The accompanying consolidated financial statements have been prepared in accordance with the provisions set forth in the Japanese Securities and Exchange Law and its related accounting regulations, and in conformity with accounting principles generally accepted in Japan (“Japanese GAAP”), which are different in certain respects as to application and disclosure requirements of International Financial Reporting Standards. The accounts of overseas subsidiaries are based on their accounting records maintained in conformity with generally accepted accounting principles prevailing in the respective countries of domicile. The accompanying consolidated financial statements have been restructured and translated into English (with some expanded descriptions and the inclusion of consolidated statements of shareholders' equity) from the consolidated financial statements of Kadokawa Holdings, Inc. (the “Company”) prepared in accordance with Japanese GAAP and filed with the appropriate Local Finance Bureau of the Ministry of Finance as required by the Securities and Exchange Law. Some supplementary information included in the statutory Japanese language consolidated financial statements, but not required for fair presentation, is not presented in the accompanying consolidated financial statements. In the year ended March 31, 2005, the Company did not adopt early the new accounting standard for impairment of fixed Assets (“Opinion Concerning Establishment of Accounting Standard for Impairment of Fixed Assets” issued by the Business Accounting Deliberation Council on August 9, 2002) and the implementation guidance for the accounting standard for impairment of fixed assets (the Financial Accounting Standard Implementation Guidance No. 6 issued by the Accounting Standards Board of Japan on October 31, 2003). The new accounting standard is required to be adopted effective April 1, 2005. The translation of the Japanese yen amounts into U.S. dollars are included solely for the convenience of readers outside Japan, using the prevailing exchange rate at March 31, 2005, which was ¥107.41 to U.S. $1. The convenience translations should not be construed as representations that the Japanese yen amounts have been, could have been, or could in the future be, converted into U.S. dollars at this or any other rate of exchange. (a) Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant inter-company transactions, accounts and unrealized profits or losses have been eliminated in consolidation. The investments in affiliated companies (all 20% to 50% owned and certain others 15% to 20% owned) are accounted for by the equity method. Certain subsidiaries have December 31 fiscal year-end and their operating results and financial position are consolidated by making appropriate adjustments of inter-company transaction during three months period. The excess cost of the Company's investment in subsidiaries over the underlying net equity of these companies at the date of acquisition is recorded in goodwill, and amortized over five years on a straight-line basis. In the elimination of investments in subsidiaries, the assets and liabilities of the subsidiaries, including the portion attributable to minority shareholders, are recorded based on the fair value at the time the Company acquired control of the respective subsidiaries. (b) Derivatives and Hedge Accounting The accounting standard for financial instruments requires Company and its subsidiaries (the “Companies”) to state derivative financial instruments at fair value and to recognize changes in the fair value as gains or losses unless derivative financial instruments are used for hedging purposes. If derivative financial instruments are used as hedges and meet certain hedging criteria, the Companies defer recognition of gains or losses resulting from changes in fair value of derivative financial instruments until the related losses or gains on the hedged items are recognized. (c) Foreign Currency Translation Assets and liabilities denominated in foreign currency are translated into Japanese yen at the rate prevailing at the balance sheet date. Resulting exchange gains and losses are included in other income. The financial statements of an overseas subsidiary are translated into Japanese yen using the year-end rate except for shareholders' equity using the historical rate. (d) Cash and Cash Equivalents Cash and cash equivalents include cash on hand, readily available deposits and short-term highly liquid investments with maturities not exceeding three months at the time of purchase. (e) Marketable Securities and Investment Securities Upon applying the accounting standard for financial instruments, all companies are required to examine the intent of holding each security and classify those securities as (a) securities held for trading purposes (hereafter, "trading securities"), (b) debt securities intended to be held to maturity (hereafter, "held-to-maturity debt securities"), (c) equity securities issued by subsidiaries and affiliated companies, and (d) for all other securities that are not classified in any of the