HEIWA CORPORATION ANNUAL REPORT 2002
Transcription
HEIWA CORPORATION ANNUAL REPORT 2002
HEIWA CORPORATION ANNUAL REPORT 2002 January 1, 2002- December 31, 2002 Profile Heiwa Corporation was established in 1949, during the tumultuous period following World War II. Over the years, it has evolved into a comprehensive business that includes the development, manufacture and marketing of pachinko machines and automatic ball-replenishing systems, the development and marketing of pachislo machines, the development and marketing of computer systems and peripheral equipment for pachinko parlors, and pachinko parlor management consulting. The word “Heiwa” means “peace” in Japanese. The wartime experiences of the Company’s founder, Kenkichi Nakajima, strengthened his belief that peace is crucial for the well-being of all humankind and that the pachinko industry should be the symbol of peace. He named his company “Heiwa” after his deep-rooted belief. The value of Japan’s leisure market is calculated at over ¥85.0 trillion (US$708.3 billion), out of which pachinko ball “rental” charges amount to ¥28.7 trillion (US$239.2 billion). (Before playing the game of pachinko, players rent the necessary number of balls from the parlor, with the term “rental charges” signifying money paid during this transaction; approximately 80% to 90% of this money is returned to the players in the form of prizes.) With pachinko fans numbering 20.2 million, it is widely accepted as the “king” of recreation for the general public. Pachinko machines have continued to evolve to meet the demands of the game’s wide range of fans. Today they are the epitome of high-technology, equipped with Japan’s cutting-edge electronic devices such as microprocessors and color liquid crystal displays, not to mention their state-of-the-art mechanisms, software and components. Over the years, Heiwa has developed numerous innovative “hit” models of pachinko machines, and in August 1988 became the first firm in the industry to go public as an over-the-counter company. In December 1991, Heiwa qualified for registration on the Second Section of the Tokyo Stock Exchange (TSE), and in June 1997 its shares were moved to the TSE’s First Section. In August 2000, Heiwa became the first company in the pachinko and pachislo industry to obtain ISO9001 certification. With consolidated net sales of ¥98,384 million (US$820 million) for the fiscal year ended December 2002, and with consolidated subsidiaries that include manufacturers of electronic circuit boards which function as the “brain” of pachinko machines, as well as a company which manages pachinko parlors, the Heiwa Group has established itself as the leader in the Japanese pachinko industry. Guided by our theme of “High-Tech Recreation with a Warm Touch,” we will strive to merge our state-of-the-art electronics technology with strong human values while pursuing our quest for the ultimate in leisure and recreation. PACHINKO Pachinko is a form of gaming popular in Japan, with pachinko parlors commonly found in almost every Japanese neighborhood. Together with pachinko slot games (hereafter called pachislo), in 2002 pachinko/pachislo parlors in Japan numbered 16,504. Based on the Law on Control and Improvement of Amusement Business, Chapter 1, Section 7, a pachinko/pachislo parlor is defined as an amusement business that may stimulate customers’ ambitions. Since pachinko addiction has recently become a social issue, there has been a movement among pachinko/pachislo manufacturers to make the game more sound and healthy, and a self-imposed regulation for supplying less ambitious games is becoming widely accepted. CAUTIONARY STATEMENT WITH RESPECT TO FORWARD-LOOKING STATEMENTS Statements made in this annual report with respect to Heiwa’s current plans, estimates, strategies and beliefs, including any forecasts, are forward-looking statements about the future performance of Heiwa. These statements are based on management’s assumptions and beliefs in light of information currently available to it, and therefore, you should not place undue reliance on them. A number of important factors could cause actual results to be materially different from and worse than those discussed in the forward-looking statements. Such factors include but are not limited to (i) changes in economic conditions affecting our operations; (ii) fluctuations in currency exchange rates, particularly with respect to the value of the Japanese yen, the U.S. dollar and the euro; (iii) our ability to continue to win acceptance of our products, which are offered in highly competitive markets characterized by the continuous introduction of new products, rapid developments in technology and subjective and changing consumer preferences; (iv) regulatory developments and changes and our ability to respond and adapt to those changes; (v) our expectations with regard to further acquisitions and the integration of any companies we may acquire; and (vi) the outcome of contingencies. Contents Consolidated Financial Highlights ――1 To Our Shareholders ――2 Special Report: “Promoting Growth by Meeting Customer Needs” ――4 Review of Operations ――8 Market Trends in the Pachinko Industry ――11 Financial Review ――12 Consolidated Five-Year Financial Summary ――13 Consolidated Balance Sheets ――14 Consolidated Statements of Income ――16 Consolidated Statements of Shareholders’ Equity ――17 Consolidated Statements of Cash Flows ――18 Notes to Consolidated Financial Statements ――19 Independent Auditors’ Report ――28 Network and Subsidiaries ――29 Board of Directors ――29 Corporate Data ――29 00 Consolidated Financial Highlights Thousands of U.S. Dollars Millions of Yen 2002 Fiscal year ended December 31 Net sales Net income Total assets Total shareholders’ equity Per share data (yen and U.S. dollars): Net income per share Cash dividend per share Book value per share 2001 2002 ¥ 98,384 5,952 218,713 188,492 ¥ 97,468 5,917 219,778 187,936 $ 819,868 49,596 1,822,608 1,570,763 ¥ ¥ $ 0.43 0.21 13.58 $ 19.04 11.67 Financial ratios (percent): Equity ratio Return on sales Return on average assets Return on average equity 51.36 25.00 1,629 50.52 25.00 1,605 86.2 6.0 2.7 3.2 85.5 6.1 2.7 3.2 Prices quoted on the Tokyo Stock Exchange First Section (yen and U.S. dollars): High Low ¥ Number of shareholders Number of employees 2,285 1,400 14,668 880 ¥ 2,600 1,290 16,897 817 Note: U.S. dollar amounts are converted, for convenience only, at the rate of ¥120.00=US$1, the approximate rate of exchange at December 31, 2002. 100.6 12.9 97.5 98.4 213.2 213.8 91.2 226.4 219.8 218.7 68.0 6.4 5.9 6.0 ’01 ’02 4.2 ’98 ’99 ’00 ’01 Net Sales (Billions of Yen) ’02 ’98 ’99 ’00 Net Income (Billions of Yen) ’98 ’99 ’00 ’01 ’02 Total Assets (Billions of Yen) 1 To Our Shareholders Operating Results for Fiscal 2002 Jun Nakajima President 2 In fiscal 2002, ended December 31, 2002, Japan’s economy showed signs of improvement in some sectors, with a slight increase in exports and modest gains in manufacturing. Overall, however, conditions remained harsh and a full-fledged economic recovery is still not in sight. The nation’s struggle with low employment and declining income levels continued, and uncertainties about future prospects were heightened by the growing anxiety about the U.S. economy and the falling stock prices in Japan. The outlook for the pachinko industry, on the other hand, showed some signs of promise when in June 2002 the Japan Game Machine Industry Association (Nikkoso), whose members include pachinko machine manufacturers, amended its bylaws to substantially broaden the nature of gaming. Overall, however, conditions remained unfavorable. One new challenge facing the industry involves the Regulation Classification List published in August 2002. Based on the SelfRegulation Concerning Limited Gambling Recreational Gaming Machines established by the Japan Electric Game Manufacturers’ Association (Nichidenkyo), whose members include pachislo machine manufacturers, the Regulation Classification List specifies approximately 150 types of pachislo machines that will become subject to self-regulation. Against this background, in fiscal 2002 Heiwa’s consolidated net sales edged upward by 0.9% from the previous year’s level, to ¥98,384 million (US$820 million). Consolidated operating income fell by 38.9%, to ¥11,586 million (US$97 million), while consolidated net income rose by 0.6%, to ¥5,952 million (US$50 million). Looking at operating results by business segment, in the pachinko machines segment we focused our sales efforts on three new machine series. The Kaettekita Koumonchama series, which we launched in March 2002, was outfitted with a new-concept detachable housing that represents a dramatic upgrade from conventional pachinko machines. The Chiki Chiki Machine series was brought to market in April 2002. The Lupin The Third series, introduced in November 2002, became a runaway hit with sales reaching more than 120,000 units. Overall sales in this business were solid in the first half of the fiscal year, posting an 11.4% gain over the previous year’s level, to ¥63,734 million (US$531 million). Sales in the second half, however, fell short of our target due to such factors as reduced capital investment at pachinko parlors and self-imposed restrictions on purchasing new replacement models during the 2002 FIFA World CupTM soccer tournament, held in May and June. In the supply machines segment, sales increased by 19.5%, to ¥10,231 million (US$85 million), as the weak investment at pachinko parlors led to fewer commitments for new machines. In the amusement parlors segment, Heiwa’s sales were up by 20.9% from the previous year, reaching ¥11,262 million (US$94 million). In the pachislo machines segment, on the other hand, sales dropped by 41.6%, to ¥13,016 million (US$108 million). In May 2002 we introduced Fujiko 2, the industry’s first detachable pachislo machine. Despite our vigorous efforts to promote it, however, sales of Fujiko 2 fell short of the level we had hoped, due to the self-imposed restrictions on pachislo machines. Market Trends and Prospects for Fiscal 2003 Challenges and Outlook The game machine industry is likely to face challenges in the fiscal year ending December 31, 2003, in its efforts to stimulate demand beyond this past year’s level. Conditions in the pachinko parlor business are expected to remain bleak, due to both the continuation of Japan’s prolonged economic slump and the sales-dampening effects of the self-imposed restrictions on pachislo machines. Accordingly, we do not anticipate overall growth in demand in the pachinko and pachislo machine markets. Despite the cloudy outlook for our industry as a whole in fiscal 2003, we believe we will be able to boost our sales of pachinko machines. Our strategy includes improving the conditions for obtaining approval of new machines and, drawing on the results of our October 2002 review of the Company’s product planning and development system, quickly and aggressively introducing products that satisfy the demands of Japan’s pachinko enthusiasts. In addition, we plan to strengthen our business development and sales system alliance with Olympia Co., Ltd. This will allow us to boost our share of the pachislo machine market by offering