Annual Report 2007 [PDF:1.75MB]
Transcription
Annual Report 2007 [PDF:1.75MB]
Shiseido commenced operations as Japan’s first Western-style pharmacy in Tokyo’s Ginza district in 1872. The name Shiseido derives from a Chinese expression meaning “praise the virtues of the great Earth, which nurtures new life and brings forth new values.” In line with this expression, our founding spirit of “serving our customers and contributing to society by integrating all things on Earth to create new value,” lives on in our corporate mission of “identifying new, richer sources of value and using then to create a beautiful lifestyle.” This policy has led to high-value-added products and services in the cosmetics and other businesses promoting people’s beauty and well-being. The fiscal year ending March 2008 is the final year of our Three-Year Plan to maximize growth potential and improve profitability, and we are devoting all of our capabilities to assisting customers in revealing their full beauty. By successfully implementing reforms, we aim to assist society, customers and all people in experiencing “This moment. This life. Beautifully.” Contents Financial Highlights ......................................................... 4 To Our Stakeholders ........................................................ 5 An Interview with President Maeda ............................... 6 Shiseido at a Glance ......................................................... 10 Business Review Domestic Cosmetics Business.................................... 12 Overseas Cosmetics Business .................................... 16 Feature: Revealing the Beauty of Each and Every Customer........................................... 20 Research and Development, Intellectual Assets ........... 26 Corporate Governance, Corporate Social Responsibility .................................. 28 Global Network ................................................................. 33 Financial Section Six-Year Summary of Selected Financial Data .......... 34 Management’s Discussion and Analysis.................... 35 Consolidated Financial Statements ............................ 46 Notes to the Consolidated Financial Statements ................................................. 51 Report of Independent Auditors ................................. 68 Corporate Information...................................................... 69 Forward-Looking Statements In this annual report, statements other than historical facts are forward-looking statements that reflect the Company’s plans and expectations. These forward-looking statements involve risks, uncertainties and other factors that may cause actual results and achievements to differ from those anticipated in these statements. Financial Highlights Shiseido Company, Limited, and Subsidiaries For the years ended March 31, 2005, 2006 and 2007 Millions of yen (Except per share data) 2005 2006 2007 Percent change Thousands of U.S. dollars (Note 1) (Except per share data) 2007/2006 2007 Operating Results: Net sales ·········································· Operating income (Note 2) ················ Net income (loss) ······························ ¥639,828 26,529 (8,856) ¥670,957 38,879 14,436 ¥694,594 50,005 25,293 +3.5% +28.6 +75.2 $5,881,904 423,448 214,184 Financial Position (At year-end): Total assets ······································ Net assets ········································ ¥701,095 369,957 ¥671,842 387,613 ¥739,833 403,797 +10.1% +4.2 $6,264,993 3,419,400 Per Share Data (In yen and U.S. dollars): Net income (loss) (Note 3) ················· Net assets (Note 3) ··························· Cash dividends ································· ¥ (21.5) 866.5 24.0 ¥ 34.4 906.1 30.0 ¥ 60.9 940.8 32.0 +77.0% +3.8 +6.7 $0.52 7.97 0.27 Financial Ratios: Operating profitability (Note 2) ··········· Return on equity ······························· Total return ratio (Note 4) ·················· 4.1% (2.4) — 5.8% 3.9 105.1 7.2% 6.6 52.6 Notes: 1. All dollar amounts herein refer to U.S. currency. Yen amounts have been translated, solely for the convenience of the reader, at the rate of ¥118.09 to US$1 prevailing on March 31, 2007. 2. Operating income and operating profitability for the year ended March 31, 2005 have been retrospectively restated to reflect changes in accounting policies for the year ended March 31, 2006. 3. Net income (loss) per share (basic) is calculated based on the weighted average number of shares outstanding during each respective year. Net assets per share is calculated based on the number of shares outstanding at the end of each respective year. 4. Total return ratio = (Cash dividends + Share buybacks*) ÷ Consolidated net income *Excluding odd-lot purchases Net Sales / Overseas Sales Ratio Operating Income / Operating Profitability (Billions of yen) 600 (%) 621.3 624.2 639.8 671.0 (Billions of yen) 30 10 38.9 37.5 24.5 27.5 26.5 7.6 20 50 14.4 15 25 5.8 5 7.0 0 4.1 7.6 34.4 30.0 32.0 20.0 7.2 6.0 15 30 25.3 15 32.4 60.9 58.0 30 200 (Yen) 64.9 45 29.4 (%) 50.0 47.1 40 27.5 24.8 26.0 Net Income (Loss) per Share/ Cash Dividends per Share (Billions of yen) (%) 694.6 400 Net Income (Loss) / Return on Equity 6.6 3.9 0 22.0 24.0 0 (2.4) 0 0 03 04 05 Net Sales Overseas Sales Ratio 06 0 07 07 03 04 05 Net Income (Loss) Return on Equity (15) 06 Business Segment Information Geographic Segment Information Net Sales (Outer circle) Operating Income (Inner circle) (Year ended March 31, 2007) Net Sales (Outer circle) Operating Income (Inner circle) (Year ended March 31, 2007) 3.3% 4.5% 07 (25) (21.5) 03 04 05 06 Net Income (Loss) per Share Cash Dividends per Share 07 12.0% 32.3% 21.1% 74.4% 64.4% Domestic Cosmetics Business Overseas Cosmetics Business 12.7% 23.5% 7.5% Others 13.2% 4 (8.9) (15) 0 03 04 05 06 Operating Income Operating Profitability SHISEIDO ANNUAL REPORT 2007 5.9% 57.4% 67.8% Japan Americas Europe Asia/Oceania Note: Segment sales represent sales to external customers only and do not include intersegment sales or transfers. To Our Stakeholders In the fiscal year ended March 2007, the second year of the Three-Year Plan to maximize growth potential and increase profitability, Shiseido continued to implement domestic marketing reforms, accelerate expansion of the China business, and carry out further fundamental structural reforms. As a result, both consolidated net sales and operating income achieved record levels. Consolidated net sales increased 3.5 percent to ¥694.6 billion, backed by a substantial increase in overseas sales, particularly in China. Marginal gains from overseas sales expansion and cost reduction efforts increased operating income 28.6 percent year-on-year to ¥50.0 billion, raising operating profitability to 7.2 percent. As a result, net income increased a solid 75.2 percent to ¥25.3 billion. In the fiscal year ending March 2008, the final year of the Three-Year Plan, we will: 1) accomplish domestic marketing reforms to establish a stable earnings base; 2) continue investing in overseas markets with high growth potential, primarily China; and 3) continue promoting fundamental structural reforms that qualitatively transform the cost structure. These initiatives are expected to lead to increases in sales and profits and a reduction in the cost of sales ratio, through which Shiseido aims to fulfill its commitment to achieve operating profitability of 8 percent or higher as announced at the beginning of the Three-Year Plan. In addition, we will prepare to implement a clear scenario for the next three years. At the same time, to support these reforms, we will actively foster human resources and strengthen corporate governance. All employees and top management, including myself, will concentrate our maximum effort on raising the value of the corporate brand and the quality of its management in order to reveal the full beauty of our customers. Through these actions, Shiseido will work to earn the support of all stakeholders. We look forward to your continued support as we embrace the challenges of the future. June 26, 2007 SHINZO MAEDA President & CEO (Representative Director) SHISEIDO ANNUAL REPORT 2007 5 An Inter view with President Maeda In the year ending March 2008, Shiseido will complete its current Three-Year Plan, and begin preparing for the next three years. Maintaining the pace of reform, we will focus on accomplishing remaining domestic marketing reform objectives, further strengthening global development and continuing with fundamental structural reforms. Shiseido decisively implemented reforms under the theme of “improving execution and speed.” How do you rate the achievements and progress of the Three-Year Plan at this point in time? The Three-Year Plan is aimed at maximizing growth potential and improving profitability in order to transform Shiseido into a corporation that can compete successfully with its global peers. To do this, we are implementing the three key themes of the Three-Year Plan: “to become thoroughly committed to customer-oriented marketing,” “to give Shiseido a solid profit structure” and “to improve the execution and speed of all reforms.” Resolving to break down and rebuild the company structure if necessary, over the past two years we have reviewed all aspects of our corporate activities, from research and development to production, marketing, sales and the activities of Beauty Consultants. We implemented our reform scenario without delay and this led to results exceeding initial forecasts in the first and second years of the plan. A can-do spirit has raised employee confidence and motivation. I would give SHINZO MAEDA President & CEO (Representative Director) 6 SHISEIDO ANNUAL REPORT 2007 our progress over the past two years a passing grade. We are aiming for even more challenging levels of sales and profits in the year ending March 2008, the percent, which is the minimum necessary for competing third and final year of the plan. We intend to fulfill our effectively with global peers. To do so, we intend to commitment to achieve operating profitability of 8 per- achieve the numerical objective of the current plan this cent or higher and all other targets. Specifically, we will year, and prepare the groundwork for the next three- concentrate on three key points: “accomplishing remain- year period, in which we will aim for 10 percent operat- ing domestic marketing reform objectives,” “further ing profitability. strengthening global development,” and “continuing with fundamental structural reforms.” In domestic marketing reform, considerable attention focused on large-scale changes such as the The numerical objective of the Three-Year Plan is launches of mega lines. What will Shiseido operating profitability of 8 percent or higher for emphasize in completing reforms during the year the year ending March 2008. Will Shiseido achieve ending March 2008? this goal? In Japan, two issues are critical for success: developing In the past two years, we have allocated marketing long-selling brands/lines that benefit our customers and expenditures under the theme of “distinction and concen- strengthening our model for coexistence and co-prosperi- tration,” and have reduced fixed expenses by reorganizing ty with sales channels for the twenty-first century. domestic production facilities and scaling back or with- Launches of mega lines were completed in the year drawing from unprofitable businesses. These measures ended March 2007. In the year ending March 2008, we will have transformed our cost structure, and operating prof- work to generate additional sales growth that exceeds itability is improving faster than planned. I therefore con- those launches by cultivating existing brands/lines. Of sider operating profitability of 8 percent or higher for the course, this is no simple task, but the pillars of “broad year ending March 2008 an achievable goal. and strong” brands/lines are now established. Rather However, operating profitability of over 8 percent is than relying on launches of new brands/lines, we intend to not the final goal. We need to evolve into a company that transform our corporate structure into one where long- can consistently achieve operating profitability above 10 selling brands/lines are nurtured to benefit our cus- Reforms Implemented in the Past Two Years R&D Production/ Logistics Marketing Sales Beauty Consultants Solution-based R&D structure that integrates beauty methods and product research Reorganization of domestic factories from 6 to 4 Outsourcing of logistics operations Renovation of brand strategy (mega-line concept, etc.) Appointment of Brand Managers by category Integration of cosmetics and toiletries business divisions Formation of channel-based sales force Reform of business trade system Removal of sales quotas from evaluations Installation of customer satisfaction evaluation system SHISEIDO ANNUAL REPORT 2007 7 tomers. We will do so by establishing a structure that percent year-on-year, a significant increase. The overseas unifies efforts from research and development to produc- sales ratio was 32 percent for the full year, exceeding 30 per- tion, sales and service. cent for the first time ever. Strengthening our model for coexistence and co- Sales in China, which is driving this growth, have prosperity with sales channels for the twenty-first century nearly doubled over the two-year period from April 2004 to will entail introducing new, meticulous business trade March 2006. Looking forward, China is positioned as our terms that capitalize on the particular characteristics and key market and we will strengthen our channel-based strengths of each brand/line and store. Moreover, in brand strategy, enter new channels and execute other cooperation with voluntary chain stores, we will create initiatives with the aim of generating additional sales and provide support for a new circle of specialty stores growth. At the same time, we will further refine cus- focused on revealing their customers’ beauty. We will tomer service at sales counters, one of Shiseido’s also analyze and use customer purchase data to support the strengths, by enhancing training for local Beauty creation of sales corners, centering on structured retailers Consultants. Moreover, we have established a consumer (such as drugstores and general merchandisers), while information center in China to improve service and working to enhance the activities of Retail Supporters, reflect customer feedback in marketing. who are field staff that support retail stores in areas In addition to our expansion in China, with firm including merchandising, inventory management and growth in Europe and North America and operations in ordering. markets with growth potential such as Russia, we aim to achieve an overseas sales ratio of 40 percent or higher in the next three years. Over the past two years we have executed You have stated that Shiseido must transform itself structural reforms such as downsizing and withdrawing into a truly global corporation, which means the devel- from underperforming businesses, and reorganizing opment of the overseas cosmetics business is critical. North American operations to generate synergy among How is Shiseido going to do this? businesses there. Income from overseas operations has In the year ended March 2007, overseas sales rose 14 Three-Year Plan Operating Profitability of 8% or Higher 800 4.1% 639.8 5.8% 720 694.6 671.0 50.0 400 38.9 26.5 25.3 14.4 (Billions of yen) 58 33 26.7% Selling, general and administrative expenses 66.1% 2005 50 (10) 2006 Net Sales (Left scale) Net Income (Right scale) 2007 2008 (Estimate) Operating Income (Right scale) Operating Profitability (Right scale) SHISEIDO ANNUAL REPORT 2007 (Estimate) 0.8pt Improvement 25.9% 75 0.1pt Improvement 66.0% Constant ratio of advertising and promotional expenses to net sales 0 (8.9) 8 Cost of sales 25 0 2008 2007 5.0 600 200 Toward Operating Profitability of 8 Percent or Higher 10.0 8.1% 7.2% (Billions of yen) (%) improved significantly as a result. Looking forward, we Operating profitability 7.2% +0.9pt 8.1% An Inter view with President Maeda intend to accelerate these initiatives to increase sales and improve profitability. In this way, we will further strengthen our efforts to become a global corporation based on the foundation for an “aggressive global strategy” that we have been developing during these past two years. How will Shiseido reform its cost structure to achieve the goal of operating profitability of 8 percent or higher? proportion of dividends in the total return. Cash divi- We will work to improve the overall cost structure dends per share for the year ended March 2007 while maintaining a constant ratio of marketing expenses increased by ¥2 compared with the previous fiscal year to to net sales. First of all, we will continuously reduce cost of ¥32 per annum. For the year ending March 2008, we sales in ways such as improving productivity. Moreover, we plan to increase cash dividends by ¥2 per share again to will work to reduce administrative and other expenses ¥34. This will be the sixth consecutive annual increase in by raising efficiency through standardization of work dividends. processes. By increasing profitability and returning profits to In addition, a goal for the three years ending March shareholders, we intend to maintain shareholders’ equity at 2011 will be to re-engineer our production, logistics and an appropriate level and improve capital efficiency. In information system infrastructure. As part of this effort, in the past two years, return on equity rose in tandem with April 2007 we began outsourcing logistics and started operating profitability, reaching 6.6 percent in the year constructing a new core information system. ended March 2007, a year-on-year increase of 2.7 per- Shiseido projects operating profitability of 8.1 percent for the year ending March 2008. We will steadily and briskly execute various initiatives to achieve this goal and complete the reforms of the Three-Year Plan. centage points. We expect it to reach 8.3 percent for the year ending March 2008. At the same time, we will actively promote corporate governance and fulfill our social responsibilities as a corporation. I am confident that raising the value of the corporate brand and improving the quality Please outline Shiseido’s shareholder return policy and its approach to raising corporate value in the future. of management will result in higher corporate value. We will continue to devote all of our energy to achieving the goals of our Three-Year Plan and to Shieido’s progress. As a basic policy, Shiseido has set a “total return ratio*” of 60 percent for the medium term. Looking forward, we will prioritize stable dividends while raising the * Total return ratio = (Cash dividends + Share buybacks excluding odd-lot purchases) ÷ Consolidated net income SHISEIDO ANNUAL REPORT 2007 9 Shiseido at a Glance Major Brands/Lines Cosmetics Counseling Domestic Cosmetics Business The domestic cosmetics business segment handles products/services for the Japanese market, primarily cosmetics. The core cosmetics division manufactures and markets cosmetics, cosmetics equipment and toiletries. The professional division manufactures and markets products/services for hair and beauty salons. The healthcare division manufactures and markets food products and over-the-counter drugs. The nonShiseido and mail-order division manufactures and markets cosmetics that are not branded as Shiseido products. Share of total net sales Share of total operating income 64.4% 74.4% clé de peau BEAUTÉ Bénéfique Elixir Superieur Maquillage Revital Haku SHISEIDO Global Lines Overseas Cosmetics Business Composed of the cosmetics division and the professional division, the overseas cosmetics business segment handles products for overseas markets. It manufactures and markets cosmetics and other products/services in the Americas, Europe and Asia/Oceania. White Lucent Share of total net sales Share of total operating income 32.3% 21.1% Benefiance Others The others business segment includes the frontier science division, which manufactures and markets medical-use drugs and cosmetics, and conducts a variety of other activities including the sale of clothing and accessories, restaurant operation, and real estate management and sales. Share of total net sales Share of total operating income 3.3% 4.5% Notes: Segment sales represent sales to external customers only and do not include intersegment sales or transfers. 10 SHISEIDO ANNUAL REPORT 2007 Bio-hyaluronic acid Professional Healthcare Non-Shiseido and Mail-Order Tsubaki System Qurl Collagen EX IPSA Integrate Sengan Senka Qi Q10 Series d’ici lá Uno SEA BREEZE SHISEIDO Beauty Saloon Ferzea Soka-Mocka Self-selection Toiletries Aqua Label Cosmetics Professional Non-Shiseido China SUPREME AUPRES Jean Paul GAULTIER JOICO ISSEY MIYAKE AUPRES NARS URARA CAPCELL PAK (Liquid chromatography columns) NAVISION (Cosmetic dermatology treatment) DECLÉOR CARITA THE GINZA SHISEIDO ANNUAL REPORT 2007 11 Business Review Domestic Cosmetics Business In the domestic cosmetics business, Shiseido continued to Domestic Cosmetics: Sales by Division promote reforms to implement 100 percent customeroriented marketing. We reorganized the portfolio of Shiseido’s regional lines to enhance concentration and raise Non-Shiseido and Mail-Order 4.9% Others 2.7% Healthcare 2.8% Professional 3.7% cost efficiency. We also reinforced sales activities by establishing a channel-specific sales force structure through the integration of the cosmetics and toiletries business divi- Cosmetics 85.9% Toiletries 11.8% sions. In the year ending March 2008, we will accomplish Self-selection 22.6% our remaining objectives and establish stable growth and a Counseling 51.5% solid profit structure. 12 SHISEIDO ANNUAL REPORT 2007 ■ Continued to implement brand strategy renovation aimed at establishing “broad and strong” brands/lines. ■ Established structure for prioritizing brands/lines for cultivation through the introduction of two new mega lines and improved cost efficiency. ■ In the year ending March 2008, cultivate long-selling brands/lines by integrating all activities from R&D and production to sales and in-store services. TAMIO INABA Corporate Officer Responsible for Business Strategy and Marketing of Domestic Cosmetics Business Brand Strategy Renovation Framework of Major Brands/Lines Priority Brands/Lines In the year ended March 2007, we continued to implement brand strategy renovation to increase distinction Skincare Elixir Superieur Aqua Label Makeup Maquillage Integrate and concentrate marketing spending, with the aim of establishing “broad and strong” brands/lines. We launched two new mega lines – the Elixir Superieur skincare line and the Integrate makeup line – Brands/lines that expand customer contact points product categories in a wide range of channels. With Men's these additions to the four other mega lines launched in the year ended March 2006, we established a six mega line portfolio. All of these lines secured either the top or near top market share position in their respective categories Brands/lines that deeply entrench customer contact points (Selected) Revital Haku Sengan Senka Anessa SEA BREEZE Ag+ Bodycare Haircare aimed at expanding customer contacts and leading their Core Brands/Lines Tsubaki Super Mild Ma Chérie Uno Adenogen Department clé de peau BEAUTÉ stores, Voluntary Bénéfique chain stores White Lucent Benefiance Structured retailers, etc. Kesho-wakusei &Face Majolica Majorca within a month of being launched and contributed significantly to increased sales. In brands/lines that deeply entrench customer con- Measures for the Year Ending March 2008 tact points and strengthen customer relationships in limited In the year ending March 2008, we will develop a retail channels, we innovated the Clé de Peau BEAUTÉ framework in which all functions, from R&D and produc- high-end prestige brand and the exclusive voluntary tion to sales and in-store services, are focused on culti- chain store line Bénéfique. vating existing brands/lines into long-sellers. We will Our eight brands/lines prioritized for cultivation, revitalize front-line sales activities through measures including our six mega lines and Clé de Peau BEAUTÉ and including shopfront-driven promotions and adding culti- Bénéfique, accounted for 52 percent of cosmetics division vation of existing brands/lines to sales evaluation criteria. sales within the segment, up four percentage points from We will also enhance our product development process in the year ended March 2006. The brand strategy renovation order to reflect customer opinions even more rapidly. In is bearing fruit, with marketing cost efficiency improving addition, we will reduce the number of stock-keeping through brand/line concentration. units to increase the amount of management resources dedicated to each. SHISEIDO ANNUAL REPORT 2007 13 ■ In innovating the activities of Beauty Consultants, steadily improved customer evaluations through implementation of the new customer satisfaction evaluation system throughout Japan. ■ In sales reforms, integrated the cosmetics and toiletries business divisions in April 2006, and established a channel-specific sales force structure. ■ In the year ending March 31, 2008, enhance framework for coexistence and co-prosperity with sales channels in the twenty-first century. TOSHIMITSU KOBAYASHI Director and Corporate Senior Executive Officer Responsible for Domestic Cosmetics Business Sales President and Representative Director, Shiseido Sales Co., Ltd. Innovating the Activities of Beauty Consultants In addition, we will further enhance support for Beauty Shiseido is innovating the activities of its Beauty Consultant activities by establishing a Beauty Training Consultants to raise corporate value at the point of contact Control Group at the head office to consolidate tasks with customers. In the year ended March 2007, we dis- related to such operations. Through these measures, we continued work evaluations based on sales targets and will bolster their skills as beauty professionals and fur- rolled out the customer satisfaction evaluation system ther strengthen shopfront services. throughout Japan. In this system, customers who have received over-the-counter service from Beauty Consul- Customer Satisfaction Evaluation System tants provide evaluations by reply postcard. In addition, we enhanced communication through measures including 1 focused on activities that bring us into contact with the maximum number of customers and ensure that we can continue to reveal their beauty. With solid initial progress in these activities aimed at Send survey results 4 3 Reflect in performance reviews 5 Individual training and instruction to raise service level Head Office the performance evaluations of sales representatives. We Customers reflecting customer evaluations of Beauty Consultants in Feedback on individual survey results Branches Distribute surveys Beauty Consultants improved consciousness on the front line of sales and 6 2 Submit completed surveys gaining further customer satisfaction and trust, we saw a steady increase in the number of phone calls and letters from customers appreciative of the Beauty Consultants’ services. Measures for the Year Ending March 2008 In the year ending March 2008, we will work to evolve Beauty Consultant activities further. With the customer satisfaction evaluation system, we will shift to a system focused on making the sales-front more dynamic through measures including tailoring customer evaluation survey questions to specific regions and channels. 