 31, 2014 ... Vested Outstanding at December 31, 2013 ... Vested ........................................ Exercised .................................... Expired ....................................... Outstanding at December 31, 2014 ... Exercise price — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — 4,000 — 4,000 — — 4,000 — 4,000 — — 288,000 — 46,000 242,000 — 5,000 — 1,000 — 4,000 4,000 — 3,000 — 1,000 430,000 — 85,000 — 345,000 11,000 — 3,000 — 8,000 9,000 — 4,000 — 5,000 367,000 — 93,000 — 274,000 16,000 — — — 16,000 10,000 — 2,000 — 8,000 Yen ................................................. U.S. dollars ..................................... ¥1 $0.01 ¥1 $0.01 ¥3,446 $28.83 ¥1 $0.01 ¥1 $0.01 ¥3,100 $25.93 ¥1 $0.01 ¥1 $0.01 ¥2,355 $19.70 ¥1 $0.01 ¥1 $0.01 Average stock price at exercise Yen ................................................. U.S. dollars ..................................... ¥3,445 $28.82 ¥3,872 $32.39 ¥4,033 $33.74 ¥4,000 $33.46 ¥3,752 $31.39 ¥3,933 $32.90 ¥4,402 $36.82 ¥3,995 $33.42 ¥3,768 $31.52 — — ¥4,313 $36.08 Fair value price at grant date Yen ................................................. U.S. dollars ..................................... ¥3,063 $25.62 ¥3,063 $25.62 ¥420 $3.51 ¥2,865 $23.97 ¥2,865 $23.97 ¥426 $3.56 ¥2,115 $17.69 ¥2,115 $17.69 ¥394 $3.30 ¥1,749 $14.63 ¥1,749 $14.63 (Number of shares) Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option Stock option 2010 III 2011 III 2011 II 2012 II 2013 II 2014 II 2011 I 2013 I 2014 I 2012 I For the year ended December 31, 2014 Non-vested Outstanding at December 31, 2013 ... Granted ...................................... Expired ....................................... Vested ........................................ Outstanding at December 31, 2014 ... Vested Outstanding at December 31, 2013 ... Vested ........................................ Exercised .................................... Expired ....................................... Outstanding at December 31, 2014 ... Exercise price — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — 244,000 — 80,000 — 164,000 23,000 — 4,000 — 19,000 18,000 — 4,000 — 14,000 421,000 — 90,000 — 331,000 28,000 — 5,000 — 23,000 49,000 — 7,000 — 42,000 22,000 — — — 22,000 27,000 — — — 27,000 — 12,000 — 12,000 — — 12,000 — — 12,000 — 28,000 — 28,000 — — 28,000 — — 28,000 Yen ................................................. U.S. dollars ..................................... ¥2,190 $18.32 ¥1 $0.01 ¥1 $0.01 ¥2,254 $18.86 ¥1 $0.01 ¥1 $0.01 ¥1 $0.01 ¥1 $0.01 ¥1 $0.01 ¥1 $0.01 Average stock price at exercise Yen ................................................. U.S. dollars ..................................... ¥3,910 $32.71 ¥3,280 $27.44 ¥3,447 $28.84 ¥3,575 $29.91 ¥4,231 $35.39 ¥4,335 $36.26 — — — — — — — — Fair value price at grant date Yen ................................................. U.S. dollars ..................................... ¥245 $2.05 ¥1,718 $14.37 ¥1,718 $14.37 ¥211 $1.77 ¥2,119 $17.73 ¥2,119 $17.73 ¥3,027 $25.32 ¥3,027 $25.32 ¥3,808 $31.86 ¥3,808 $31.86 The fair value prices for 2014 stock options were estimated using the Black-Scholes Option Pricing Model with the following assumptions: Stock option 2014 II Stock option 2014 I Volatility of stock price ......................................................................................................................... Estimated remaining outstanding period ............................................................................................. Estimated dividend per share 20.560% 3.5 years Yen ................................................................................................................................................... U.S. dollars ....................................................................................................................................... Risk-free interest rate .......................................................................................................................... ¥64 $0.54 0.120% 20.560% 3.5 years ¥64 $0.54 0.120% Kao Corporation Annual Report 2014 63 12 Comprehensive Income Each component of other comprehensive income for the years ended December 31, 2014 and 2013 was as follows: Millions of yen Dec. 2014 Dec. 2013 Unrealized gain (loss) on available-for-sale securities Gains (losses) arising during the year ................................................................... Reclassification adjustments to profit or loss ....................................................... Amount before income tax effect ......................................................................... Income tax effect .................................................................................................. Total ...................................................................................................................... 