attractive products such as our Pachislo Machine Named Antonio Inoki, which is enjoying immense popularity in the market. With regard to ball-replenishing systems, Heiwa has decided to set a more prudent sales target—one that reflects the diminishing capital investment at pachinko parlors resulting from Japan’s lingering recession and problems in raising funds from financial institutions. Altogether, these factors lead Heiwa to project that fiscal 2003 will see some improvement in consolidated operating results compared to fiscal 2002. Specifically, we expect net sales to increase by around 18.4%, to ¥116,500 million (US$971 million), operating income to grow by 46.7%, to ¥17,000 million (US$142 million), and net income to climb by 74.7%, to ¥10,400 million (US$87 million). Heiwa will address three key strategic issues in fiscal 2003. First, in line with one of our corporate principles, we will make our pachinko business more “customer-centered” while also stepping up efforts to develop new recreational game machines that deliver true customer satisfaction to both pachinko parlors and pachinko enthusiasts. Following the wideranging organizational review conducted last October, we consolidated our marketing research and planning functions into the Product Strategy Division and clarified the roles and responsibilities of this division relative to those of the Product Development Division. In fiscal 2003, the smooth operation of these two divisions will drive our efforts to plan and develop products that fully and accurately meet the diverse needs of our pachinko parlor and pachinko enthusiast customers. Second, we will increase our share of the pachislo machine market by forging even closer development and sales ties with Olympia Co., Ltd., our alliance partner. In addition, we will pursue our own in-house system for developing pachislo machines, and aiming to conform to the model-testing standards set by the Security Electronics and Communications Technology Association, we will work toward the establishment of a complete pachislo machine production system. In this regard, the detachable pachislo machine case we introduced in April 2002 has received high praise from pachinko parlors, because it not only helps lower costs and saves labor but also provides easier recycling. Third, we will address the question of how Heiwa, as a leading manufacturer of recreational game machines, can help promote higher recycling rates. We will make environmental protection a high priority in product development. Recreational game machines are subject to recycling regulations established under the Effective Use of Natural Resources Law amended in April 2001. Nikkoso has stated to the Ministry of Economy, Trade and Industry that it has established a self-imposed target of reusing or recycling 55% (by weight) of recreational game machines by fiscal 2005. Further, Nikkoso has declared its intent to establish a recycling management system that fulfills the responsibility of game machine manufacturers to increase the service lives of parts and materials in their products. In line with this program, in fiscal 2003 Heiwa will begin constructing a trade-in recovery system aimed at increasing the reuse of parts and materials in our machines, and will make “reduce, reuse and recycle” a key guideline in our product development system. These measures will not only benefit the environment today, they will also lead to lower product costs tomorrow. While we expect business conditions to remain quite difficult in fiscal 2003, we will continue formulating and implementing aggressive measures to strengthen Heiwa, meet shareholders’ expectations, and boost corporate value. We look forward to your kind understanding and support as we face the challenges ahead. MAIN COMPANIES IN THE HEIWA GROUP Heiwa Corp. Business and capital tie-up Wholly owned subsidiaries Amtex Co., Ltd. Olympia Co., Ltd. Shinko Co., Ltd. Joyco Systems Co., Ltd. Heiwa Insurance Inc. Jun Nakajima, President 3 Special Report Promoting Growth by Meeting Customer Needs In October 2002, Heiwa undertook a major restructuring effort aimed at the “creation of customer-centered machines” that in turn will spur our business into new growth. Since the restructuring, the Company has stepped up its activities in every department to provide value-added products and services that meet customer needs. Here, representatives of four divisions discuss the Company’s product planning and development processes, and the basic approach to the environment under the new system. Product Strategy Division Strengthening our checking system to create products that meet customer needs and ’ enjoy long-term success in the marketplace Yoshihisa Takada, Executive Manager (As of April 1, 2003) Yoshihisa Takada Executive Manager 4 The pachinko machine market today requires that we plan and develop products that meet customer needs as quickly as possible, and launch them in timely fashion into the market. Toward that end, we split the department that traditionally handled these activities into two divisions. The new Product Strategy Division is in charge of marketing research and planning. This includes such tasks as collecting information, analyzing market trends, negotiating with testing organizations, managing copyrights, and all other activities related to planning and creating new product proposals. The new Product Development Division oversees the actual development of products. We believe that dividing up the tasks and clarifying the roles in this way allows us to improve the quality of products and shorten development time. Today, after many years of developing recreational game machines, we are putting our focus back to where it began—on the “creation of customer-centered machines.” Our goal, and our most important challenge, is to develop the kinds of machines that pachinko parlors and pachinko enthusiasts can truly enjoy. For this purpose, the Product Strategy Division is trying to improve the “check system” up to the product launch, to grasp customer needs directly and quickly, and verify if the products under development actually satisfy these needs. Our first step in grasping customer needs was relocation. We moved our department to Tokyo, Japan’s largest pachinko market, to be in closer proximity to our customers. Then we focused on nurturing an environment for gathering information that would help us in our efforts. We distributed questionnaires to pachinko enthusiasts, interviewed pachinko parlor managers, consulted with marketing and salespeople, held meetings with customer companies, and attended a number of events and exhibitions. These and other activities are helping us stay aware of the latest social trends and gain a better understanding of what it takes to satisfy our customers. As part of setting up our check system, we strengthened our in-house Planning Approval Committee, the group that decides which products to develop and bring to market. Each manager of our department attends the committee’s meetings, and the decisions are made while the actual trial screens or samples are observed at the meetings, showing what a machine image or “face” looks like. At the same time, we spread information throughout the Company and urge employees to provide us feedback, suggestion and ideas. Prior to the approval of a new pachinko machine, we hold play-and-evaluate sessions at which employees are asked to look at a final prototype machine through the eyes of a pachinko enthusiast, try it out, and offer a frank assessment of its performance and appeal. At the end of these play-and-evaluate sessions if we are not convinced that a product is fully satisfactory, we reconsider its design. I firmly believe that this kind of double or triple checking is a key reason why Heiwa creates some of the best products on the market. In April 2003, we introduced Shenron Monogatari, the first product developed under this new system. This is the world’s first camera-equipped pachinko machine, which actually projects the player’s face onto the machine’s screen. We’re looking forward to developing more innovative products that will provide the best in leisure-time entertainment for pachinko enthusiasts. Product Development Division Accelerating the development process to get the product to market in a more timely manner Satoshi Taniguchi, General Manager (As of April 1, 2003) Our role in the Product Development Division is to design and develop a pachinko machine for commercialization by taking over plans from the Product Strategy Division. These processes involve a great number of different skills and activities. For example, the pachinko machine’s “face” or board surface—the part that customers see—needs a creative design. There’s also design and development of the machine’s internal hardware and software, and design and control of the pictures that will appear on the liquid crystal display (LCD) panel. And there are such secondary works as creating the documentation, including the machine’s specifications, that must be presented along with a prototype machine to the testing organizations. Our goal is to reduce the time it takes from planning to development. Before, when a single division of the Company handled the whole process, large blocks of time were allotted to planning. As a result, post-planning activities often fell behind schedule during the development phase. Our new structure, such as responsibilities between two divisions, makes it much easier to focus on the development process. There’s no more worrying about schedule delays. The biggest issue the Product Development Division must address today is further improvements in development speed. Even if we quickly formulate plans for an attractive product, but we do not execute them as soon as possible and launch products into the market in a timely manner, we will be unable to seize business opportunities. We have made three changes in our approach to improve our performance. First, we introduced the team system. Before, we were using a project system that means an engineer from each department such as drawing and designing was assigned to a project for developing the model. But since the skills and creative abilities of any one individual are limited, we have decided to shift to a team approach. For example, we’ve created teams, such as a design team and an artwork team, and adopted a style of undertaking development while team members exchange opinions among themselves. Second, we will utilize more outsourcing. We have a plan to broaden the scope of outsourcing from previous artwork and CG to the one including some designing division works. And third, we are strengthening our verification function during the prototype production stage to avoid problems in the final development phase. Our new arrangement demands early verification timing and swift decision-making. However, shorter development time is not sufficient for creating products that provide true customer satisfaction. It’s vital that we link the planning and development aspects of product creation Satoshi Taniguchi General Manager 5 so that they work smoothly together. That’s why we regularly hold joint sessions with the Product Strategy Division, exchange ideas and share information