14 SHISEIDO ANNUAL REPORT 2007 Feedback on postcard survey results helps motivate Beauty Consultants to improve customer service. Business Review Sales Reforms In April 2006, we integrated the cosmetics and toiletries business divisions to enable marketing that matches customer purchasing behavior. Through this integration, we Channel-Specific Sales Force Structure Voluntary Chain Stores Branch offices (9) Branches (59) introduced a channel-specific sales force structure that reor- Structured Retailers Department Stores Wholesalers Sales divisions (11) Department store sales divisions (7) Wholesale sales divisions (6) ganizes front-line sales functions into the voluntary chain store, structured retailing, department store and wholesale distribution channels. A symbol of these sales reforms, the Tsubaki line became a major hit in the highly competitive ■ Enhanced community-based sales and approach to specialty store groups ■ Strengthed negotiation and sales corner creation capabilities ■ Strengthened development of selected stores in each region ■ Enhanced cooperation with large retail groups haircare category following its launch in March 2006, group, we will fully support activities involving employee achieving sales 1.8 times the first-year sales plan. training, store creation and merchandising. For sales channels, primarily structured retailers, we Measures for the Year Ending March 2008 will conduct customer relationship management. This will In the year ending March 2008, we will enhance our entail analyzing detailed customer purchasing data, and, framework for coexistence and co-prosperity with sales based on the findings, developing and recommending channels in the twenty-first century. Our first task will be to changes to sales corners and methods. Introduced at a reform our long-established uniform business trade number of major drugstores in the year ended March terms. We will shift to a more detailed system that fully 2007, proposals based on this analysis will be steadily leverages the characteristics of each store by matching cus- expanded to include other chains starting from April 2007. In tomer purchasing behavior and channel features. Based on order to effectively implement the proposals adopted on a this new system, we will conduct more defined marketing headquarter-to-headquarter level at each store, we will further that capitalizes on the characteristics of each brand/line enhance the activities of Retail Supporters, a group of and store. approximately 1,000 staff who regularly visit the stores. In In addition, we will further enhance channel-specific ini- order to improve their operating environment and skill tiatives for voluntary chain stores and structured retailers. level, we will strengthen communication between Retail For voluntary chain stores, we will form a new circle of Supporters and sales representatives, and provide support stores that are focused on revealing the beauty of cus- through the sales divisions with measures including utilizing tomers. Concentrating management resources on this information terminals with built-in cameras. Shiseido aims to assist voluntary chain stores in leveraging their distinctive characteristics by offering diverse customization proposals. Retail Supporters visit each store to assist with sales corner creation, inventory management, ordering and item replenishment. SHISEIDO ANNUAL REPORT 2007 15 Overseas Cosmetics Business In the overseas cosmetics business, sales were strong in all Overseas Cosmetics: Sales by Division regions, particularly in China. Professional In China, our key market, we pursued a channel-specific 14.3% brand strategy that generated a high level of growth in both the voluntary chain store and department store channels. Cosmetics (China) 19.8% In markets other than China, we further increased the presence of the brand and improved profitability through structural reforms including reorganization of our operations in North America. 16 SHISEIDO ANNUAL REPORT 2007 Cosmetics (Americas, Europe and Asia/Oceania excluding China) 65.9% Cosmetics 85.7% Business Review ■ Steadily advanced structural reforms centered on reorganization of operations in North America. ■ Established a global R&D network with five bases around the world. ■ In the year ending March 2008, carry out further structural reforms to improve profitability in preparation for an aggressive global strategy in the next three years. CARSTEN FISCHER Corporate Executive Officer Responsible for International Business Chief Officer of International Business Division Global Business Development In the year ended March 2007, we concentrated marketing Measures for the Year Ending March 2008 In the year ending March 2008, we will focus on expanding activities in anti-aging and skin-brightening products, areas the number of loyal customers for the of strength for Shiseido, and gained more customer support in and Beauté Prestige International designer fragrances. In key countries in Europe, the Americas and the Asia-Pacific May 2007, we established the sales subsidiary Shiseido region. In particular, stepping up our presence in the skin- (RUS), LLC in the Russian Federation, where the cosmetics care product category, we secured the top position in the market has been rapidly expanding due to economic growth in German market for cosmetics, excluding fragrances, and recent years. Preparations are currently underway toward greatly increased sales in the U.S. skincare market. the start of full-scale operation in January 2008. In addition, we In addition, in October 2006, we established a research center in Southeast Asia and reorganized an R&D base in brand will aggressively develop growth areas including the travel retail business, focusing on airport duty-free shops. Europe, thereby creating a global R&D network spanning Moreover, we will establish the basis for an aggressive five regions around the world, including Japan, North global strategy for the next three years through structural America and China. We are enhancing our efforts to create reforms that increase profitability. Measures will include global value by utilizing overseas R&D bases to research developing efficient marketing focused on major brands and customer needs, develop new product seeds and cultivate consolidating management functions. locally rooted marketing. Furthermore, to improve productivity and strengthen marketing, we established and began implementing a structural reform plan centered on reorganization of infrastructure, management and sales for the North America region, where Group-wide synergy was not fully leveraged. Such initiatives to enhance management stability, in addition to regional sales growth, led to a substantial improvement in the operating profitability of overseas businesses. In Europe and North America, Shiseido sells through department stores and perfumeries, with a focus on “high quality, high image and high service.” SHISEIDO ANNUAL REPORT 2007 17 ■ In the department store channel, sales of AUPRES were brisk. ■ In the voluntary chain store channel, in addition to an increase in the number of stores, the new URARA brand contributed to sales growth at existing stores. ■ In the year ending March 2008, reinforce channel-based brand strategy to sustain a high level of growth. TATSUOMI TAKAMORI Corporate Officer Chief Officer of China Business Division Accelerating Expansion of the China Business In the China market, an engine of overseas growth, sales have been increasing at the remarkable rate of more than 30 percent annually on a local currency basis. This is a Sales in China (Billions of yen) 50 40 result of the channel-specific brand strategy of developing products and promotions tailored to specific customer needs in each channel, which are all undergoing signifi- 30 20 cant changes. In the voluntary chain store channel, we increased contracts for Shiseido Chain Stores. Under this system, we 10 0 2000 2001 2002 2003 2004 2005 2006 2007 enter contracts with independently owned cosmetics stores that share the Shiseido management philosophy to also introduced SUPREME AUPRES, a prestige line within make them officially designated stores for handling the AUPRES brand. Specialty counters for SUPREME Shiseido products. As of fiscal year-end, we had estab- AUPRES at two department stores in Beijing and Shanghai lished a Shiseido Chain Store network in China compris- produced solid results. ing over 1,700 stores, as planned. While increasing the number of these stores, we also took measures to increase sales at existing stores. Introduced in October 2006, the URARA brand of products sold exclusively in this channel was a big hit and grew into a mainstay brand in its first year of sales. The success of URARA and increased sales of existing products helped us achieve excellent results, with sales growth at existing stores averaging over 30 percent. In the department store channel, our exclusive China brand AUPRES maintained its top position due to enhanced promotions and advertising. In November 2006, we 18 SHISEIDO ANNUAL REPORT 2007 The URARA brand contributed to sales growth at existing Shiseido Chain Stores. Makeup items were added to the lineup in March 2007. Business Review Measures for the Year Ending March 2008 In the year ending March 2008, we will concentrate on the following priority tasks in order to sustain a high level of growth in our China business. Training for local Beauty Consultants is being enhanced to increase their customer service skills. First, to strengthen our channel-specific brand strategy, we will work to increase the number of customer contact points and expand sales at existing stores, with a focus on AUPRES, SUPREME AUPRES and URARA. We will also bolster efforts to enter new growth channels. In order to further refine Shiseido strengths, we will work to enhance customer service at sales counters and customers relations in general. To spread our spirit of omotenashi (hospitality) to local Beauty Consultants and enable them to provide services that surpasses customer expectations, we will strengthen training programs by Business Development in China Cities Where AUPRES Is Sold Shiseido Chain Store Service Area sending highly experienced Beauty Consultants from Japan on an unprecedented scale. In addition, we have established a consumer information center to enhance consultation functions and reflect customer feedback in marketing. In addition, we will work to become a company that is trusted and needed in China through a range of social Manufacturing and sales company Research center Manufacturer Investment and sales company contributions and environmental initiatives including holding beauty seminars for women’s organizations. Sales company Sales company AUPRES is the top-selling in-store brand at many of the approximately 600 prestige department stores where it is sold. SUPREME AUPRES, developed to compete against imported brands, is sold at different specialty counters than AUPRES. SHISEIDO ANNUAL REPORT 2007 19 Feature: Revealing the Beauty of Each and Every Customer Tsubaki : A Stor y of Domestic Marketing Reform 20 SHISEIDO ANNUAL REPORT 2007 In domestic marketing reforms, Shiseido promotes brand strategy renovations aimed at creating “broad and strong” brands/lines while working to implement sales reforms that leverage the comprehensive strengths of the Shiseido Group. As an actual example of these efforts, this article presents the stor y of Tsubaki, which was launched in March 2006. April 2005 Beginning of Brand Strategy Renovation Brand strategy renovations began as part of the domestic marketing reforms of the Three-Year Plan. Aiming to create “broad and strong” brands/lines, Shiseido reorganized its portfolio into two categories: those that expand customer contact points and those that deeply entrench customer contact points. August 2005 Introduction of the First Mega Lines To expand customer contact points, Shiseido promoted its “mega line” concept aimed at acquiring the top position in each product category. The first step was to launch Maquillage and renew Uno in August 2005. March 2006 Tsubaki Launch Tsubaki was launched to offer new value in the extremely competitive haircare category. This mega line, jointly developed by the cosmetics and toiletries business divisions, conveys the message, “Japanese women are beautiful.” April 2006 Integration of the Cosmetics and Toiletries Businesses Removing the organizational lines separating the former cosmetics and toiletries business divisions, Shiseido changed its marketing to a brand manager system organized by product category and sales channel. The sales force was regrouped by channel, as well. April 2006 Tsubaki Acquires the Top Market Share in Its Categor y Tsubaki was the focus of considerable pre-launch interest and anticipation. It won the hearts of Japanese women on its launch, thus acquiring the top market share in its category*. Tsubaki, entrusted with achieving Shiseido’s dreams, was off to a smooth start. March 2007 Second Development Stage for Tsubaki Begins Tsubaki surpassed first-year targets by 1.8 times with sell-in sales of ¥18 billion. But the true test of the line’s value is yet to come. Aiming to reveal the beauty of its customers, Shiseido will develop Tsubaki into a long-selling line. *Source: SRI Weekly survey of in-bath haircare product market share by INTAGE Inc. (April 3, 2006 - July 2, 2006) SHISEIDO ANNUAL REPORT 2007 21 Brand Management Created to acquire the number-one position in the haircare categor y, Tsubaki is a symbol of Shiseido’s mega line concept. Power marketing was conducted for Tsubaki’s launch, with the aim of establishing its position as an unmistakably Shiseido shampoo that celebrates Japanese women. Mission: To Create the Number-One Line in the Haircare Categor y On becoming President of Shiseido in 2005, Shinzo Maeda declared: “My goal is to refine our brands, which are a valuable management resource.” President Maeda envisaged the mega line concept, Chapter 1 which aims to cultivate “broad and strong” brands/lines by achieving top category position. Although Shiseido holds the leading position in the Japanese cosmetics market, it faced severe com- Lead-Up to Development petition in the haircare category. The Company had fallen into a negative cycle of excessive line segmentation and deconcentration of marketing power. To overcome these hurdles, President Maeda initiated a haircare project team and assembled top marketers from the cosmetics and toiletries divisions. Their mission was to put an end to the negative cycle and become number one in the category. Aiming to Create a Shampoo that Celebrates Women To this end, Shiseido came up with the idea of aesthetic luxury — to fully utilize Shiseido’s superiority in creating a cosmetics-like shampoo that succeeds in the haircare market. In addition, the Chapter 2 Shampoo from a Cosmetics Company Company refocused on the concept of Japanese beauty, which was much closer to home than Hollywood or Asian beauty. The aim was to create a new product that symbolized Japanese beauty through the use of camellia oil, which has been used as a skin beautifying ingredient since ancient times in Japan; the elegant scent of camellia nectar; and packaging evocative of beautiful camellia petals. This is the origin of the Tsubaki line and the message “Japanese women are beautiful,” which is imbued with Shiseido’s ardent desire to celebrate them. A Series of Promotions Produces Harmonious Marketing The promotions that convey Shiseido’s celebration of women were created in the same manner as makeup promotions. Shiseido used various actresses to depict the diversity of Japanese beauty in adver- Chapter 3 tisements that received a high evaluation in preliminary surveys. Shiseido concentrated expenditures in this Mega Line Promotions series of advertisements, one of its largest mass media promotions to date. The spark that ignited the PR campaign was the appearance of the Tsubaki actresses at the opening of Tokyo’s trendy new Omotesando Hills. This event was televised nationwide on large public screens and through TV broadcasts, and served as the kick-off for countrywide sampling campaigns. The harmonization of sales promotions, advertisements, events, sampling campaigns and sales corners helped Tsubaki to achieve rapid recognition. Lines in Former Divisions Cosmetics Toiletries ■ Ma Chérie ■ ■ Tiara ■ ■ ■ ■ Fino Suibun Hair Pack Super Mild Tessera Neué 22 SHISEIDO ANNUAL REPORT 2007 Japanese Scent of women’s hair camellia nectar Hair-beautifying ingredient High-purity Tsubaki Oil EX Revealing the Beauty of Each and Ever y Customer Sales Shiseido combined the overall capabilities of the cosmetics and toiletries sales forces to implement detailed measures tailored to each store. As a result, Tsubaki also met the needs of sales channels. Integration of the Cosmetics and Toiletries Business Divisions Prior to the integration of the cosmetics and toiletries business divisions, President Maeda established a sales task force comprising managers from both divisions and gave them the mission of making Chapter 4 Company-wide Efforts Tsubaki a symbol of the success of this business integration. In December 2005, the two divisions held their first-ever joint new product exhibition. Sales corners that display cosmetics and toiletries together were proposed. Following that, based on a carefully devised strategy, a full-year plan was presented in discussions with retailers in all channels on a Group-wide basis. This plan focused on the strength of the Tsubaki products and maintaining their allure at sales corners. Expectations among sales channels were high and response was enthusiastic. Enhancing Capabilities to Create Sales Corners In order to create the sales corners proposed for each retailer group, sales representatives and Chapter 5 Field Partners* began implementing consistent store-by-store sales activities that leveraged the combined strengths of cosmetics direct sales and toiletries wholesale channels. Each store has different Store-by-Store Sales Activities needs for in-store tools, product leaflets, original sets, samples and other materials. Shiseido Beauty Consultants, who normally provide cosmetics counseling, distributed samples throughout Japan, transcending divisional frameworks. In these ways, sales channels were inspired to conduct aggressive activities of their own, such as introducing Tsubaki at cosmetics buyer conferences. * Currently known as “Retail Supporters,” Field Partners are sales staff who create sales corners, manage inventory and handle ordering. Japanese Sales Corners Bathed in Tsubaki Red It was the end of March 2006. On the day of the launch, Tsubaki products covered many sales corners, Chapter 6 strongly dominating other brands. The Company’s intranet was filled with photographs sent from Field Partners who created sales corners until late at night. There were even stores that offered Dominant InStore Position advance ordering and devoted shelf space for a countdown promotion one week before the launch. Tsubaki’s value and sales plans had been positively evaluated. By working together with retailers toward the same goals, Shiseido was able to secure the largest display space at haircare sales corners right from the product launch. SHISEIDO ANNUAL REPORT 2007 23 Analysis Tsubaki achieved the number-one position in its category immediately following its launch. As a result of enthusiastic response from customers and sales channels, this major hit product achieved profitability with 1.8 times projected sales in its first year. Unprecedented Success of Achieving Profitability in Its First Year Tsubaki achieved the number-one market share in its category soon after being introduced. Sell-in sales Chapter 7 Reaping Results Ahead of Schedule for the first year were ¥18 billion, or 1.8 times the plan. Although the line had only five items to take on the competition, sales for each item were high and earnings were higher than planned. Tsubaki achieved profitability in its first year, despite expectations that recovering investment would take three years. President Maeda believes that this unprecedented success in the haircare market was the overall result of four achievements: creation of new value through an original concept; strong communication activities; Company-wide sales activities; and sales corner creation capabilities. Shiseido Expressed Its Resolve with Tsubaki and Sales Channels Understood Retailers have called Tsubaki products earth-shaking harbingers of change in the shampoo market and Chapter 8 superior goods that secure profitability through stable prices. The line has led retailers to renew their expectations for Shiseido. Some have commented that they felt the Shiseido Group’s organizational Expectations of Sales Channels strength. Others have noted that the period ahead will be the most important for refining Tsubaki into a truly long-selling line. Some have expressed interest in jointly exploring a sales approach that encompasses cosmetics, toiletries and even pharmaceuticals. Tsubaki represents an important first step toward creating a new framework for coexistence and co-prosperity with sales channels. Concentrating on Customer Opinion Since the launch of Tsubaki, the Shiseido Consumer Information Center has been receiving calls from Chapter 9 100 Percent CustomerOriented enthusiastic customers nearly every day. Many customers say that they now look forward to bathtime every night, and that their hair feels and smells great after washing. There are even those who say that they were moved to tears by the Tsubaki advertisements. Many customers thank Shiseido for continuing to support the beauty of Japanese women, and express their desire for these efforts to continue. These messages of gratitude are proof that customers approve of Shiseido’s dream. For Shiseido, a company that aims to implement 100 percent customer-oriented marketing, everything depends on customer evaluation. Consumer Opinions Concerning Tsubaki Sell-in Sales (Billions of yen) 20 15 Neutral 3% Plan Actual 10 Like 58% 5 0 3/06 ~6/06 3/06 ~9/06 3/06 ~12/06 Like very much 39% 3/06 ~3/07 Source: Shiseido customer survey, April 2007 24 SHISEIDO ANNUAL REPORT 2007 Revealing the Beauty of Each and Ever y Customer 2nd Stage In the year ending March 2008, Shiseido will work to establish long-selling brands/lines and to strengthen sales activities at sales corners as part of the second stage of its brand strategy renovation. By cultivating Tsubaki, Shiseido will continue to support all women. A Line That Customers Continue to Love The year ahead will be the true test of the value of Shiseido’s brand strategy. As President Maeda announced, the main theme during this phase will be cultivating long-selling brands/lines. Tsubaki Chapter 10 A Long-Selling Line must evolve endlessly so that its phenomenal success does not end with the current boom. The framework of its initiatives must also be incorporated in the corporate structure, or Shiseido will not be able to become a 100 percent customer-oriented company. To achieve its goals, Shiseido will build an integrated development framework that extends from R&D and production to sales and in-store services and rapidly reflects customer opinion in product enhancements. Shiseido intends to develop Tsubaki into a continuously successful line of shampoos that customers call their favorites. Developing Strategies for Success in the Second Stage The true challenges for Tsubaki lie ahead in its second year, so Shiseido will redouble its efforts to further leverage Group synergies. To strengthen connections with customers, advertising and sales corners will Chapter 11 communicate personal messages and provide grooming information concerning haircare. New items will be introduced, such as Hair Mask, launched in March 2007, and the Golden Repair series for treating dam- The Next Stage aged hair, scheduled for an autumn 2007 release. In sales initiatives, comprehensive sales corner proposals will be formulated to urge in-store managers in charge of haircare and cosmetics, and even store managers, to get involved. Retail Supporters will also strive to create dynamic sales corners. As the first step toward making Tsubaki into a globally accepted line, sales began in Taiwan in May 2007. Spreading the New Values of Tsubaki Women Tsubaki is imbued with Shiseido’s desire to celebrate women. It expresses Shiseido’s belief that Chapter 12 the ideal image of Japanese feminine beauty for the future will not be cherry or peach blossoms that bloom in clusters, but the camellia, which blossoms elegantly as a single flower. The tremendous suc- The Tsubaki Dream cess of the first year was the result of the creation of new values and concepts that customers identified with. Shiseido will continue to refine Tsubaki into a truly glorious line that reveals the beauty of each and every customer. Shiseido carries on its long exploration of beauty with the aim of assisting Japanese women and all people in experiencing “This Moment. This Life. Beautifully.” SHISEIDO ANNUAL REPORT 2007 25 Research and Development, Intellectual Assets ods and treatments. In doing so, we conduct research Research and Development Policy Shiseido’s R&D aims to develop superior products and offer services that assist our customers in fulfilling and development that brings together a wide range of fields to offer customers greater satisfaction. their dreams of beauty. One can argue that cosmetics are indeed integrated human scientific products, com- Research and Development Bases prising an extremely wide range of technologies. Shiseido’s R&D activities form a global network span- Shiseido combines findings from diverse research disci- ning five regions including Japan. Domestically, Research plines to provide customers with new values that inte- Center (Shin-Yokohama), Research Center (Kanazawa- grate functionality, sensitivity and safety. Hakkei) and the Beauty Solution Development Center play To alleviate customers’ concerns and fulfill their desires, in the year ended March 2007 Shiseido upgraded central roles in basic research as well as in developing product formulations and beauty methods. its system for developing solutions that combine the tan- Overseas, Shiseido conducts research surveys to gible elements of products, such as functions and formu- become thoroughly acquainted with local customers. At the lations, with intangible elements such as beauty meth- same time, we integrate each region’s unique technology into global product development. In the year ended March 2007, in addition to existing facilities in the Researching and Developing Solutions United States, Europe and China, we established an Developing formulations Physical properties, scent, color R&D base in Southeast Asia (Thailand). Furthermore, Skin and hair research Human science research Mechanisms of skin physiology Physiological psychology, cognitive science Developing agents and raw materials Discovery, synthesis, biotechnology Beautiful skin, Youthful skin Enjoyable feel, Emotional satisfaction, Joy Functionality Sensitivity Developing formulation techniques Emulsion, dispersion, etc. Customers Developing packaging and wrappings Beauty care research Beauty information development, color research, sensory evaluation, etc. Developing in-store terminal Convenience, environmental compatibility Safety Considering effects on body and environment Research centers in Europe conduct R&D that incorporates local considerations. Verifying solutions and methods Discrepancies with design targets, customer perspective For skin analysis, counseling Quality assurance Guarantee stability, safety, sterility Putting Intellectual Assets to Work Shiseido conducts operations that fully leverage the voluntary chain stores, who share Shiseido’s marketing diverse intellectual assets it has accumulated through multifaceted approach; and the Shiseido Style corporate design meme that is corporate activities since its foundation. In the process of value passed on through advertising created in house. creation, we firmly maintain a level of superiority that goes Most of all, we consider our “brand” to be a core manage- beyond world standards for our advanced R&D capabilities, as ment resource that connects the customer and Shiseido, and well as for patents, copyrights and beauty methods and theories have carefully handed it down over time. The pertaining to product use. Shiseido also utilizes various intellectual porate brand is an aggregate of intellectual assets that have assets to convey value to customers, some of which are the cus- been cultivated over 135 years of history. Shiseido will continue to tomer service skills and expertise of Beauty Consultants who nurture its corporate brand, the people that oversee the cre- embody Shiseido’s spirit of hospitality; customer information ation of its intellectual assets, and customer trust for future received via a domestic organization of loyal users called the generations in order to achieve enduring growth in corporate “Hanatsubaki Club”; a network of business partners, including value in the years to come. 26 SHISEIDO ANNUAL REPORT 2007 cor- we reorganized and reopened our European base to them, and whether shades were vivid. reinforce development of products aimed at local mar- With that in mind, we investigated new colors and suc- kets. In these ways, Shiseido is enhancing its global ceeded in developing Trans-red, a color compound of dye and R&D network in conjunction with expansion of overseas powder. This coloring material changes ultraviolet light business. and blue light into a luminous red that has never been seen before. It permits the creation of highly transparent Research and Development Initiatives and beautiful, vivid tones, thus broadening the spectrum of IFSCC Congress Award lipstick colors. As evidence of its advanced R&D capabilities, Shiseido Trans-red is used in Maquillage Sheer Climax Rouge has received numerous awards throughout its history and Maquillage Color On Climax Rouge, hit products that have from the International Federation of Societies of Cosmetic acquired top market share since their launch. Chemists (IFSCC), recognized as the highest authority in Source: SRI Weekly survey of lipstick market share by INTAGE Inc. cosmetic science. At the 24th IFSCC Congress held in (January 1, 2007 - May 20, 2007) October 2006 in Osaka, Japan, we won the Congress Award for How Can We Improve the Appearance of Conspicuous Facial Pores?, as well as an honorary mention for the presentation Identification of a Regulatory Molecule in Keratinocyte Denucleation and its Relevance to Barrier Disruption. New Technologies in the Year Ended March 2007 With Trans-red Without Trans-red R&D Data for the Year Ended March 2007 R&D Expenses ◆Jointly developed a sensor for measuring the feel of human hair with Tohoku University (April 2006) ◆Launched a joint industry-university project concerning surface-to-surface interaction between skin and materials with Keio Leading-edge Laboratory of Science and Technology (April 2006) ◆Developed a novel nano-emulsification technology for quick and easy production of oil-in-water (O/W) ultrafine emulsion; used in Ma Chérie (August 2006) ◆Discovered that citron seed extract repairs basal membrane damage and promotes the production of hyaluronic acid in the epidermis (November 2006) ¥16.1 billion Ratio of R&D Expenses to Net Sales 2.32% Number of Patents 937 257 (As of March 31, 2007) Number of Researchers (As of March 31, 2007) Japan Overseas Total patents in all countries* Japan Overseas Total 1,095 approx. 