above categories (hereafter, "available-for-sale securities"). The Companies do not have trading securities. Held-to-maturity debt securities are stated at amortized cost. The other securities with available fair market values are stated at fair market value. Unrealized gains and unrealized losses on these securities are reported, net of applicable income taxes, as a separate component of shareholders' equity. Cost of such securities for sales is computed using the moving-average method. The other securities without available fair market values are stated at cost determined by the moving-average method. (f) Inventories Merchandises and raw materials are stated at cost determined by the first-in first-out method. Finished products and supplies are stated at cost determined by the weighted-average method. Films and work-in-process are stated at cost determined by the specific identification method. Costs of films are amortized using the method prescribed by the Japanese tax laws. (g) Property and Equipment Property and equipment are stated at cost. The Company and its domestic subsidiaries compute depreciation using primarily the declining-balance method. Buildings (excluding structures)acquired after March 31, 1998 are depreciated using the straight-line method. Overseas subsidiaries compute depreciation using the straight-line method based on the accounting standard prevailing in the country of domicile.   The ranges of useful lives for computing depreciation are generally as follows: Buildings and structures 3 to 50 years Furniture and fixtures 2 to 20 years Machinery and vehicles 2 to 15 years (h) Amortization Software included in other non-current assets used by the Companies is amortized using the straight-line method over the estimated useful lives (five years), and other intangible assets are amortized using the straight-line method. Amortization of the long-term prepaid expenses is computed using the straight-line method over mainly 5 years. (i) Allowance for Doubtful Accounts The allowance for doubtful accounts is provided in an amount sufficient to cover possible losses on collection by estimating individually uncollectible amounts and applying a percentage based on the past credit loss experience to the remaining accounts. (j) Allowance for Employees' Bonuses The Companies provide allowance for employees' bonuses based on estimated amounts to be paid in the subsequent period. (k) Allowance for Sales Returns For certain subsidiaries, an allowance for sales returns is provided for estimated losses on sales returns subsequent to the balance sheet date based on the past history sales returns. (l) Employees' Severance and Retirement Benefits Under the accounting standard for Employees' Severance and Pension Benefits, the liabilities and expenses for severance and retirement benefits are determined based on the amounts actuarially calculated using certain assumptions. The Companies provided allowance for employees' severance and retirement benefits at the balance sheet date based on the estimated amounts of the projected benefit obligation and the fair value of the plan assets at that date. Actuarial gains and losses are amortized using the straight-line method over five years commencing with the succeeding period. (m) Allowance for Directors' and Corporate Auditors' Retirement Benefits The Companies provided for directors' and corporate auditors' retirement and severance benefit liabilities if all such individuals retired at the balance sheet date. (n) Bond issuance costs All bond issuance costs are charged to income when incurred and included in other expenses. (o) Income Taxes Income taxes comprise corporate, enterprise and inhabitants taxes. Deferred income taxes are recognized for temporary differences between the financial statement basis and the tax basis of assets and liabilities. (p) Amount Per Share Amount per share of common stock is based on the weighted average number of shares outstanding during the year. Diluted net income per share is based on the weighted average number of shares of common stock issued and dilutive common stock equivalents. The stock purchase rights were considered as common stock equivalents and were included in the calculation of earnings per share when they were dilutive. Diluted net income per share for the year ended March 31, 2003 was not presented because the Company had no outstanding securities with dilutive effect. (q) Accounting for Leases Finance leases other than those, which are deemed to transfer the ownership of the leased assets to lessees, are accounted for in the same manner as operating leases. (r) Reclassification Certain prior year amounts have been reclassified to conform to the presentation in the year ended March 31, 2005. These changes had no impact on previously reported results of operations or shareholders' equity. (a) For the year ended March 31, 2005, the Company newly consolidated subsidiaries (Nippon Herald Films, Inc. and its subsidiary, Herald Enterprise, Inc., Glovison Inc. and Cineplex Asia, Inc.). The amounts of assets and liabilities at the beginning of