using a videoconference system. This structure, with two separate divisions working close together, will help Heiwa introduce innovative pachinko machines to the market ahead of its competitors. Pachislo Machine Development Division Creating our own development system to promote substantial growth in the pachislo machine business Kenji Hiramatsu, General Manager (As of April 1, 2003) Kenji Hiramatsu General Manager 6 Heiwa entered the pachislo machine business through a business tie-up with Olympia Co., Ltd. in 1998. This cooperative arrangement, in which Olympia handles product development and manufacturing while Heiwa handles sales, has helped us achieve steady growth and earn a solid reputation and position within the industry. Now, with the pachislo machine market expected to see continuous growth, we feel the time is right for us to initiate full-scale in-house development and manufacturing of pachislo machines. Our goals are to boost our share of the market and develop the pachislo machine business into our second cornerstone operation. To spearhead this exciting new project, the Pachislo Machine Development Division was created in October 2002. The division was given responsibility for activities ranging from product planning and development to submitting applications to testing organizations and providing manufacturing support. It works to produce attractive and unique pachislo machines in close cooperation with the Company’s Product Strategy Division, which handles marketing and pachislo machine planning, and the Sales and Marketing Headquarters. Aiming to register as a pachislo machine manufacturer in 2003 and introduce products to the market in 2004, we have nearly completed developing the prototype of a product. We are making steady progress in our preparations for a full-scale market entry, including the construction of a new mass-production manufacturing line. Heiwa has three distinct advantages to the pachislo machine market. First, we have the outstanding marketing capabilities that we’ve cultivated in our many years of pachinko machine sales and in our sales of pachislo machines through our alliance with Olympia. All our sales representatives sell both pachinko machines and pachislo machines. We are miles ahead of competitors, with our marketing style that directly supports parlors’ management needs while analyzing total balance of pachinko and pachislo machines there. Second, in our years of production pachinko machines we’ve acquired the expertise to create attractive, customer-pleasing products within the limits of regulations. And third, we expect that our pachinko machine operations will provide synergistic benefits in terms of parts procurement. That is, utilizing the routes the Company has already established will provide us with more favorable purchasing terms than our competitors. We believe that in-house development has several big advantages, especially in light of the cost advantages offered by pachislo machines compared with pachinko machines. A pachislo machine has a simpler basic structure, for example, and so we can keep manufacturing capital investment low. Also, there’s a great deal of similarity between different types of pachislo machines, so we can design parts that can be used in more than one type of machine and thus reduce the risk of having excess inventory. To consistently develop new models, we need the abilities to plan innovative products and get those products to market quickly, to take advantage of every sales opportunity. We believe that working closely with other Company divisions and recruiting efficient staff will give us those abilities. And by adding up sales of current Olympia-made pachinko machines and our future inhouse-developed ones, we are convinced that our division can enjoy significant success and make a valuable contribution to corporate earnings. Environmental Coordination Division Aiming to both realize the recycling-oriented society and reduce costs by reusing parts from recovered products Tsutomu Ochiai General Manager Tsutomu Ochiai, General Manager (As of April 1, 2003) At Heiwa, our basic approach to the environment is to strive to find the ideal position for manufacturers in the coming recycling-oriented society and to make environment-friendliness a key consideration in the product development process. The Environmental Coordination Division promotes 3R, “reduce, reuse and recycle,” in this direction. Our activities include promotion product design that reflects the “reduce, reuse and recycle” concept and setting up systems to recover pachinko machines and other products and recycle or reuse them. Over many years of concern for the environment, we’ve sought to use parts and materials with low environmental impact, and we’ve had some experience with recycling parts of used pachinko machines to create solid fuel (thermal recycling). To expand this process, one area that we’re focusing on ahead of others in the industry involves the reuse of internal parts from retired pachinko machines into newly developed machines. We have already conducted two studies aimed at determining the durability and quality of recovered parts and finding ways to reuse them. One result is that we’ve learned we can reuse electrical components, including expensive LCD units, and certain plastic components. However, to increase our reuse percentage, we must consider reusing the parts from the stage of developing and designing the products. That’s a topic we plan to focus on. Reusing components is not only good for the environment, it’s also recognized as an excellent way to reduce manufacturing costs. Lower overhead means that Heiwa can offer products at attractive prices and give more satisfaction to pachinko parlors. So our company policy will be to aggressively develop systems in the future that allow maximum recycling and reuse of parts and materials from the standpoint of “creation of customer-centered machines.” 7 Review of Operations Pachinko Machines Sales Results During fiscal 2002, the general market environment in the pachinko machines segment reflected the weak demand for capital investment at pachinko parlors. At the same time, the industry set a self-imposed restriction on new model replacements during the 2002 FIFA World CupTM soccer tournament, held in May and June. Finally, problems with the main unit housing on some of the Company’s pachinko machines introduced during fiscal 2001 resulted in lower sales. Under these circumstances, the Company focused its sales efforts on its Kaettekita Koumonchama series, which was launched in March 2002 with a new main unit housing based on a fresh concept that revamped the conventional pachinko machine image, the Chiki Chiki Machine series brought to market in April 2002, and the Lupin The Third series, which became a runaway-hit model following its introduction in November 2002 and achieved sales that broke the 120,000-unit mark. As a result of these factors, the Company sold 318,808 machines in 2002 (138,167 in the first half and 180,641 in the second half), 24,684 fewer machines than in the previous year. Net sales of pachinko machines increased by 11.4% compared to the previous fiscal year, to ¥63,734 million (US$531 million); ¥28,354 million (US$236 million) in the first half, and ¥35,380 million (US$295 million) in the second half. Consolidated operating income fell by 22.0%, to ¥13,891 million (US$116 million). Prospects for the Next Term Pachinko machine Lupin The Third In fiscal 2003, Japan’s lengthy economic recession will cast a shadow over the nation’s recreational game machine market. Given these circumstances, we do not anticipate further market growth. As pachinko parlor operators strive to attract customers in the wake of increasing competition, pachinko parlors are expected to become more discriminating in their product selection. Following the wide-ranging organizational review conducted last October, the Company improved its “product power” and shortened its product development period through product planning enhancements. By rapidly introducing attractive products that cater accurately to pachinko enthusiasts’ needs, management believes that the Company will be able to achieve pachinko machine sales exceeding the level achieved in 2002. Based on these circumstances, for fiscal 2003 the Company has set a combined sales objective for pachinko machines and gauge boards of 360,000 units and net sales of ¥66,000 million (US$550 million), up by 3.6% from the fiscal year under review. Pachinko machine PX2002 (future model) 8 Supply Machines Sales Results The pachinko parlor business continued to operate under difficult industry conditions during 2002. The desire to undertake capital investment in ballreplenishing systems, including computer-related devices, remained particularly weak. Although this presented fewer sales opportunities, the Company achieved strong positive results, and net sales in the supply machines segment rose by 19.5% compared to the previous fiscal year, to ¥10,231 million (US$85 million); ¥4,540 million (US$38 million) in the first half and ¥5,690 million (US$47 million) in the second half. Operating income was ¥198 million (US$2 million). Prospects for the Next Term Joyco Systems Co., Ltd., a joint venture firm funded by eight manufacturers including Heiwa, began sales of its prepaid-coin system in January 2002. The number of pachinko parlors that have introduced this system continues to grow steadily, which is contributing to increased sales in the Company’s supply machines division. With expected capital investment at pachinko parlors weakening in the face of various difficulties, including the lingering recession and problems in raising funds from financial institutions, however, conditions are likely to be similar to the previous year in terms of large-scale, high-volume sales. In consideration of these conditions, the Company has established a prudent sales objective for its supply machines division, projecting net sales of ¥8,000 million (US$67 million), a decrease of 21.8% compared to the previous year. Joyco System (Joyco) Pachislo Machines Sales Results In the pachislo machines segment, the Company concentrated its sales efforts on Fujiko 2, the industry’s first detachable pachislo machine, which was introduced in May 2002. The number of machines sold, however, did not increase due to the effect of the industry’s self-imposed restrictions on pachislo machines. During the year, the Company sold 41,831 machines (20,851 in the first half and 20,980 in the second half), a decline of 27,715 machines compared to the previous fiscal year. Net sales were 41.6% lower than the previous fiscal year, at ¥13,016 million (US$108 million); ¥6,619 million (US$55 million) in the first half and ¥6,397 million (US$53 million) in the second half. Operating income dropped by 70.3% from the previous fiscal-year level, to ¥1,419 million (US$12 million). Prospects for the Next Term Given the likelihood that the effects of the self-imposed restrictions on pachislo machines since last August will linger in the pachislo machine market during fiscal 2003, the trend in replacement demand will probably be slightly negative. In the pachislo machine segment, our Pachislo