800 approx. 200 approx. 1,000 * Excluding duplicate patents filed in multiple countries. ◆Successfully developed technology for maintaining transparency in the stratum corneum (November 2006) ◆Developed Trans-red, a new color compound using dye and powder composite technology; used in Maquillage (December 2006) New Luminescent Coloring, Trans-red When exploring what people expect in lipstick, we found that how color appears on the lips is the most important factor. People were interested in whether shades suited SHISEIDO ANNUAL REPORT 2007 27 Corporate Governance, Corporate Social Responsibility Corporate Governance also serves as the Chief Operating Officer, chairs this Corporate Governance Policy Committee. The term of office of directors and corporate Shiseido is setting higher standards of corporate gover- officers is one year. nance based on the understanding that maximizing corporate and shareholder value, fulfilling social responsibilities and To obtain an outside point of view and further achieving sustainable growth and development are key to strengthen the Board of Directors’ supervisory function in maintaining support as a valuable company from stakeholders regard to business execution, Shiseido appointed two (customers, business partners, shareholders, employees independent external directors from the year ended and society). March 2007. Introducing external directors has stimulated discussion on significant management matters at Board of Directors meetings. Management and Execution Structure Composed of nine members including two external To promote transparency and objectivity in manage- directors, the Board of Directors is small and able to ment, Shiseido established two committees to play an make decisions quickly. The Board of Directors meets at advisory role to the Board of Directors: the Remuneration least once a month to discuss all significant matters. Committee, charged with setting executive remuneration, Attendance at the 17 Board of Directors meetings in and the Nomination Advisory Committee, which evaluates the year ended March 2007 was nearly 100 percent. and nominates candidates for directors and corporate officers. Both committees are chaired by external directors to Through the adoption of a corporate executive officer maintain objectivity. system, we are separating the decision-making and supervisory functions of the Board of Directors from In the year ended March 2006, the Remuneration the business execution functions of corporate officers. Committee formulated a new system that reduces the pro- The Corporate Executive Officer Committee, which portion of fixed remuneration and increases the perfor- acts as the final decision-making body regarding corpo- mance-linked portion. The committee makes decisions rate officers’ material issues, serves to transfer authority including those concerning performance-linked remunera- to corporate officers, thereby clarifying their responsi- tion payments based on the achievement of performance bilities targets and share price. and accelerating operational execution. In addition to nominating candidates for executive Shiseido’s President & Chief Executive Officer, who ■ Shiseido’s Management and Business Execution System General Meeting of Shareholders Resolution at the General Meeting of Shareholders based on laws Appointment, termination Accounting Auditors Audit Appointment, termination Appointment, termination Board of Directors, Shiseido Company, Limited Audit Board of Auditors CSR Committees under jurisdiction of the Board of Directors Compliance Committee Report Remuneration Committee Supervision Corporate Value Creation Committee Nomination Advisory Committee Corporate Executive Officer Committee Proposal of material issues based on laws Resolution, approval Proposal Resolution, approval Decision-Making Meeting of Corporate Officers 28 SHISEIDO ANNUAL REPORT 2007 Policy Meeting of Corporate Officers positions, the Nomination Advisory Committee has built which are nearly equal. The performance-linked portion and is enforcing a fair and highly transparent framework consists of a bonus based an annual consolidated performance; designed to enhance the capabilities of top management medium-term incentive stock options based on targets of and ensure that all executives deliver a consistently high the Three-Year Plan started in 2005; and long-term incen- level of results. Measures include the establishment of tive stock options, primarily aimed at fostering a shared term limits for corporate officers and the formation of awareness of profits with shareholders. These three types of rules governing promotions, demotions and retirements. remuneration have been designed to give directors and cor- The term limit of corporate officers is four years in principle porate officers a medium-to-long-term perspective, not just a and six years maximum. single-year focus, and to motivate management to become more aware of Shiseido’s performance and stock price. Audit Structure External directors receive fixed basic remuneration Shiseido’s Board of Auditors consists of two standing cor- only, as performance-linked remuneration is inconsistent porate auditors and three independent external corporate with their supervisory functions from a stance independent auditors. Corporate auditors monitor the legality and ade- from business execution. Due to the nature of auditing, quacy of directors’ performance by attending Board of corporate auditors receive fixed basic remuneration only, Directors meetings and other important meetings. to eliminate linkage with performance. Representative directors and corporate auditors meet Shiseido sets appropriate remuneration levels by making regularly to exchange opinions on actions that will resolve comparisons with companies in the same industry or of the corporate governance issues. Shiseido maintains a frame- same scale. Basic remuneration is within the monthly work to ensure that corporate auditors discharge their remuneration limits decided by the General Meeting of duties effectively. For example, at the corporate auditors’ Shareholders; performance-linked remuneration, including request, it arranges liaison meetings with the accounting bonuses and stock options, is also set by resolution at the auditors and the Internal Auditing Department in addition to General Meeting of Shareholders each year. assigning full-time employees to assist in audits. Corporate auditor attendance was nearly 100 percent for the 15 Board of Auditors meetings and 17 Board of Directors meetings held in the year ended March 2007. Internal audits of the entire Group are conducted to ensure that business is executed in an appropriate manner, and audit results are reported to the Board of Directors and Board of Auditors. Remuneration to Directors, Corporate Officers and Corporate Auditors The unfunded retirement benefit plan for directors and corporate auditors was abolished in the year ended March 2005 and the current remuneration policy for directors, corporate officers and corporate auditors was introduced in April 2005. This system consists of a basic fixed portion and a performance-linked portion that fluctuates according to attainment of performance targets and stock price, both of Remuneration to Directors and Corporate Auditors (Year ended March 2007) Directors (9 people) External directors (2 of the 9) Corporate auditors (5 people) External auditors (3 of the 5) Total Basic Bonuses Stock options (Millions of yen) Total 208 126 16 351 19 — — 19 89 — — 89 36 — — 36 297 126 16 440 Notes: 1. Basic remuneration for directors was within the limit of ¥30 million per month as per resolution of the 89th Ordinary General Meeting of Shareholders (June 29, 1989). Basic remuneration for corporate auditors was within the limit of ¥10 million per month as per resolution of the 105th Ordinary General Meeting of Shareholders (June 29, 2005). 2. The above-noted amount for directors’ bonuses was based on a resolution of the 107th Ordinary General Meeting of Shareholders held on June 26, 2007. 3. In addition to the above amounts, directors and corporate auditors received the following remuneration during the year ended March 2007. ➀ Directors’ bonuses for the year ended March 2006 A total of ¥121 million was paid to seven directors. This payment was based on a resolution of the 106th Ordinary General Meeting of Shareholders held on June 29, 2006. ➁ Deferred retirement benefits ¥316 million was paid to two retiring directors, and ¥17 million was paid to one retiring corporate auditor. These payments were based on the abolishment of the retirement benefit system and the award of retirement benefits as per resolution of the 104th Ordinary General Meeting of Shareholders on June 29, 2004. Remuneration to Accounting Auditors (Year ended March 2007) (Millions of yen) Amount Item Remuneration paid for services rendered as accounting auditors for the fiscal year under review 61 Total cash and other remuneration to be paid by the Company and its subsidiaries to their accounting auditors 92 SHISEIDO ANNUAL REPORT 2007 29 business practices. Management System Unique to Shiseido Guided by the idea that fulfilling corporate social The Compliance Committee holds regular work- responsibility (CSR) is crucial to sustainable development, shops on corporate ethics, and assigns a Code Leader to we have established two CSR committees under the juris- each office to ensure observance of The Shiseido Code. diction of the Board of Directors as part of our governance We have also established multiple reporting and consul- structure: the Compliance Committee and the Corporate tation help lines including external lawyers to detect and Value Creation Committee. Both committees are headed correct at an early stage actions that contravene the law, by the CEO and comprise members elected company- The Shiseido Code or other regulations, and to identify dis- wide. They make proposals for and report on plans and tress in employees. A cross-departmental team of specialists under the results of activities to the Board of Directors. The Compliance Committee works to ensure legiti- Compliance Committee promotes necessary preventative mate and fair business practices in the Group, and pro- measures to deal with business risks. The team creates motes activities including corporate ethics, risk manage- contingency manuals for dealing with potential emergencies. ment and environmental response. In the event of an emergency, it responds by organizing a The Corporate Value Creation Committee works to increase the value of the brand by promot- ing corporate cultural activities as well as gender equality, countermeasure headquarters, project, team, or other grouping as dictated by the seriousness of the situation. In accordance with the Corporate Law, Shiseido’s Board of Directors has adopted and disclosed a basic communication and social contribution activities. policy for internal control systems that outlines the necessary systems to ensure that directors execute their Compliance and Risk Management We have enacted Group-wide Corporate Ideals, The Shiseido Way (Corporate Behavior Declaration) and duties in conformance with laws and regulations and to ensure the propriety of business with other companies. The Shiseido Code (Corporate Ethics and Behavior Standards), which outline the standards of behavior We will work to further raise corporate value and that individual Group employees should apply in their the quality of our corporate activities through ongoing work, and are actively promoting legitimate and fair improvements to our governance structure. With our customers Through the creation of products possessing true value and exceptional quality, we strive to help our customers realize their dreams of beauty, well-being and happiness. Joining forces with partners who share our goals, we act in a spirit of sincere With our business partners cooperation and mutual assistance. Corporate Ideals With our shareholders We strive to win the support and trust of our shareholders through transparent management practices and sound business results achieved by high quality growth, enabling the retention of earnings for future investments and payment of dividends. With our employees The diversity and creativity of our employees make them our most valuable corporate asset. We strive to promote their professional development and we evaluate them fairly. We recognize the importance of our employees’ personal satisfaction and well-being, and seek to grow together with them. With our society We respect and obey all laws in regions in which we do business. Safety and preservation of the natural environment are among our highest priorities. In cooperation with local communities and in harmony with international society, we employ our cultural resources in creating a beautiful lifestyle. THE SHISEIDO WAY (Corporate Behavior Declaration) THE SHISEIDO CODE (Corporate Ethics and Behavior Standards) Company Regulations and Rules Corporate Behavior and Daily Work Activities 30 SHISEIDO ANNUAL REPORT 2007 Corporate Governance, Corporate Social Responsibility Board of Directors, Auditors and Corporate Officers (As of June 26, 2007) Directors Shinzo Maeda Seiji Nishimori Representative Director President & CEO Kimie Iwata Yasuhiko Harada Toshimitsu Kobayashi Director Representative Director Corporate Senior Executive Officer Vice President Responsible for Domestic Responsible for China Business, Professional Business, Cosmetics Business Sales Advertising Creation, Public Relations and Corporate Culture President and Representative Chief Area Managing Officer of China Chief Officer of Professional Business Operations Division Director, Shiseido Sales Co., Ltd. Masaaki Komatsu Kiyoshi Kawasaki Director Corporate Executive Officer Corporate Executive Officer Responsible for overseeing Research & Responsible for Personnel and Development, Production, Technical Affairs Consumer Information and Technical Planning Director Director Corporate Executive Officer Responsible for Finance Shoichiro Iwata Tatsuo Uemura External Director External Director Director Corporate Officer General Manager of Corporate Planning Department Corporate Auditors Kiyoharu Ikoma Kazuko Ohya Akio Harada Eiko Ohya Nobuo Otsuka Corporate Auditor Corporate Auditor External Corporate Auditor External Corporate Auditor External Corporate Auditor New appointment New appointment Corporate Officers Corporate Executive Officers Carsten Fischer Kohei Mori Responsible for International Business Chief Officer of International Business Division Responsible for Information System Planning and Logistics Corporate Officers Kozo Hanada Kazutoshi Satake Takemasa Yamanaka General Manager of Sales Department, Structured Retail Stores President and Representative Director, FT Shiseido Co., Ltd. Vice President and Director, Shiseido Sales Co., Ltd. Responsible for Domestic Non-Shiseido Brand Business and Boutique Business Responsible for Healthcare Business and Frontier Science Business General Manager of Healthcare Business Division President and Representative Director, Shiseido Beauty Foods Co., Ltd. Toshihide Ikeda Responsible for Technical Planning Tamio Inaba Responsible for Business Strategy and Marketing of Domestic Cosmetics Business Kiyoshi Nakamura Responsible for Technical Affairs Tatsuomi Takamori Chief Officer of China Business Division Mitsuo Takashige General Manager of Personnel Department Kazuo Tokubo Responsible for Basic Research, R&D Strategy, Patent and Global R&D Takafumi Uchida Yutaka Yamanouchi President and Representative Director, Shiseido Amenity Goods Co., Ltd. Toshio Yoneyama Responsible for Product Development and Software Development General Manager of General Affairs Department SHISEIDO ANNUAL REPORT 2007 31 Corporate Governance, Corporate Social Responsibility Corporate Social Responsibility (CSR) Shiseido’s unique CSR defines three areas: cosmetics, women and cultural capital. Initiatives in our core cosmetics domain include development of leading edge cosmetics business partnerships, the protection of personal information, and work environment safety/sanitation. For further information regarding Shiseido’s CSR techniques and products/beauty methods for increasing activities, please see the CSR Report 2007 on our website. quality of life, and activities to meet the beauty needs of http://www.shiseido.co.jp/e/csr/ each individual, whether young or old. For women, who make up 90 percent of our customers, we work energetically Creation of new markets Proposal of new values to help them lead beautiful, happy and healthy lives. We also conduct social activities to widely distribute the cultural Shiseido’s Unique CSR Social contribution activities (Corporate philanthropy) capital we have cultivated since Shiseido’s foundation 135 years ago. In the area of fundamental CSR, the most basic respon- Environmental protection, information disclosure, personal information protection, human rights advocacy Legal compliance sibilities of a company, Shiseido is addressing subjects that raise the quality of corporate activities. In addition to corporate ethics, these include product safety and reliability, environmental response, respect for employee diversity, Provision of high quality products and services Emphasis on employees Business partnerships Profit and dividends Payment of taxes, provision of employment opportunities Corporate viability Fundamental CSR ■ Principal CSR Activities in the Year Ended March 2007 Cosmetics ◆ Opened the Social Beauty Care Center to provide therapeutic makeup products and practical training to address troubling facial features (bruises, external injuries) ◆ Held nationwide beauty seminars for the disabled and elderly (110,000 participants) ◆ Provided makeup and beauty information for young people on website Women ◆ Contributed funds through the Shiseido Social Contribution Club (Hanatsubaki Fund) to selected support groups that work to improve the daily lives of women ◆ Conducted beauty assistance activities for the All-China Women’s Federation Cultural Capital ◆ Held the “shiseido art egg” exhibition, supporting up-and-coming artists at the Shiseido Gallery Fundamental CSR ◆ Deployed Kangaroo Staff to stores nationwide to take over work in busy evening hours for Beauty Consultants with young children ◆ Expanded operations at the Hanatsubaki Factory, a special subsidiary primarily for the developmentally disabled ■ Principal Environmental Initiatives up to the Present Environmental ◆ ISO 14001 certification acquired for 15 domestic and overseas cosmetics factories management system Reduction of CO2 emissions Recycling of resources ◆ Introduced cogeneration system at Kuki factory ◆ Reduced fixed energy consumption through elimination and consolidation of domestic factories ◆ Emissions in the year ended March 2007 improved by 3 percentage points on a production volume unit index from the previous year due to boiler energy source conversion at Osaka and Kakegawa factories ◆ Zero emissions (zero waste) achieved at the head office, all domestic factories and research centers 32 SHISEIDO ANNUAL REPORT 2007 ■ CO2 Emissions t-CO2 Index CO2 emissions(t-CO2) Index 45,000 40,000 160 140 35,000 30,000 120 100 85 25,000 100 (Target) 80 20,000 60 15,000 10,000 40 5,000 20 0 91 01 02 03 04 05 06 07 11 0 Notes: 1. Six domestic factories: Kamakura, Kakegawa, Osaka, Kuki, Itabashi and Maizuru (Itabashi and Maizuru factories closed in the year ended March 2006.) 2. Index: 1991 emissions = 100 Global Network (As of March 31, 2007) Business Area Manufacturing/ Sales and Other Region Manufacturing Japan The Company Japan: 35 Overseas: 62 (Americas: 14, Europe: 26, Asia/Oceania: 22) Kamakura Factory Kakegawa Factory Osaka Factory Kuki Factory Shiseido Honeycake Industries Co., Ltd.** Domestic Cosmetics Sales and Other Consolidated Subsidiaries and Equity-method Affiliates Shiseido Co., Ltd. Japan Shiseido Co., Ltd. Japan Kamakura Factory Kakegawa Factory Osaka Factory Kuki Factory Total 2 (5) Shiseido Sales Co., Ltd. FT Shiseido Co., Ltd. Shiseido FITIT Co., Ltd. Shiseido International Inc. d'ici là Co., Ltd. IPSA Co., Ltd. AYURA Laboratories Inc. Ettusais Co., Ltd. Amenity Goods Co., Ltd. Shiseido Professional Co., Ltd. Shiseido Beauty Salon Co., Ltd. Shiseido Pharmaceutical Co., Ltd. Shiseido Beauty Foods Co., Ltd. Shiseido Logistics Co., Ltd. Shiseido Information Network Co., Ltd. Hanatsubaki Factory Co., Ltd. KINARI Inc. Fullcast Co., Ltd. Shiseido Beautech Co., Ltd. Beauty Technology Co., Ltd. ETWAS Co., Ltd. Orbit, Inc. AXE Co., Ltd. Pierre Fabre Japon Co., Ltd.** 25 1 (4) Americas Shiseido America, Inc. Davlyn Industries, Inc. Zotos International, Inc.* Europe Shiseido International France S.A.S. (Gien and Val de Loire: 2 factories) Laboratoires Decléor S.A.* Asia/Oceania Shiseido Liyuan Cosmetics Co., Ltd.* Shanghai Zotos Citic Cosmetics Co., Ltd. Taiwan Shiseido Co., Ltd.* (Chung-Li and Shin-Tsu: 2 factories) Shiseido (N.Z.) Ltd.* Shanghi Huani Transparent Beauty Soap Co., Ltd.** Beauté Prestige International Co., Ltd. (Japan) InterAct Co., Ltd. Tai Shi Trading Co., Ltd. 4 Americas Shiseido International Corporation Shiseido Cosmetics (America) Ltd. Shiseido of Hawaii, Inc. Shiseido Travel Retail America Inc. Shiseido (Canada) Inc. Shiseido do Brasil Ltda. Beauté Prestige International, Inc. (Miami) Nars Cosmetics, Inc. Zirh International Corporation Decléor U.S.A., Inc. Piidea Canada, Ltd. 11 Europe Shiseido International Europe S.A. Shiseido Europe S.A.S. Shiseido Deutschland GmbH Shiseido Cosmetici (Italia) S.p.A. Shiseido France S.A. Shiseido España S.A. Shiseido United Kingdom Co., Ltd. Beauté Prestige International S.A. Beauté Prestige International GmbH (Germany) Beauté Prestige International S.A.U. (Spain) Beauté Prestige International S.p.A. (Italy) Beauté Prestige International SPRL (Belgium) Beauté Prestige International GmbH (Austria) Beauté Prestige International B.V. (Netherlands) Noms de Code S.A.S. Decléor UK Ltd. Carita S.A Carita International S.A. Carita UK Ltd. Les Salons du Palais Royal Shiseido S.A. FIPAL S.A. Joico Holding B.V. Joico Laboratories Europe B.V. Salle des Fêtes S.A.S.** 24 Asia/Oceania Shiseido China Co., Ltd. Shiseido China Research Centor Co., Ltd. Shiseido Dah Chong Hong Cosmetics Ltd. Shiseido Dah Chong Hong Cosmetics (Guangzhou) Ltd. Shiseido Dah Chong Hong Cosmetics (Guandong) Ltd. FLELIS International Inc. Shiseido Korea Co., Ltd. Shiseido Thailand Co., Ltd. SAHA Asia-Pacific Co., Ltd. Shiseido Singapore Co., (Pte.) Ltd. Shiseido Malaysia Sdn. Bhd. Shiseido (Australia) Pty., Ltd. Shiseido Travel Retail Asia Pacific Pte. Ltd. Beauté Prestige International Pte. Ltd. (Singapore) Tai Tsu Holding Limited** Shiseido Professional (Thailand) Co., Ltd. PT. Prana Dewata Ubud 3 (3) Manufacturing Japan Overseas Cosmetics Sales and Other Shiseido Co., Ltd. Manufacturing Japan Others Total Sales and Other Japan 2 (3) The Ginza Co., Ltd. Shiseido Parlour Co., Ltd. 17 1 (1) Shiseido Irica Technology Inc.* Shiseido Co., Ltd. 5 (6) Shiseido Kaihatsu Co., Ltd. Shiseido Astech Co., Ltd. Shiseido Lease Co., Ltd. Selan Anonymous Association 7 13 (18) Manufacturing 1(4) Japan: 2 (2), Americas: 3 (3), Europe: 2 (3), Asia/Oceania: 5 (6) Sales and Other — Japan: 33, Americas: 11, Europe: 24, Asia/Oceania: 17 85 Total 1 Japan: 35, Americas: 14, Europe: 26, Asia/Oceania: 22 98 Japan Research and Development Facilities Americas Europe Asia/Oceania Shiseido Asia Techno-Center Research Center (within Shiseido Co., Ltd.) (Shin-Yokohama) Shiseido Professional Co., Ltd. Research Center (Kanazawa-Hakkei) Beauty Solution Development Center (3 facilities) America Product Development Center (within Shiseido America, Inc.) 5 (2 facilities) Zotos International, Inc. Shiseido America Techno-Center (within Zotos International, Inc.) 3 (3 facilities) Laboratoires Decléor S.A. Shiseido Europe Research Center (within Shiseido International Europe S.A.) Shiseido International France S.A.S. (within Val de Loire Factory) (3 facilities) Shiseido China Research Center Co., Ltd. Shiseido Southeast Asia Research Center (2 facilities) Note: Numbers in parentheses refer to the number of factories ** Manufacturing and Sales ** Affiliates 3 2 SHISEIDO ANNUAL REPORT 2007 33 Six-Year Summar y of Selected Financial Data Shiseido Company, Limited, and Subsidiaries For the years ended March 31, 2002 to 2007 Thousands of dollars (Note 1) Millions of yen (Except per share data) Operating Results: Net sales ··························· Cost of sales (Note 2) ·········· Selling, general and administrative expenses (Note 2) ················ Operating income (Note 2) ··· EBITDA (Note 3) ················· Net income (loss) ················ Financial Position (At year-end): Total assets ······················· Short-term liabilities (Note 4) ····· Long-term debt··················· Interest-bearing debt ··········· Net assets ························· (Except per share data) 2002 2003 2004 2005 2006 ¥589,962 157,140 ¥621,250 170,702 ¥624,248 166,299 ¥639,828 168,636 ¥670,957 176,884 409,608 23,214 412 (22,768) 403,459 47,089 66,827 24,496 420,471 37,478 82,341 27,541 444,663 26,529 29,043 (8,856) 455,194 38,879 58,963 14,436 ¥664,041 25,685 72,485 98,170 357,948 ¥663,403 55,117 44,291 99,408 364,728 ¥626,730 47,678 18,480 66,158 385,336 ¥701,095 25,213 69,114 94,327 369,957 ¥671,842 12,786 69,492 82,278 387,613 2007 2007 ¥694,594 $5,881,904 185,533 1,571,116 459,056 50,005 78,036 25,293 3,887,340 423,448 600,818 214,184 ¥739,833 $6,264,993 66,144 560,115 61,694 522,432 127,838 1,082,547 403,797 3,419,400 Per Share Data (In yen and U.S. dollars): Net income (loss) (Note 5) ···· Net assets (Note 5) ·············· Cash dividends ··················· Weighted average number of shares outstanding during the period (in thousands) ····· ¥ (54.6) 818.0 16.0 ¥ 58.0 844.7 20.0 ¥ 64.9 903.7 22.0 ¥ (21.5) 866.5 24.0 ¥ 34.4 906.1 30.0 ¥ 60.9 940.8 32.0 416,708 419,580 414,723 414,219 412,855 412,573 Financial Ratios: Operating profitability (%) (Note 2) Return on assets (%) ··········· Operating ROA (%) (Notes 2 and 6) ··· Return on equity (%) ············ Equity ratio (%) ··················· Interest coverage ratio (times) (Note 7) Debt-equity ratio (times) ······· Payout ratio (Consolidated)(%) ····· Total return ratio (%) (Note 8) ···· 3.9 (3.4) 3.7 (6.4) 52.1 18.7 0.28 — — 7.6 3.7 7.3 7.0 53.3 30.0 0.28 34.5 53.2 6.0 4.3 6.0 7.6 59.8 18.2 0.18 33.9 51.2 4.1 (1.3) 4.3 (2.4) 51.2 22.1 0.26 — — 5.8 2.1 5.9 3.9 55.7 8.6 0.22 87.2 105.1 7.2 3.6 7.4 6.6 52.5 30.6 0.32 52.6 52.6 Number of employees at year-end ····· Net sales per employee ········ 25,021 ¥23.6 25,202 ¥24.7 24,839 ¥25.1 24,184 ¥26.5 25,781 ¥26.0 27,460 ¥25.3 $0.52 7.97 0.27 $0.21 Notes: 1. U.S. dollar amounts are converted from yen, for convenience only, at the rate of ¥118.09 = US$1 prevailing on March 31, 2007. 2. Cost of sales, selling, general and administrative expenses, operating income, operating profitability and operating ROA for years up to March 31, 2005 have been retrospectively restated to reflect changes in accounting policies for the year ended March 31, 2006. 3. EBITDA (Earnings before interest, tax, depreciation and amortization) = Income (loss) before income taxes + Interest expense + Depreciation 4. Short-term liabilities = Short-term debt + Current portion of long-term debt 5. Net income (loss) per share (primary) is based on the average number of shares outstanding during the fiscal year. Net assets per share is calculated using the number of shares outstanding as of the balance sheet date. 6. Operating ROA = (Income from operations + Interest and dividend income) / Total assets (Yearly average) 7. Interest coverage ratio = Net cash provided by operating activities/Interest paid* *As stated in the consolidated statements of cash flows 8. Total return ratio = (Cash dividends + Share buybacks*) ÷ Consolidated net income *Excluding odd-lot purchases 34 SHISEIDO ANNUAL REPORT 2007 Management’s Discussion and Analysis Operating Results Overview for allocating operating expenses and segment presentation. (Please refer to Notes to the Consolidated Financial State- During the fiscal year ended March 31, 2007, in Shiseido's ments, “2. Summary of Significant Accounting Policies,” on operating environment, overall corporate earnings of the page 51, for additional details regarding the changes in Japanese economy were steady. However, household con- accounting policies.) sumption did not reflect strong corporate performance, which impeded full-scale economic recovery. The trend toward maturi- Net Sales ty in the cosmetics industry was evident in indicators such as the Net sales increased 3.5 percent on a yen basis to ¥694,594 lack of year-on-year growth in the value of cosmetics ship- million. While domestic sales decreased slightly year-on-year, ments.