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 Gains (losses) arising during the year ................................................................... Total ...................................................................................................................... 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 ...................................................................................................................... Remeasurements of defined benefit plans Adjustments arising during the year ..................................................................... Reclassification adjustments to profit or loss ....................................................... Amount before income tax effect ......................................................................... Income tax effect .................................................................................................. Total ...................................................................................................................... ¥ 1,005 (11) 994 (355) ¥ 639 ¥24,709 — 24,709 — ¥24,709 ¥ 222 ¥ 222 — — — — — ¥ (5,127) (460) (5,587) 1,862 ¥ (3,725) ¥ 3,122 55 3,177 (1,133) ¥ 2,044 ¥44,201 — 44,201 — ¥44,201 ¥ 335 ¥ 335 ¥ (4,401) 748 (3,653) 894 ¥ (2,759) — — — — — Thousands of U.S. dollars Dec. 2014 $ 8,407 (92) 8,315 (2,970) $ 5,345 $206,701 — 206,701 — $206,701 $ 1,857 $ 1,857 — — — — — $ (42,889) (3,848) (46,737) 15,576 $ (31,161) Total other comprehensive income .......................................................................... ¥21,845 ¥43,821 $182,742 64 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements 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 cosmetics, skin care and 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. (a) Information related to sales, profit (loss), assets, and other items Information by reportable segment of the Companies for the years ended December 31, 2014 and 2013 was as follows: Millions of yen Dec. 2014 Reportable segment Consumer Products Business Beauty Care Business Human Health Fabric and Home Care Business Care Business Total Sales to customers ........................... Intersegment sales ........................... Total sales ......................................... Segment profit (Operating income) .. Segment assets** ............................ ¥589,907 — 589,907 ¥ 28,437 ¥466,128 ¥240,077 — 240,077 ¥ 21,880 ¥161,280 — 324,505 ¥324,505 ¥1,154,489 — 1,154,489 ¥ 60,952 ¥ 111,269 ¥158,552 ¥ 785,960 Chemical Business ¥247,218 40,804 288,022 ¥ 22,060 ¥273,397 Reconciliations* Consolidated ¥ — (40,804) (40,804) (59) ¥ ¥138,876 ¥1,401,707 — 1,401,707 ¥ 133,270 ¥1,198,233 Other Depreciation and amortization*** .. Investments in equity method affiliates** ..................... Increase in property, plant and equipment and intangible assets .. ¥ 30,302 ¥ 10,618 ¥ 9,541 ¥ 50,461 ¥ 14,101 ¥ — ¥ 64,562 3,782 1,122 1,328 6,232 3,032 17,042 22,956 13,781 53,779 14,705 — — 9,264 68,484 * Reconciliation of segment profit includes elimination of intersegment transactions of inventory. Reconciliation of assets includes ¥163,750 million of the Company’s financial assets and negative ¥24,874 million elimination of receivables among reportable segments. ** Balances as of December 31, 2014 *** Depreciation and amortization excludes amortization of goodwill. Kao Corporation Annual Report 2014 65 Millions of yen Dec. 2013 Reportable segment Consumer Products Business Beauty Care Business Human Health Fabric and Home Care Business Care Business Total Sales to customers ........................... Intersegment sales ........................... Total sales ......................................... Segment profit (Operating income) ... Segment assets** ............................ ¥570,268 — 570,268 ¥ 23,933 ¥482,704 ¥210,628 — 210,628 ¥ 16,850 ¥130,610 — 311,023 ¥311,023 ¥1,091,919 — 1,091,919 ¥ 62,183 ¥ 102,966 ¥148,936 ¥ 762,250 Chemical Business ¥223,298 37,894 261,192 ¥ 21,509 ¥245,720 Reconciliations* Consolidated ¥ — (37,894) (37,894) ¥ 181 ¥125,306 ¥1,315,217 — 1,315,217 ¥ 124,656 ¥1,133,276 Other Depreciation and amortization*** .. Investments in equity method affiliates** ..................... Increase in property, plant and equipment and intangible assets .. ¥ 32,094 ¥ 8,993 ¥ 9,008 ¥ 50,095 ¥ 13,373 ¥ — ¥ 63,468 3,074 994 1,116 5,184 2,026 19,219 13,628 14,699 47,546 16,141 — — 7,210 63,687 * Reconciliation of segment profit includes elimination of intersegment transactions of inventory. Reconciliation of assets includes ¥152,828 million of the Company’s financial assets and negative ¥27,522 million elimination of receivables among reportable segments. ** Balances as of December 31, 2013 *** Depreciation and amortization excludes amortization of goodwill. Thousands of U.S. dollars Dec. 2014 Reportable segment Consumer Products Business Beauty Care Business Human Health Fabric and Home Care Business Care Business Total Chemical Business Reconciliations* Consolidated Sales to customers ........................... $4,934,809 Intersegment sales ........................... — Total sales ......................................... 4,934,809 Segment profit (Operating income) .. $ 237,887 Segment assets** ............................ $3,899,347 — 2,008,340 $2,008,340 $2,714,614 $9,657,763 — — 9,657,763 2,714,614 $ 183,035 $ 509,888 $ 930,810 $1,349,172 $1,326,351 $6,574,870 $2,068,078 $ — (341,342) 341,342 (341,342) 2,409,420 $ 184,541 (494) $2,287,075 $1,161,754 $ $11,725,841 — 11,725,841 $ 1,114,857 $10,023,699 Other Depreciation and amortization*** .. $ 253,488 $ 88,824 $ 79,814 $ 422,126 $ 117,961 $ — $ 540,087 Investments in equity method affiliates** ..................... Increase in property, plant and equipment and intangible assets .. 31,638 9,386 11,109 52,133 25,364 142,563 192,036 115,284 449,883 123,013 — — 77,497 572,896 * Reconciliation of segment profit includes elimination of intersegment transactions of inventory. Reconciliation of assets includes $1,369,834 thousand of the Company’s financial assets and negative $208,081 thousand elimination of receivables among reportable segments. ** Balances as of December 31, 2014 *** Depreciation and amortization excludes amortization of goodwill. 66 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements (b) Information related to reportable segments Sales by geographic area for the years ended December 31, 2014 and 2013 were as follows: Sales to customers ................................................... ¥937,696 ¥203,174 Japan Asia Sales to customers ................................................... ¥908,801 ¥171,202 Japan Asia Millions of yen Dec. 2014 Americas* ¥125,324 Millions of yen Dec. 2013 Americas* ¥112,569 Europe** ¥135,513 Consolidated ¥1,401,707 Europe** ¥122,645 Consolidated ¥1,315,217 Thousands of U.S. dollars Dec. 2014 Sales to customers ................................................... $7,844,203 $1,699,632 $1,048,385 $1,133,621 $11,725,841 Japan Asia Americas* Europe** Consolidated Note: Sales are classified by country or region based on the location of customers. Property, plant and equipment by geographic area at December 31, 2014 and 2013 was as follows: Property, plant and equipment ................................. ¥199,484 ¥75,294 Japan Asia Property, plant and equipment ................................. ¥188,533 ¥56,636 Japan Asia Millions of yen Dec. 2014 Americas* ¥13,721 Millions of yen Dec. 2013 Americas* ¥12,642 Europe** ¥19,116 Consolidated ¥307,615 Europe** ¥19,473 Consolidated ¥277,284 Thousands of U.S. dollars Dec. 2014 Property, plant and equipment .................................... $1,668,764 $629,864 *Americas: North America, South America, and Oceania **Europe: Europe and South Africa Japan Asia Americas* $114,782 Europe** $159,913 Consolidated $2,573,323 Kao Corporation Annual Report 2014 67 (c) Impairment losses by reportable segment Impairment losses by reportable segment for the years ended December 31, 2014 and 2013 were as follows: Millions of yen Dec. 2014 Reportable segment Consumer Products Business Beauty Care Business Human Health Fabric and Home Care Business Care Business Impairment losses of assets .............. ¥62 ¥28 ¥42 Total ¥132 Chemical Business ¥— Reconciliations Consolidated ¥— ¥132 Reportable segment Consumer Products Business Beauty Care Business Human Health Fabric and Home Care Business Care Business Impairment losses of assets .............. ¥96 ¥35 ¥54 Total ¥185 Chemical Business ¥785 Reconciliations Consolidated ¥ — ¥970 Millions of yen Dec. 2013 Reportable segment Consumer Products Business