Machine Named Antonio Inoki, which we put on the market in January 2003, has become a smash hit. By strengthening our development and sales system tie-up with alliance partner Olympia Co., Ltd. in the future, we believe we can expand our market share. During fiscal 2003, we aim to sell 120,000 pachislo machines, and increase net sales by 138.2% over the previous fiscal year, to ¥31,000 million (US$258 million). Pachislo machine Pachislo Machine Named Antonio Inoki 9 Amusement Parlors Sales Results This business segment consists of pachinko parlor management operations at the Company’s wholly owned consolidated subsidiary, Shinko Co., Ltd. Given the influence of the prolonged economic downturn, we did not expect an increase in the amount of recreational game spending per pachinko player. Furthermore, competition among pachinko parlors was gradually intensifying, creating a situation in which pachinko parlors battled to attract and retain customers by means such as improving the rate of returns to pachinko players and staging newly remodeled parlor opening events based on rapid replacement with new models. In these conditions, the segment recorded net sales of ¥11,262 million (US$94 million); ¥5,707 million (US$48 million) in the first half and ¥5,555 million (US$46 million) in the second half. This was an increase of 20.9% compared to the previous fiscal year. Operating income rose by 892.3%, to ¥129 million (US$1 million). Prospects for the Next Term The three pachinko parlors managed by Shinko fulfill the role of “antenna shops” for Heiwa’s products. During the past year, however, competition to attract customers has grown severe as competitors have opened large-scale parlors in suburban neighborhoods. Pachinko parlors enjoy the patronage of pachinko enthusiasts who live or work within approximately 30 minutes’ travel time of the pachinko parlor. Thus, to differentiate Heiwa’s parlors from those of nearby rivals, management is working to improve its ability to attract customers by reviewing the composition of installed machines, staging renewal reopening events, attracting new pachinko enthusiasts, building an efficient management system and improving the rate of return to the Company’s customers. Based on the above efforts, the Company plans to increase net sales of recreational gaming facilities by 1.8%, to ¥11,400 million (US$95 million) compared to the previous year. Others Sales Results The Company’s business operations in this segment include leasing, reinsurance and investment activities. Combined net sales for these operations increased by 60.2%, to ¥141 million (US$1,176 thousand); ¥77 million (US$642 thousand) in the first half and ¥64 million (US$533 thousand) in the second half. The combined operating loss was ¥50 million (US$414 thousand). 10 Showroom (Tokyo Branch Office) Market Trends in the Pachinko Industry 5,000 20,000 1,000 200 4,000 16,000 800 160 3,000 12,000 600 120 2,000 8,000 400 80 1,000 4,000 200 40 0 ’98 ’99 ’00 ’01 Number of Pachinko and Pachislo Machines Installed (Thousands) Pachinko machines Pachislo machines Source: The National Police Agency. ’02 0 ’98 ’99 ’00 ’01 Number of Parlors Pachinko parlors Parlors specializing in pachislo Note: “Pachinko parlors” includes Note: parlors featuring both pachinko Note: and pachislo machines. Source: The National Police Agency. ’02 0 ’99 ’00 ’01 Estimated Market Value of the Pachinko and Pachislo Markets (Billions of Yen) Pachinko Pachislo Source: Yano Research Institute. 0 ’99 ’00 ’01 Market Size of BallReplenishing Systems and Peripheral Products (Billions of Yen) Pachinko machines Source: Yano Research Institute. 11 Financial Review Please note that Heiwa’s business segment information included in this report is derived from the management reports of the Company and its subsidiaries, which are based on accounting principles and practices generally accepted in Japan (“Japanese GAAP”). Analysis of Operating Results Heiwa’s consolidated net sales for fiscal 2002 rose by 0.9%, or ¥916 million (US$8 million) in comparison with the previous year, to ¥98,384 million (US$820 million). By segment, sales of pachinko machines advanced by 11.4%, or ¥6,516 million (US$54 million), to ¥63,734 million (US$531 million). Supply machines increased by 19.5%, or ¥1,670 million (US$14 million), to ¥10,231 million (US$85 million). Revenues from amusement parlors surged by 20.9%, or ¥1,950 million (US$16 million), to ¥11,262 million (US$94 million). Sales of pachislo machines, however, dropped by 41.6%, or ¥9,273 million (US$77 million), to ¥13,016 million (US$108 million), and fell to 13.2% of consolidated net sales, compared with 22.9% a year earlier. The cost of sales rose by ¥6,577 million (US$55 million), or 10.7%, to ¥67,848 million (US$565 million). Gross profit declined by ¥5,661 million (US$47 million), or 15.6%, to ¥30,536 million (US$254 million), and the gross margin fell to 31.0% from 37.1%. Selling, general and administrative (SG&A) expenses were up by 9.9%, or ¥1,700 million (US$14 million), to ¥18,950 million (US$158 million). SG&A expenses as a percentage of net sales rose to 19.3% from 17.7% a year earlier. Research and development costs (which are included in SG&A expenses) were up by 18.5%, or ¥709 million (US$6 million), to ¥4,535 million (US$38 million). Operating income dropped by ¥7,361 million (US$61 million), or 38.9%, to ¥11,586 million (US$97 million), and the operating margin decreased to 11.8% from 19.4%. Nonoperating expenses exceeded nonoperating income by ¥953 million (US$8 million), an improvement compared with the previous year’s net nonoperating expenses of ¥8,158 million, which had included a sizeable loss on devaluation of inventories. Nonoperating expenses for the fiscal year under review consisted primarily of a loss on devaluation of inventories of ¥1,576 million (US$13 million), a foreign exchange loss of ¥927 million (US$8 million), retirement benefits for directors and corporate auditors of ¥292 million (US$2 million), and a loss on sales or disposals of property, plant and equipment—net of ¥283 million (US$2 million). Owing to the decrease in net nonoperating expenses compared with the previous year, income before income taxes was down by just 1.4%, or ¥156 million (US$1 million), to ¥10,633 million (US$89 million). Total income taxes also declined, to ¥4,681 million (US$39 million), a drop of ¥191 million (US$2 million), or 3.9%. Total income taxes comprised current income taxes of ¥3,248 million (US$27 million) and deferred income taxes of ¥1,433 million (US$12 million). As a result of the above, the Company recorded net income of ¥5,952 million (US$50 million), up by 0.6%, or ¥35 million (US$292 thousand). Net income per share improved to ¥51.36 (US$0.43), compared with ¥50.52 a year earlier. Cash dividends applicable to the year were maintained at ¥25.00 (US$0.21). The payout ratio was 48.7%, compared with 49.5% a year earlier. Analysis of Financial Position Total assets fell by 0.5%, or ¥1,065 million (US$9 million), to ¥218,713 million (US$1,823 million). Total current assets declined by ¥14,104 million (US$118 million), or 11.4%, to ¥110,083 million (US$917 million). Total current assets comprised 50.3% of total assets, compared with 56.5% the prior year. 12 Cash and cash equivalents declined by 26.6%, or ¥14,612 million (US$122 million) from a year earlier, to ¥40,304 million (US$336 million). Time deposits dropped by 46.4%, or ¥3,272 million (US$27 million), to ¥3,783 million (US$32 million). Marketable securities rose by 20.3%, or ¥3,460 million (US$29 million), to ¥20,523 million (US$171 million). Notes and accounts receivable, net of an allowance for doubtful accounts, rose by 14.9%, or ¥4,139 million (US$34 million), to ¥32,006 million (US$267 million). Inventories declined by 15.6%, or ¥1,866 million (US$16 million), to ¥10,104 million (US$84 million). Net property, plant and equipment totaled ¥22,570 million (US$188 million), virtually unchanged from the prior year, and comprised 10.3% of total assets, versus 10.4% the year before. Total investments and other assets expanded by 18.5%, or ¥13,411 million (US$112 million), to ¥86,060 million (US$717 million). Investment securities rose by 18.7%, or ¥11,037 million (US$92 million), to ¥70,035 million (US$584 million). Total investments and other assets comprised 39.3% of total assets, compared with 33.1% the prior year. Total current liabilities declined by 5.5%, or ¥1,685 million (US$14 million), to ¥28,891 million (US$241 million), primarily because of a drop in trade notes payable of ¥2,843 million (US$24 million), or 28.2%, to ¥7,237 million (US$60 million). Trade accounts payable increased by ¥611 million (US$5 million), or 4.1%, to ¥15,377 million (US$128 million). Total current liabilities comprised 95.6% of total liabilities, compared with 96.0% a year earlier. The current ratio declined to 381% from 406%. Total long-term liabilities rose by ¥64 million (US$533 thousand), to ¥1,330 million (US$11 million), and consisted mainly of liability for employees’ retirement benefits of ¥724 million (US$6 million) and warranty reserves of ¥415 million (US$3 million). Total shareholders’ equity rose by ¥556 million (US$5 million), or 0.3%, to ¥188,492 million (US$1,571 million). During the fiscal year under review, the Company retired a total of 1,321 thousand shares of its common stock, representing approximately 1.1% of the shares outstanding at the start of the fiscal year, with an aggregated purchase amount of ¥2,467 million (US$21 million), canceling the shares by charging the amount to retained earnings. The equity ratio improved to 86.2% from 85.5%. Analysis of Cash Flow Net cash provided by operating activities advanced by 54.9%, to ¥7,169 million (US$60 million). Income before income taxes provided ¥10,633 million (US$89 million), and depreciation and amortization comprised ¥2,406 million (US$20 million). Major changes in assets and liabilities included an increase in trade notes and accounts receivable of ¥3,783 million (US$32 million), income taxes paid of ¥2,379 million (US$20 million), a decrease in trade notes and accounts payable of ¥2,215 million (US$18 million) and a decrease in inventories of ¥1,866 million (US$16 million). Net cash used in investing activities totaled ¥16,110 million (US$134 million), down by 3.7% from the prior year. Major components of investing activities during the fiscal year under review included purchases of investment securities of ¥39,879 million (US$332 million) and proceeds from sales of investment securities of ¥23,419 million (US$195 million). Net cash used in financing activities rose by 15.0%, to ¥5,018 million (US$42 million), of which cash dividends paid comprised ¥2,906 million (US$24 million) and purchases of treasury stocks comprised ¥2,112 million (US$18 million). For the year, the Company recorded a net decrease in cash and cash equivalents of ¥14,612 million (US$122 million). At the fiscal year-end, cash and cash equivalents amounted to ¥40,304 million (US$336 million). Consolidated Five-Year Financial Summary Fiscal year ended December 31 Balance-sheet data: Total assets Total current assets Net property, plant and equipment Total investments and other assets Total current