* Overseas, the U.S. economy continued to expand overseas sales (export sales and sales by overseas sub- despite the risk of a slowdown, and moderate economic recovery sidiaries) increased substantially, centered on China. continued in Europe. Asian economies sustained high growth Net Sales/Overseas Sales Ratio rates, driven by continued strong investment in China. (%) (Billions of yen) 800 * Source: Cosmetics Shipment Statistics, Fiscal 2006 (Calendar Year), Ministry of Economy, Trade and Industry 60 600 45 400 30 200 15 Amid these conditions, Shiseido completed the second year of its Three-Year Plan aimed at expanding growth and raising profitability through continued implementation of the three key strategies of “reforming domestic marketing activities,” “accelerating expansion of our China business” and year under review, net sales increased 3.5 percent compared to the previous fiscal year to ¥694,594 million, and operating income increased 28.6 percent to ¥50,005 million. The operating profitability ratio was 7.2 percent. Despite other expenses including impairment loss and restructuring expenses, net 0 0 “fundamental structural reforms.” As a result, for the fiscal 2003 Net Sales Overseas Sales Ratio 2004 2005 2006 2007 621.3 624.2 639.8 671.0 694.6 24.8 26.0 27.5 29.4 32.4 Domestic Sales 467.1 461.8 464.1 473.7 469.8 Overseas Sales 154.2 162.4 175.7 197.3 224.8 income increased 75.2 percent to ¥25,293 million. Changes in Accounting Policies Cost of Sales and Selling, General and Administrative Expenses Shiseido formerly classified its operations into the three Cost of sales increased 4.9 percent compared to the previous segments of Cosmetics, Toiletries and Others. Beginning with the fiscal year to ¥185,533 million, and the ratio of cost of sales to period under review, we reclassified business segment presen- net sales increased 0.3 percentage points to 26.7 percent. tation to reflect the integration of cosmetics with peripheral Changes to the presentation of rebates in Europe added 0.3 per- businesses and other internal organizational changes, and to centage points and changes to the method of calculating clarify overseas cosmetics business results. The new seg- reserve for sales returns added 0.2 percentage points to this ments are Domestic Cosmetics, Overseas Cosmetics and ratio. Excluding these factors, the ratio of cost of sales to net Others. sales would have improved by 0.2 percentage points com- During the period under review, Shiseido applied Practical pared to the previous fiscal year. Shiseido’s cost structure Solution on Application of Control Criteria and Influence Criteria to has improved for several reasons. Consolidation of domestic pro- Investment Associations, and included Selan Anonymous duction facilities completed in March 2006 has resulted in Association in the scope of consolidation. This change had the steady gains in factory capacity utilization rates and reduced effect of increasing operating income by ¥1,376 million, expenses for subcontractor fees. Moreover, higher overseas decreasing net income by ¥337 million and increasing total sales have enhanced productivity through increased production, assets by ¥26,434 million compared with the previous calculation and we have also implemented ongoing cost reduction pro- method. We also revised several other accounting policies during grams for new and existing products. the period under review, such as the method for allocating Selling, general and administrative (SG&A) expenses operating expenses including a portion of administrative increased 0.8 percent compared to the previous fiscal year to expenses and long-term basic research spending, as well as ¥459,056 million. The ratio of SG&A expenses to net sales the accounting standard for director and corporate auditor decreased 1.7 percentage points to 66.1 percent. bonuses, and the accounting standard for stock options. The ratio of advertising and promotional expenses to net Data for prior years have been retrospectively restated to sales decreased 1.5 percentage points to 23.6 percent. The reflect changes in accounting policies, such as the method improvement was the result of more efficient marketing SHISEIDO ANNUAL REPORT 2007 35 spending due to the concentration on key brands/lines in Other Income (Expenses) Japan and reduction of expenses including a cutback in Net other expenses totaled ¥2,239 million, compared to advertising in the healthcare division. Shiseido intends to net other expenses of ¥9,341 million for the previous fiscal year. maintain a constant ratio of advertising and promotional Net interest expenses, calculated as interest expense less expenses to net sales in coming years. interest and dividend income, decreased to ¥219 million from The ratio of personnel expenses to net sales increased 0.6 ¥572 million for the previous fiscal year. Net gain on sales of percentage points compared to the previous fiscal year to property, plant and equipment decreased ¥1,073 million, 21.6 percent, reflecting the impact of performance-linked while gain on investments in business limited partnership bonuses in Japan and additions to personnel in China due to decreased ¥1,436 million compared to the previous fiscal business expansion. year due to the inclusion of investment associations in the The ratio of other expenses to net sales decreased 0.8 percentage points to 20.9 percent. Primary factors included lower expenses at domestic administrative divisions and reduced rental payments due to the inclusion of investment associations in the scope of consolidation. scope of consolidation. Equity in earnings of affiliates decreased 5.2 percent compared to the previous fiscal year to ¥58 million. Shiseido recorded impairment loss on fixed assets totaling ¥4,598 million, improving from a loss of ¥12,404 million in the previous fiscal year. Factors included impairment of logistics facil- Cost of Sales Ratio/ SG&A Expenses Ratio ities and idle assets in Japan, as well as impairment of goodwill (%) (%) 30 70 29 69 28 68 27 67 26 66 25 65 24 64 23 63 2003 2004 2005 2006 27.5 26.6 26.4 26.4 26.7 SG&A Expenses Ratio (Right scale) 64.9 67.4 69.5 67.8 66.1 seas brand. Shiseido undertook fundamental structural reforms for improved profitability, with ongoing efforts to thoroughly scale back brands/lines and business areas that do not contribute sufficiently to earnings through downsizing, withdrawal and other means. As a result, Shiseido incurred restructuring expenses totaling ¥1,102 million, which included those for logistics outsourcing and those related to withdrawal from 2007 Cost of Sales Ratio (Left scale) resulting from the reduced profitability of an acquired over- underperforming brands/lines. Income before Income Taxes Income before income taxes increased 61.7 percent com- Operating Income pared to the previous fiscal year to ¥47,766 million. Operating income increased 28.6 percent compared to the previous fiscal year to ¥50,005 million. Marginal gains Income Taxes through growth in net sales, efficient marketing spending and Income taxes, net of deferrals, increased 56.6 percent com- reduced administrative expenses compensated for the pared to the previous fiscal year to ¥19,175 million as a result of increase in personnel expenses. Operating profitability the increase in income before income taxes. The effective tax increased 1.4 percentage points to 7.2 percent. rate was 40.1 percent, a decrease of 1.4 percentage points from 41.5 percent in the previous fiscal year. Operating Income/Operating Profitability (%) (Billions of yen) 60 8 45 6 Minority Interests in Net Income of Consolidated Subsidiaries Minority interests in net income of consolidated subsidiaries increased 15.5 percent compared to the previous fiscal 30 4 15 2 year to ¥3,298 million, due to improved performance of joint ventures in Asia, primarily in China and Taiwan. 0 0 Operating Income Operating Profitability Net Income 2007 Net income increased 75.2 percent compared to the previous 47.1 37.5 26.5 38.9 50.0 fiscal year to ¥25,293 million. Net income per share increased to 2003 7.6 2004 6.0 2005 4.1 2006 5.8 7.2 ¥60.9 from ¥34.4 for the previous fiscal year. Improved profitability supported an increase of 2.7 percentage points in return on equity to 6.6 percent from 3.9 percent for the previous fiscal year. 36 SHISEIDO ANNUAL REPORT 2007 Management’s Discussion and Analysis [Healthcare Division] Net Income (Loss)/Return on Equity (%) (Billions of yen) 30 9 The healthcare division supplies supplements and medicaluse drugs. We launched the Detoxing & Retuning line of food for 20 6 enhanced metabolic activity, and sales of Collagen EX, a food for enhanced skin regeneration, exceeded forecasts. However, 10 3 0 0 division sales decreased 35.5 percent compared to the previous fiscal year because of the significant impact of a shrinking market (10) (3) 2007 Operating income of the domestic cosmetics segment 24.5 27.5 (8.9) 14.4 25.3 increased 7.6 percent compared to the previous fiscal year to 2003 Net Income (Loss) Return on Equity for the Q10 series of foods with health claims (FHC) for anti-aging. 7.0 2004 2005 7.6 (2.4) 2006 3.9 6.6 ¥36,870 million. Greater efficiency in allocating marketing expenses resulting from Shiseido's focus on key brands/lines and reduction of administrative expenses compensated for Review by Business Segment lower margins caused by reduced sales and higher personnel expenses. Results by business segment follow below. Domestic Cosmetics Sales in the domestic cosmetics segment decreased 1.3 percent compared to the previous fiscal year to ¥447,557 million. Despite an overall year-on-year market decline, sales of the cosmetics division increased 0.5 percent compared to the previous fiscal year. However, segment sales were strongly impacted by the 35.5 percent year-on-year decrease in sales of the healthcare division caused by contraction of the market for coenzyme Q10. [Cosmetics Division] Sales in the cosmetics division increased 0.5 percent compared to the previous fiscal year. In counseling-based cosmetics, Shiseido launched the Elixir Overseas Cosmetics Sales in the overseas cosmetics segment increased 7.0 percent compared to the previous fiscal year on a local currency basis and, supported by the depreciation of the yen, 14.3 percent on a yen basis, to ¥224,320 million. Sales increased in both the cosmetics and professional divisions. [Cosmetics Division] Division sales increased 7.6 percent on a local currency basis, with steady sales growth in each of the regions in which Shiseido operates, led by the key market, China. Sales of core Performance, Benefiance and White Lucent skincare lines to increase the number of loyal customers. Brands other than Superieur skincare line as a mega line and executed innovations for the high-end prestige brand Clé de Peau BEAUTÉ and the exclusive voluntary chain store line Bénéfique. However, sales in this category decreased, particularly for skincare products, because of unseasonable weather. Sales increased in the self-selection category due to the solid performance of the new makeup mega line Integrate and the Majolica Majorca line of makeup for women in their teens and early twenties. In toiletries, Tsubaki made a substantial contribution to growth in sales. [Professional Division] The professional division serves hair and beauty salons. Sales in this division decreased 4.6 percent compared to the previous fiscal year. Sales of System Qurl, which uses special equipment to retain curls in perming, were strong due to growth the number of hair salons employing it. Moreover, in the growing market of the esthetic spa field, Shiseido increased transactions with large hotels and hot spring inns with salon facilities. However, the impact of intense competition in the markets for core haircare and hair color products inhibited sales growth. brands increased steadily as Shiseido concentrated on expanding sales of the Bio- generated solid sales growth, including the highend prestige brand Clé de Peau BEAUTÉ, the international fragrance brands of Beauté Prestige International S.A. such as ISSEY MIYAKE, Jean Paul GAULTIER and Narciso Rodriguez, and the U.S. makeup brand NARS. Shiseido executed a channel-based brand strategy in China, including Hong Kong. Strong growth continued in this region, as sales increased 31.3 percent compared to the previous fiscal year on a local currency basis. Behind the increase were strong sales of the exclusive Chinese brand AUPRES and the brand in the department store channel, and the smooth launch of the new prestige SUPREME AUPRES line in Beijing and Shanghai in November 2006. Moreover, in the voluntary chain store channel, the number of stores that handle Shiseido products expanded, and the URARA brand launched in October 2006 was a major hit. In addition, Shiseido worked to expand in growing fields by aggressively developing its travel retail business, centered on airport duty-free shops. [Professional Division] The professional division serves beauty salons. Sales of SHISEIDO ANNUAL REPORT 2007 37 the renewed haircare line from JOICO of Zotos International, Inc. increased, and sales of the CARITA and DECLÉOR brands for Review by Geographic Segment Results by geographic segment (by location) follow below. esthetic beauty and spa treatments were firm. Division sales increased 3.5 percent on a local currency basis as a result. Japan Sales in Japan decreased 0.9 percent compared to the previ- Operating income of the overseas cosmetics segment increased 268.4 percent to ¥10,445 million, as sales growth compensated for strategic marketing outlays in certain regions including China. ous fiscal year to ¥471,205 million due to a decline in sales of the core domestic cosmetics business. Operating income in Japan increased 13.8 percent compared to the previous fiscal year to ¥27,335 million, due to more effective allocation of marketing outlays and reduced Others administrative expenses. Sales in other businesses increased 6.8 percent compared to the previous fiscal year to ¥22,717 million. Americas [Frontier Science Division] Sales in the Americas increased 6.4 percent compared to the The frontier science division, which handles items such as previous fiscal year on a local currency basis. Depreciation of the medical-use drugs and cosmetic dermatology treatments, yen versus the U.S. dollar contributed to a 12.4 percent year-on- increased sales of bio-hyaluronic acid, a raw material used in cos- year increase in sales on a yen-denominated basis to ¥51,730 metics, pharmaceuticals and foods. million. In the cosmetics division, Shiseido generated strong Operating income from other businesses increased 128.8 percent compared to the previous fiscal year to ¥2,245 million due to factors such as the inclusion of investment associations in the scope of consolidation. growth for its major brands in the United States. Sales of major brands were also solid in Canada and Brazil. In the professional division, sales of Zotos International, Inc. were strong. Operating income in the Americas increased 202.0 percent Net Sales by Business Segment compared to the previous fiscal year to ¥2,809 million, with high- (Billions of yen) 750 er marginal gains as a result of increased sales and lower administrative expenses. 500 Europe Sales in Europe decreased 3.2 percent compared to the 250 previous fiscal year on a local currency basis due to changes in the method for recording rebates. However, the depreciation of the yen versus the euro contributed to a 3.3 percent year-on-year 0 2003 2007 increase in sales on a yen-denominated basis to ¥88,364 million. Domestic Cosmetics 448.5 444.3 445.3 453.4 447.6 Absent the effect of the accounting change, sales would have Overseas Cosmetics 152.7 161.1 174.5 196.3 224.3 increased 4.5 percent year-on-year on a local currency basis Others Total 2004 2005 2006 20.1 18.8 20.0 21.3 22.7 621.3 624.2 639.8 671.0 694.6 and 11.5 percent on a yen-denominated basis. In the cosmetics division, sales were solid in Italy, Germany and France. Sales increased significantly in Spain Operating Income by Business Segment (Billions of yen) 2003 2004 and in the travel retail business, both growth markets. 2005 2006 2007 Domestic Cosmetics 49.1 38.9 25.5 34.3 36.9 Overseas Cosmetics (2.2) (1.2) Others (0.6) (0.9) (0.1) 0.7 2.8 10.4 1.0 2.2 In the professional division, sales of the CARITA and DECLÉOR brands were solid. Operating income in Europe increased 17.4 percent compared to the previous fiscal year to ¥6,311 million supported by higher earnings at Beauté Prestige International S.A. Operating Profitability by Business Segment (%) 2003 2004 2005 2006 2007 Domestic Cosmetics 10.6 8.7 5.7 7.5 8.1 Overseas Cosmetics (1.5) (0.8) 0.4 1.4 4.6 Others (1.6) (2.4) (0.2) 2.4 4.9 Note: Operating profitability is calculated against sales for the segment, including intersegment sales. Asia/Oceania Sales in Asia/Oceania increased 21.4 percent on a local currency basis. Depreciation of the yen versus major currencies contributed to a 30.7 percent year-on-year increase in sales on a yen-denominated basis to ¥83,295 million. In the cosmetics division, the high rate of growth in China continued. Sales were also solid in countries other than China, 38 SHISEIDO ANNUAL REPORT 2007 Management’s Discussion and Analysis Liquidity and Capital Resources particularly in Taiwan and Thailand. Operating income in Asia/Oceania increased 46.2 percent Financing and Liquidity Management compared to the previous fiscal year to ¥11,212 million, as Shiseido seeks to generate stable operating cash flow and higher marginal gains resulting from sales growth compen- ensure a wide range of funding methods, with the aims of sated for an increase in strategic marketing expenditures and securing sufficient capital for operating activities and main- higher personnel expenses in China. taining sufficient liquidity and a sound financial position. We fund working capital, capital expenditures, and investments and Net Sales by Geographic Segment (Billions of yen) 2003 loans needed for sustainable growth by supplementing cash on 2004 2005 2006 2007 469.2 465.3 467.0 475.7 471.2 Japan Americas 45.4 43.5 43.1 46.0 51.7 Europe 65.8 72.4 79.8 85.6 88.4 Asia/Oceania 40.9 43.0 49.9 63.7 83.3 Outside Japan 152.1 158.9 172.8 195.3 223.4 2003 2004 2005 2006 2007 37.6 26.2 12.5 24.0 27.3 1.6 (0.4) (0.2) 0.9 2.8 Japan Americas Europe 1.6 issues. As of March 31, 2007, Shiseido maintained a sufficient level of liquidity. The use of diverse funding methods provided a high level of financial flexibility. One of our targets for shortterm liquidity is to maintain cash on hand at a level of approximately 1.5 months of consolidated net sales to provide for Operating Income by Geographic Segment (Billions of yen) hand and operating cash flow with bank borrowings and bond 3.0 5.0 5.4 6.3 6.5 7.7 11.2 Asia/Oceania 4.1 5.3 Outside Japan 7.3 7.9 11.3 14.0 20.3 extraordinary capital demands. Shiseido procured ¥20 billion in March 2007 through an issue of 1.12 percent unsecured yen bonds in preparation for the redemption of ¥50 billion in 0.40 percent unsecured yen bonds due in May 2007. Consequently, as of March 31, 2007, cash and time deposits together with short-term investments in securities totaled ¥150,997 million, but after reducing this figure by the amount of the pending bond redemption, it represented an appropriate Operating Profitability by Geographic Segment level of 1.7 months of consolidated net sales. (%) 2003 2005 2006 2007 Japan Americas 7.7 5.4 2.6 2.9 (0.8) (0.3) 4.8 1.7 5.5 4.7 Europe 2.4 6.0 6.8 Asia/Oceania 2004 4.0 6.1 10.0 12.2 12.9 12.0 13.4 4.4 Outside Japan 4.6 6.2 6.7 8.6 Note: Operating profitability is calculated against sales for the segment, including intersegment sales. As of March 31, 2007, interest-bearing debt totaled ¥127,838 million. Shiseido has diversified funding methods. These include an unused shelf registration in Japan for ¥50.0 billion of straight bonds. Shiseido Co., Ltd. and financial subsidiaries in the United States and Europe have established a syndicated loan program with unused commitments totaling $280 million. A financial subsidiary in the United States has also established an unused commercial paper program totaling $100 million. Overseas Sales (by Destination) (Billions of yen) 250 Credit Ratings Shiseido recognizes that it needs to maintain a certain level of 200 credit rating to secure financial flexibility that suits its 150 capital/liquidity policies and to secure access to sufficient capital resources through capital markets. Shiseido has 100 acquired ratings from Moody’s Investors Service Inc. 50 (Moody’s) and Standard and Poor’s (S&P) to facilitate fund 0 2003 2004 2005 2006 2007 Americas 46.7 45.8 44.3 47.6 54.0 Europe 61.7 68.1 74.9 80.4 79.3 Asia/Oceania 45.8 48.5 56.5 69.3 91.5 Total 154.2 162.4 175.7 197.3 224.8 procurement in global capital markets. In June 2006, S&P raised its outlook for Shiseido’s longterm credit rating from “Stable” to “Positive.” This was based on its projection that Shiseido will enhance its ability to generate cash flow by increasing profitability as a result of the strong performance of mainstay lines in the domestic cosmetics business, which has made progress in divesting unprofitable businesses and streamlining brands/lines, and expected further growth in earnings of the overseas cosmetics business driven by continued expansion in China. SHISEIDO ANNUAL REPORT 2007 39 The following table presents Shiseido's long- and short- long-term debt pending redemption in May 2007. As of March 31, 2007, interest-bearing debt including term credit ratings as of March 31, 2007. short- and long-term debt increased 55.4 percent from a year Long-term Moody’s S&P earlier to ¥127,838 million. Primary factors in the increase A1 (Outlook: Stable) A (Outlook: Positive) were the inclusion of investment associations within the A-1 scope of consolidation and the March 2007 issue of unse- Short-term P-1 cured yen bonds. As of March 31, 2007, bonds on Shiseido’s Assets, Liabilities and Net Assets balance sheet consisted of 0.40 percent unsecured yen As of March 31, 2007, total assets increased 10.1 percent bonds due in May 2007 and 1.12 percent unsecured yen bonds due in March 2010 issued by Shiseido Co., Ltd., and from a year earlier to ¥739,833 million. Current assets increased 24.2 percent from a year earlier to ¥373,208 million, primarily because Shiseido added a total of ¥60,541 million to cash and time deposits and short-term investments in securities in preparation for the redemption of medium-term notes issued by finance subsidiaries in the United States and Europe. Total net assets increased 4.2 percent from a year earlier to ¥403,797 million. Net income and foreign currency translation adjustments ¥50 billion in unsecured yen bonds due in May 2007. Investments and other assets decreased 9.9 percent from a increased net assets by ¥25,293 million and ¥8,315 million, year earlier to ¥145,247 million, mainly due to sale of invest- respectively. The payment of cash dividends from retained ments in securities and a decrease in valuation gains as a earnings reduced net assets by ¥12,787 million, and unrealized result of lower market prices. gains on available-for-sale securities, net of taxes, decreased Property, plant and equipment, net of accumulated depreci- ¥4,535 million from a year earlier. As a result, net assets per ation, increased 7.1 percent from a year earlier to ¥171,636 mil- share increased ¥34.7 from a year earlier to ¥940.8. The equity lion. While acquisition of fixed assets was about the same ratio decreased 3.2 percentage points to 52.5 percent from level as depreciation expense, the inclusion of investment 55.7 percent a year earlier. associations in the scope of consolidation added ¥20,117 million Net Assets/ Interest-bearing Debt to buildings and structures. (Billions of yen) 400 Total Assets/Operating ROA (Billions of yen) 800 (%) 8 600 6 400 4 200 2 300 200 100 0 2003 Net Assets 0 0 2003 Total Assets Operating ROA 2004 2005 2006 2007 2004 2005 2006 2007 364.7 385.3 370.0 387.6 403.8 Interest-bearing Debt 99.4 66.2 94.3 82.3 127.8 663.4 626.7 701.1 671.8 739.8 7.3 6.0 4.3 5.9 7.4 Equity Ratio/ Debt-Equity Ratio Total liabilities as of March 31, 2007 increased 18.2 percent (%) 100 (Times) 1.00 75 0.75 50 0.50 25 0.25 from a year earlier to ¥336,036 million. Current liabilities increased 36.2 percent from a year earlier to ¥227,841 million due to factors including the increase in the current portion of longterm debt pending the redemption of ¥50 billion in 0.40 percent unsecured yen bonds due in May 2007. Long-term liabilities 0 decreased 7.5 percent from a year earlier to ¥108,195 million. 0 2003 2004 2005 2006 2007 Long-term debt increased as a result of the inclusion of Equity Ratio 53.3 59.8 51.2 55.7 52.5 investment associations within the scope of consolidation Debt-Equity Ratio 0.28 0.18 0.26 0.22 0.32 (¥27,100 million) and a March 2007 issue of ¥20 billion in 1.12 percent unsecured bonds. However, ¥50 billion in unsecured yen bonds shifted from long-term debt to the current portion of 40 SHISEIDO ANNUAL REPORT 2007 Management’s Discussion and Analysis Cash Flows Cash Flows from Financing Activities Cash and cash equivalents (net cash) as of March 31, 2007 Net cash provided by financing activities totaled ¥1,837 totaled ¥145,260 million, an increase of ¥56,245 million from a million. In the previous fiscal year, financing activities used year earlier. net cash totaling ¥29,959 million. Capital procurement exceeded shareholder returns. In Cash Flow Summary (Billions of yen) 2005 2006 2007 terms of capital procurement, factors included a net increase in short-term debt of ¥854 million, compared to a net repayment of ¥10,049 million for the previous fiscal year. In addition, Cash flows from operating activities 52.4 21.8 69.4 net proceeds from long-term debt totaled ¥14,950 million, Cash flows from investing activities (24.9) (12.6) (18.5) compared to a net repayment of ¥4,278 million for the previous Cash flows from financing activities 17.4 (30.0) 1.8 Cash and cash equivalents at end of year 108.3 89.1 145.3 fiscal year. In terms of shareholder returns, factors included payment of cash dividends totaling ¥12,794 million, compared to ¥11,560 million for the previous fiscal year. In addition, proceeds from sale of treasury stock provided cash totaling ¥298 million, while in the previous fiscal year acquisition of treasury stock Cash Flows from Operating Activities used cash totaling ¥2,731 million. For the fiscal year under review, net cash provided by operating activities increased ¥47,619 million from the previous Research and Development In the fiscal year under review, Shiseido’s R&D expenses fiscal year to ¥69,431 million. Primary factors included an increase of ¥18,228 million in totaled ¥16,133 million, or 2.3 percent of net sales. R&D income before income taxes to ¥47,766 million and the expenses include basic research costs and other expenses absence of payment for additional retirement benefits totaling totaling ¥3,105 million that cannot be allocated to specific ¥43,770 million in the previous fiscal year. businesses. Main R&D initiatives and results by business segment were as follows. Cash Flows from Operating Activities/Acquisition of Fixed Assets (Property, Plant and Equipment + Intangible Assets + Long-term Prepaid Expenses) (Billions of yen) 80 Domestic Cosmetics With the goal of contributing to beautiful skin and beautiful lifestyles, Shiseido conducts research in basic dermatology 60 and functional foods and develops cosmetic ingredients, 40 products, beauty methods and beauty theories. 