the consolidation period of newly consolidated subsidiaries utilized in the scope of consolidation for the year ended March 31, 2005 are as follows: (b) For the year ended March 31, 2004, the Company newly consolidated subsidiaries (MediaLeaves, Inc. and its subsidiaries, Ascii Corporation, Enterbrain, Inc. and Sarugakucho Inc.). The amounts of assets and liabilities at the beginning of the consolidation period of newly consolidated subsidiaries utilized in the computation of consolidation for the year ended March 31, 2004 and the acquisition cost of investments are as follows: (c) For the year ended March 31, 2003, Kadokawa-Daiei Pictures, Inc. acquired all of the business operations from Daiei Co., Ltd. The amounts of assets and liabilities increased due to this acquisition, and the payment for acquiring business operations are as follows: (d) For the year ended March 31, 2003, the Company newly consolidated subsidiaries (Media Works Inc. and its subsidiary, Toy'sworks Inc.). The amounts of assets and liabilities at the beginning of the consolidation period of newly consolidated subsidiaries utilized in the scope of consolidation for the year ended March 31, 2003 are as follows: (e) For the year ended March 31, 2003, Asmik Ace Entertainment, Inc. made a share capital increase to the third parties and accordingly became affiliated company, which was previously a consolidated subsidiary. Due to this change, the Company excluded subsidiaries ( Asmik Ace Entertainment, Inc. and its subsidiary, Tycoon Corporation) from scope of consolidation for the year ended March 31, 2003. The amounts of assets and liabilities at the date of the exclusion from scope of consolidation for the year ended March 31, 2003 are as follows: A. The following tables summarize acquisition costs, book values and fair values of securities with available fair values as of March 31, 2005, 2004 and 2003:   (a) Held-to-maturity debt securities:   (b) Available-for-Sale Securities: B. The following tables summarize book values of available-for-sale securities with no available fair values as of March 31, 2005, 2004 and 2003: C. Maturities of available-for-sale securities and held-to-maturity debt securities are as follows: D. The proceeds and gross realized losses from the sale of held-to-maturity debt securities are as follows: E. The proceeds and gross realized gains (losses) from the sale of available-for-sale securities are as follows: F. For the year ended March 31, 2005, the Company reclassified one of equity securities, which was previously classified as available-for-sale securities, to securities issued by subsidiaries and affiliated company. As a result of the reclassification, investment securities and retained earnings decreased by ¥15 million ($ 140 thousand) respectively compared with what would have been recorded under the previous accounting. For the year ended March 31, 2004, the Company reclassified one of equity securities, which was previously classified as available-for-sale securities, to securities issued by subsidiaries and affiliated company. As a result of the reclassification, investment securities increased by ¥53 million, retained earnings increased by ¥6 million and loss on devaluation of investment securities decrease by ¥47 million compared with what would have been recorded under the previous accounting. Inventories at March 31, 2005, 2004 and 2003 are summarized as follows: Short-term borrowings at March 31, 2005, 2004 and 2003 consisted of notes to banks and bank overdrafts. The interest rates on short-term borrowings at March 31, 2005, 2004 and 2003 ranged from 0.39% to 2.00%, from 0.49% to 2.00% and from 0.48% to 1.75%, respectively. Long-term debt at March 31, 2005, 2004 and 2003 are summarized as follows: The aggregate annual maturities of long-term debt are as follows: As is customary in Japan, security may have to be given if requested by a lending bank and such bank has the right to offset cash deposited with it against any debt or all obligations that become due and, in the case of default or certain other specified events, against all debts payable to the bank. The Company has never received such a request. At March 31, 2005, the following real estate at net book value were pledged as collateral for long-term debt: Taxes on income applicable to the Companies resulted in a normal statutory tax rate of approximately 40.69% for the year ended March 31, 2005 and 42.05% for the years ended March 31, 2004 and 2003, respectively. The actual effective tax rate in the accompanying consolidated statements of income differed from the normal statutory tax rate due principally to certain expenses that are permanently non-deductible for tax purposes. The following table summarizes the significant differences between the statutory tax rate and effective tax rate of the Companies for financial statement purposes for the years ended March 31, 2005, 2004 and 2003: The aggregate statutory income tax rate was reduced for the years commencing on April 1, 2004 or later due to the revised local tax law. At March 31, 2003, the Company and