liabilities Total long-term liabilities Total shareholders’ equity 2002 Millions of Yen (except where noted) 2001 2000 1999 1998 ¥ 218,713 110,083 22,570 86,060 28,891 1,330 188,492 ¥ 219,778 124,187 22,942 72,649 30,576 1,266 187,936 ¥ 226,388 188,715 22,676 14,997 39,351 278 186,759 ¥ 213,775 182,792 22,872 8,111 27,332 391 186,052 ¥ 213,226 170,205 34,951 8,070 30,149 131 182,946 ¥ 98,384 63,734 10,231 13,016 11,262 141 67,848 30,536 18,950 11,586 4,681 5,952 ¥ 97,468 57,218 8,561 22,289 9,312 88 61,271 36,197 17,250 18,947 4,872 5,917 ¥ 100,589 65,891 9,085 15,347 10,143 123 59,709 40,880 15,849 25,031 11,091 12,914 ¥ 91,246 62,153 8,677 9,232 10,570 614 55,111 36,135 14,032 22,103 5,210 6,427 ¥ 67,966 47,966 6,737 Per share data: Net income per share (yen) Cash dividend per share (yen) Book value per share (yen) Payout ratio (percent) ¥ 51.36 25.00 1,629 48.7 ¥ 50.52 25.00 1,605 49.5 ¥ 107.77 25.00 1,591 23.2 ¥ 52.53 27.50 1,521 47.6 ¥ 34.22 25.00 1,495 80.4 Stock-related data: Stock price quoted on the TSE First Section: High (yen) Low (yen) Price-earnings ratio (high) (times) Price-earnings ratio (low) (times) Weighted average number of shares (thousands) Number of shareholders (persons) ¥ 2,285 1,400 44.5 27.3 115,870 14,668 ¥ 2,600 1,290 51.5 25.5 117,114 16,897 ¥ 2,470 1,400 22.9 13.0 119,832 20,970 ¥ 3,870 1,150 73.7 21.9 122,360 19,507 ¥ 1,500 1,001 43.8 29.3 122,360 7,430 Efficiency: Gross margin (percent) Operating margin (percent) Return on sales (percent) Return on average assets (percent) Return on average equity (percent) SG&A expenditures as a % of net sales (percent) Net sales per employee 31.0 11.8 6.0 2.7 3.2 19.3 112 37.1 19.4 6.1 2.7 3.2 17.7 119 40.6 24.9 12.8 5.9 6.9 15.8 116 39.6 24.2 7.0 3.0 3.5 15.4 108 32.6 16.0 6.2 2.1 2.3 16.7 72 ¥ 81,192 8,358 86.2 381 ¥ 93,611 7,742 85.5 406 ¥ 149,364 14,666 82.5 480 ¥ 155,460 8,396 87.0 669 ¥ 140,056 6,252 85.8 565 ¥ 2,225 2.3 4,535 4.6 880 ¥ 3,188 3.3 3,826 3.9 817 ¥ 2,284 2.3 3,276 3.3 870 ¥ 4,583 5.0 2,406 2.6 848 ¥ 2,909 4.3 2,147 3.2 946 Income statement data: Net sales Pachinko machines Supply machines Pachislo machines Amusement parlors Other Cost of sales Gross profit Selling, general and administrative expenses Operating income Income taxes Net income Liquidity: Working capital Cash flow* Equity ratio (percent) Current ratio (percent) Other: Capital expenditure Capital expenditure as a % of net sales (percent) R&D costs R&D costs as a % of net sales (percent) Number of employees (persons) 12,080 1,183 45,783 22,183 11,324 10,859 6,527 4,187 * Cash flow = Net income plus depreciation and amortization. 13 Consolidated Balance Sheets December 31, 2002 and 2001 Thousands of U.S. Dollars (Note 1) 2002 Millions of Yen ASSETS CURRENT ASSETS: Cash and cash equivalents Time deposits Marketable securities (Note 3) Notes and accounts receivable: Notes receivable—trade Accounts receivable—trade Accounts receivable—other Allowance for doubtful accounts Inventories (Note 4) Deferred tax assets—current (Note 7) Prepaid expenses and other Total current assets PROPERTY, PLANT AND EQUIPMENT: Land Buildings and structures Machinery and equipment Furniture and fixtures Construction in progress Total Accumulated depreciation Net property, plant and equipment INVESTMENTS AND OTHER ASSETS: Investment securities (Note 3) Investments in unconsolidated subsidiaries and associated companies Deferred tax assets—non-current (Note 7) Other assets (Note 5) Allowance for doubtful accounts Total investments and other assets TOTAL See notes to consolidated financial statements. 14 2002 2001 ¥ 40,304 3,783 20,523 ¥ 54,916 7,055 17,063 $ 335,865 31,525 171,024 23,587 7,630 807 (18) 10,104 2,825 538 110,083 16,070 11,314 493 (10) 11,970 4,431 885 124,187 196,561 63,579 6,727 (147) 84,199 23,542 4,482 917,357 10,872 13,351 3,098 6,321 10 33,652 (11,082) 22,570 10,872 13,198 2,921 5,775 14 32,780 (9,838) 22,942 90,600 111,255 25,821 52,672 85 280,433 (92,352) 188,081 70,035 58,998 583,625 535 2,002 13,560 (72) 86,060 10 1,738 12,016 (113) 72,649 4,458 16,682 113,001 (596) 717,170 ¥ 218,713 ¥ 219,778 $ 1,822,608 Thousands of U.S. Dollars (Note 1) 2002 Millions of Yen LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Notes and accounts payable: Notes payable—trade Accounts payable—trade Accounts payable—other Income taxes payable Accrued expenses Deferred tax liabilities—current (Note 7) Other current liabilities Total current liabilities LONG-TERM LIABILITIES: Liability for employees’ retirement benefits (Note 6) Warranty reserves Deferred tax liabilities—non-current (Note 7) Other long-term liabilities Total long-term liabilities SHAREHOLDERS’ EQUITY (Note 9): Common stock, no par value— authorized, 228,903 thousand shares in 2002 and 230,224 thousand shares in 2001; issued, 115,743 thousand shares in 2002 and 117,064 thousand shares in 2001 Additional paid-in capital Retained earnings Unrealized (loss) gain on available-for-sale securities Foreign currency translation adjustments Total Treasury stock—at cost, 323 thousand shares in 2002 and 500 thousand shares in 2001 Total shareholders’ equity TOTAL 2002 ¥ 2001 7,237 15,377 2,192 2,996 340 13 736 28,891 ¥ 10,080 14,766 2,337 2,127 659 14 593 30,576 $ 60,310 128,141 18,269 24,965 2,832 112 6,134 240,763 724 415 25 166 1,330 563 600 35 68 1,266 6,036 3,455 209 1,382 11,082 16,755 16,675 155,720 (78) (68) 189,004 16,755 16,675 155,356 65 (48) 188,803 139,625 138,958 1,297,664 (648) (571) 1,575,028 (512) 188,492 (867) 187,936 (4,265) 1,570,763 ¥ 218,713 ¥ 219,778 $ 1,822,608 15 Consolidated Statements of Income Years Ended December 31, 2002 and 2001 2002 2001 Thousands of U.S. Dollars (Note 1) 2002 ¥ 98,384 ¥ 97,468 $ 819,868 COST OF SALES Gross profit 67,848 30,536 61,271 36,197 565,401 254,467 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (Note 10) Operating income 18,950 11,586 17,250 18,947 157,914 96,553 1,631 (927) (1,576) 1,257 653 (8,601) 13,593 (7,724) (13,131) (283) 58 (961) (600) (2,363) 487 Millions of Yen NET SALES OTHER INCOME (EXPENSES): Interest and dividend income Foreign exchange (loss) gain Loss on devaluation of inventories Loss on sales or disposals of property, plant and equipment—net Reversal of (provision for) warranty reserves Charge for full amount of transitional obligation for retirement benefits Retirement benefits for directors and corporate auditors Other—net Other expenses—net INCOME BEFORE INCOME TAXES INCOME TAXES (Note 7): Current Deferred Total income taxes NET INCOME (307) (292) 436 (953) 401 (8,158) (2,435) 3,631 (7,942) 10,633 10,789 88,611 3,248 1,433 4,681 8,187 (3,315) 4,872 27,071 11,944 39,015 ¥ 5,952 ¥ 5,917 $ 49,596 Yen PER SHARE OF COMMON STOCK (Note 2.q): Net income Cash dividends applicable to the year See notes to consolidated financial statements. 16 ¥ 51.36 25.00 U.S. Dollars ¥ 50.52 25.00 $ 0.43 0.21 Consolidated Statements of Shareholders’ Equity Years Ended December 31, 2002 and 2001 Thousands BALANCE, JANUARY 1, 2001 Outstanding Number of Shares of Common Stock 117,360 Millions of Yen Common Stock Additional Paid-in Capital Retained Earnings ¥ 16,755 ¥ 16,675 ¥ 153,329 Net income 5,917 Cash dividends, ¥25 per share Bonuses to directors and corporate auditors (2,930) (407) Net changes in unrealized gain on available-for-sale securities Unrealized Foreign (Loss) Gain on Currency Available-for-sale Translation Securities Adjustments ¥ 65 Net changes in foreign currency translation adjustments Purchase of treasury stock ¥ (48) ¥ (1,420) (796) Retirement of treasury stock (296 thousand shares) BALANCE, DECEMBER 31, 2001 (553) 116,564 16,755 16,675 155,356 Net income 5,952 Cash dividends, ¥25 per share Bonuses to directors and corporate auditors (2,904) (217) Net increase in unrealized loss on available-for-sale securities Net changes in foreign currency translation adjustments Purchase of treasury stock Retirement of treasury stock (1,321 thousand shares) BALANCE, DECEMBER 31, 2002 Treasury Stock 553 65 (48) (867) (143) (20) (1,144) (2,112) 2,467 (2,467) 115,420 ¥ 16,755 ¥ 16,675 ¥ 155,720 ¥ (78) ¥ (68) ¥ (512) Thousands of U.S. Dollars (Note 1) Common Stock BALANCE, DECEMBER 31, 2001 $ 139,625 Additional Paid-in Capital $ 138,958 Net income Cash dividends, $0.21 per share Retained Earnings $ 1,294,630 Unrealized Foreign (Loss) Gain on Currency Available-for-sale Translation Securities Adjustments $ 543 $ (7,222) 49,596 (24,198) Bonuses to directors and corporate auditors Net increase in unrealized loss on available-for-sale securities (1,804) (1,191) Net changes in foreign currency translation adjustments (171) Purchase of treasury stock Retirement of treasury stock BALANCE, DECEMBER 31, 2002 $ (400) Treasury Stock (17,603) 20,560 (20,560) $ 139,625 $ 138,958 $ 1,297,664 $ (648) $ (571) $ (4,265) See notes to consolidated financial statements. 17 Consolidated Statements of Cash Flows Years Ended December 31, 2002 and 2001 Millions of Yen 2002 OPERATING ACTIVITIES: Income before income taxes Adjustments for: Income taxes paid Depreciation and amortization Loss on sales or disposals of property, plant and equipment—net Reversal of allowance for doubtful accounts Provision for retirement allowances (Reversal of) provision for warranty reserves Bonuses to directors and corporate auditors Foreign exchange loss Changes in assets and liabilities: (Increase) decrease in notes and accounts receivable—trade Decrease (increase) in inventories Decrease in notes and accounts payable—trade Other—net Total adjustments Net cash provided by operating activities INVESTING ACTIVITIES: Purchases of property, plant and equipment Purchases of investment securities Proceeds from sales of investment securities Proceeds from time deposits Investments in venture capital funds Investments in life insurance funds Proceeds from cancellation of life insurance funds Decrease in other assets Net cash used in investing activities FINANCING ACTIVITIES: Purchases of treasury stocks Cash dividends paid Net cash used in financing activities FOREIGN CURRENCY TRANSLATION ADJUSTMENTS ON CASH AND CASH EQUIVALENTS NET DECREASE IN CASH AND CASH EQUIVALENTS CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR (Note 2.b) CASH AND CASH EQUIVALENTS, END OF YEAR See notes to consolidated financial statements. 