20 the stratum corneum culminated in a new theory of stratum In the cosmetics division, Shiseido’s research results on corneum formation, which it applied to the new skin care line 0 2003 2004 2005 2006 2007 Cash Flows from Operating Activities 66.8 47.1 52.4 21.8 69.4 Acquisition of Fixed Assets 27.3 33.7 30.0 27.5 28.6 Elixir Superieur. Shiseido also developed an original microcoating production process that achieves extremely fine powder dispersion for a smooth, uniform coating of ingredients on each particle. Used to produce foundation for the Maquillage makeup line, this process offers superior application properties and a fine, smooth finish. In addition, Shiseido developed Cash Flows from Investing Activities Net cash used in investing activities increased ¥5,843 million from the previous fiscal year to ¥18,483 million. Primary factors Haku Melanofocus 2, which contains 4MSK, an original active ingredient for skin-brightening used in quasi-drugs that was the subject of over 10 years of research. included a net increase in time deposits totaling ¥2,851 million. In the healthcare division, ongoing research on internal and Acquisition of fixed assets, calculated as the sum of acquisition external beauty identified concern among women about bodily of property, plant and equipment, intangible assets and long- impurities and a strong demand for products that work internally term prepaid expenses, totaled ¥28,558 million, which was to remove them. Shiseido applied this knowledge to create about the same level as depreciation. Capital expenditures Detoxing & Retuning, a new concept in supplements. included upgrade and renovation of existing domestic facilities, as well as expansion of overseas production capacity R&D expenses for the fiscal year under review in the domestic cosmetics business totaled ¥11,177 million. centered on the growing Chinese market. SHISEIDO ANNUAL REPORT 2007 41 Outlook for the Year Ending March 31, 2008 Overseas Cosmetics Aiming for “high quality, high image and high service” in The market environment in which Shiseido operates will overseas cosmetics brands, Shiseido develops products that remain challenging, both domestically and overseas. None- fully capitalize on high- quality, high-performance ingredients. theless, we will continue implementing the Three-Year Plan In the year under review, Shiseido developed a product for aimed at enhancing growth potential and raising profitability in treating stratification of the stratum corneum caused by epi- order to establish a strong competitive edge. dermal regeneration disorders, and employed it in the The year ending March 31, 2008 is the final period of advanced global skincare line Bio-Performance. In addition, Shiseido's current three-year business plan. During the year, we Shiseido employed a new powder technology for the global will continue promoting domestic marketing reforms, further makeup line The Makeup to create a highly transparent, easy-to- strengthening global development, and continuing with fun- apply liquid foundation with excellent UV scattering properties. damental structural reforms. We expect these strategies to In China, local consumer awareness and behavior studies pri- help boost overall sales and operating income, while also marily conducted by Shiseido China Research Co., Ltd. identified lowering the cost of sales. strong demand among women for moisturizing and skin- For the fiscal year, Shiseido forecasts a 4 percent increase in brightening cosmetics. Based on these findings, Shiseido consolidated net sales to ¥720 billion, a 16 percent increase in launched the exclusive Chinese brand URARA with the operating income to ¥58 billion, and a 30 percent increase in theme of “bright, clear skin that is rich in moisture.” net income to ¥33 billion. On April 2, 2007, Shiseido transferred its R&D expenses for the fiscal year under review in the overseas cosmetics business totaled ¥1,623 million. logistics-related facilities and shares in Shiseido Logistics Company, Ltd., a consolidated subsidiary, to Hitachi Transport System, Ltd. and other entities. This is expected to generate an Others extraordinary gain of ¥2.3 billion. Shiseido conducts R&D at Research Center (Kanazawa- The above outlook is based on the assumption that domestic Hakkei) in Yokohama for the frontier science division, which han- real GDP will grow approximately 2 percent in the fiscal year. dles medical-use drugs and materials, chromatography, and Based on Ministry of Economy, Trade and Industry statistics for cosmetic dermatology treatments. In this division, Shiseido cosmetics shipments, we estimate that demand for cosmetics develops high-performance liquid chromatography columns products will increase slightly. Our forecasts are based on employing technology used in makeup powder development, as exchange rates of ¥115 per U.S. dollar, ¥150 per euro and well as a variety of instruments for analysis and purification of ¥15 per Chinese yuan. chemicals. R&D expenses for the fiscal year under review in other businesses totaled ¥228 million. Income Distribution Policy The shareholder return policy of Shiseido Co., Ltd. aims to maximize returns to shareholders through direct means, in addition to R&D Expenses/Ratio of R&D Expenses to Net Sales generating medium- and long-term share price gains. To this (Billions of yen) 20 (%) 4 end, in allocating internal capital resources, we prioritize (a) strategic investments linked to renewed growth, and (b) stable 15 3 dividends and flexible implementation of share buybacks. 10 2 sents the amount of profits returned to shareholders - the 5 1 We have established a “total return ratio,” which represum of dividends paid and share buybacks - as a proportion of 0 0 2003 R&D Expenses 2004 2005 2006 2007 17.3 17.6 16.8 16.5 16.1 Ratio of R&D Expenses to Net Sales 2.8 2.8 2.6 2.5 2.3 consolidated net income. We hope to achieve a 60 percent total return ratio in the medium term while increasing the percentage of dividends. For the fiscal year ended March 31, 2007, Shiseido Co., Ltd. increased cash dividends per share by ¥2 to ¥32, consisting of an interim cash dividend of ¥16 per share and a year-end cash dividend of ¥16 per share. The dividend payout ratio, therefore, was 52.6 percent on a consolidated basis. Since no treasury stock was acquired (excluding odd-lot purchases), the total return ratio was also 52.6 percent. For the year ending March 31, 2008, Shiseido plans to increase the interim and the year-end dividend by ¥1 to ¥17 each, which will increase annual cash dividends to ¥34 per share. 42 SHISEIDO ANNUAL REPORT 2007 Management’s Discussion and Analysis Business and Other Risks tioned as a pillar of its growth strategy, the competitive envi- The various risks that could potentially affect the business per- ronment is becoming increasingly challenging as well-capitalized formance and financial position of Shiseido are summarized U.S. and European corporations are aggressively conducting below. We feel that these risks could have a major impact on mergers and acquisitions and expanding market share by investors’ decisions. Items that deal with future events are executing marketing activities to raise consumer awareness of based on our judgment as of June 26, 2007, the date of issue their brands. Inability to respond to this competitive environment for this annual report. Please note that the potential risks are not as effectively as global competitors could potentially affect limited to those listed below. Shiseido's business performance and financial position. 1. Decrease in Value of the Brand Corporate 5. Overseas Business Activities Shiseido’s business is conducted in 67 countries overseas, corporate brand is shared by all Group and overseas sales account for a growing percentage of con- companies in Shiseido’s domestic and overseas business solidated net sales each year, totaling 32.4 percent in the fiscal activities. We will continue working to enhance the value of this year under review. The trend of overseas business expansion is brand, but a decline in the brand’s value from an unforeseen expected to continue in the future. In the course of conducting event could potentially affect Shiseido’s business perform- overseas business, Shiseido’s business performance and ance and financial position. financial position could potentially be affected by various factors. The These include the occurrence of sudden and unpredictable 2. Customer Services economic, political and social crises; terrorism, war and civil war; Shiseido places high priority on its relationships with cus- economic and civil upheaval resulting from the spread of con- tomers. Chapter 1 of The Shiseido Code (Corporate Ethics tagious diseases such as avian influenza; and severe or and Behavior Standards) clearly states that we shall act in a man- abnormal weather. ner that earns the satisfaction and trust of customers, and we will continue working to ensure that all employees are 6. Foreign Exchange Fluctuations aware of these standards. However, an unforeseen event Export, import and other transactions denominated in foreign could cause loss of such satisfaction and trust, leading to a currencies expose Shiseido to foreign exchange rate risk. decline in the value of Shiseido Group brands. Shiseido’s Although we hedge foreign exchange rate risk through business performance and financial position could potentially be means such as limiting export and import transactions by affected as a result. establishing production bases to serve local markets, we are unable to completely eliminate risk. Moreover, the financial 3. Strategic Investment Activities statements of consolidated subsidiaries and equity affiliates When making decisions about investments in strategic domiciled overseas are denominated in local currencies that are markets such as China and strategic investments in mergers and translated into yen upon inclusion in the consolidated financial acquisitions, new businesses and new markets, Shiseido statements. This has the potential to exert a negative impact on endeavors to collect ample information and undertake due operating performance if the yen appreciates versus foreign cur- diligence prior to making rational judgments. Due to various rencies when revenues exceed expenses. Foreign exchange unforeseeable factors that may cause the operating environment fluctuations that exceed assumptions could potentially affect to deteriorate, however, we may not achieve the results origi- Shiseido’s business performance and financial position. nally anticipated. This could potentially affect Shiseido's business performance and financial position. 7. Responding Appropriately to Market Needs Shiseido’s ability to develop and cultivate products and 4. The Competitive Environment of the Cosmetics Industry brands/lines and to conduct marketing activities that respond Shiseido operates in the cosmetics industry, in which com- sales and earnings. To respond to market needs, we continuously petition is intensifying on a global scale. The competitive develop appealing new products and brands/lines; reinforce and environment of the mature domestic market is becoming cultivate new and existing products and brands/lines through increasingly challenging because of factors including the creation marketing activities; and withdraw existing products and of influential domestic corporate groups through mergers and brands/lines that no longer meet market needs. However, by acquisitions, the expanding influence of global U.S. and nature these activities entail uncertainties that may prevent European corporations in the field of prestige cosmetics, and the Shiseido from achieving its intended results, which could negatively entry of new competitors from other industries. In addition, in affect Shiseido’s business performance and financial position. appropriately to market needs exerts a significant impact on its overseas markets such as China, which Shiseido has posi- SHISEIDO ANNUAL REPORT 2007 43 8. Specific Business Partners Significant changes are taking place in retail and wholesale Fundamental Policy on Control of the Company distribution channels in Shiseido’s core domestic cosmetics Shiseido’s fundamental policy on control of the Company business. Failure to respond effectively to these changes was resolved by the Board of Directors at its meeting on could negatively affect Shiseido’s business performance and April 27, 2006, the date the Board resolved to introduce financial position. Countermeasures to Large Acquisitions of Shiseido Co., Ltd. Shares (Take-over Defense). The policy was approved as 9. Regulatory Risk Resolutions 3 and 7 at the 106th Ordinary General Meeting of Shiseido is subject to a host of domestic and overseas Shareholders. (For details, please refer to the business report of legal provisions in the course of conducting its business. the 107th Ordinary General Meeting of Shareholders on the These include the Pharmaceuticals Law, as well as quality- investor relations section of the Shiseido website.) related standards, environmental standards, accounting standards and tax regulations. We aspire to be completely ethical based on legal compliance and corporate social responsibility. ● (1) Secure the required information and time for shareholders to adequately consider whether they should accept or reject a tender offer, and for Shiseido's Board of Directors to make an alternative proposal to shareholders. However, future regulatory changes or the establishment of unanticipated new regulations may limit Shiseido’s activities, which could negatively affect Shiseido’s business performance and financial position. (2) Enable the Board of Directors to conduct activities such as negotiations on behalf of the shareholders in the event of an unreasonable tender offer. 10. Material Litigation As of June 26, 2007, the date of issue of this annual ● The precautionary rights plan will be implemented through Resolution 3 (Amendment of the Articles of Incorporation that allows gratis allotment of stock acquisition rights as a General Shareholder Meeting resolution or an entrustment to the Board of Directors, in addition to a Board of Directors resolution) and Resolution 7 (Entrustment of gratis allotment of stock acquisition rights for takeover defense to the Board of Directors) of the 106th Ordinary General Meeting of Shareholders. ● In the event of a large-volume tender offer, an independent committee consisting of two highly independent external directors and one external auditor will be formed to consult with outside specialists and advise the Board of Directors in order to preclude an arbitrary decision on the part of the Board. ● The Board of Directors will follow the advice of the independent committee and resolve whether or not to invoke the gratis allotment of stock acquisition rights. ● The term of entrustment to the Board of Directors will be until the Ordinary General Meeting of Shareholders for the fiscal year ending March 31, 2008, the final fiscal year of the current threeyear management plan. Shareholders will then decide whether or not to continue the countermeasure based on the level of achievement of the objectives of the current three-year plan and the content of the subsequent plan. report, Shiseido is not involved in material litigation. In the future, unfavorable judgments resulting from material litigation could negatively affect Shiseido's business performance and financial position. 11. Information Security Risk Shiseido takes various measures aimed at protecting its information assets, which include customers’ personal infor- Objectives: mation and industrial secrets. For example, in April 2005, the Personal Information Protection Law was fully enacted. In anticipation of this, Shiseido Co., Ltd. in March 2004 obtained Privacy Mark certification, a Japanese Industrial Standard that recognizes the appropriateness of a company’s systems for protecting personal information. However, due to unforeseeable events, such as leakage of information due to unauthorized access, Shiseido's business performance and financial position could potentially be affected. 12. Natural Disasters and Accidents Shiseido has developed a business continuation plan covering issues critical to the continued operation of production bases, distribution bases, information systems and the head office to minimize loss due to interruption of production, distribution or sales resulting from the occurrence of a natural disaster or accident, such as a major earthquake. However, a natural disaster or accident that exceeds the assumptions of this plan and disrupts production, distribution or sales could negatively affect Shiseido’s business performance and financial position. 44 SHISEIDO ANNUAL REPORT 2007 Management’s Discussion and Analysis Significant Accounting Estimates Shiseido prepares its consolidated financial statements in accordance with accounting principles generally accepted in Japan. In preparing these statements, we select and apply accounting policies and necessarily make estimates that affect the presentation of reported amounts for assets, liabilities, income and expenses. We consider information including historical data in making rational estimates. However, unpredictable changes in the assumptions underlying these estimates may cause actual results to vary, which could affect Shiseido’s business performance and financial position. Shiseido considers the following significant accounting policies to exert a large effect on key decisions regarding the estimates used in the consolidated financial statements. Property, Plant and Equipment Shiseido reviews fixed assets, primarily property, plant and equipment, for impairment whenever circumstances indicate that their carrying value may not be recoverable. Businessuse assets are pooled by business division to estimate future cash flow, and the net sale value of idle assets is estimated for Deferred Tax Assets Shiseido has established an allowance primarily for deferred tax assets deemed unrecoverable using appropriate deferred tax asset accounting. Historical data and future projections are used to evaluate the recoverability of deferred tax assets to sufficiently determine taxable status. Retirement Benefits and Obligations Shiseido’s domestic retirement benefit plan consists primarily of a corporate pension plan and a termination allowance plan. Employee benefits and obligations are calculated based on assumptions including discount rate, turnover rate, mortality rate and projected rate of return on pension plan assets. These assumptions are revised annually. Discount rate and expected return on plan assets are two critical assumptions in determining benefits and obligations. The discount rate is determined with reference to the market rate for long-term fixed-rate bonds that carry little or no risk. Expected return on pension plan assets is determined based on an expected weighted-average return for the various types of assets held within the plan. each separate property. Based on these estimates, assets are devalued from book value to recoverable value. Goodwill and Intangible Assets with Indefinite Useful Lives In general, goodwill and intangible assets determined to have indefinite useful lives at overseas consolidated subsidiaries are not amortized, but instead are tested for impairment at least once annually. Certain oversees subsidiaries employ the opinions of experts and other data in estimating fair value and determining impairment. The discounted cash flow method primarily used to estimate fair value relies extensively on estimates and assumptions regarding future cash flow and discount rate. Investments in Securities Shiseido recognizes impairment for securities primarily reported in available-for-sale securities for which fair value or market price has fallen substantially below acquisition cost. Securities deemed recoverable are excluded. Securities with a fair value that is more than 50 percent below acquisition cost as of the balance sheet date are deemed unrecoverable. The recoverability of securities with a fair value from 30 to 50 percent below acquisition cost is evaluated according to the performance and financial condition of the issuing entity. Impairment is recognized for securities for which fair value is not available if current net asset value per share according to the financial condition of the issuing entity is more than 50 percent below net asset value per share at the time of acquisition. Securities deemed recoverable are excluded. SHISEIDO ANNUAL REPORT 2007 45 Consolidated Financial Statements CONSOLIDATED BALANCE SHEETS Shiseido Company, Limited, and Subsidiaries March 31, 2006 and 2007 Thousands of U.S. dollars (Note 1. (1)) Millions of yen 2006 2007 2007 Cash and time deposits (Notes 3 and 6) ······························· Short-term investments in securities (Notes 3 and 4) ············· ¥ 53,511 36,945 ¥ 82,453 68,544 Notes and accounts receivable: Trade ·········································································· Unconsolidated subsidiaries and affiliates ························· ........................................................................................... 105,050 24 105,074 106,454 31 106,485 901,465 263 901,728 Less: allowance for doubtful accounts ····························· ........................................................................................... (1,649) 103,425 (1,304) 105,181 (11,043) 890,685 Inventories (Note 5)·························································· Deferred tax assets (Note 8) ·············································· Other current assets ························································ 72,344 25,778 8,602 73,891 32,344 10,795 625,718 273,893 91,413 Total current assets ··················································· 300,605 373,208 3,160,369 87,774 62,173 526,488 1,316 30,637 9,494 17,708 14,317 1,428 32,630 10,241 11,837 26,938 12,093 276,315 86,722 100,237 228,114 161,246 145,247 1,229,969 Buildings and structures (Note 6) ········································ Machinery and equipment ················································· ........................................................................................... 167,705 180,206 347,911 186,342 174,853 361,195 1,577,966 1,480,676 3,058,642 Less: accumulated depreciation ········································· ........................................................................................... (246,988) 100,923 (244,498) 116,697 (2,070,438) 988,204 Land ·············································································· Construction in progress ··················································· 57,176 2,097 52,370 2,569 443,475 21,755 Total property, plant and equipment ····························· 160,196 171,636 1,453,434 Intangible Assets (Note 16): Goodwill ········································································· Other intangible assets ····················································· 23,742 26,053 23,103 26,639 195,639 225,582 Total intangible assets···················································· 49,795 49,742 421,221 Total Assets ············································································ ¥ 671,842 ¥ 739,833 $ 6,264,993 ASSETS Current Assets: Investments and Other Assets (Note 16): Investments in securities (Notes 4 and 6) ···························· Investments in and advances to unconsolidated subsidiaries and affiliates ······················ Prepaid pension expenses (Note 7) ····································· Long-term prepaid expenses ············································· Deferred tax assets (Note 8) ·············································· Other investments (Note 6) ··············································· Total investments and other assets ······························ $ 698,222 580,438 Property, Plant and Equipment, at Cost (Note 16): The accompanying notes are an integral part of the financial statements. 46 SHISEIDO ANNUAL REPORT 2007 Thousands of U.S. dollars (Note 1. (1)) Millions of yen 2006 LIABILITIES AND NET ASSETS Current Liabilities: Short-term debt (Note 6) ··················································· Current portion of long-term debt (Note 6) ··························· Notes and accounts payable: Trade ·········································································· Unconsolidated subsidiaries and affiliates ························· Other·········································································· ........................................................................................... Accrued income taxes ······················································ Reserve for sales returns ·················································· Accrued bonuses for employees ········································ Accrued bonuses for directors and corporate auditors ············ Provision for liabilities and charges······································ Deferred tax liabilities (Note 8) ··········································· Other current liabilities ······················································ Total current liabilities ················································ Long-Term Liabilities: Long-term debt (Note 6)···················································· Accrued retirement benefits (Note 7) ·································· Accrued retirement benefits for directors and corporate auditors ····················································· Allowance for loss on guarantees ······································· Deferred tax liabilities (Note 8) ··········································· Other long-term liabilities ·················································· Total long-term liabilities ············································· Total Liabilities ························································ ¥ 3,323 9,463 2007 ¥ 4,456 61,688 2007 $ 37,734 522,381 60,492 1,284 50,230 112,006 56,525 1,207 52,982 110,714 478,660 10,221 448,658 937,539 8,950 4,767 12,465 — 1,261 127 14,935 167,297 10,026 8,686 11,703 122 1,377 — 19,069 227,841 84,901 73,554 99,102 1,033 11,661 — 161,480 1,929,385 69,492 36,204 61,694 38,643 522,432 327,233 285 350 2,020 8,581 116,932 284,229 72 350 4,145 3,291 108,195 336,036 610 2,964 35,100 27,869 916,208 2,845,593 64,507 64,507 546,253 70,258 244,768 (17,159) 70,294 255,410 (16,896) 595,258 2,162,842 (143,078) 362,374 373,315 3,161,275 18,279 — (6,754) 11,525 — 13,714 387,613 ¥671,842 13,744 (233) 1,561 15,072 52 15,358 403,797 ¥739,833 116,386 (1,973) 13,219 127,632 440 130,053 3,419,400 $6,264,993 CONTINGENT LIABILITIES (Note 9) NET ASSETS (Note 10) Shareholders’ Equity: Common stock····························································· Authorized: 784,561,000 shares as of March 31, 2006 and 1,200,000,000 shares as of March 31, 2007 Issued: 424,562,353 shares as of March 31, 2006 and 2007 Capital surplus ····························································· Retained earnings ························································· Less: treasury stock, at cost ··········································· Treasury stock: 12,105,939 shares as of March 31, 2006 and 11,730,235 shares as of March 31, 2007 Total shareholders’ equity ················································· Valuation, Translation Adjustments and Others: Unrealized gains on available-for-sale securities, net of taxes ··· Deferred losses on hedges ············································ Foreign currency translation adjustments·························· Total valuation, translation adjustments and others ················ Stock Acquisition Rights ················································· Minority Interests in Consolidated Subsidiaries ················ Total Net Assets ······················································ Total Liabilities and Net Assets ·············································· SHISEIDO ANNUAL REPORT 2007 47 CONSOLIDATED STATEMENTS OF OPERATIONS Shiseido Company, Limited, and Subsidiaries For the years ended March 31, 2005, 2006 and 2007 Thousands of U.S. dollars (Note 1. (1)) Millions of yen 2005 2006 2007 2007 Net Sales (Note 17) ··················································· ¥639,828 ¥670,957 ¥694,594 $5,881,904 Cost of Sales ························································ Gross profit ···················································· 168,636 471,192 176,884 494,073 185,533 509,061 1,571,116 4,310,788 Selling, General and Administrative Expenses (Note 12) ······· Operating Income (Note 17) ······························ 444,663 26,529 455,194 38,879 459,056 50,005 3,887,340 423,448 Other Income (Expenses): Interest and dividend income ································ Gain on investments in business limited partnerships ··· Interest expense ················································· Equity in earnings of affiliates ······························· Gain on sale of securities (Note 4)····························· Write-down of investments in securities and other investments ···················· Gain on sales of property, plant and equipment ········ Loss on disposal of property, plant and equipment ······· Impairment loss (Note 16) ···································· Restructuring expenses ······································· Additional retirement benefits (Note 7) ··················· Gain on changes in retirement benefit plans (Note 7) ··· Others, net ························································ ............................................................................ Income (loss) before income taxes ····················· 1,892 1,802 (2,371) 22 552 1,880 1,826 (2,452) 61 519 2,176 390 (2,395) 58 143 18,427 3,303 (20,281) 491 1,211 (226) 2,928 (1,516) — (2,664) (30,987) 2,567 736 (27,265) (736) — 3,408 (1,601) (12,404) (2,703) — — 2,125 (9,341) 29,538 — 1,987 (1,253) (4,598) (1,102) — — 2,355 (2,239) 47,766 — 16,826 (10,611) (38,936) (9,332) — — 19,942 (18,960) 404,488 Income Taxes (Note 8) Current ····························································· Deferred ···························································· ............................................................................ ............................................................................ 6,126 (374) 5,752 (6,488) 12,274 (27) 12,247 17,291 13,660 5,515 19,175 28,591 115,674 46,702 162,376 242,112 Minority Interests in Net Income of Consolidated Subsidiaries ··························· (2,368) (2,855) (3,298) (27,928) Net income (loss) ······································· ¥ (8,856) ¥ 14,436 ¥ 25,293 Yen U.S. dollars (Note1. (1)) Per Share Net income (loss) — basic ···································· — fully diluted* ························· Cash dividends ··················································· ¥(21.5) — 24.0 ¥34.4 34.4 30.0 ¥60.9 60.7 32.0 Weighted Average Number of Shares (thousands) ···· 414,219 412,855 412,572 * Diluted net income per share in 2005 is not disclosed due to the net loss. The accompanying notes are an integral part of the financial statements. 