Beauty Care Business Human Health Fabric and Home Care Business Care Business Impairment losses of assets .............. $519 $234 $351 Total $1,104 Chemical Business $— Reconciliations Consolidated $— $1,104 Thousands of U.S. dollars Dec. 2014 (d) Amortization and balance of goodwill by reportable segment Amortization and balance of goodwill by reportable segment for the years ended December 31, 2014 and 2013 were as follows: Millions of yen Dec. 2014 Amortization of goodwill ................... Goodwill at December 31, 2014 ....... Reportable segment Beauty Care Business ¥ 15,098 139,941 Consumer Products Business Human Health Fabric and Home Care Business Care Business ¥— — ¥— — Total ¥ 15,098 139,941 Chemical Business ¥— — Reconciliations ¥— — Consolidated ¥ 15,098 139,941 Millions of yen Dec. 2013 Reportable segment Consumer Products Business Amortization of goodwill .................... Goodwill at December 31, 2013 ........ ¥ 13,829 152,286 ¥ — — ¥ — — Beauty Care Business Human Health Fabric and Home Care Business Care Business Total ¥ 13,829 152,286 Chemical Business ¥ — — Reconciliations Consolidated ¥ — — ¥ 13,829 152,286 68 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements Thousands of U.S. dollars Dec. 2014 Beauty Care Business Amortization of goodwill .................... $ 126,301 1,170,663 Goodwill at December 31, 2014 ........ Reportable segment Consumer Products Business Human Health Fabric and Home Care Business Care Business $— — $— — Total $ 126,301 1,170,663 Chemical Business $— — Reconciliations $— — Consolidated $ 126,301 1,170,663 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: Loss related to cosmetics ........................................................................................ Loss on sales or disposals of property, plant and equipment, and intangible assets, net .................................................... Other, net ................................................................................................................ Total ...................................................................................................................... Millions of yen Dec. 2014 ¥ 92,410 73,072 51,739 130,974 81,391 Dec. 2013 ¥ 86,406 69,554 49,650 130,265 77,253 Millions of yen Dec. 2014 Dec. 2013 ¥(8,896)* ¥ (9,652)** (2,706) 1,978 ¥(9,624) (2,645) 708 ¥(11,589) Thousands of U.S. dollars Dec. 2014 $ 773,047 611,277 432,817 1,095,650 680,868 Thousands of U.S. dollars Dec. 2014 $(74,419)* (22,637) 16,547 $(80,509) * Compensation-related and other expenses of ¥8,896 million (US$74,419 thousand) have been recognized as “Loss related to cosmetics” as the substantive amount of loss on Kanebo Cosmetics brightening products containing Rhododenol, for which a voluntary recall was announced on July 4, 2013. Of this amount, ¥8,220 million (US$68,764 thousand) for estimated future expenditures has been recorded in “Liability for loss related to cosmetics” under current liabilities on the consolidated balance sheet. ** In connection with the voluntary recall by Kanebo Cosmetics Inc., Lissage Ltd. and e’quipe, Ltd., gross profit decreased by ¥2,400 million due to various factors including the deduction from net sales of goods returned from retailers, and ¥9,652 million in expenditures, including an estimated portion recognized as other expenses, was recognized as “Loss related to cosmetics” under other expenses in the consolidated statement of income. The relevant amount of impact was included in the operating income of the “Beauty Care Business” segment in segment information (Note 13). Please note that items in compensation expenses for which actual losses cannot be estimated have not been recognized in “Loss related to cosmetics”. Kao Corporation Annual Report 2014 69 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 collateral 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 paper of highly-rated companies, bond investment trusts 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 maintenance of appropriate capital cost ratio 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 December 31, 2014 and 2013 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 ................................................................................................................... Millions of yen Dec. 2014 Fair value ¥107,412 123,639 211,464 10,473 ¥452,988 ¥ 1,137 20,810 195,178 28,108 85,258 ¥330,491 Carrying amount ¥107,412 123,639 212,835 (1,371) 211,464 10,473 ¥452,988 ¥ 1,137 20,776 195,178 28,108 84,152 ¥329,351 Unrealized gain/(loss) ¥ — — — — ¥ — ¥ — 34 — — 1,106 ¥1,140 Derivatives ............................................................................................................ ¥ (412) ¥ (412) ¥ — 70 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements 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 ................................................................................................................... Millions of yen Dec. 2013 Fair value ¥126,314 101,645 184,483 9,595 ¥423,037 ¥ 1,278 21,299 170,890 32,322 85,313 ¥311,102 Unrealized gain/(loss) ¥ — — — — ¥ — ¥ — (43) — — (397) ¥(440) Carrying amount ¥126,314 101,645 186,986 (1,503) 185,483 9,595 ¥423,037 ¥ 1,278 21,256 170,890 32,322 84,916 ¥310,662 Derivatives ............................................................................................................ ¥ (189) ¥ (189) ¥ — 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 Dec. 2014 Fair value $ 898,544 1,034,290 1,768,981 87,611 $3,789,426 $ 9,511 174,084 1,632,742 235,135 713,218 $2,764,690 Carrying amount $ 898,544 1,034,290 1,780,450 (11,469) 1,768,981 87,611 $3,789,426 $ 9,511 173,800 1,632,742 235,135 703,965 $2,755,153 Unrealized gain/(loss) $ — — — — $ — $ — 284 — — 9,253 $9,537 Derivatives ............................................................................................................ $ (3,447) $ (3,447) $ — Cash and time deposits The carrying values of cash and time deposits approximate fair value because of their short maturities. Notes and accounts receivable 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 values of other marketable securities, such as commercial paper, investment trust funds and others, approximate fair value because of their short maturities. See Note 4 for information on 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 Corporation Annual Report 2014 71 Notes and accounts payable, and income taxes payable The carrying values of notes and accounts payable, and income taxes 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 December 31, 2014 and 2013 consisted of the following: Investment securities that do not have a quoted market price in an active market ............................................................................. ¥1,182 ¥1,181 $9,888 (4) Maturity analysis for financial assets and securities with contractual maturities The maturity analysis for financial assets and securities with contractual maturities as of December 31, 2014 was as follows: Millions of yen Dec. 2014 Dec. 2013 Thousands of U.S. dollars Dec. 2014 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 ............................................................................................ Short-term investments and investment securities: Held-to-maturity debt securities ........................................................................... Available-for-sale other securities with contractual maturities ............................. Notes and accounts receivable ................................................................................. Total ...................................................................................................................... ¥107,412 ¥— 76,000 212,835 ¥396,247 — — — ¥— ¥— — — — ¥— Due within one year Thousands of U.S. dollars Due after Due after five years one year through ten through five years years Cash and time deposits ............................................................................................ Short-term investments and investment securities: Held-to-maturity debt securities ........................................................................... Available-for-sale other securities with contractual maturities ............................. Notes and accounts receivable ................................................................................. Total ...................................................................................................................... $ 898,544 $— 635,771 1,780,450 $3,314,765 — — — $— $— — — — $— Please see Note 5 for annual maturities of long-term debt. Due after ten years ¥— — — — ¥— Due after ten years $— — — — $— 72 Kao Corporation Annual Report 2014 Notes to Consolidated Financial Statements 17 Derivatives (a) Derivative transactions to which hedge accounting is not applied The Company had the following derivative contracts outstanding to which hedge accounting was not applied at December 31, 2014 and 2013: Foreign exchange forward contracts: Buying U.S. Dollar ................................................................................................. Buying Japanese Yen .......................................................................................... Buying other currencies ........................................................................................ Selling U.S. Dollar ................................................................................................. Selling Chinese Yuan ............................................................................................ Selling other currencies ....................................................................................... Foreign currency swaps: Receiving Japanese Yen, paying Chinese Yuan ................................................... Receiving U.S. Dollar, paying Indonesian Rupiah ................................................. Interest rate swaps: Receiving floating rate, paying fixed rate .............................................................. Foreign exchange forward contracts: Buying U.S. Dollar ................................................................................................. Buying Japanese Yen .......................................................................................... Buying other currencies ........................................................................................ Selling U.S. Dollar ................................................................................................. Selling other currencies ....................................................................................... Foreign currency swaps: Receiving Japanese Yen, paying Chinese Yuan ................................................... Receiving U.S. Dollar, paying Indonesian Rupiah ................................................. Interest rate swaps: Receiving floating rate, paying fixed rate .............................................................. Millions of yen Dec. 2014 Contract amount ¥3,652 863 27 6,285 3,053 1,368 2,279 7,750 Contract amount due after one year ¥2,980 808 — — 3,053 — 2,279 7,750 Fair value Unrealized gain / (loss) ¥ 154 (115) (0) (162) (67) 36 (602) 405 ¥ 154 (115) (0) (162) (67) 36 (602) 405 2,637 2,637 (61) (61) Millions of yen Dec. 2013 Fair value Unrealized gain / (loss) Contract amount ¥3,974 33 8 6,996 1,120 2,279 2,832 Contract amount due after one year ¥2,739 — — — — 2,279 2,832 ¥ (12) (3) 0 (36) 2 (380) 295 ¥ (12) (3) 0 (36) 2 (380) 295 (55) 281 281 (55) Thousands of U.S. dollars Dec. 2014 Foreign exchange forward contracts: Buying U.S. Dollar ................................................................................................. Buying Japanese Yen .......................................................................................... Buying other currencies ........................................................................................ Selling U.S. Dollar ................................................................................................. Selling Chinese Yuan ............................................................................................ Selling other currencies ....................................................................................... Foreign currency swaps: Receiving Japanese Yen, paying Chinese Yuan ................................................... Receiving U.S. Dollar, paying Indonesian Rupiah ................................................. Interest rate swaps: Receiving floating rate, paying fixed rate .............................................................. Contract amount $30,550 7,219 226 52,577 25,540 11,444 Contract amount due after one year $24,929 6,759 — — 25,540 — Fair value Unrealized gain / (loss) $ 1,288 (962) (0) (1,355) (560) 301 $ 1,288 (962) (0) (1,355) (560) 301 19,065 64,832 19,065 64,832 (5,036) 3,388 (5,036) 3,388 22,060 22,060 (510) (510) Kao Corporation Annual Report 2014 73 (b) Derivative transactions to which hedge accounting is applied The Companies had the following derivative contracts outstanding to which hedge accounting was applied at December 31, 2014 and 2013: Millions of yen Fair value Contract amount Dec. 2014 Contract amount due after one year Dec. 2013 Contract amount due after one year Fair value Hedged item Contract amount Thousands of U.S. dollars Dec. 2014 Contract amount due after one year Fair value Contract amount Interest rate swaps: (Fixed rate payment, Floating rate receipt) .......... Long-term debt ¥20,000 — — ¥40,000 ¥20,000 — $167,308 — — 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. 