18 2001 Thousands of U.S. Dollars (Note 1) 2002 ¥ 10,633 ¥ 10,789 $ 88,611 (2,379) 2,406 (15,807) 1,825 (19,828) 20,053 360 (33) 161 (185) (216) 633 1,098 (389) 563 600 (408) 2,998 (279) 1,346 (1,544) (1,804) 5,272 (3,783) 1,866 (2,215) (79) (3,464) 7,169 9,481 (521) (1,669) (933) (6,160) 4,629 (31,525) 15,553 (18,460) (656) (28,874) 59,737 (2,478) (39,879) 23,419 3,015 (11) (3,434) 1,200 2,058 (16,110) (2,695) (46,620) 29,829 5,219 (1,150) (1,671) 357 (16,731) (20,647) (332,328) 195,155 25,127 (92) (28,612) 10,004 17,148 (134,245) (2,112) (2,906) (5,018) (1,419) (2,943) (4,362) (17,603) (24,217) (41,820) (653) (14,612) 38 (16,426) (5,442) (121,770) 54,916 71,342 457,635 ¥ 40,304 ¥ 54,916 $ 335,865 Notes to Consolidated Financial Statements Years Ended December 31, 2002 and 2001 1. BASIS OF PRESENTING CONSOLIDATED FINANCIAL STATEMENTS The accompanying consolidated financial statements of Heiwa Corporation (the “Company”) and consolidated subsidiaries have been prepared in accordance with the provisions set forth in the Japanese Securities and Exchange Law and its related accounting regulations, and in conformity with accounting principles and practices generally accepted in Japan (“Japan GAAP”), which are different in certain respects as to application and disclosure requirements of International Financial Reporting Standards. The consolidated financial statements are not intended to present the financial position, results of operations and cash flows in accordance with accounting principles and practices generally accepted in countries and jurisdictions other than Japan. In preparing these consolidated financial statements, certain reclassifications and rearrangements have been made to the consolidated financial statements of the Company and its consolidated subsidiaries issued domestically in order to present them in a form which is more familiar to readers outside Japan. In addition, certain reclassifications and rearrangements have been made in the 2001 consolidated financial statements to conform to the classifications used in 2002. The consolidated financial statements are stated in Japanese yen, the currency of the country in which the Company is incorporated and operates. The translations of Japanese yen amounts into U.S. dollar amounts are included solely for the convenience of readers outside Japan and have been made at the rate of ¥120.00 to $1, the approximate rate of exchange at December 31, 2002. Such translations should not be construed as representations that the Japanese yen amounts could be converted into U.S. dollars at that or any other rate. 2. SIGNIFICANT ACCOUNTING POLICIES a. Consolidation—The accompanying consolidated financial statements as of December 31, 2002 include the accounts of the Company and its four significant (three in 2001) subsidiaries (together, the “Group”). Under the control or influence concept, those companies in which the Company, directly or indirectly, is able to exercise control over operations are fully consolidated, and those companies over which the Company has the ability to exercise significant influence are accounted for by the equity method. a. Investments in the remaining one (nil in 2001) unconsolidated subsidiary and one (one in 2001) associated company are stated at cost. If the equity method of accounting had been applied to the investments in these companies, the effect on the accompanying consolidated financial statements would not be material. a. All significant intercompany balances and transactions have been eliminated in consolidation. All material unrealized profit included in assets resulting from transactions within the Group is eliminated. a. On August 9, 2002, the Company established Meteor LLC (“Meteor”), a wholly owned subsidiary of the Company. Meteor’s main business is to perform investment activities through life insurance funds for the Company’s directors. a. On March 27, 2001, the Company established HEIWA INSURANCE INC. (“HII”). The Company holds 100% of the shares of HII. HII’s main business is to provide captive insurance as one of the risk management techniques for the Group. b. Cash Equivalents—Cash equivalents are short-term investments that are readily convertible into cash and that are exposed to insignificant risk of changes in value. Cash equivalents include time deposits, certificate of deposits, money market mutual funds, midterm government bond funds and call loans that represent short-term investments, all of which mature or become due within three months of the date of acquisition. c. Marketable and Investment Securities—Marketable and investment securities are classified and accounted for, depending on management’s intent, as follows: (1) held-to-maturity debt securities, which are expected to be held to maturity with the positive intent and ability to hold to maturity are reported at amortized cost, and (2) available-for-sale securities, which are not classified as the aforementioned securities, are reported at fair value, with unrealized gains and losses, net of applicable taxes, reported in a separate component of shareholders’ equity. a. Non-marketable available-for-sale securities are stated at cost determined by the moving-average method. For other than temporary declines in fair value, investment securities are reduced to net realizable value by a charge to income. d. Inventories—Merchandise and manufacturing inventories are principally stated at cost determined by the average method. Supplies are principally stated at the most recent purchase price which approximates cost determined by the first-in, first-out method. e. Property, Plant and Equipment—Property, plant and equipment are stated at cost. Depreciation is computed on the declining-balance method over the estimated useful lives of assets. Estimated useful lives are as follows: Buildings and structures 8 to 50 years Machinery and equipment 3 to 11 years Furniture and fixtures 2 to 15 years f. Other Assets—Intangible assets, goodwill and prepaid expenses—non-current are carried at cost less accumulated amortization, which is calculated by the straight-line method principally over 5 to 20 years for intangible assets, 5 years for goodwill and 1 to 15 years for prepaid expenses—non-current. Computer software used for internal purpose is recorded at cost less accumulated amortization and is amortized by the straight-line method over 5 years, the estimated useful life of the software. 19 g. Allowance for Doubtful Accounts—The allowance for doubtful accounts is stated in amounts considered to be appropriate based on the Group’s past credit loss experience and an evaluation of potential losses in the receivables outstanding. h. Employees’ Retirement Benefit—The Group has a non-contributory funded pension plan covering substantially all of its employees. The liability for employees’ retirement benefits is accounted for based on projected benefit obligations and plan assets at the balance sheet date. a. In addition to the above pension plan, the Company has a special retirement payment plan under which additional retirement payments will be made and expensed to employees who contribute distinguished services to the Company for a long period of time. i. Warranty Reserves—The warranty reserves are stated in amounts considered to be appropriate based on an evaluation of potential warranty expenses in the products sold. j. Leases—All leases are accounted for as operating leases. Under Japan GAAP for leases, finance leases that deem to transfer ownership of the leased property to the lessee are to be capitalized, while other finance leases are permitted to be accounted for as operating lease transactions if certain “as if capitalized” information is disclosed in the notes to the lessee’s financial statements. k. Income Taxes—The provision for income taxes is computed based on the pretax income included in the consolidated statements of income. The asset and liability approach is used to recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred taxes are measured by applying currently enacted tax laws to the temporary differences. l. Accounting for Consumption Tax—The consumption tax imposed on revenue from customers for the Group’s services is withheld by the Group at the time of receipt and subsequently paid to the national government. The consumption tax withheld upon recognition of revenue and the consumption tax paid by the Group on the purchase of products, merchandise and services from vendors, are not included in the related accounts in the accompanying consolidated statements of income. The consumption tax paid is generally offset against the balance of consumption tax withheld, and net overpayment is included in current assets and net over withholding is included in current liabilities. m. Appropriations of Retained Earnings—Appropriations of retained earnings are reflected in the accompanying consolidated statements of shareholders’ equity for the following year upon shareholders’ approval. Semiannual interim dividends paid upon resolution of the Board of Directors are reflected in the respective years. n. Foreign Currency Transaction—All short-term and long-term monetary receivables and payables denominated in foreign currencies are translated into Japanese yen at the exchange rates at the balance sheet date. The foreign exchange gains and losses from translation are recognized in the consolidated statements of income to the extent that they are not hedged by forward exchange contracts. o. Foreign Currency Financial Statements—The balance sheet accounts of the consolidated foreign subsidiaries are translated into Japanese yen at the current exchange rate as of the balance sheet date except for shareholders’ equity, which is translated at the historical rate. Differences arising from such translation were shown as “Foreign currency translation adjustments” in a separate component of shareholders’ equity. Revenue and expense accounts of consolidated foreign subsidiaries are translated into yen at the average exchange rate. p. Derivative Financial Instruments—The Group uses derivative financial instruments (“derivatives”) to manage their exposure to fluctuation in foreign exchange rate. Foreign exchange forward contracts are utilized by the Group to reduce foreign currency exchange risk. The Group does not enter into derivatives for trading or speculative purposes. a. Japan GAAP require that: (a) all derivatives be recognized as either assets or liabilities and measured at fair value, and gains or losses on derivative transactions are recognized in the statement of income and (b) for derivatives used for hedging purposes, if derivatives qualify for hedge accounting because of high correlation and effectiveness between the hedging instruments and the hedged items, gains or losses on derivatives are deferred until maturity of the hedged transactions. The foreign exchange forward contracts employed to hedge foreign exchange exposures are measured at the fair value and the unrealized gains/losses are recognized in income. q. Per Share Information—The computation of net income per share is based on the weighted average number of shares of common stock outstanding during each year. The weighted average number of common shares used in the computation was 115,870 thousand shares for 2002 and 117,114 thousand shares for 2001. Diluted net income per common share is not disclosed because no convertible bonds or warrants are issued. Cash dividends per common share presented in the accompanying consolidated statements of income are dividends applicable to the respective years including dividends to be paid after the end of the year. 3. MARKETABLE AND INVESTMENT SECURITIES Marketable and investment securities at December 31, 2002 and 2001 consisted of the following: 2002 2001 Thousands of U.S. Dollars 2002 Current: Debt securities Trust fund investments and other Total ¥ 5,015 15,508 ¥ 20,523 ¥ 2,001 15,062 ¥ 17,063 $ 41,795 129,229 $ 171,024 Non-current: Equity securities Debt securities Trust fund investments and other Total ¥ 5,209 64,726 100 ¥ 70,035 ¥ 5,227 45,487 8,284 ¥ 58,998 $ 43,407 539,386 832 $ 583,625 Millions of Yen 20 The carrying amounts and aggregate fair values of marketable and investment