48 SHISEIDO ANNUAL REPORT 2007 $ 214,184 $0.52 0.51 0.27 Consolidated Financial Statements CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS Shiseido Company, Limited, and Subsidiaries For the years ended March 31, 2005, 2006 and 2007 Thousands Number of shares of common stock Balance as of March 31, 2004 ·········· Net loss for the year ended March 31, 2005 ···· Cash dividends from retained earnings as appropriation of earnings ················· Directors’ and corporate auditors’ bonuses as appropriation of earnings ···· Other increase ······························· Other decrease ······························· Disposal (purchase) of treasury stock ··· Change in unrealized gains on availablefor-sale securities, net of taxes ········ Change in foreign currency translation adjustments ················ Increase in minority interests ··········· Balance as of March 31, 2005 ·········· Net income for the year ended March 31, 2006 ···· Cash dividends from retained earnings as appropriation of earnings ················· Directors’ and corporate auditors’ bonuses as appropriation of earnings ··· Other decrease ······························· Disposal (purchase) of treasury stock ··· Change in unrealized gains on availablefor-sale securities, net of taxes ········ Change in foreign currency translation adjustments ·············· Increase in minority interests ··········· Balance as of March 31, 2006 ·········· Net income for the year ended March 31, 2007··· Cash dividends from retained earnings as appropriation of earnings ················· Directors’ and corporate auditors’ bonuses as appropriation of earnings ···· Cash dividends from retained earnings ··· Other decrease ······························· Disposal (purchase) of treasury stock ··· Change in scope of consolidation······ Change in unrealized gains on availablefor-sale securities, net of taxes ········ Change in fair market value of derivatives ································ Change in foreign currency translation adjustments ·············· Issuance of stock acquisition rights ···· Increase in minority interests ··········· Balance as of March 31, 2007 ·········· Millions of yen Common stock Capital surplus Retained earnings Deferred losses on hedges Foreign currency translation adjustments Stock acquisition rights Minority interests in consolidated subsidiaries 424,562 — ¥64,507 — ¥70,258 — ¥260,493 (8,856) ¥(14,476) — ¥ 7,208 — — — ¥(13,440) — — — ¥10,786 — — — — (9,113) — — — — — — — — — — — — — — — — — — (144) 21 (54) (5) — — — 42 — — — — — — — — — — — — — — — — — — — — — — — — 795 — — — — — — 424,562 — — — 64,507 — — — 70,258 — — — 242,342 14,436 — — (14,434) — — — 8,003 — — — — — 1,768 — (11,672) — — — — — — 167 10,953 — — — — (11,571) — — — — — — — — — — — — — — — (15) (417) (7) — — (2,725) — — — — — — — — — — — — — — — — — — — — 10,276 — — — — — — 424,562 — — — 64,507 — — — 70,258 — — — 244,768 25,293 — — (17,159) — — — 18,279 — — — — — 4,918 — (6,754) — — — — — — 2,761 13,714 — — — — (6,186) — — — — — — — — — — — — — — — — — — — 36 — (133) (6,601) (174) — (1,557) — — — 263 — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — (4,535) — — — — — — — — — — (233) — — — — — — 424,562 — — — ¥64,507 — — — ¥70,294 — — — ¥255,410 — — — ¥(16,896) — — — ¥13,744 — 8,315 — — — — ¥(233) ¥ 1,561 — 52 — ¥52 — — 1,644 ¥15,358 Thousands Number of shares of common stock Balance as of March 31, 2006 ·········· Net income for the year ended March 31, 2007··· Cash dividends from retained earnings as appropriation of earnings ················· Directors’ and corporate auditors’ bonuses as appropriation of earnings ···· Cash dividends from retained earnings ··· Other decrease ······························· Disposal (purchase) of treasury stock ··· Change in scope of consolidation ········· Change in unrealized gains on availablefor-sale securities, net of taxes ········ Change in fair market value of derivatives ································ Change in foreign currency translation adjustments ·············· Issuance of stock acquisition rights ···· Increase in minority interests ··········· Balance as of March 31, 2007 ·········· Unrealized gains Treasury stock, (losses) on availablefor-sale securities, at cost net of taxes Thousands of U.S. dollars (Note 1.(1)) Common stock Capital surplus Retained earnings Unrealized gains Treasury stock, (losses) on availableat cost for-sale securities, net of taxes 424,562 — $546,253 — $594,953 $2,072,724 $(145,304) $154,789 — 214,184 — — — — — (52,384) — — — — — — — — — — — — — — 305 — (1,126) (55,898) (1,473) — (13,185) — — — — — — — — — 424,562 — — — $546,253 Deferred losses on hedges Foreign currency translation adjustments Stock acquisition rights Minority interests in consolidated subsidiaries — — $(57,194) — — — $116,132 — — — — — — — — — 2,226 — — — — — — — — — — — — — — — — — — — — — — — — — — — — (38,403) — — — — — — — (1,973) — — — — 70,413 — — — — $(1,973) $ 13,219 — 440 — $440 — — 13,921 $130,053 — — — — — — — — — — — — $595,258 $2,162,842 $(143,078) $116,386 The accompanying notes are an integral part of the financial statements. SHISEIDO ANNUAL REPORT 2007 49 Consolidated Financial Statements CONSOLIDATED STATEMENTS OF CASH FLOWS Shiseido Company, Limited, and Subsidiaries For the years ended March 31, 2005, 2006 and 2007 Thousands of U.S. dollars (Note 1.(1)) Millions of yen 2005 Cash Flows from Operating Activities: Income (loss) before income taxes ········································· Depreciation ······································································· Amortization of goodwill ······················································· Impairment loss ·································································· Increase (decrease) in liabilities for additional retirement benefits ···· Restructuring expenses························································ (Increase) decrease in prepaid pension expenses ····················· Increase (decrease) in allowance for doubtful accounts·············· Increase (decrease) in reserve for sales returns ························ Increase in accrued bonuses for directors and corporate auditors ···· Decrease in provision for liabilities and charges ························ Increase (decrease) in accrued retirement benefits ··················· Decrease in accrued retirement benefits to directors and corporate auditors ··· Interest and dividend income ················································ Interest expense ································································· Equity in earnings of affiliates ················································ Gain on sale of securities ······················································ Write-down of investments in securities and other investments ···· Gain on sale of property, plant and equipment, net ··················· Decrease in notes and accounts receivable ····························· (Increase) decrease in inventories ·········································· Increase (decrease) in notes and accounts payable ··················· Payment for prior portion of defined contribution pension ·········· Other ················································································ Subtotal ········································································· Interest and dividends received ············································· Interest paid ······································································· Income tax paid ·································································· Net cash provided by operating activities ····························· Cash Flows from Investing Activities: Transfers to time deposits ···················································· Proceeds from maturity of time deposits································· Acquisition of short-term investments in securities ··················· Proceeds from sales of short-term investments in securities ······ Acquisition of investments in securities ·································· Proceeds from sale of investments in securities ······················· Acquisition of property, plant and equipment ··························· Proceeds from sale of property, plant and equipment ················ Acquisition of intangible assets·············································· Payments of long-term prepaid expenses ································ Proceeds from sale of shares of consolidated subsidiary due to change in scope of consolidation (Note 3) ····················· Proceeds from sale of investments in affiliates due to change in scope of consolidation································· Acquisition of shares of consolidated subsidiaries ····················· Other ················································································ Net cash used in investing activities ··································· Cash Flows from Financing Activities: Net increase (decrease) in short-term debt ······························ Proceeds from long-term debt ··············································· Repayment of long-term debt ················································ Proceeds from sale (acquisition) of treasury stock····················· Cash dividends paid ····························································· Cash dividends paid to minority shareholders ··························· Other ······················································································· Net cash provided by (used in) financing activities ·················· Effect of Exchange Rate Changes on Cash and Cash Equivalents ··· Net Change in Cash and Cash Equivalents·································· Cash and Cash Equivalents at Beginning of Year (Note 3) ·········· Increase (Decrease) in Cash and Cash Equivalents due to the Consolidation (Deconsolidation) of Subsidiaries ·················· Cash and Cash Equivalents at End of Year (Note 3) ····················· The accompanying notes are an integral part of the financial statements. 50 SHISEIDO ANNUAL REPORT 2007 ¥ 2006 2007 (736) 26,523 779 — 44,015 1,767 (31,768) 134 (99) — (198) (5,908) (255) (1,892) 2,371 (22) (552) 226 (1,412) 7,441 (509) 11,073 — 10,430 61,408 2,133 (2,372) (8,735) 52,434 ¥ 29,538 26,415 731 12,404 (43,879) 2,238 1,118 (206) 587 — (123) 1,166 (309) (1,880) 2,452 (61) (519) — (1,807) 2,223 (4,319) 663 (6,176) 7,751 28,007 1,873 (2,540) (5,528) 21,812 ¥ 47,766 27,876 741 4,598 — 1,102 (2,018) (501) 3,734 122 (31) 2,506 (213) (2,176) 2,395 (58) (143) — (734) 1,542 216 (3,756) (2,362) 2,901 83,507 2,151 (2,269) (13,958) 69,431 $ 404,488 236,057 6,275 38,936 — 9,332 (17,089) (4,242) 31,620 1,033 (262) 21,221 (1,804) (18,427) 20,281 (491) (1,211) — (6,215) 13,058 1,829 (31,806) (20,002) 24,566 707,147 18,215 (19,214) (118,198) 587,950 (2,610) 1,158 (1,674) 2,087 (59,589) 58,406 (19,638) 5,752 (4,335) (6,061) (1,468) 3,912 (383) 3,052 (4,767) 11,183 (20,096) 4,159 (2,504) (4,871) (4,519) 1,668 (1,354) 370 (1,725) 9,842 (20,558) 4,161 (2,878) (5,122) (38,267) 14,125 (11,466) 3,133 (14,607) 83,343 (174,088) 35,236 (24,371) (43,374) — — 195 (11) 1,420 (24,900) — (1,690) 833 (12,640) — — 1,500 (18,483) — — 12,702 (156,516) (1,068) 61,158 (31,774) 36 (9,103) (1,828) — 17,421 1,291 46,246 59,364 (10,049) 8,612 (12,890) (2,731) (11,560) (1,208) (133) (29,959) 1,768 (19,019) 108,281 854 25,927 (10,977) 298 (12,794) (1,672) 201 1,837 1,930 54,715 89,015 7,232 219,553 (92,955) 2,524 (108,341) (14,159) 1,702 15,556 16,343 463,333 753,790 132 2007 1,118 2,671 (247) 1,530 12,956 ¥108,281 ¥89,015 ¥145,260 $1,230,079 Notes to the Consolidated Financial Statements Shiseido Company, Limited, and Subsidiaries 1. BASIS OF PRESENTING CONSOLIDATED FINANCIAL STATEMENTS Accounting Principles and Presentation The financial statements of Shiseido Company, Limited (the “Company”) and its domestic consolidated subsidiaries have been prepared in accordance with the provisions set forth in the Japanese Securities and Exchange Law and Corporate Law and in conformity with accounting principles generally accepted in Japan. The financial statements of the Company’s overseas subsidiaries have been prepared in conformity with generally accepted accounting principles prevailing in the respective countries of domicile. The accompanying consolidated financial statements have been prepared from the accounts maintained by the Company and its consolidated subsidiaries in conformity with accounting principles generally accepted in Japan, which are different from International Financial Reporting Standards in certain respects as to the application and disclosure requirements. Certain items presented in the consolidated financial statements filed with the Director of the Kanto Finance Bureau in Japan have been reclassified for the convenience of the reader. Certain reclassifications have been made in the consolidated financial statements for the years ended March 31, 2005 and 2006 to conform to presentation for the year ended March 31, 2007. Amounts in U.S. dollars are included solely for the convenience of the reader. The rate of ¥118.09 = US$1 prevailing on March 31, 2007 has been used in translating the consolidated financial statements expressed in Japanese yen into U.S. dollars. Such translations should not be construed as representations that the Japanese yen amounts could be readily converted, realized or settled in U.S. dollars at this rate. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (1) Scope of Consolidation The Company has 100 subsidiaries (companies over which the Company exercises control over operations) as of March 31, 2007 (101 and 97 as of March 31, 2005 and 2006, respectively). The accompanying consolidated financial statements as of March 31, 2007 include the accounts of the Company and its 92 (97 and 93 as of March 31, 2005 and 2006, respectively) significant subsidiaries (the “Companies”). The Company has 28 affiliates (companies that are not subsidiaries and over which the Company exercises significant influence) as of March 31, 2007 (5 and 5 as of March 31, 2005 and 2006, respectively). Investments in 5 affiliates (3 and 5 as of March 31, 2005 and 2006, respectively) are accounted for by the equity method as of March 31, 2007. Since the Company adopted the Practical Solution on Application of Control Criteria and Influence Criteria to Investment Associations (Accounting Standards Board of Japan, PITF No. 20, September 8, 2006), Selan Anonymous Association and 3 fund investment partnerships have been included in the scope of consolidation from the year ended March 31, 2007. Shiseido Dah Chong Hong Cosmetics (Guangdong) Ltd., which was established and commenced operations in the year ended March 31, 2007, is included in the scope of consolidation during the period. Mieux Products Co., Ltd. was excluded from the scope of consolidation in the year ended March 31, 2007, following the divestment of shares in this company. Five other companies have also been excluded from the scope of consolidation. Of those, 2 companies, Beijing Huazhiyou Cosmetics Sales Center and Shiseido Investment Co., Ltd., are in the process of being liquidated and 3 fund investment partnerships have been dissolved. The major consolidated subsidiaries are listed below: Equity ownership percentage, including indirect ownership Shiseido Sales Co., Ltd ································································· Shiseido FITIT Co., Ltd. ································································ FT Shiseido Co., Ltd. ···································································· 100.0% 100.0 100.0 Shiseido International Corporation ················································· 100.0 Common stock (Millions of yen) ¥100 ¥ 10 ¥100 (Thousands of U.S. dollars) $403,070 (Thousands of euro) Shiseido International Europe S.A. ················································ Beauté Prestige International S.A. ················································· 100.0 100.0 Shiseido China Co., Ltd. ······························································· Shiseido Liyuan Cosmetics Co., Ltd. ············································· 100.0 65.0 Taiwan Shiseido Co., Ltd. ····························································· 51.0 247,473 17,760 (Thousands of yuan) CNY 353,007 CNY 94,300 (Thousands of NT dollars) NTD 1,154,588 Since the fiscal year-end for certain consolidated subsidiaries is December 31, their financial statements as of that date are used in the preparation of the Company’s consolidated financial statements. When significant transactions occur at those subsidiaries between their fiscal year end and the Company’s fiscal year end, these transactions are included in consolidation as necessary. SHISEIDO ANNUAL REPORT 2007 51 Investments in 8 unconsolidated subsidiaries and 23 affiliates not accounted for under the equity method are stated at cost as they are immaterial to the consolidated financial statements. The Company has adopted the “full fair value method” so that the full portion of the assets and liabilities of the subsidiaries are marked to fair value as of the date of acquisition of control. All significant intercompany balances and transactions have been eliminated in consolidation. All material unrealized profits included in assets resulting from transactions with the Companies are eliminated. (2) Inventories Inventories held by the Company are valued at cost, determined by the average method. Inventories held by the consolidated subsidiaries are valued at cost, determined principally by the last purchase price method. (3) Property, Plant and Equipment Buildings (excluding leasehold improvements) are depreciated using the straight-line method. Other tangible fixed assets are, in principle, depreciated using the declining-balance method at the Company and its domestic consolidated subsidiaries and the straight-line method at overseas consolidated subsidiaries. Major fixed assets in Japan are depreciated over specific useful lives based on durability, level of deterioration, and special characteristics (20-30% reduction from legal useful lives). (4) Intangible Assets Intangible assets are, in principle, amortized using the straight-line method over the following time periods. Trademark rights: 10 years, in principle Software: 5 years, in principle (5) Goodwill Amortization of goodwill and negative goodwill is evaluated on an individual basis and amortized within a reasonable period not exceeding 20 years. Goodwill that is on the balance sheet of certain overseas consolidated subsidiaries is not amortized, but instead is tested for impairment at least annually or more frequently if certain indicators arise, and the relevant amount is accounted for at that time, pursuant to U.S. generally accepted accounting principles and other principles. (6) Valuation of Securities The Company and its domestic consolidated subsidiaries categorize their existing securities as available-for-sale securities. These securities with market prices are carried at fair values prevailing at the balance sheet date, with net unrealized gains and losses, net of related taxes, reported separately in net assets. The cost of securities sold is mainly calculated using the moving average method. If fair value is not available, securities are carried at cost, which is determined mainly by the moving average method. Investments in business limited partnerships are recorded at the amount of interest in such partnerships calculated based on ownership percentage. Investment gain or loss is included in net income or loss in proportion to the ownership interests in the net asset value of the partnership. Securities with remaining maturities of one year or less and securities that are recognized as cash equivalents are classified as short-term investments in securities and non-current securities are included in investments in securities. (7) Accounting for Leases Finance leases of the Company and its domestic consolidated subsidiaries, other than those deemed to transfer the ownership of the leased assets to lessees, are accounted for as operating lease transactions. Those of overseas consolidated subsidiaries are principally capitalized. (8) Net Income and Cash Dividends per Share Net income per share of common stock is based on the weighted average number of shares of common stock outstanding during each year. The computation of diluted net income per common stock reflects the maximum possible dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock. Cash dividends per share shown for each year in the consolidated statements of operations represent dividends declared as applicable to the respective year, rather than those paid in each year. (9) Accounting for Consumption Tax In Japan, consumption tax is imposed at a flat rate on all domestic consumption of goods, assets and services (with certain exemptions). The consumption tax withheld upon sales is recorded as a liability. Consumption tax, which is paid by the Company and its domestic consolidated subsidiaries on purchases of goods, assets and services, is offset against the balance withheld, and the net amount is subsequently paid to the national government. Transactions subject to consumption taxes are recorded at amounts exclusive of consumption taxes. (10) Allowance for Doubtful Accounts The Company and its domestic consolidated subsidiaries provide the allowance for doubtful accounts based on the percentage of actual bad debt losses against the balance of total receivables and the amount of uncollectible receivables estimated on an individual basis. Overseas consolidated subsidiaries record the allowance based primarily on the amount of uncollectible receivables estimated on an individual basis. 52 SHISEIDO ANNUAL REPORT 2007 Notes to the Consolidated Financial Statements (11) Reserve for Sales Returns The Companies provide reserve for sales returns for losses due to sales returns, at past return ratios calculated based mainly on historical experience prior to the current year and an estimated amount for future losses. Prior to the year ended March 31, 2007, the Companies provided the reserve for sales returns based on historical results. As a result of accumulation of past data and improvements in analytical precision, effective in the year ended March 31, 2007, the Company and its domestic consolidated subsidiaries adopted a new methodology to more accurately estimate sales returns that considers the market distribution status and product resale status. Accordingly, as a result of this change, operating income and income before income taxes decreased ¥3,636 million ($30,790 thousand), and net income decreased ¥2,145 million ($18,164 thousand). (12) Accrued Bonuses for Employees The Companies provide accrued bonuses for employees based on future projections for the current fiscal year. This reserve includes bonuses for corporate officers who are non-Board members, and the calculations are the same as those for the reserve for bonuses for directors and corporate auditors. Previously, the Company included accrued bonuses for employees in other current liabilities. Due to the introduction of a performance-based bonus system, the accrued amount does not meet the defined requisite, and therefore the Company recategorized this line item as accrued bonuses for employees from the year ended March 31, 2007. (13) Accrued Bonuses for Directors and Corporate Auditors The Company and its domestic consolidated subsidiaries provide accrued bonuses for corporate officers who are also directors on the Board based on the projected amount for the current fiscal year. Effective from the year ended March 31, 2007, the Company and its domestic consolidated subsidiaries applied Accounting Standard for Directors’ Bonuses (Accounting Standards Board of Japan, Statement No. 4, November 29, 2005). As a result, in the year ended March 31, 2007, selling, general and administrative expenses increased ¥122 million ($1,033 thousand). Operating income, income before income taxes, and net income decreased by the same amount. Previously, certain overseas consolidated subsidiaries included provision for liabilities and charges in other current liabilities. In order to clearly present its state, this item is presented separately on the balance sheet from the year ended March 31, 2007. (14) Provision for Liabilities and Charges To provide for losses due to contingency expenses incurred in addressing legal risk, product guarantee risk, currency risk, tax risk, and other factors, certain overseas consolidated subsidiaries provide provision, the amount of which is based on estimated losses that would be incurred considering the potential necessity of such contingencies in the future. Previously, certain overseas consolidated subsidiaries included provision for liabilities and charges in other current liabilities. In order to clearly present its state, this item is presented separately on the balance sheet from the year ended March 31, 2007. (15) Accrued Retirement Benefits The Companies have an obligation to pay retirement benefits to its employees, and therefore the Company, its domestic consolidated subsidiaries and certain overseas consolidated subsidiaries provide accrued retirement benefits based on the estimated amount of projected benefits obligation and the fair value of plan assets. Unrecognized prior service cost is amortized by the straight-line method over a 10-year period, which is shorter than the average remaining years of service of the eligible employees. Unrecognized net actuarial gain or loss is primarily amortized immediately from the following year on a straight-line method over a 10-year period, which is shorter than the average remaining years of service of the eligible employees. The reserve includes an accrual for corporate officers’ retirement benefits, which is subject to the same standards as those used for accrued retirement benefits for directors and corporate auditors. (16) Accrued Retirement Benefits for Directors and Corporate Auditors In the year ended March 31, 2004, the Board of Directors of the Company resolved to abolish the unfunded retirement benefit plans for directors, corporate auditors and corporate officers, effective on the date of the Ordinary General Meeting of Shareholders for the year ended March 31, 2004. The Company provided the amount equivalent to the unfunded lump-sum payments for their duties up to March 31, 2004 as accrued retirement benefits for directors and corporate auditors, as determined by the Board of Directors. (17) Allowance for Loss on Guarantees The Company provides an allowance for estimated potential losses on guarantees based on the financial status of the identified parties. (18) Foreign Currency Translation Receivables and payables denominated in foreign currencies are translated at the exchange rate prevailing on the respective balance sheet dates, and resulting exchange gains or losses are included in net income or loss for the period. Investments in unconsolidated subsidiaries and affiliates denominated in foreign currencies are translated at the historical exchange rates prevailing at the time of the transaction. SHISEIDO ANNUAL REPORT 2007 53 (19) Derivatives and Hedging Activities The Companies use foreign currency exchange agreements, currency swap agreements and interest rate swap agreements to avoid or reduce market risk and to obtain stabilized profit. The Companies limit their use of such transactions to the amounts of foreign currency denominated receivables and payables and the scope of actual requirement, and do not use derivatives for speculative trading. The Company’s basic policies regarding derivatives are determined by the Board of Directors, and contracts are entered into and controlled by the Financial Department. Transactions involving derivative contracts are exposed to market risk, but they are limited to highly rated banking institutions and the Companies consider there are no material credit risks associated with them. Derivatives are carried at fair value with gains or losses recognized in the consolidated statements of operations. For derivatives used for hedging purposes, gains or losses on derivatives are deferred until maturity of the hedged transactions. The Company’s policy is to evaluate on a semiannual basis the effectiveness of derivatives based on the difference between either the accumulated amount of cash flows from the hedging instrument and from the corresponding hedged item or variance between the market value of the hedging instrument and the hedged item. (20) Foreign Currency Financial Statements The financial statements of overseas consolidated subsidiaries and affiliates are translated into yen at the exchange rate prevailing at the respective balance sheet dates of those subsidiaries for assets and liabilities, and at the historical exchange rate for shareholders’ equity. All income and expense accounts are translated at the average rate of exchange during the fiscal year of those subsidiaries and affiliates. The resulting translation adjustments are allocated proportionately in net assets as foreign currency translation adjustments and minority interests in consolidated subsidiaries. (21) Definition of “Cash and Cash Equivalents” in Statements of Cash Flows Cash and cash equivalents as shown in the consolidated statements of cash flows are composed of cash in hand, readily available time deposits, and short-term investments with maturities of 3 months or less when purchased that are exposed to insignificant risk of change in value. (22) Accounting Standard for Impairment of Fixed Assets On August 9, 2002, the