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 Group 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. 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, 2006, which was ￥117.47 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 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 and qualify as hedges, in which case the instrument gains and losses are deferred until the related losses or gains on the hedged items are also recognized. However, if interest rate swap contracts are used as hedges and meet certain hedging criteria, the net amount to be paid or received under the interest rate swap contract is reported as part of net interest expense. (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 overseas subsidiaries 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 Company and its subsidiaries (the "Companies") don’t 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. Some 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 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 long-term prepaid expenses is computed using the straight-line method. Software, other intangible assets and long-term prepaid expenses are included in other non-current assets. (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 historical sales returns. (l) Employees’ Severance and Retirement Benefits 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 At March 31, 2005 and 2004, the Companies provided for directors’ and corporate auditors’ retirement and severance benefit liabilities if all such individuals retired at the balance sheet date. At March 31, 2006, the Companies did not provide allowance for directors’ and corporate auditors’ retirement benefit, because institution of directors’ and corporate auditors’ retirement and severance benefit was abolished for the year ended March 31, 2006. (n) Bond issuance costs All bond issuance costs are charged to income when incurred and included in other expenses. (o) Impairment Loss of Long-Lived Assets Effective April 1, 2005, the Company and domestic subsidiaries adopted 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 "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). As a result of this change, income before income taxes decreased by ¥61 million ($519 thousand) compared with what would have been recorded under the previous accounting policy. Accumulated loss on impairment was deducted directly from the acquisition costs of the related assets. (p) 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. (q) Net Income Per Share Net income 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. (r) 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. (s) Reclassification Certain prior year amounts have been reclassified to conform to the presentation in the year ended March 31, 2006. These changes had no impact on previously reported results of operations or shareholders’ equity. (a) For the year ended March 31, 2006, the Company newly consolidated subsidiaries (Intercontinental Group Holdings Ltd. and its ten subsidiaries). The 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, 2006 and the acquisition cost of investments are as follows: (b) For the year ended March 31, 2006, Kadokawa-J:com Media Co., Ltd. became affiliated company due to sale of the subsidiaries’ shares. Due to this change, the Company excluded the subsidiary from the scope of consolidation for the year ended March 31, 2006. The assets and liabilities at the date of the exclusion from the scope of consolidation for the year ended March 31, 2006 and the net payment for sales are as follows: (c) For the year ended March 31, 2005, the Company newly consolidated subsidiaries (Nippon Herald Films, Inc. and its subsidiaries, Herald Enterprise, Inc., Glovision Inc. and Cineplex Asia, Inc.). The 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: (d) 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 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: A.The following tables summarize acquisition costs, book values and fair values of securities with available fair values as of March 31, 2006, 2005 and 2004:   (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, 2006, 2005 and 2004: C. The proceeds and gross realized gains (losses) from the sales of available-for-sale securities are as follows: D. 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 companies. As a result of the reclassification, investment securities and retained earnings decreased by ¥15 million respectively compared with what would have been recorded under the previous accounting. Inventories at March 31, 2006, 2005 and 2004 are summarized as follows: Short-term borrowings at March 31, 2006, 2005 and 2004 consisted of notes to banks and bank overdrafts. The interest rates on short-term borrowings at March 31, 2006, 2005 and 2004 ranged from 0.36% to 6.50%, from 0.39% to 2.00% and from 0.49% to 2.00%, respectively. Long-term debt at March 31, 2006, 2005 and 2004 are summarized as follows: The aggregate annual maturities of long-term debt are as follows: At March 31, 2006, the following assets were pledged as collateral for short-term borrowings, long-term debt, opening of letters of guarantee and credit, and bank overdraft: Breakdown of impairment loss of long-lived assets for the year ended March 31, 2006 are as follows: The companies impaired book values of such idle assets to recoverable amounts because the idle assets had no prospect for use. In calculating recoverable amounts the Companies use net realizable value for idle assets. The net realizable value is calculated and based on assessed value of fixed assets. Taxes on income applicable to the Companies resulted in a normal statutory tax rate of approximately 40.69% for the years ended March 31, 2006 and 2005, and 42.05% for the year ended March 31, 2004, 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, 2006, 2005 and 2004: 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. Significant components of the Companies’ deferred tax assets and liabilities as of March 31, 2006, 2005 and 2004 are as follows: Under Japanese laws and regulations, the entire amount of payment for new shares is required to be designated as common stock, although, generally, a company may, by a resolution of the Board of Directors, designate an amount not exceeding one-half of the price of the new shares as additional paid-in capital. Japanese Company Law (“the Law”) became effective on May 1, 2006, and, at the same time, the Japanese Commercial Code was repealed (“the Code”). Under the Code, companies were required to set aside an amount equal to at least 10% of cash dividends and other cash appropriations as legal earnings reserve until the total of legal earnings reserve and additional paid-in capital equaled 25% of common stock. Under the Law, in cases when dividends are paid, an amount equal to 10% of the dividends or the excess of 25% of common stock over the total of additional paid-in capital and legal earnings reserve, whichever is the smaller, must be set aside as additional paid-in capital or legal earnings reserve. Under the Code, additional paid-in capital and legal earnings reserve were available for distribution by the resolution of the shareholders’ meeting as long as the total amount of legal earnings reserve and additional paid-in capital remained equal to or exceeded 25% of common stock. Under the Law, even when the total amount of additional paid-in capital and legal earnings reserve is less than 25% of common stock, additional paid-in capital and legal earnings reserve may be available for dividends if there are sufficient distributable surplus. Under the Code, legal earnings reserve and additional paid-in capital could be used to eliminate or reduce a deficit by a resolution of the shareholders’ meeting or may be capitalized by a resolution of the Board of Directors. Under the Law, both of those appropriations require a resolution of the shareholders’ meeting. Legal earnings reserve is included in retained earnings in the accompanying consolidated balance sheets. The maximum amount that the Company can distribute as dividends is calculated based on the non- consolidated financial statements of the Company in accordance with Japanese laws and regulations. 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 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 2006, the shareholders approved the declaration of a cash dividend applicable to the year ended March 31, 2006, totaling ¥748 million ($6,368 thousand). In conformity with the Code, this declaration of a cash dividend is not reflected in the consolidated financial statements as of March 31, 2006. The liabilities for severance and retirement benefits included in the liability section of the consolidated balance sheets as of March 31, 2006, 2005 and 2004 consist of the following: Severance and retirement benefit expenses included in the consolidated statements of income for the years ended March 31, 2006, 2005 and 2004 comprise the following: The discount rate and the rate of expected return on plan assets are 2.0% and 0.5%, respectively for the years ended March 31, 2006 and 2005, 2.0% and 2.0%, respectively for the year ended March 31, 2004. 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. Certain domestic subsidiaries use 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 subsidiaries 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 subsidiaries evaluate 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, 2006, 2005 and 2004, are as follows: (a) Acquisition Cost, Accumulated Depreciation and Book Value of Leased Assets: (b) Future Minimum Lease Payments (Including Interest Portion): (c) Lease Expenses and Depreciation:   Depreciation is 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 is 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, 2006, 2005 and 2004, the fair value of the land declined ¥655 million ($5,576 thousand), ¥564 million and ¥411 million, respectively. Copyright KADOKAWA GROUP HOLDINGS, INC. All rights reserved.