securities at December 31, 2002 and 2001 were as follows: Millions of Yen Cost December 31, 2002 Securities classified as: Available-for-sale: Equity securities Debt securities Other Held-to-maturity ¥ Unrealized Gains 231 68,275 13,342 1,758 ¥ 36 518 272 91 Unrealized Losses ¥ 54 809 127 Fair Value ¥ 213 67,984 13,487 1,849 December 31, 2001 Securities classified as: Available-for-sale: Equity securities Debt securities Other Held-to-maturity 212 5,089 13,727 50,416 39 73 41 210 5,162 13,256 50,434 471 270 288 Thousands of U.S. Dollars December 31, 2002 Securities classified as: Available-for-sale: Equity securities Debt securities Other Held-to-maturity $ Cost Unrealized Gains Unrealized Losses 1,928 568,957 111,186 14,649 $ 303 4,318 2,268 762 $ 456 6,742 1,064 Fair Value $ 1,775 566,533 112,390 15,411 Available-for-sale securities and held-to-maturity securities whose fair value is not readily determinable as of December 31, 2002 and 2001 were as follows: Carrying Amount Millions of Yen 2002 ¥ 4,996 2,000 120 ¥ 7,116 Available-for-sale: Equity securities Certificate of deposits Held-to-maturity—Certificate of deposits Total 2001 ¥ 5,017 2,000 ¥ 7,017 Thousands of U.S. Dollars 2002 $ 41,631 16,666 1,005 $ 59,302 Proceeds from sales of available-for-sale securities for the years ended December 31, 2002 and 2001 were ¥68,375 million ($569,791 thousand) and ¥58,774 million, respectively. Gross realized gains and losses on these sales, computed on the moving average cost basis, were ¥22 million ($185 thousand) and zero, respectively, for the year ended December 31, 2002 and ¥198 million and ¥17 million, respectively, for the year ended December 31, 2001. The carrying values of debt securities by contractual maturities for securities classified as available-for-sale and held-to-maturity at December 31, 2002 are as follows: Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Total Millions of Yen AvailableHeld-tofor-Sale Maturity Thousands of U.S. Dollars AvailableHeld-tofor-Sale Maturity ¥ 5,000 48,575 10,843 4,000 ¥ 68,418 $ 41,667 404,788 90,358 33,333 $ 570,146 ¥ 434 1,409 ¥ 1,843 $ 3,615 11,747 $ 15,362 As a result of consideration of the holding purpose concerning investment securities held as of January 1, 2002, the Group decided to reclassify a portion of held-to-maturity debt securities into available-for-sale securities. The effect of the change in the classification and accounting for investments was to increase marketable securities, investment securities and deferred tax assets—non-current as of December 31, 2002 and income before income taxes for the year ended December 31, 2002, by ¥6 million ($47 thousand), ¥545 million ($4,538 thousand), ¥96 million ($801 thousand) and ¥775 million ($6,457 thousand), respectively, and to decrease deferred tax assets—current and unrealized gain on available-for-sale securities by ¥2 million ($19 thousand) and ¥131 million ($1,091 thousand), respectively, as compared with the amounts that would have been recognized had the prior method been used. 21 4. INVENTORIES Inventories at December 31, 2002 and 2001 consisted of the following: Thousands of U.S. Dollars Millions of Yen 2002 ¥ 3,007 43 6,718 336 ¥ 10,104 Finished products and merchandise Work in process Raw materials Supplies Total 2001 771 400 10,488 311 ¥ 11,970 2002 $ 25,062 361 55,978 2,798 $ 84,199 ¥ 5. OTHER ASSETS Other assets at December 31, 2002 and 2001 consisted of the following: Thousands of U.S. Dollars Millions of Yen 2002 ¥ 2,402 101 11,057 ¥ 13,560 Intangible assets Long-term loans receivable Others Total 2001 ¥ 2,558 153 9,305 ¥ 12,016 2002 $ 20,013 842 92,146 $ 113,001 6. EMPLOYEES’ RETIREMENT BENEFITS Under the Group’s pension plan, employees terminating their employment are entitled to lump-sum payments or an annuity from the pension fund based on their rates of pay at the time of termination and years of service. If the termination is involuntary or caused by retirement at the mandatory retirement age, the employee is usually entitled to greater payments than in the case of voluntary termination. The liability for employees' retirement benefits at December 31, 2002 and 2001 consisted of the following: Thousands of U.S. Dollars 2002 $ 21,799 (14,023) (1,740) $ 6,036 Millions of Yen 2002 ¥ 2,616 (1,683) (209) ¥ 724 Projected benefit obligation Fair value of plan assets Unrecognized actuarial gain Net liability 2001 ¥ 2,405 (1,628) (214) ¥ 563 The components of net periodic benefit costs are as follows: Thousands of U.S. Dollars Millions of Yen 2002 ¥ 178 60 (41) 214 Service cost Interest cost Expected return on plan assets Recognized actuarial loss Amortization of transitional obligation Premium severance pay Net periodic benefit costs 1 ¥ 412 2001 ¥ 164 67 (37) 2002 $ 1,486 497 (339) 1,787 307 11 $ 3,442 ¥ 501 Assumptions used for the years ended December 31, 2002 and 2001 are set forth as follows: 2002 Discount rate Expected rate of return on plan assets Attribution of projected benefit obligation to periods of service Recognition period of actuarial gain/loss Amortization period of transitional obligation 22 2.0% (2.5% at the beginning of the fiscal year) 2.0% (2.5% at the beginning of the fiscal year) The projected unit credit method 1 year (amortized in the following fiscal year) 2001 2.5% (3.0% at the beginning of the fiscal year) 2.5% The projected unit credit method 1 year (amortized in the following fiscal year) 1 year 7. INCOME TAXES The Company and its domestic subsidiaries are subject to Japanese national and local income taxes which, in the aggregate, resulted in a normal effective statutory tax rate of 41.7% in 2002 and 2001. The tax effects of significant temporary differences which resulted in deferred tax assets and liabilities at December 31, 2002 and 2001 are as follows: Millions of Yen Current: Deferred tax assets: Loss on devaluation of inventories Accrued enterprise tax Accrued expenses Inventories Marketable and investment securities denominated in foreign currencies Unrealized profit Others Subtotal Deferred tax liabilities: Marketable and investment securities denominated in foreign currencies Unrealized gain on available-for-sale securities Unrealized loss Subtotal Net deferred tax assets 2002 2001 ¥ 2,072 255 89 218 ¥ 3,938 200 104 90 $ 17,266 2,124 746 1,821 227 14 13 2,888 5 147 4,484 1,889 116 106 24,068 63 13 76 ¥ 2,812 41 12 14 67 ¥ 4,417 527 111 638 $ 23,430 Millions of Yen Non-current: Deferred tax assets: Nondeductible amortization expense of deferred assets for income tax purpose Nondeductible depreciation expense of tangible fixed assets for income tax purpose Liability for employees’ retirement benefits Intangible asset Nondeductible depreciation expense of small depreciable assets for income tax purpose Loss on disposals of fixed assets Warranty reserves Loss on devaluation of investment securities Loss on devaluation of investments in venture capital funds Unrealized loss on available-for-sale securities Unrealized profit Others Subtotal Deferred tax liabilities: Marketable and investment securities denominated foreign currencies Unrealized gain on available-for-sale securities Appropriations Unrealized loss Subtotal Net deferred tax assets Thousands of U.S. Dollars 2002 2002 2001 Thousands of U.S. Dollars 2002 ¥ 146 ¥ 169 $ 1,216 136 301 944 133 234 529 1,132 2,510 7,869 129 44 173 66 97 344 250 61 1,079 368 1,442 547 73 121 129 6 2,268 45 134 28 2,024 605 1,010 1,072 50 18,900 236 232 1,970 2 43 10 291 ¥ 1,977 34 46 9 321 ¥ 1,703 19 355 83 2,427 $ 16,473 The amounts of current and non-current deferred tax assets and liabilities on the balance sheets at December 31, 2002 and 2001 are as follows: Millions of Yen Current: Deferred tax assets Deferred tax liabilities Net deferred tax assets Non-current: Deferred tax assets Deferred tax liabilities Net deferred tax assets Thousands of U.S. Dollars 2002 2001 2002 ¥ 2,825 13 ¥ 2,812 ¥ 4,431 14 ¥ 4,417 $ 23,542 112 $ 23,430 ¥ 2,002 25 ¥ 1,977 ¥ 1,738 35 ¥ 1,703 $ 16,682 209 $ 16,473 23 A reconciliation between the normal effective statutory tax rate and the actual effective tax rate reflected in the accompanying statements of income for the years ended December 31, 2002 and 2001 is as follows: 2002 Normal effective statutory tax rate 41.7 % Expenses not deductible for income tax purposes 1.7 % Inhabitant taxes—per capita 0.4 % Other—net 0.2 % Actual effective tax rate 44.0 % consolidated 2001 41.7 % 1.4 % 0.3 % 1.6 % 45.0 % 8. LEASES The Group leases certain machinery, equipment, furniture and fixtures. Total lease payments under finance leases that do not transfer ownership of the leased property to the lessee were ¥180 million ($1,500 thousand) and ¥201 million for the years ended December 31, 2002 and 2001, respectively. Pro forma information of leased property under finance leases such as acquisition cost including the imputed interest expense portion, accumulated depreciation, obligation under finance lease and depreciation expense of finance leases that do not transfer ownership of leased property to the lessee on an “as if capitalized” basis for the years ended December 31, 2002 and 2001, was as follows: Millions of Yen 2002 Furniture and Fixtures ¥ 383 204 ¥ 179 Acquisition cost Accumulated depreciation Net leased property Machinery and Equipment ¥ 280 137 ¥ 143 Acquisition cost Accumulated depreciation Net leased property Thousands of U.S. Dollars 2002 Machinery Furniture and and Equipment Fixtures Total $ 2,332 $ 3,195 $ 5,527 1,143 1,698 2,841 $ 1,189 $ 1,497 $ 2,686 Total ¥ 663 341 ¥ 322 2001 Furniture and Fixtures ¥ 547 331 ¥ 216 Machinery and Equipment ¥ 347 152 ¥ 195 Total ¥ 894 483 ¥ 411 Obligations under finance leases including the imputed interest expense portion: Millions of Yen Due within one year Due after one year Total 2002 ¥ 129 193 ¥ 322 2001 ¥ 146 265 ¥ 411 Thousands of U.S. Dollars 2002 $ 1,073 1,613 $ 2,686 Depreciation expense under finance leases: Millions of Yen Depreciation expense 2002 ¥ 180 2001 ¥ 201 Thousands of U.S. Dollars 2002 $ 1,500 Depreciation expense, which are not reflected in the accompanying consolidated statements of income, is computed by the straight-line method. The minimum rental commitments under noncancelable operating leases at December 31, 2002 were as follows: Millions of Yen Due within one year Due after one year Total 9. SHAREHOLDERS’ EQUITY ¥ 317 173 ¥ 490 Thousands of U.S. Dollars $ 2,642 1,440 $ 4,082 Japanese companies are subject to the Japanese Commercial Code (the “Code”) to which certain amendments became effective from October 1, 2001. Prior to October 1, 2001, the Code required at least 50% of the issue price of new shares, with a minimum of the par value thereof, to be designated as stated capital as determined by resolution of the Board of Directors. Proceeds in excess of amounts designated as stated capital were credited to additional paid-in capital. Effective October 1, 2001, the Code was revised and common stock par values were eliminated resulting in all shares being recorded with no par value. 