18 Net Income per Share A reconciliation of the differences between basic and diluted net income per share (“EPS”) for the years ended December 31, 2014 and 2013 was as follows: Millions of yen Net income Thousands of shares Weighted average shares Yen U.S. dollars EPS For the year ended December 31, 2014: Basic EPS Net income available to common shareholders .................... Effect of dilutive securities Warrants ............................................................................... Diluted EPS Net income for computation ................................................. ¥79,590 508,687 ¥156.46 $1.31 — 710 ¥79,590 509,397 ¥156.24 $1.31 Millions of yen Net income Thousands of shares Weighted average shares Yen EPS For the year ended December 31, 2013: Basic EPS Net income available to common shareholders .................... Effect of dilutive securities Warrants ............................................................................... Diluted EPS Net income for computation ................................................. ¥64,764 513,880 ¥126.03 — 550 ¥64,764 514,430 ¥125.89 74 Kao Corporation Annual Report 2014 Independent Auditor’s Report Kao Corporation Annual Report 2014 75 Principal Subsidiaries and Affiliates (As of March 25, 2015) Country/Area Business Company Country/Area Business Company Japan China Taiwan Vietnam Philippines Thailand Malaysia ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● Kao Customer Marketing Co., Ltd. Kanebo Cosmetics Inc. Australia Canada Kanebo Cosmetics Sales Inc. United States E'quipe, Ltd. Kanebo Cosmillion Ltd. Nivea-Kao Co., Ltd. Kao Sanitary Products Ehime Co., Ltd. Kao Professional Services Co., Ltd. Kao-Quaker Co., Ltd. Kao (China) Holding Co., Ltd. Mexico Germany Kao Corporation Shanghai Netherlands Kao Commercial (Shanghai) Co., Ltd. United Kingdom Kanebo Cosmetics (China) Co., Ltd. Shanghai Kanebo Cosmetics Co., Ltd. Kao Chemical Corporation Shanghai Switzerland Kao Trading Corporation Shanghai Kao (Shanghai) Chemical Industries Co., Ltd. Spain ● ● ● ● ● Kao (Hong Kong) Ltd. ● Kao (Taiwan) Corporation  ● ● Kao Vietnam Co., Ltd. Pilipinas Kao, Inc. Kao Industrial (Thailand) Co., Ltd. Kao Commercial (Thailand) Co., Ltd. Kao Soap (Malaysia) Sdn. Bhd. ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● Kao (Malaysia) Sdn. Bhd.   ● ● ● ● ● ● ● ● ● ● ● ● ● Kao Australia Pty. Limited ● ● ● 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 Manufacturing Germany GmbH ● Kao Chemicals GmbH Kao Netherlands B.V. Kao (UK) Limited KPSS (UK) 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 ● ● ● ● 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 ● ● ● ● ● ● 76 Kao Corporation Annual Report 2014 Investor Information (As of December 31, 2014) 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: 504,000,000 shares Outstanding (excluding treasury stock): 512,726,542 shares Number of Shareholders: 46,744 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 Shareholder Number of Shares (thousand shares) Ratio of Shareholding* (percentage) 30,106 Japan Trustee Services Bank, Ltd. (Trust Account) The Master Trust Bank of Japan, Ltd. (Trust Account) State Street Bank and Trust Company 505223 State Street Bank and Trust Company Tokio Marine & Nichido Fire Insurance Co., Ltd. JPMorgan Chase Bank 380055 State Street Bank and Trust Company 505225 Northern Trust Co. (AVFC) Re U.S. Tax Exempted Pension Funds Mellon Bank, N.A. as Agent for its Client Mellon Omnibus US Pension Northern Trust Co. (AVFC) Re Silchester International Investors International Value Equity Trust * Ratio of shareholding is calculated based on the outstanding shares. 26,480 20,050 9,790 8,664 8,380 8,275 7,228 7,053 7,313 5.97 5.25 3.98 1.94 1.72 1.66 1.64 1.45 1.43 1.40 Composition of Shareholders Securities Companies 3.68% Other Japanese Companies 4.00% Individuals and Others 11.87% Financial Institutions 31.58% Treasury Stock 0.47% Companies and Individuals in Foreign Countries 48.39% 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 Website: 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) 5,000 4,000 3,000 2,000 1,000 0 80 60 40 20 0 Apr. 2010 Mar. 2011 Mar. 2012 Dec. 2012 Dec. 2013 Dec. 2014 Kao Corporation Annual Report 2014 77 

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