Business Accounting Council in Japan issued Accounting Standard for Impairment of Fixed Assets. The standard requires that fixed assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss is recognized in the consolidated statement of operations by reducing the carrying amount of impaired assets or a group of assets to the recoverable amount to be measured as the higher of net selling price and value in use. The Company and its domestic consolidated subsidiaries applied the standard effective for the year beginning April 1, 2005. As a result, cost of sales decreased by ¥124 million, gross profit increased by ¥124 million, selling, general and administrative expenses increased by ¥261 million, operating income decreased by ¥137 million and income before income taxes decreased by ¥6,223 million in the year ended March 31, 2006, as compared with the amount which would have been reported if the previous standards had been applied consistently. (23) Accounting Standard for Presentation of Net Assets in the Balance Sheet Effective from the year ended March 31, 2007, the Company applied Accounting Standard for Presentation of Net Assets in the Balance Sheet (Accounting Standards Board of Japan, Statement No. 5, December 9, 2005) and Implementation Guidance on Accounting Standard for Presentation of Net Assets in the Balance Sheet (Accounting Standards Board of Japan, Guidance No. 8, December 9, 2005). The amount corresponding to conventional total shareholders’ equity is ¥388,620 million ($3,290,880 thousand). (24) Accounting Standards for Business Combinations Effective from the year ended March 31, 2007, the Company and its domestic consolidated companies applied Accounting Standard for Business Combinations (Business Accounting Council, October 31, 2003) and Accounting Standard for Business Divestitures (Accounting Standards Board of Japan, Statement No. 7, December 27, 2005) and Guidance on Accounting Standard for Business Combinations and Accounting Standard for Business Divestitures (Accounting Standards Board of Japan, Guidance No. 10, final revision on December 22, 2006). (25) Accounting Standards for Stock Options Effective from the year ended March 31, 2007, the Company applied Accounting Standard for Share-Based Payment (Accounting Standards Board of Japan, Statement No. 8, December 27, 2005) and Implementation Guidance on Accounting Standard for Share-Based Payment (Accounting Standards Board of Japan, Guidance No. 11, final revision on May 31, 2006). As a result, in the year ended March 31, 2007, selling, general and administrative expenses increased ¥52 million ($440 thousand), operating income and income before income taxes decreased by the same amount and net income decreased by ¥45 million ($381 thousand). (26) Revision to Accounting Standard for Treasury Stock and Reduction of Legal Reserves Effective from the year ended March 31, 2007, the Company applied the revised Accounting Standard for Treasury Stock and Reduction of Legal Reserves (Accounting Standards Board of Japan, Statement No. 1, final revision on 54 SHISEIDO ANNUAL REPORT 2007 Notes to the Consolidated Financial Statements August 11, 2006) and Implementation Guidance on Accounting Standard for Treasury Stock and Reduction of Legal Reserves (Accounting Standards Board of Japan, Guidance No. 2, final revision on August 11, 2006). The change had no impact on the consolidated statements of operations for the year ended March 31, 2007. (27) Application of Control Criteria and Influence Criteria to Investment Associations Effective from the year ended March 31, 2007, the Company applied Practical Solution on Application of Control Criteria and Influence Criteria to Investment Associations (Accounting Standards Board of Japan, PITF No. 20, September 8, 2006). As a result, in the year ended March 31, 2007, operating income increased ¥1,376 million ($11,652 thousand), while income before income taxes decreased ¥507 million ($4,293 thousand), and net income decreased ¥337 million ($2,854 thousand). (28) Changes in Classification of Costs and Expenses In the year ended March 31, 2006, the Company introduced a new consolidated operations management framework. This entailed setting up a Group-standard account item system, from the perspective of combining the institutional accounting and management accounting frameworks. The Company also reassessed its method for calculating business earnings, with the aim of gaining a more accurate grasp of its financial performance. To obtain a clearer insight into cost of sales vis-à-vis net sales, the Company reassessed the nature of certain items, such as distribution costs and research and development expenses, which previously had been included within cost of sales. As from the year ended March 31, 2006, those items are now included within selling, general and administrative expenses. With a view to providing a more accurate report of the Company’s operating income, amortization of goodwill and trademark rights, previously included within other expenses, is now included within selling, general and administrative expenses, because acquisitions of goodwill and trademark rights are expected to benefit the Company’s operating earnings. As a result of this change, cost of sales, gross profit, selling, general and administrative expenses, operating income and other income (expenses) for the years up to March 31, 2005 have been retrospectively restated to reflect the changes. 3. CASH FLOW INFORMATION The reconciliation of cash and time deposits shown in the consolidated balance sheets and cash and cash equivalents shown in the consolidated statements of cash flows as of March 31, 2006 and 2007 is as follows. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2006 Cash and time deposits ··························································· Short-term investments in securities ········································ Total ··········································································· Time deposits with maturities exceeding 3 months ··················· Equity securities and debt securities with maturities exceeding 3 months ···· Cash and cash equivalents ······················································· 2007 ¥53,511 36,945 ¥90,456 (1,094) (347) ¥89,015 ¥ 82,453 68,544 ¥150,997 (4,121) (1,616) ¥145,260 2007 $ 698,222 580,438 $1,278,660 (34,897) (13,684) $1,230,079 The information of assets and liabilities of Mieux Products Co., Ltd., which was sold during the year ended March 31, 2007, and the relationship between the proceeds from sale of shares of this company and net cash proceeds from sale of shares of this company is as follows. Millions of yen Current assets ····························································································· Non–current assets ······················································································ Current liabilities ·························································································· Non–current liabilities ·························································································· Minority interests in consolidated subsidiaries ······················································ Loss on sale of shares of Mieux Products Co., Ltd. ··········································· Proceeds from sale of shares of Mieux Products Co., Ltd. ·································· Cash and cash equivalents of Mieux Products Co., Ltd. ······································ Net cash proceeds from sale of shares of Mieux Products Co., Ltd. ····················· ¥1,707 904 (790) (236) (555) (20) ¥1,010 (878) ¥ 132 Thousands of U.S. dollars (Note1. (1)) $14,455 7,655 (6,690) (1,998) (4,700) (169) $ 8,553 (7,435) $ 1,118 SHISEIDO ANNUAL REPORT 2007 55 4. SECURITIES The acquisition cost, carrying amount, gross unrealized holding gains and gross unrealized holding losses for securities with fair value by security type at March 31, 2006 and 2007, are as follows. Available-for-sale securities: Millions of yen 2006 Cost Equity securities ·········································· Corporate bonds ·········································· Other ·························································· .................................................................... ¥10,996 3,035 6,440 ¥20,471 Carrying amount Gross unrealized gains ¥41,230 2,977 6,731 ¥50,938 ¥30,238 4 513 ¥30,755 Gross unrealized losses ¥ 4 62 222 ¥288 Millions of yen 2007 Cost Equity securities ·········································· Corporate bonds ·········································· Other ·························································· ···································································· ¥11,077 8,532 1,100 ¥20,709 Carrying amount Gross unrealized gains ¥34,127 8,509 1,285 ¥43,921 ¥23,072 4 185 ¥23,261 Gross unrealized losses ¥22 27 — ¥49 Thousands of U.S. dollars (Note 1.(1)) 2007 Cost Equity securities ·········································· Corporate bonds ·········································· Other ·························································· ···································································· $ 93,801 72,250 9,315 $175,366 Carrying amount $288,991 72,055 10,882 $371,928 Gross unrealized gains $195,376 34 1,567 $196,977 Gross unrealized losses $186 229 — $415 The carrying amount of securities without fair value by security type as of March 31, 2006 and 2007 is summarized as follows. Available-for-sale securities: Carrying amount Thousands of U.S. dollars (Note1. (1)) Millions of yen 2006 Unlisted equity securities························································· 2007 ¥17,188 ¥17,822 2007 $150,918 Unlisted bonds ········································································ 3 3,669 31,070 Other ····················································································· ...................................................................................................... 56,590 ¥73,781 65,305 ¥86,796 553,010 $734,998 Proceeds from sales, gross realized gains and gross realized losses from the sale of available-for-sale securities in the years ended March 31, 2005, 2006 and 2007 are as follows. Carrying amount Thousands of U.S. dollars (Note1. (1)) Millions of yen 2005 Proceeds from sales ······························· Gross realized gains ································ Gross realized losses ······························· ¥59,941 552 — 2006 ¥13,715 519 — 2007 ¥10,069 310 167 2007 $85,265 2,625 1,414 The carrying value of debt securities by contractual maturities for securities classified as available-for-sale as of March 31, 2007 is as follows. Millions of yen Due in 1 year or less····················································································· Due after 1 year through 5 years ···································································· Due after 5 years through 10 years ································································· Due after 10 years ······························································································ 56 SHISEIDO ANNUAL REPORT 2007 ¥11,417 2,372 309 3,000 ¥17,098 Thousands of U.S. dollars (Note1. (1)) $ 96,681 20,086 2,617 25,404 $144,788 Notes to the Consolidated Financial Statements 5. INVENTORIES Inventories held by the Companies as of March 31, 2006 and 2007 are as follows. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2006 2007 2007 Merchandise and products······················································· ¥48,580 ¥ 48,346 $409,400 Raw materials ········································································· 12,998 14,218 120,400 Work in process ······································································ 3,979 3,991 33,796 Supplies ··········································································· 6,787 7,336 62,122 ¥72,344 ¥73,891 $625,718 6. SHORT-TERM AND LONG-TERM DEBT Short-term debt mainly consisting of bank borrowings as of March 31, 2006 and 2007 is ¥3,323 million and ¥4,456 million ($37,734 thousand), respectively. The weighted average interest rate on short-term debt outstanding at March 31, 2006 and 2007 are 4.21% and 5.31%, respectively. Long-term debt as of March 31, 2006 and 2007 is as follows. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2006 Long-term borrowings from banks and other financial institutions ········ 0.40% unsecured yen bonds due in May 2007 ·························· 1.12% unsecured yen bonds due in March 2010 ······················· Medium-Term Notes due 2007–2008* ····································· ........................................................................................ Less: portion due within one year············································· ........................................................................................ 2007 ¥ 7,062 50,000 — 21,893 ¥78,955 (9,463) ¥69,492 ¥ 38,367 50,000 20,000 15,015 ¥123,382 (61,688) ¥ 61,694 2007 $ 324,896 423,406 169,362 127,149 $1,044,813 (522,381) $ 522,432 *** These notes have been issued by Shiseido International Corporation and Shiseido International Europe S.A. The interest rates as of March 31, 2007 ranged from 0.70% to 4.05%. The aggregate annual maturities of long-term debt as of March 31, 2007 are as follows. For the Years Ending March 31 Millions of yen 2008 ········································································································ 2009 ········································································································ 2010 ········································································································ 2011 ········································································································ 2012 ········································································································ 2013 and thereafter ······························································································ ¥ 61,688 36,569 21,451 684 2,649 341 ¥123,382 Thousands of U.S. dollars (Note1. (1)) $ 522,381 309,670 181,650 5,792 22,432 2,888 $1,044,813 Assets pledged as collateral as of March 31, 2007 are as follows. Millions of yen 2007 Buildings and structures···························································································· Guarantee money paid ························································································ Investments in securities····················································································· Cash and time deposits ······················································································· ······················································································································ ¥20,117 15,200 1,512 1,432 ¥38,261 Thousands of U.S. dollars (Note1. (1)) 2007 $170,353 128,716 12,804 12,126 $323,999 The above assets are pledged as collateral for derivative transactions (interest rate swaps) and following liabilities. Collateralized liabilities as of March 31, 2007 are as follows. Millions of yen 2007 Current portion of long-term debt ············································································· Long-term debt ··································································································· ¥ 1,000 27,100 ¥28,100 Thousands of U.S. dollars (Note1. (1)) 2007 $ 8,468 229,486 $237,954 SHISEIDO ANNUAL REPORT 2007 57 7. ACCRUED RETIREMENT BENEFITS The Company and its domestic consolidated subsidiaries have contributory funded pension plans and unfunded termination allowance plans as part of their defined benefit plans. In September 2004, the Company shifted part of its pension plan to a termination allowance plan. In October 2004, the Company discontinued part of its defined benefit plan and shifted to a defined contribution plan and a prepaid termination allowance plan. In some cases, extra retirement benefits are paid when an employee retires. These are accounted for as retirement benefits expenses when incurred. Certain overseas consolidated subsidiaries also have defined benefit pension plans, termination allowance plans and defined contribution plans. The reconciliation of projected benefit obligations, plan assets, funded status of the pension benefit plans, prepaid pension expense and accrued retirement benefits recognized in the accompanying balance sheets as of March 31, 2006 and 2007 is as follows. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2006 2007 2007 ¥(186,389) 183,218 (3,171) 1,182 ¥(190,449) 190,405 (44) 1,083 $(1,612,745) 1,612,372 (373) 9,171 Unrecognized prior service cost ·············································· Additional minimum liability* ·················································· Net retirement benefit obligation 10,235 (12,322) (1,491) ¥ (5,567) ¥ 5,010 (9,157) (1,482) (4,590) 42,426 (77,542) (12,550) (38,868) Prepaid pension expense ······················································· Accrued retirement benefits ··················································· 30,637 ¥ (36,204) 32,630 ¥ (37,220) Projected benefit obligations··················································· Fair value of plan assets ························································· Funded status of the pension benefit plans ····························· Unamortized net obligation at transition* ································· Unrecognized net actuarial loss ··············································· $ 276,315 $ (315,183) The net periodic pension benefit cost for the years ended March 31, 2005, 2006 and 2007 are as follows. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2005 Service cost ················································ Interest cost················································ Expected return on plan assets ···················· Amortization of net obligation at transition* ············ Amortization of net actuarial loss ······················· Amortization of prior service cost ················· Net periodic pension benefit cost ················· Gain on changes in retirement benefit plans ····· Total ··························································· ¥ 8,970 4,729 (5,673) 91 5,294 (2,266) ¥11,145 (2,567) ¥ 8,578 2006 2007 ¥ 7,606 4,304 (5,983) 108 5,367 (2,124) ¥ 9,278 — ¥ 9,278 ¥ 7,876 4,546 (7,328) 113 3,069 (2,125) ¥ 6,151 — ¥ 6,151 2007 $ 66,695 38,496 (62,055) 957 25,989 (17,995) $ 52,087 — $ 52,087 *** This figure pertains to a Taiwanese subsidiary, according to the Taiwanese retirement allowance accounting system. The discount rate used to determine the actuarial present value of projected benefit obligations as of March 31, 2006 and 2007 under the plan that covers employees of the Company and certain domestic subsidiaries is 2.5%. The rate of expected return on plan assets as of March 31, 2006 and 2007 is 4.0%. Attribution of pension benefits to each year of service of the employees is based on the “benefits/years-of-service” approach, whereby the same amount of the benefits is attributed to each year. The Company implemented a special early retirement incentive plan, which aimed to support and expand options to employees in advanced age groups to suit their individual life plans. Eligible applicants were fulltime employees working for the Company and its domestic subsidiaries who were between 50 and 59 years of age, and have served more than 15 years. 1,364 employees retired as of March 31, 2005 and additional retirement benefits of ¥30,987 million were recognized for the year ended March 31, 2005. In addition, certain overseas consolidated subsidiaries record accrued retirement benefits, according to the accounting standards of their respective countries. The total amount of these accrued retirement benefits at March 31, 2007 is ¥1,423 million ($12,050 thousand). 8. INCOME TAXES Income tax applicable to the Company and its domestic consolidated subsidiaries consist of corporation, inhabitants’ and enterprise taxes. The statutory income tax rate is 41.0% for the years ended March 31, 2005, 2006 and 2007. 58 SHISEIDO ANNUAL REPORT 2007 Notes to the Consolidated Financial Statements The difference between the statutory income tax rate and the effective income tax rate for the year ended March 31, 2005 is as follows. 2005 Statutory income tax rate ······································································································· Adjustments: Entertainment expenses and others that are not deductible permanently ··································· Dividend income and others that are not taxable permanently ·················································· Temporary difference relating to consolidation adjustments ····················································· Other factors ··················································································································· Effective income tax rate ··············································································································· 41.0% (173.0) 76.5 (762.0) 35.9 (781.6)% The difference between the statutory income tax rate and the effective income tax rate as of March 31, 2006 and 2007 is less than 5% of the statutory income tax rate, and accordingly, the components of the differences arising between these two rates are omitted. Deferred tax assets and liabilities (both current and non-current) as of March 31, 2006 and 2007 are as follows. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2006 2007 2007 Deferred tax assets: Tax losses carried forward····················································· Depreciation ········································································ Write-down of investments in securities and other investments ······ Valuation loss on inventories ················································· Unrealized intercompany profit of inventory and fixed assets····· Accrued bonuses for employees ············································ Accrued retirement benefits ·················································· Accrued expenses································································ Accrued enterprise tax ·························································· Accrued retirement benefits to directors and corporate auditors ······ Other ·················································································· Total gross deferred tax assets ·············································· ¥13,989 10,958 8,085 6,758 6,071 4,836 3,204 2,888 834 115 7,444 65,182 ¥ 9,845 10,731 8,981 6,465 8,944 4,613 1,129 4,980 812 32 7,713 64,245 $ 83,369 90,871 76,052 54,746 75,739 39,063 9,561 42,171 6,876 271 65,315 544,034 Less: valuation allowance······················································ Total deferred tax assets ······················································· (7,911) ¥57,271 (10,931) ¥ 53,314 (92,565) $451,469 Deferred tax liabilities: Unrealized gains on available-for-sale securities ······················· Special tax-purpose reserve··················································· Depreciation ········································································ Goodwill and other intangible assets ······································ Other ·················································································· Total deferred tax liabilities ···················································· Net deferred tax assets ························································ ¥12,687 1,144 773 495 833 ¥15,932 ¥41,339 ¥ 9,526 1,101 518 1,636 497 ¥ 13,278 ¥ 40,036 $ 80,667 9,323 4,386 13,854 4,209 $112,439 $339,030 9. CONTINGENT LIABILITIES As of March 31, 2006, the Company was contingently liable as a guarantor for loans of employees from banks, which amounted to ¥38 million. As of March 31, 2007, the Company has no contingent liabilities. 10. NET ASSETS The Corporate Law (“the Law”) became effective on May 1, 2006, replacing the Commercial Code (“the Code”). Under Japanese laws and regulations, the entire amount paid for new shares is required to be designated as common stock. However, 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, which is included in capital surplus. Under the Law, in cases where dividend distribution of surplus is made, the smaller of an amount equal to 10% of the dividend or the excess, if any, of 25% of common stock over the total of additional paid-in capital and legal earnings reserve, must be set aside as additional paid-in capital or legal earnings reserve. Legal earnings reserve is included in retained earnings in the accompanying consolidated balance sheets. 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 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 could be capitalized by a resolution of the Board of Directors. Under the Law, both of these appropriations generally require a resolution of the shareholders’ meeting. SHISEIDO ANNUAL REPORT 2007 59 Additional paid-in capital and legal earnings reserve may not be distributed as dividends. Under the Code, however, additional paid-in capital and legal earnings reserve could be transferred to retained earnings 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 the common stock balance. Under the Law, all additional paid-in capital and legal earnings reserve may be transferred to other capital surplus and retained earnings, respectively, which are potentially available for dividends. 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 the Law. Under the 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: (1) having a Board of Directors, (2) having accounting auditors, (3) having a Board of Corporate Auditors, (4) the term of service of the directors is prescribed as one year rather than two years as the normal term by its articles of incorporation, and (5) the opinion of accounting auditors is unqualified, the Board of Directors may declare dividends if the company has prescribed so in its articles of incorporation. 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. Under the Code, certain limitations were imposed on the amount of capital surplus and retained earnings available for dividends. Cash dividends charged to retained earnings during the fiscal year were year-end cash dividends for the preceding fiscal year and interim cash dividends for the current fiscal year. The appropriations are not accrued in the consolidated financial statements for the corresponding period, but are recorded in the subsequent accounting period after shareholders’ approval has been obtained. Retained earnings at March 31, 2007 include amounts representing year-end cash dividends of ¥6,605 million ($55,932 thousand), ¥16.0 ($0.14 ) per share, which were approved at the shareholders’ meeting held on June 26, 2007. 11. STOCK OPTION PLAN Summarized information on the stock options outstanding as of March 31, 2007 is as follows. ➀ Stock option plan approved by the shareholders on June 27, 2002 Stock options granted on July 16, 2002 Number of shares for options granted Number of shares for options outstanding Exercise price Option term 578,000 shares 306,000 shares ¥1,669 July 1, 2004 - June 26, 2012 Total 578,000 shares 306,000 shares ➁ Stock option plan approved by the shareholders on June 27, 2003 Stock options granted on July 31, 2003 Number of shares for options granted Number of shares for options outstanding Exercise price Option term 878,000 shares 384,000 shares ¥1,287 July 1, 2005 - June 26, 2013 Total 878,000 shares 384,000 shares ➂ Stock option plan approved by the shareholders on June 29, 2004 Number of shares for options granted Number of shares for options outstanding Exercise price Option term Stock options granted on July 26, 2004 Stock options granted on November 30, 2004 Stock options granted on March 9, 2005 Total 1,004,000 shares 16,000 shares 78,000 shares 1,098,000 shares 892,000 shares ¥1,427 July 1, 2006 - June 28, 2014 1,000 shares 34,000 shares ¥1,419 ¥1,445 December 1, 2004 - November 30, 2007 April 1, 2005 - March 31, 2008 927,000 shares ➃ Stock option plan approved by the shareholders on June 29, 2005 Number of shares for options granted Number of shares for options outstanding Exercise price Option term Stock options granted on October 27, 2005 Number of shares for options granted 11,000 shares Number of shares for options outstanding 6,000 shares Exercise price ¥1,865 Option term November 1, 2005 - October 31, 2008 60 SHISEIDO ANNUAL REPORT 2007 Stock options granted on July 28, 2005 Stock options granted on July 28, 2005 408,000 shares 408,000 shares ¥1 July 1, 2008 - June 30, 2011 261,000 shares 261,000 shares ¥1,481 July 1, 2007 - June 28, 2015 Stock options granted on November 7, 2005 Stock options granted on March 8, 2006 Total 1,851,000 shares 63,000 shares 2,594,000 shares 1,851,000 shares ¥1,896 July 1, 2007 - June 30, 2010 41,000 shares ¥2,012 April 1, 2006 - March 31, 2009 2,567,000 shares Notes to the Consolidated Financial Statements ➄ Stock option plan approved by the shareholders on June 29, 2006 Stock options granted on August 23, 2006 Number of shares for options granted Number of shares for options outstanding Exercise price Option term Stock options granted on August 23, 2006 Number of shares for options granted 12,000 shares Number of shares for options outstanding 12,000 shares Exercise price ¥1 Option term July 1, 2008 - June 30, 2011 9,000 shares 9,000 shares ¥1 July 1, 2008 - June 30, 2011 Stock options granted on August 23, 2006 Stock options granted on August 23, 2006 Total 67,000 shares 74,000 shares 162,000 shares 67,000 shares 74,000 shares ¥2,300 ¥2,300 August 1, 2008 - July 30, 2016 August 1, 2008 - July 30, 2016 162,000 shares 12. RESEARCH AND DEVELOPMENT Research and development expenses, which are included in selling, general and administrative expenses, totaled ¥16,762 million, ¥16,452 million and ¥16,133 million ($136,616 thousand) for the years ended March 31, 2005, 2006 and 2007, respectively. There are no research and development expenses included in total manufacturing expenses for the years ended March 31, 2005, 2006 and 2007. 