consolidated domestic subsidiaries applied the reduced aggregate statutory income tax rate of 40.69% for calculating deferred tax assets and liabilities that were expected to be recovered or settled in the years commencing on April 1, 2004 or later. As a result, net deferred taxes assets decreased by ¥19 million and provision for deferred income taxes and net unrealized holding gains increased by ¥20 million and ¥1 million, respectively as of March 31, 2003, compared with what would be reported using the currently applicable tax rate of 42.05%. Significant components of the Companies' deferred tax assets and liabilities as of March 31, 2005, 2004 and 2003 are as follows: Under the Japanese Commercial Code (the “Code”), the entire amount of the issue price of shares is required to be accounted for as capital, although a company may, by resolution of its Board of Directors, account for an amount not exceeding one-half of the issue price of the new shares as additional paid-in capital, which is included in capital surplus. Effective October 1, 2001, the Code provides that an amount equal to at least 10% of cash dividends and other cash appropriations shall be appropriated and set aside as legal earnings reserve until the total amount of legal earnings reserve and additional paid-in capital equals 25% of common stock. The legal earnings reserve and additional paid-in capital may be used to eliminate or reduce a deficit by resolution of the shareholders' meeting or may be capitalized by resolution of the Board of Directors. On condition that the total amount of legal earnings reserve and additional paid-in capital remains equal to or exceeding 25% of common stock, they are available for distribution by the resolution of shareholders' meeting. Legal earnings reserve is included in retained earnings in the accompanying consolidated financial statements. The maximum amount that the Company can distribute as dividends is calculated based on the unconsolidated financial statements of the Company in accordance with the Code. Semi-annual cash dividends may be declared by the Board of Directors after the end of each interim six-month period. Such dividends are payable to stockholders of record at the end of each fiscal or interim six-month period. In accordance with the Code, the declaration of these dividends and the related appropriations of retained earnings have not been reflected in the financial statements at the end of such fiscal or interim six-month periods. Under the Code, a company may issue new common shares to existing shareholders, without consideration, as a stock split pursuant to resolution of the Board of Directors. By special resolution at the 48th general shareholders' meeting held on June 25, 2002, the Company introduced a stock option plan in accordance with Article 280-21 of the Code, and granted stock acquisition rights at advantageous terms to directors and employees of the Companies. The stock acquisition rights can be exercised at a price of ¥1,958 per share in the period from July 1, 2004 to June 30, 2007. By the approval of the Board of directors of the Company on June 1, 2004, the Company issued ¥11,400 million ($106,135 thousand) zero coupon Japanese yen convertible bonds -- bonds with stock acquisition rights -- due in 2009 on June 18, 2004. The stock acquisition rights can be exercised at a price of ¥4,800 per share in the period from July 2, 2004 to June 4, 2009. In June 2005, the shareholders approved the declaration of a cash dividend applicable to the year ended March 31, 2005, totaling ¥773 million ($7,197 thousand). In conformity with the Code, this declaration of a cash dividend is not reflected in the consolidated financial statements as of March 31, 2005. The liabilities for severance and retirement benefits included in the liability section of the consolidated balance sheets as of March 31, 2005, 2004 and 2003 consist of the following: Severance and retirement benefit expenses included in the consolidated statements of income for the years ended March 31, 2005, 2004 and 2003 comprised the following: The discount rate and the rate of expected return on plan assets are 2.0% and 0.5%, respectively for the year ended March 31, 2005, 2.0% and 2.0%, respectively for the years ended March 31, 2004 and 2003. The estimated amount of all retirement benefits to be paid at the future retirement date is allocated equally to each service year using the estimated number of total service years. Actuarial gains and losses are recognized in the income statement using the straight-line method over the next five years. (Return of Substitutional Portion of Welfare Pension Insurance) Employees of Japanese companies are compulsorily included in the Welfare Pension Insurance Scheme operated by the government. Employers are legally required to deduct employees' welfare pension insurance contributions from their payroll and to pay them to the government together with employers' own contributions. For companies that have established their own Employees' Pension Fund which meets certain legal requirements, it is possible to transfer