KADOKAWA ANNUAL REPORT 2003

Management’s Discussion and Analysis of Operations

In fiscal 2003, ended March 31, 2003, economic conditions in Japan remained extremely challenging. Amid growing international geopolitical instability and increasing uncertainty surrounding the world economy, the Japanese economy continued to experience sluggish levels of private-sector capital expenditure and personal spending as the deflationary trend persisted.
  According to a survey by Japan’s Scientific Publishing Research Institute, the Japanese publishing industry saw estimated total sales of publications slip 1.2% to ¥2,292.3 billion, marking the sixth straight year of negative growth. The advertising industry also felt the effects of the depressed economic conditions, with advertising expenses in the 2002 calendar year in the four main media falling for the second consecutive year, according to a study by a major advertising agency. Magazine advertising dropped 3.1% to ¥405.1 billion.
  In contrast, a study by the Japan Video Software Association found that video software sales in fiscal 2003 climbed 15.9% to ¥338.8 billion, driven by a 37.6% jump in sales of DVDs to ¥216.3 billion. These figures underscore how strongly these markets are growing.
  In this business climate, the company launched a three-year management plan targeting higher earnings. Under this plan, the company implemented far-reaching business process reengineering (BPR) that included major structural reforms—the cost structure was overhauled, publishing alliance operations were reformed and strategic business units were created, for example. Concurrently, the company worked to upgrade content planning, as well as editorial and marketing capabilities.
  Although fiscal 2003 net sales dropped 14.6% to ¥76,377 million, current income soared 328.0% to ¥3,204 million as the gross profit ratio improved in all business segments and an efficiency drive yielded a reduction in selling, general and administrative (SG&A) expenses.
The decline in net sales primarily reflected lower sales generated by publishing consignment operations, which were drastically revamped during the year. Net income was ¥1,359 million after extraordinary gains, including gains on the sale of property and equipment, offset by losses on the devaluation of investment securities due to deteriorating stock market conditions and other extraordinary losses.

The company showed an unappropriated retained loss of ¥156 million on its balance sheet at March 31, 2003. This resulted from a ¥1,954 million loss on the disposal of treasury stock accompanying an exchange of shares with Media Works on October 1, 2002, in accordance with the Commercial Code of Japan. Nevertheless, shareholders’ equity increased ¥2,505 million from a year ago due to net income of ¥1,359 million and a decrease in treasury stock following the share swap.
Operating results in each division were as follows.

The Magazine Editorial Division offers a wide variety of unique publications, extending from TV program guides and urban information magazines to animation-related magazines and comics.
  In TV program guides, Weekly The Television, which marked its 20th anniversary during the year under review and is now published in 14 regions throughout Japan, continued to be supported by a strong readership. Stablemate publication, Monthly The Television, which covers 8 areas across the country, saw sales grow sharply. With a circulation now exceeding 1.5 million copies, Monthly The Television is one of Japan’s most-read monthly magazines. Backed by these strong figures, Kadokawa cemented its leading position in the TV program guide genre. Related operations are also seeing business grow steadily. Monthly BS & CS The Television is enjoying higher sales and Kadokawa has expanded its business of creating custom-made magazines for other companies on a contract basis, namely J-COM Magazine, a member’s only magazine for Jupiter Telecommunications Co., Ltd. and WOWOW MAGAZINE, for subscribers to the WOWOW BS broadcasting service. All magazines are pitched squarely at meeting the demands of the new multi-channel digital era. Additionally, subsidiary Kadokawa Interactive Media is making progress in the development of an electronic program guide (EPG) distribution business.
  The company worked to develop the potential of the Walker series as an area information magazine by creating editions with a stronger regional feel. This magazine, which boasts a healthy readership among the younger generation, is already published in eight regions across Japan and is one of the country’s most recognized urban information magazines. Chou Chou, an urban information magazine for women, and Monthly Chou Chou Kansai, which was launched in June 2002 and is targeted at working women, have also been well supported by their target audiences.
  In another move, the company began the overseas development of NEWTYPE, an animation magazine that has dominated the market segment in Japan since its debut. The U.S. edition, NEWTYPE USA, hit store shelves in October 2002 and has rapidly won overwhelming support from local animation aficionados.
In comics, the company started publishing GUNDAM A, originally a bimonthly publication, as a monthly issue, in response to firmly established reader interest. Sales have been growing steadily since.
  In other areas, CD Data, a music information magazine, Hanajikan, for readers with a passion for flowers, and other magazines that meet diverse reader interests, have been highly popular and continue to enjoy strong sales. And, in a first for the company, publishing began of a weekly series of travel booklets that showcase cities around Japan—Weekly Okunohoso Michi o Aruku. This title is already opening the way to expansion in a new genre.
  Despite an extremely difficult operating environment, magazine sales declined only 0.8%, while advertising sales dipped 4.1%. Combined magazine and advertising sales declined 2.4% to ¥35,870 million.