13. TRANSACTIONS WITH RELATED PARTIES The Company contributed ¥1 million ($8 thousand) to the Shiseido Social Welfare Foundation (the Foundation) the year ended March 31, 2007. The Foundation performs social support specializing in child welfare and holds 1,000 thousand shares (0.23%) of the Company. Shinzo Maeda, President and CEO (Representative Director) of the Company, is the Chairman of the Foundation. The Company approved the amount of contribution at the Board of Directors meeting. 14. ACCOUNTING FOR LEASES The Companies have various lease agreements whereby the Companies act both as a lessee and a lessor. Information on such lease contracts of the Companies as a lessee and a lessor for the years ended March 31, 2005, 2006 and 2007, is as follows. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2005 2006 2007 2007 ¥ 5,091 9,429 ¥ 14,520 ¥ 4,166 8,107 ¥ 12,273 ¥ 2,788 4,161 ¥ 6,949 $ 23,609 35,236 $ 58,845 — — ¥ 4,849 ¥ 4,849 — — — ¥ 5,371 ¥ 5,371 — ¥ 15 ¥ 103 ¥ 3,688 ¥ 3,681 ¥ 7 $ 127 $ 872 $ 31,230 $ 31,171 $ 59 ¥ 29,020 (14,500) — ¥ 14,520 ¥ 27,187 (14,914) — ¥ 12,273 ¥15,155 (8,206) (15) ¥ 6,934 $128,334 (69,489) (127) $ 58,718 ➀ As a lessee: The scheduled maturities of future lease rental payments on such lease contracts are as follows: Due within one year ···························· Due after one year ······························ Balance of allowance for impairment loss on leased assets···························· Liquidation of lease impairment loss ··········· Lease rental expenses for the year ············· Assumed depreciation ······························ Impairment loss ······································ Leased machinery and equipment: Assumed purchase cost ······················ Assumed accumulated depreciation ········ Assumed impairment loss ····················· Assumed net book value ····················· Assumed purchase cost and the scheduled maturities of future lease rental payment include the capitalized interest thereon, as the proportion of future lease rental payments to total property, plant and equipment is low. SHISEIDO ANNUAL REPORT 2007 61 Depreciation is based on the straight-line method over the lease term of the leased assets, assuming no residual value. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2005 2006 2007 2007 ¥ 1,644 4,018 ¥ 5,662 ¥ 1,619 2,939 ¥ 4,558 ¥ 1,324 2,046 ¥ 3,370 $ 11,212 17,326 $ 28,538 Lease rental income for the year ················ Depreciation ············································ Assumed interest income ························· ¥ 1,846 ¥ 1,596 ¥ 312 ¥ 1,930 ¥ 1,757 ¥ 345 ¥ 1,999 ¥ 1,740 ¥ 203 $ 16,928 $ 14,735 $ 1,719 Leased machinery and equipment: Purchase cost ····································· Accumulated depreciation ··················· Net book value ····································· ¥ 9,425 (4,040) ¥ 5,385 ¥ 9,442 (5,164) ¥ 4,278 ¥ 8,784 (5,584) ¥ 3,200 $ 74,384 (47,286)) $ 27,098 ➁ As a lessor: The scheduled maturities of future lease rental receipts on such lease contracts are as follows: Due within one year ···························· Due after one year ······························· Lease obligations under operating leases at March 31, 2005, 2006 and 2007, are as follows. Assumed interest payments/income is based on the interest method. Thousands of U.S. dollars (Note1. (1)) Millions of yen 2005 2006 2007 2007 ➀ As a lessee: The scheduled maturities of future lease rental payments on such lease contracts are as follows: Due within one year ···························· Due after one year ······························· ¥ 3,825 30,974 ¥34,799 ¥ 3,797 27,505 ¥31,302 ¥1,629 4,454 ¥6,083 $13,795 37,717 $51,512 ¥ 177 221 ¥ 212 394 ¥ 210 381 $ 1,778 3,227 ¥ 398 ¥ 606 ¥ 591 $ 5,005 ➁ As a lessor: The scheduled maturities of future lease rental receipts on such lease contracts are as follows: Due within one year ···························· Due after one year ······························· 15. DERIVATIVE FINANCIAL INSTRUMENTS The contract amount (notional principal amount), estimated fair value and unrealized gain / loss of the outstanding contracts as of March 31, 2006 and 2007 are as follows. Millions of yen 2006 Contract amount (notional principal amount) Total Currency swap contracts: To receive Yen/to pay Euro ······················· ¥3,946 Settled over one year Estimated fair value ¥1,176 ¥(744) Unrealized gain (loss) ¥(744) Millions of yen 2007 Contract amount (notional principal amount) Total Currency swap contracts: To receive Yen/to pay Euro ······················ Interest swap contracts: To Receive variable/to pay fixed ················ 62 SHISEIDO ANNUAL REPORT 2007 Settled over one year Estimated fair value Unrealized gain (loss) ¥1,317 — ¥(334) ¥(334) ¥2,382 ¥2,382 ¥ (35) ¥ (35) Notes to the Consolidated Financial Statements Thousands of U.S. dollars (Note 1. (1)) 2007 Contract amount (notional principal amount) Total Currency swap contracts: To receive Yen/to pay Euro ······················ Interest swap contracts: To Receive variable/to pay fixed ················ Settled over one year Estimated fair value Unrealized gain (loss) $11,153 — $(2,828) $(2,828) $20,171 $20,171 $ (296) $ (296) Derivatives that meet the criteria for hedges are excluded from the above table. 16. IMPAIRMENT LOSS For impairment accounting purposes, the Companies pool their business-use assets separately from their idle assets. Business-use assets are generally pooled according to the minimum independent cash-flow-generating unit, based on business classification. Idle assets are pooled according to each separate property. As a result, businessuse assets due to be sold have been devalued from the book value to the recoverable value, with the differences reported as other expenses. Idle assets whose market value has declined have been devalued from the book value to the recoverable value, with the differences reported as other expenses. Recoverable values are calculated according to estimated net sale values, which are mainly based on real estate appraisal values. Impairment loss on overseas assets mainly refers to decreasing profitability of long-lived assets of North American subsidiaries. Impairment loss for the years ended March 31, 2005, 2006 and 2007 is as follows. Thousands of U.S. dollars (Note 1. (1)) Millions of yen 2007 2007 214 2,597 ¥1,389 699 $11,762 5,919 — — 2,356 919 1,159 143 9,815 1,211 — — — — — 3,357 2,961 ¥12,404 407 801 — ¥4,598 3,446 6,783 — $38,936 2005 Domestic Business-use assets: Land ···················································· Building and structures, etc. ·················· Idle assets: Land ···················································· Building and structures, etc. ·················· Overseas Building and structures, etc. ·················· Goodwill ·············································· Trademark rights ·································· — — 2006 ¥ 17. SEGMENT INFORMATION (1) Business Segment Information* The Companies operate principally in the following 3 business segments. Business segment information is separately disclosed on the consolidated financial statements pursuant to regulations in Japan. Domestic Cosmetics: Cosmetics division (Production and sale of cosmetics, cosmetic accessories and toiletries) Professional division (Production and sale of beauty salon products, etc.) Healthcare division (Production and sale of health & beauty foods and over-the-counter drugs) Overseas Cosmetics: Cosmetics division (Production and sale of cosmetics, cosmetic accessories and toiletries) Professional division (Production and sale of beauty salon products, etc.) Others: Frontier Sciences division (Production and sale of medical-use drugs, etc.) Others (Sale of clothing and accessories; operation of restaurants; real estate management/sale; etc.) SHISEIDO ANNUAL REPORT 2007 63 The business segment information of the Companies for the years ended March 31, 2005, 2006 and 2007, is as follows. Millions of yen 2005 Net sales Sales to outside customers ········· Intersegment sales or transfer ········· Total ·············································· Operating expenses** ···················· Operating income (loss) ·················· Total assets ··································· Depreciation ·································· Capital expenditure ························· Domestic Cosmetics Overseas Cosmetics Others ¥445,306 5,456 ¥450,762 425,248 ¥ 25,514 ¥285,358 ¥ 15,103 ¥ 17,996 ¥174,507 359 ¥174,866 174,186 ¥ 680 ¥162,188 ¥ 6,341 ¥ 5,568 ¥20,015 19,335 ¥39,350 39,434 ¥ (84) ¥56,623 ¥ 5,919 ¥ 5,034 Subtotal ¥639,828 25,150 ¥664,978 638,868 ¥ 26,110 ¥504,169 ¥ 27,363 ¥ 28,598 Elimination/ corporate — (25,150) ¥ (25,150) (25,569) ¥ 419 ¥196,926 ¥ 45 ¥ 33 Consolidation ¥639,828 — ¥639,828 613,299 ¥ 26,529 ¥701,095 ¥ 27,408 ¥ 28,631 Millions of yen 2006 Net sales Sales to outside customers ··············· Intersegment sales or transfer ········· Total ·············································· Operating expenses** ···················· Operating income ··························· Total assets ··································· Depreciation ·································· Impairment loss ····························· Capital expenditure ························· Domestic Cosmetics Overseas Cosmetics Others ¥453,360 5,131 ¥458,491 424,231 ¥ 34,260 ¥237,936 ¥ 15,040 ¥ 4,840 ¥ 14,991 ¥196,331 379 ¥196,710 193,875 ¥ 2,835 ¥211,156 ¥ 6,595 ¥ 6,360 ¥ 8,578 ¥21,266 19,293 ¥40,559 39,577 ¥ 982 ¥53,311 ¥ 5,360 ¥ 1,256 ¥ 5,028 Subtotal ¥670,957 24,803 ¥695,760 657,683 ¥ 38,077 ¥502,403 ¥ 26,995 ¥ 12,456 ¥ 28,597 Elimination/ corporate — (24,803) ¥ (24,803) (25,605) ¥ 802 ¥169,439 ¥ (23) ¥ (52) ¥ 29 Consolidation ¥670,957 — ¥670,957 632,078 ¥ 38,879 ¥671,842 ¥ 26,972 ¥ 12,404 ¥ 28,626 Millions of yen 2007 Net sales Sales to outside customers ········· Intersegment sales or transfer ········· Total ·············································· Operating expenses** ···················· Operating income ··························· Total assets ··································· Depreciation ·································· Impairment loss ····························· Capital expenditure ··························· Domestic Cosmetics Overseas Cosmetics Others ¥447,557 6,232 ¥453,789 416,919 ¥ 36,870 ¥243,310 ¥ 14,362 ¥ 2,115 ¥ 12,150 ¥224,320 1,347 ¥225,667 215,222 ¥ 10,445 ¥229,568 ¥ 7,617 ¥ 1,255 ¥ 8,739 ¥22,717 23,113 ¥45,830 43,585 ¥ 2,245 ¥77,966 ¥ 6,519 ¥ 1,228 ¥ 5,463 Subtotal ¥694,594 30,692 ¥725,286 675,726 ¥ 49,560 ¥550,844 ¥ 28,498 ¥ 4,598 ¥ 26,352 Elimination/ corporate — (30,692) ¥ (30,692) (31,137) ¥ 445 ¥188,989 ¥ (23) — ¥ 14 Consolidation ¥694,594 — ¥694,594 644,589 ¥ 50,005 ¥739,833 ¥ 28,475 ¥ 4,598 ¥ 26,366 Thousands of U.S. dollars (Note 1. (1)) 2007 Net sales Sales to outside customers ········· Intersegment sales or transfer ········· Total ·············································· Operating expenses** ···················· Operating income ··························· Total assets ··································· Depreciation ·································· Impairment loss ····························· Capital expenditure ························· Domestic Cosmetics Overseas Cosmetics $3,789,966 52,773 $3,842,739 3,530,519 $ 312,220 $2,060,378 $ 121,619 $ 17,910 $ 102,888 $1,899,568 11,407 $1,910,975 1,822,526 $ 88,449 $1,944,009 $ 64,502 $ 10,627 $ 74,003 Others $192,370 195,724 $388,094 369,083 $ 19,011 $660,225 $ 55,204 $ 10,399 $ 46,261 Subtotal Elimination/ corporate Consolidation $5,881,904 259,904 $6,141,808 5,722,128 $ 419,680 $4,664,612 $ 241,325 $ 38,936 $ 223,152 — (259,904) $ (259,904) (263,672) $ 3,768 $1,600,381 $ (195) — $ 118 $5,881,904 — $5,881,904 5,458,456 $ 423,448 $6,264,993 $ 241,130 $ 38,936 $ 223,270 *** Effective for the year ended March 31, 2007, the Company has reclassified business segment reporting from “cosmetics,” “toiletries” and “others” to “domestic cosmetics,” “overseas cosmetics” and “others.” • “Cosmetics” includes toiletries, beauty salon products, health & beauty foods, and over-the-counter drugs, which had previously been included in “toiletries” and “others” segments. • “Cosmetics” with its wider product domain is divided into domestically-operated “domestic cosmetics” and overseas-operated “overseas cosmetics.” • “Others” include medical-use drugs, clothing, accessories, and other businesses that are not included in the scope of “domestic cosmetics” and “overseas cosmetics.” Through these changes, segments are reclassified to reflect the integration of cosmetics with its peripheral businesses and other internal organizational changes, and to clarify overseas cosmetics business results. Business segment information for years up to March 31, 2006 have been restated to retrospectively reflect changes in accounting policies for the year ended March 31, 2007. 64 SHISEIDO ANNUAL REPORT 2007 Notes to the Consolidated Financial Statements *** Effective for the year ended March 31, 2007, the Company has reassessed the segment allocation of its operating expenses. Certain administrative expenses and basic research and development expenses, etc., which had previously been included under the Elimination line as unallocatable operating expenses, are allocated to each segment. The Company also redefined certain intersegment transactions. By allocating all administrative expenses to each business, these changes aim to provide a more accurate presentation and disclosure of business segment results, in line with the reclassification in business segment reporting. Business segment information for years up to March 31, 2006 have been restated to retrospectively reflect changes in accounting policies for the year ended March 31, 2007. (2) Geographic Segment Information* The geographic segment information of the Companies for the years ended March 31, 2005, 2006 and 2007 is as follows. Millions of yen 2005 Japan Net sales Sales to outside customers ········· Transfer between geographical segments············· Total ·············································· Operating expenses** ···················· Operating income (loss) ·················· Total assets ··································· Americas Europe Asia/Oceania ¥467,027 ¥43,097 ¥79,776 ¥49,928 17,965 ¥484,992 472,515 ¥ 12,477 ¥316,626 7,621 ¥50,718 50,879 ¥ (161) ¥53,960 3,407 ¥83,183 78,138 ¥ 5,045 ¥87,497 164 ¥50,092 43,629 ¥ 6,463 ¥43,132 Elimination/ corporate Consolidation ¥639,828 — ¥639,828 29,157 ¥668,985 645,161 ¥ 23,824 ¥501,215 (29,157) ¥ (29,157) (31,862) ¥ 2,705 ¥199,880 — ¥639,828 613,299 ¥ 26,529 ¥701,095 Subtotal Millions of yen 2006 Japan Net sales Sales to outside customers ········· Transfer between geographical segments············· Total ·············································· Operating expenses** ···················· Operating income ··························· Total assets ··································· Americas Europe Asia/Oceania ¥475,654 ¥46,016 ¥85,573 ¥63,714 21,072 ¥496,726 472,699 ¥ 24,027 ¥309,246 8,476 ¥54,492 53,562 ¥ 930 ¥59,547 3,870 ¥89,443 84,065 ¥ 5,378 ¥84,696 84 ¥63,798 56,131 ¥ 7,667 ¥65,383 Elimination/ corporate Consolidation ¥670,957 — ¥670,957 33,502 ¥704,459 666,457 ¥ 38,002 ¥518,872 (33,502) ¥ (33,502) (34,379) ¥ 877 ¥152,970 — ¥670,957 632,078 ¥ 38,879 ¥671,842 Subtotal Millions of yen 2007 Japan Net sales Sales to outside customers ········· Transfer between geographical segments············· Total ·············································· Operating expenses** ···················· Operating income ··························· Total assets ··································· Americas Europe Asia/Oceania Subtotal ¥471,205 ¥51,730 ¥88,364 ¥83,295 ¥694,594 22,116 ¥493,321 465,986 ¥ 27,335 ¥337,145 8,139 ¥59,869 57,060 ¥ 2,809 ¥59,428 4,335 ¥92,699 86,388 ¥ 6,311 ¥95,801 112 ¥83,407 72,195 ¥11,212 ¥74,131 34,702 ¥729,296 681,629 ¥ 47,667 ¥566,505 Elimination/ corporate Consolidation — ¥694,594 (34,702) — ¥ (34,702) ¥694,594 (37,040) 644,589 ¥ 2,338 ¥ 50,005 ¥173,328 ¥739,833 Thousands of U.S. dollars (Note1.(1)) 2007 Net sales Sales to outside customers ········· Transfer between geographical segments············· Total ·············································· Operating expenses** ···················· Operating income ··························· Total assets ··································· Asia/Oceania Subtotal Elimination/ corporate Japan Americas Europe $3,990,219 $438,056 $748,277 $705,352 $5,881,904 187,281 $4,177,500 3,946,024 $ 231,476 $2,854,984 68,922 $506,978 483,191 $ 23,787 $503,243 36,709 $784,986 731,544 $ 53,442 $811,254 (293,861) 949 293,861 $706,301 $6,175,765 $ (293,861) (313,659) 611,356 5,772,115 $ 94,945 $ 403,650 $ 19,798 $627,750 $4,797,231 $1,467,762 Consolidation — $5,881,904 — $5,881,904 5,458,456 $ 423,448 $6,264,993 *** Classification of the geographic segments is determined by geographical location. *** Effective for the year ended March 31, 2007, the Company has reassessed the segment allocation of its operating expenses. Certain administrative expenses and basic research and development expenses, etc., which had previously been included under the Elimination line as unallocatable operating expenses, are allocated to each segment. The Company also redefined certain intersegment transactions. By allocating all administrative expenses to each geographic area, etc., these changes aim to provide a more accurate presentation and disclosure of geographic segment results, in line with the reclassification in geographic segment reporting. Geographic segment information for years up to March 31, 2006 have been restated to retrospectively reflect changes in accounting policies for the year ended March 31, 2007. SHISEIDO ANNUAL REPORT 2007 65 (3) Overseas Sales* Overseas sales of the Companies (which represent the exports made by the Company and its domestic consolidated subsidiaries and sales of its overseas consolidated subsidiaries) for the years ended March 31, 2005, 2006 and 2007, are as follows. Thousands of U.S. dollars (Note 1.(1)) Millions of yen 2005 2006 2007 ¥ 44,282 74,929 56,465 ¥175,676 ¥ 47,527 80,395 69,319 ¥197,241 ¥ 53,969 79,326 91,503 ¥224,798 2007 Overseas sales: Americas ·········································· Europe ················································ Asia/Oceania······································ ...................................................... Percentage of such sales against consolidated net sales ·························· 27.5% 29.4% $457,016 671,742 774,858 $1,903,616 32.4% 32.4% *** Classification of overseas sales is determined by geographical location. 18. SUBSEQUENT EVENT (Outsourcing of Logistics Operations and Transfer of Logistics Subsidiary and Fixed Assets) (1) Notice and Reason for Transfer Since April 2005, Shiseido has been implementing its three-year business plan aimed at maximizing growth potential and raising profitability. The plan calls for fundamental structural reforms to boost profitability, including reforms of its logistics system. Having duly considered such reforms, the Company decided to outsource this function to a dedicated logistics company in order to better address future changes in the logistics environment. The Company decided to treat this matter with urgency, as it would permit further increase in the quality and efficiency of its logistics services in response to the needs of structured retailers. On December 14, 2006, the Company’s Board of Directors resolved to outsource logistics operations currently performed by subsidiary Shiseido Logistics Company, Ltd., to Hitachi Transport System, Ltd. Under an arrangement proposed by Hitachi Transport System, this change will be accompanied by the transfer of Shiseido Logistics shares (90% of total shares outstanding) to Hitachi Transport System and of logistics-related facilities to ProLogis K.K. and Hitachi Capital Corporation (The transfers were executed on April 2, 2007). Details of these decisions are as follows. (2) Overview of Business Outsourcing Agreement ➀ Companies Involved Shiseido Company, Ltd. (the Company), 8 consolidated subsidiaries and 1 equity-method affiliate. ➁ Partners in Arrangement Name Hitachi Transport System, Ltd. Name Shiseido Logistics Company, Ltd. (Note) Representative Takao Suzuki Representative Shigeki Kubo Headquarters 7-2-18 Toyo, Koto-ku, Tokyo, Japan Headquarters 23-9 Higashi-Ohgishima, Kawasaki-ku, Kawasaki-shi, Kanagawa, Japan Main business System logistics (domestic and international) Main business Packing, transport, and storage of cosmetics and other products Relationship with Shiseido Logistics contractor for toiletry products Relationship with Shiseido Same as above Note: On April 2, 2007, Shiseido Logistics Co., Ltd. changed its name to Hitachi Collabonext Transport System Co., Ltd. ➂ Date of Agreement Conclusion March 22, 2007 ➃ Business Covered by Agreement Domestic logistics ➄ Significant Effects of Agreement on Business Activities, Etc. The effect of the agreement on the business results for the year ending March 31, 2008 is estimated to be minimal. ➅ Agreement Period April 2007 to March 2012 (5 years) (3) Share Transfer Agreement ➀ Company Involved Shiseido Company, Ltd. (the Company) 66 SHISEIDO ANNUAL REPORT 2007 Notes to the Consolidated Financial Statements ➁ Recipient of Share Transfer Name Hitachi Transport System, Ltd. Representative Takao Suzuki Headquarters 7-2-18 Toyo, Koto-ku, Tokyo, Japan Main business System logistics (domestic and international) Relationship with Shiseido Logistics contractor for toiletry products ➂ Date of Agreement Conclusion December 14, 2006 ➃ Date of Share Transfer April 2, 2007 ➄ Subsidiary Involved Name Shiseido Logistics Company, Ltd. (Note) Representative Shigeki Kubo Headquarters 23-9 Higashi-Ohgishima, Kawasaki-ku, Kawasaki-shi, Kanagawa, Japan Main business Packing, transport, and storage of cosmetics and other products Relationship with Shiseido Same as above Note: On April 2, 2007, Shiseido Logistics Co., Ltd. changed its name to Hitachi Collabonext Transport System Co., Ltd. ➅ Number of shares transferred, price of transfer, gain on transfer and share ownership following transfer Shares to be transferred 1,260 (90% of total shares outstanding) Transfer price ¥2,782 million ($23,558 thousand) Gain on transfer Shiseido expects to post a ¥2,309 million ($19,553 thousand) extraordinary gain on the share transfer for the year ending March 31, 2008 Share ownership following transfer 10% ➆ Other The Company sends 1 part-time director to the Board of Hitachi Collabonext Transport System Co., Ltd. (4) Fixed Assets Transfer Agreement ➀ Company Involved Shiseido Company, Ltd. (the Company) ➁ Assets Covered by Agreement Name and type of asset Logistics centers (9 locations), land, buildings, and machinery and equipment Book value ¥17,274 million ($146,278 thousand) Prior use Logistics centers ➂ Recipients of Transfer Land and Buildings Machinery and Equipment Name ProLogis Cosmos SPC Name Representative Kazuhiro Tsutsumi, Lee Kok Sun Representative Hitachi Capital Corporation Kazuo Takano Headquarters Shiodome City Center, 1-5-2, Higashi-Shimbashi, Minato-ku, Tokyo, Japan Headquarters 2-15-12, Nishi-Shimbashi, Minato-ku, Tokyo, Japan Main business Development, ownership, and operational management of logistics facilities Main business Finance and financial services Relationship with Shiseido None Relationship with Shiseido None ➃ Date of Agreement Conclusion February 28, 2007 ➄ Date of Transfer April 2, 2007 ➅ Transfer Price ¥18,269 million ($154,704 thousand) ➆ Gain/Loss on Transfer The effect of gain or loss from the transfer on Shiseido’s consolidated results in the year ending March 31, 2008 is estimated to be minimal. SHISEIDO ANNUAL REPORT 2007 67 Repor t of Independent Auditors To the Shareholders and Board of Directors of Shiseido Company, Limited: We have audited the accompanying consolidated balance sheet of Shiseido Company, Limited and consolidated subsidiaries as of March 31, 2007, and the related consolidated statements of operations, changes in net assets and cash flows for the year then ended, expressed in Japanese yen. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to independently express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements of Shiseido Company, Limited and consolidated subsidiaries for the years ended March 31, 2006 and 2005 were audited by other auditors whose report, dated June 29, 2006, expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in Japan. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2007 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Shiseido Company, Limited and subsidiaries as of March 31, 2007 and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in Japan. Without qualifying our opinion, we draw attention to the following: (1) As discussed in Note 2 (27) to the consolidated financial statements, effective for the year ended March 31, 2007, Shiseido Company, Limited applied Practical Solution on Application of Control Criteria and Influence Criteria to Investment Associations. (2) As discussed in Note 17 (1) to the consolidated financial statements, Shiseido Company, Limited changed the classification of business segments in the year ended March 31, 2007. The U.S. dollar amounts in the accompanying consolidated financial statements with respect to the year ended March 31, 2007 are presented solely for the convenience of the reader. Our audit also included the translation of yen amounts into U.S. dollars and, in our opinion, such translation has been made on the basis described in Note 1 to the consolidated financial statements. Tokyo, Japan June 26, 2007 68 SHISEIDO ANNUAL REPORT 2007 Corporate Information (As of March 31, 2007) Shareholders’ Meeting The Ordinary General Meeting of Shareholders is normally held in June in Tokyo. Head Office Shiseido Company, Limited 5-5, Ginza 7-chome, Chuo-ku Tokyo 104-0061, Japan Tel: +81-3-3572-5111 Stock Listings Common Stock: Tokyo Stock Exchange (Code: 4911) American Depositary Receipts: U.S. Over-the-Counter Foundation September 17, 1872 Accounting Auditors KPMG AZSA & Co. Incorporation June 24, 1927 Share Registrar The Chuo Mitsui Trust and Banking Company, Ltd. 33-1, Shiba 3-chome, Minato-ku, Tokyo 105-8574, Japan Capital ¥64,506,725,140 American Depositary Receipts CUSIP: 824841407 Ratio (ADR:ORD): 1:1 Exchange: OTC (Over-the-Counter) Symbol: SSDOY Depositary: The Bank of New York 101 Barclay Street New York, NY 10286, U.S.A. Tel: +1 (212) 815-8161 U.S. toll free: (888) 269-2377 http://www.adrbny.com Number of Employees 3,344 (27,460 for the Shiseido Group) Fiscal Year-End March 31 Common Shares Issued and Outstanding 424,562,353 (including 11,730,235 in treasury stock) Number of Shareholders 34,750 Principal Shareholders Composition of Shareholders Number of shares held (thousands) Shareholders Hero & Co. State Street Bank and Trust Company The Master Trust Bank of Japan, Ltd. (Trust Account) Mizuho Bank, Ltd. NIPPONKOA Insurance Company, Ltd. Asahi Mutual Life Insurance Company Japan Trustee Services Bank, Ltd. (Trust Account) Mizuho Corporate Bank, Ltd. Mitsui Sumitomo Insurance Company, Ltd. Nippon Life Insurance Company 24,883 22,798 21,506 17,226 13,112 12,079 11,614 11,382 10,211 9,747 Percentage of shareholding 5.86% 5.36 5.06 4.05 3.08 2.84 2.73 2.68 2.40 2.29 (by number of shares) Other Japanese Companies 5.22% Securities Companies Treasury Stock 2.76% Foreign Investors 1.65% Financial 30.94% Institutions 41.91% Individuals 17.52% In addition to the above, Shiseido Company, Limited holds 11,730 thousand shares of treasury stock. Monthly Share Price Range and Trading Volume (¥) 3,000 Share Price Trading Volume Change in Composition of Shareholders (Nikkei Stock Average) Nikkei Stock Average (Closing Price) 18,000 2,500 14,000 10,000 2,000 (Thousands of shares) 1,500 60,000 1,000 40,000 500 20,000 2006 2007 Foreign Investors 26.45 Individuals 18.96 Financial Institutions 44.97 Securities Companies 1.44 Other Japanese Companies 5.32 Treasury Stock 2.85 30.94 17.52 41.91 1.65 5.22 2.76 2006 2007 Foreign Investors 1.17 Individuals 96.67 Financial Institutions 0.42 Securities Companies 0.12 Other Japanese Companies 1.61 Treasury Stock 0.00 1.25 96.52 0.47 0.12 1.64 0.00 (By number of shares) (By number of shareholders) 0 0 04/04 05/04 For Further Information, Please Contact Investor Relations, Financial Department Shiseido Company, Limited 6-2, Higashi-shimbashi 1-chome Minato-ku, Tokyo 105-8310, Japan F a x : +81-3-6218-5544 E-mail: irmail@to.shiseido.co.jp 06/04 07/01 Website English Edition: http://www.shiseido.co.jp/e/ Japanese Edition: http://www.shiseido.co.jp/ Printed with soy ink approved by the American Soybean Association on 70% recycled paper.