a part of their welfare pension insurance contributions (referred to as the "substitutional portion" of the government's Welfare Pension Insurance Scheme) to their own Employees' Pension Fund under the government's permission and supervision. Based on the newly enacted Defined Benefit Corporate Pension Law, one of domestic subsidiaries decided to restructure their Employees' Pension Fund and was permitted by the Minister of Health, Labor and Welfare on April 23, 2002 to be released from their future obligation for payments for the substitutional portion of the Welfare Pension Insurance Scheme. Pension assets for the substitutional portion maintained by the Employees' Pension Fund are to be transferred back to the government's scheme. This domestic subsidiary applied the transitional provisions as prescribed in paragraph 47-2 of the JICPA Accounting Committee Report No.13, "Practical Guideline for Accounting of Retirement Benefits (Interim Report)", and the effect of transferring the substitutional portion was recognized on the date permission was received from the Ministry of Health, Labor and Welfare. As a result, in the year ended March 31, 2003, this subsidiary recorded gains on the release from the substitutional portion of the government's Welfare Pension Insurance Scheme amounting to ¥64 million, which was calculated based on the amount of the substitutional portion of the projected benefit obligations as of the permission date, the related pension assets determined pursuant to the government formula, and the related unrecognized items. One of domestic subsidiaries uses foreign currency option contracts and interest rate swaps as derivative financial instruments only for the purpose of mitigating future risks of fluctuation of foreign currency exchange rates and interest rates, respectively. Foreign currency option contracts and interest rate swaps are subject to risks of foreign exchange rate changes and interest rate changes. The derivative transactions are executed and managed by the subsidiary's Finance Department according to the established policies that provide dealings authority and amount of dealing limits. The following summarizes hedging derivative financial instruments used by the subsidiary and items hedged:     Hedging instruments:     Hedged items:    Foreign currency option contracts    Foreign currency account payable and future commitments      Interest rate swap contracts    Interest on short-term borrowings and long-term debt The subsidiary evaluates hedge effectiveness semi-annually, however if an important condition of hedging instruments and hedged items is the same, the verification of the effect of hedging is omitted. Other income (expenses) - other-net consisted of the following: Finance leases, excluding those leases for which the ownership of the leased assets is considered to be transferred to the lessee, as of and for the years ended March 31, 2005, 2004 and 2003, are as follows: (a) Equivalent of Purchase Price, Accumulated Depreciation and Book Value of Leased Assets: (b) Lease Commitments (Including Interest Portion): (c) Lease Expenses and Depreciation Equivalents:   Depreciation equivalents are computed by the straight-line method over the lease terms with no residual value. (a) Business Segment Information The Companies operate primarily in the following business segments. (1) Publication...........books and magazines (2) Software..............films, videos, game software and others (3) Digital content......web-site, digital content (4) Others.................distribution, real estate agent and other (b) Geographic Segment Information Geographic segment information was not presented as domestic sales and assets exceed 90% of consolidated net sales and assets. (c) Overseas Sales Overseas sales were less than 10% of total consolidated sales. Pursuant to Article 2, Paragraphs 3 Enforcement Ordinance for the Law concerning Revaluation Reserve for Land (the “Law”), the Company recorded its owned land used for business at the fair value of ¥3,517 million (the original book value was ¥4,236 million) as of March 31, 2002, and related net unrealized loss was debited to “Revaluation reserve for land”, in the equity section. According to the Law, the Company is not permitted to revalue the land at any time, even in the case that the fair value of the land declines. As of March 31, 2005, 2004 and 2003, the fair value of the land declined ¥564 million ($ 5,251 thousand), ¥411 million and ¥265 million, respectively. (a) Share Exchange On March 17, 2005, the Company and Nippon Herald Films, Inc. (“Nippon Herald Films”) concluded the agreement, which provides that Nippon Herald Film shall become the Company's wholly owned subsidiary by way of share exchange. The Company's shareholders approved the agreement on June 26, 2005. The expected date of the share exchange is August 2, 2005, and the Company intends to utilize treasury stock for the share exchange.  [MORI] TATSUO TAKAYAMA 1995 [SONZAI TSUIOKU KAGIRINAKI TOKI NO NAKANI] TATSUO TAKAYAMA 1999  Copyright KADOKAWA HOLDINGS, INC. All rights reserved.