In each book field, the company has produced a number of bestsellers. In hardbacks, Brave Story by Miyuki Miyabe sold 320,000 copies. Other popular hardbacks included Wasure Yuki by Miyuki Shindo, Ai ni kansuru 12 syou by Hiroyuki Itsuki, and Mango Rain by Seishu Hase. In paperbacks, Loveholic by Fumio Yamamoto, Hachiman by Yasuo Uchida and Konyaha Nemurenai by Miyuki Miyabe all sold well. Furthermore, Ao no honou by Yusuke Kishi, T.R.Y. by Naoto Inoue, and TRICK 1 & 2 by Yukihiko Tsutsumi sold extremely well, driven by the popularity of the movies. In the non-fiction genre, Sanshoku Borupen de Yomu Nihongo by Takashi Saitoh, Denchi ga Kireru Made from the Suzuran no kai collection and Sata Suma by The Television editorial, proved popular with readers. In comics, Neon Genesis Evangelion vol 8 by Sadamoto Yoshiyuki, Mobile Suit GUNDAM THE ORIGIN Vol 2 and 3 by Yoshikazu Yasuhiko and Tajyujinkaku Tantei Psycho Vol 8 by Shou Tajima were standout performers.
These and other publications lifted book sales 5.1% year on year to ¥19,266 million.

The most noteworthy development during the year under review was significant expansion in DVD and video operations supported by sharply higher sales. Leading the way were titles such as Twixt Calm & Passion and The Yin-Yang Master, major movie hits in the previous fiscal year, as well as FULL METAL PANIC!, Sakura Wars The Movie, Spy Kids and Honogurai Mizunosoko Kara. The sharp growth in sales suggests that new market needs are emerging. In movies, Koi ni utaeba, T.R.Y. and Ao no honou did well at the box office. Meanwhile, the foreign-made movie The Lord of the Rings captivated moviegoers. Another highlight of the year, was the popularity in both the U.S. and Japan of the ring, a remake of Kadokawa’s 1998 blockbuster, RING. The renowned Hollywood film studio DreamWorks SKG was the force behind the U.S. remake. The success of this latest version of the movie has opened the way to more Japanese film content making its way overseas.
Segment sales increased 1.1% year on year to ¥9,060 million as a result of these and other developments.

In these operations, where sales and logistics are undertaken for other publishing companies on a consignment basis, the company implemented drastic reforms after determining that continuing consignment operations for certain customers would not generate the earnings the company had initially expected.
The review of profitability was taken as part of ongoing structural reforms begun in the previous fiscal year.
As a result, sales declined 52.0% to ¥12,179 million.

During the fiscal year under review, capital expenditures were used for improving the logistics system, developing an advanced magazine editing system, putting in place a system for new magazine and other projects. Capital expenditures in fiscal 2003 totaled ¥185 million.

No funds were procured during fiscal 2003.

With the Japanese economy still in the doldrums, it is likely to be some time before any recovery in consumer sentiment and corporate advertising. The difficulties in the group’s operating environment are therefore expected to persist for the foreseeable future.
Against this backdrop, Kadokawa Holdings is laying the foundation for the next stage of growth, as outlined below. Aiming to create an operating framework with the flexibility and speed to adapt to drastic change in its operating environment, Kadokawa Holdings will strengthen management of the group and draw on the entire group’s resources to further develop operations in the publishing, movie and DVDs, and new publishing fields.

On April 1, 2003, the company’s name was changed from Kadokawa Shoten Publishing Co., Ltd. to Kadokawa Holdings, Inc. in conjunction with its move to a holding company structure. This move was based on a split-off plan and amendment to the company’s articles of incorporation, which were approved at the 48th annual general meeting of shareholders last year.
The corporate split-off created a new operating company, Kadokawa Shoten Publishing Co., Ltd., which will continue to conduct all existing publishing operations under the umbrella of the holding company. Other operating companies to be overseen by the holding company are: SS Communications, acquired in fiscal 2002; Media Works, acquired through a share swap in October 2002; Kadokawa-Daiei Pictures, established to take over the entire filmmaking operations of Daiei Co., Ltd. in November 2002; and logistics company Building and Book Center. Kadokawa Holdings will work to develop its businesses, taking a holistic approach to managing the group.
In addition to devoting its energies to management of the entire Kadokawa Group in its capacity as a holding company, Kadokawa Holdings also intends to strengthen corporate governance centered on existing directorship and auditor systems—the company will maintain a system of outside directors and two external auditors.

Another important theme will be enhancing editorial, planning and marketing capabilities in core publishing operations. Group-wide efforts will be directed at offering a rich lineup of content imbued with originality that reflects the interests of readers.
In software operations, ongoing efforts target the planning and production of high value-added movie content based on a media-mix strategy that is closely linked with publishing activities. The development of rights businesses and DVD and other packaged software businesses to take full advantage of existing content is also crucial to driving growth in software operations.
Achieving all of these goals mandates that resources be selectively channeled into key businesses. Strategic steps will also be taken to strengthen the Publishing and Software Operations operating framework, which will include reform of the personnel system.

The newly established Kadokawa Shoten Publishing will be at the vanguard of a drive to create new publishing businesses. This includes developing businesses such as a “free magazine (annual),” which can be used throughout the course of a year, and a “free magazine (monthly),” a newspaper provided free of charge offering up-to-date local information.
The aim is to use information content efficiently and diversely to supplement information distribution services that use existing magazines, the Internet and mobile phones. This will help satisfy consumer needs for information and convenience in various ways, and create new sources of earnings in magazine and advertising operations.
With the aim of becoming a Mega Content Provider with publishing activities at its nucleus, the Kadokawa Group is working to create more corporate value by relentlessly reforming its business models to generate stable earnings and drive continuous growth.