24 Prior to October 1, 2001, the Code also provided that an amount at least equal to 10% of the aggregate amount of cash dividends and certain other cash payments which are made as an appropriation of retained earnings applicable to each fiscal period shall be appropriated and set aside as a legal reserve until such reserve equals 25% of stated capital. Effective October 1, 2001, the revised Code allows for such appropriations to be set aside as a legal reserve until the total additional paid-in capital and legal reserve equals 25% of stated capital. The amount of total additional paid-in capital and legal reserve which exceeds 25% of stated capital can be transferred to retained earnings by resolution of the shareholders, which may be available for dividends. The Company’s legal reserve amount, which is included in retained earnings, totals ¥3,486 million ($29,048 thousand) and ¥3,486 million as of December 31, 2002 and 2001, respectively. Under the Code, companies may issue new common shares to existing shareholders without consideration as a stock split pursuant to a resolution of the Board of Directors. Prior to October 1, 2001, the amount calculated by dividing the total amount of shareholders’ equity by the number of outstanding shares after the stock split could not be less than ¥50. The revised Code eliminated this restriction. Prior to October 1, 2001, the Code imposed certain restrictions on the repurchase and use of treasury stock. Effective October 1, 2001, the Code eliminated these restrictions allowing companies to repurchase treasury stock by a resolution of the shareholders at the general shareholders meeting and dispose of such treasury stock by resolution of the Board of Directors after March 31, 2002. The repurchased amount of treasury stock cannot exceed the amount available for future dividend plus amount of stated capital, additional paid-in capital or legal reserve to be reduced in the case where such reduction was resolved at the general shareholders meeting. The Code permits companies to transfer a portion of additional paid-in capital and legal reserve to stated capital by resolution of the Board of Directors. The Code also permits companies to transfer a portion of unappropriated retained earnings, available for dividends, to stated capital by resolution of the shareholders. Dividends are approved by the shareholders at a meeting held subsequent to the fiscal year to which the dividends are applicable. Semiannual interim dividends may also be paid upon resolution of the Board of Directors, subject to certain limitations imposed by the Code. The Company repurchased a total of 323 thousand shares of the Company’s common stock at the aggregate amount of ¥511 million ($4,257 thousand) during the period from December 3, 2002 to December 20, 2002, through the Tokyo Stock Exchange. Upon resolution and approval of the Board of Directors on November 29, 2002, the Company was authorized to repurchase the Company’s common stock with no par value at an upper limit of 400 thousand shares or ¥700 million ($5,833 thousand). On March 29, 2002, the Company retired a total of 1,321 thousand shares of the treasury stock with the aggregated repurchase amount of ¥2,467 million ($20,560 thousand) by charging to retained earnings. At the general shareholders meeting held on March 27, 2002, the Company’s shareholders approved the Company to repurchase the Company’s common stock with no par value at an upper limit of 5 million shares or ¥12.5 billion ($104 million), for the purpose of retiring the shares by charging such amounts to retained earnings. The Company repurchased a total of 361 thousand shares of the Company’s common stock at the aggregate amount of ¥708 million ($5,889 thousand) during the period from February 14, 2002 to March 8, 2002 and a total of 460 thousand shares at the aggregate amount of ¥893 million ($7,441 thousand) during the period from January 8, 2002 to February 8, 2002, through the Tokyo Stock Exchange for the purpose of retiring the shares by charging such amounts to retained earnings. As of March 8, 2002, the accumulated number and the aggregate amount of the Company’s treasury stock were 1,321 thousand shares and ¥2,467 million ($20,560 thousand), respectively. Upon resolution and approval of the Board of Directors on December 14, 2001, the Company repurchased a total of 500 thousand shares of the common stock with no par value at the aggregate purchase amount of ¥866 million through the Tokyo Stock Exchange on December 17, 2001, for the purpose of retiring the shares by charging such amounts to retained earnings. The Company was also authorized to repurchase, upon resolution and approval of the Board of Directors, the Company’s common stock with no par value at an upper limit of 1.5 million shares or the aggregate amount of ¥3 billion. Upon resolution and approval of the Board of Directors held on February 27, 2001, the Company was authorized to repurchase the Company’s common stock with no par value at an upper limit of 1 million shares or the aggregate repurchase amount of ¥2 billion for the period from February 28, 2001 to March 19, 2001 through the Tokyo Stock Exchange, for the purpose of retiring the shares by charging such amounts to retained earnings. The Company eventually repurchased a total of 296 thousand shares of the stock at the aggregate repurchase amount of ¥553 million, and then all the stock was retired on March 27, 2001. 10. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses for the years ended December 31, 2002 and 2001, consisted of the following: Millions of Yen Sales commissions Advertisement Payroll Research and development costs Depreciation and amortization Others Total 2002 ¥ 1,359 1,392 2,768 4,535 839 8,057 ¥ 18,950 2001 ¥ 1,430 1,129 2,824 3,826 899 7,142 ¥ 17,250 Thousands of U.S. Dollars 2002 $ 11,320 11,603 23,067 37,787 6,993 67,144 $ 157,914 All research and development costs were included in selling, general and administrative expenses for the fiscal year 2002 and 2001. 11. DERIVATIVE FINANCIAL INSTRUMENTS The Group enters into foreign currency forward contracts to hedge foreign exchange risk associated with certain assets and liabilities denominated in foreign currencies. It is the Group’s policy to use derivatives only for the purpose of reducing market risks associated with assets and liabilities. The Group does not hold or issue derivatives for trading purposes. Derivatives are subject to market risk and credit risk. Market risk is the exposure created by potential fluctuations in market conditions, including interest or foreign exchange rates. Credit risk is the possibility that a loss may result from a counterparty’s failure to perform according to the terms and conditions of the contract. Because the counterparties to those derivatives are limited to financial institutions with high rating, the Group does not anticipate any losses arising from credit risk. Derivative transactions entered into by the Group have been made in accordance with internal policies which regulate the authorization and credit limit amount. Each derivative transaction is reported to the chief financial officer and, if necessary, to the Board of Directors. The contract or notional amounts of derivatives which are shown in the following table do not represent the amounts exchanged by the parties and do not measure the Group’s exposure to credit or market risk. 25 Fair Value of Derivative Financial Instruments The fair value of the derivative financial instruments at December 31, 2002 is as follows: Contract Amount ¥ 54,417 35,437 ¥ 89,854 Foreign currency forward contracts: Receivables—U.S. dollars Payables—U.S. dollars Total Millions of Yen 2002 Fair Value ¥ 53,743 34,792 ¥ 88,535 Unrealized Gain/(Loss) ¥ 674 (645) ¥ 29 Thousands of U.S. Dollars 2002 Contract Fair Amount Value Foreign currency forward contracts: Receivables—U.S. dollars Payables—U.S. dollars Total $ 453,476 295,311 $ 748,787 Unrealized Gain/(Loss) $ 447,856 289,938 $ 737,794 $ 5,620 (5,373) $ 247 The fair value in the above table is based on forward quotation. 12. RELATED PARTY TRANSACTIONS Transactions with related parties which consisted primarily of associated subcontractors for the years ended December 31, 2002 and 2001 were as follows: Millions of Yen 2002 ¥ 20 94 Sales—trade Purchases 2001 ¥ 21 88 Thousands of U.S. Dollars 2002 $ 163 780 The balances due to and from these associated companies at December 31, 2002 and 2001 consisted of the following: Millions of Yen 2002 ¥ 12 3 Notes and accounts receivable—trade Accounts payable—other 2001 ¥ 11 1 Thousands of U.S. Dollars 2002 $ 97 24 13. SEGMENT INFORMATION The Group operates in the following business segments: (1) Pachinko machines—Pachinko machines and gauge boards of pachinko machines (2) Supply machines—Pachinko ball replenishing systems and computers for pachinko parlors (3) Pachislo machines—Pachislo machines (4) Amusement parlors— Operation of amusement parlors (5) Other———————Leasing, reinsurance, investments and other Information about business segments, geographical segments and sales to foreign customers of the Group for the years ended December 31, 2002 and 2001, is as follows: (1) Business Segment Information a. Sales and Operating Income Sales to customers Intersegment sales Total sales Operating expenses Operating income (loss) Pachinko Machines ¥ 63,734 13,779 77,513 63,622 ¥ 13,891 Supply Machines ¥ 10,231 42 10,273 10,075 ¥ 198 Millions of Yen 2002 Pachislo Amusement Other Machines Parlors ¥ 13,016 ¥ 11,262 ¥ 141 10 237 11,262 378 13,026 11,133 428 11,607 ¥ 129 ¥ (50) ¥ 1,419 b. Total Assets, Depreciation and Capital Expenditures Total assets Depreciation Capital expenditures ¥ 73,821 1,844 1,787 ¥ 5,334 95 49 ¥ 7,417 26 34 26 ¥ 6,698 169 224 ¥ 1,662 2 Eliminations/ Corporate Consolidated ¥ 98,384 ¥ (14,068) 98,384 (14,068) 86,798 (10,067) ¥ (4,001) ¥ 11,586 ¥ 123,781 215 131 ¥ 218,713 2,351 2,225 a. Sales and Operating Income Sales to customers Intersegment sales Total sales Operating expenses Operating income (loss) Pachinko Machines $ 531,118 114,823 645,941 530,179 $ 115,762 Supply Machines $ 85,255 347 85,602 83,955 $ 1,647 Thousands of U.S. Dollars 2002 Pachislo Amusement Eliminations/ Other Machines Parlors Corporate Consolidated $ 108,469 $ 93,850 $ 1,176 $ 819,868 82 1,977 $ (117,229) 108,551 93,850 3,153 (117,229) 819,868 96,729 92,776 3,567 (83,891) 723,315 $ 11,822 $ 1,074 $ (414) $ (33,338) $ 96,553 b. Total Assets, Depreciation and Capital Expenditures Total assets Depreciation Capital expenditures $ 615,174 15,369 14,894 $ 44,447 789 404 $ 61,810 217 285 Millions of Yen 2001 Pachislo Amusement Other Machines Parlors ¥ 22,289 ¥ 9,312 ¥ 88 23 263 22,312 9,312 351 17,538 9,299 246 ¥ 4,774 ¥ 13 ¥ 105 Eliminations/ Corporate Consolidated ¥ 97,468 ¥ (12,773) (12,773) 97,468 (9,041) 78,521 ¥ (3,732) ¥ 18,947 ¥ 7,341 10 74 ¥ 143,642 288 29 a. Sales and Operating Income Sales to customers Intersegment sales Total sales Operating expenses Operating income (loss) Pachinko Machines ¥ 57,218 12,432 69,650 51,848 ¥ 17,802 Supply Machines ¥ 8,561 55 8,616 8,631 ¥ (15) b. Total Assets, Depreciation and Capital Expenditures Total assets Depreciation Capital expenditures ¥ 54,793 1,269 2,269 ¥ 5,730 128 47 $ 55,821 1,403 1,862 ¥ 6,738 133 769 $ 13,847 $ 1,031,509 $ 1,822,608 17 1,794 19,589 1,095 18,540 ¥ 1,534 1 ¥ 219,778 1,829 3,188 Notes: 1. Operating expenses mainly incurred in the Company’s administrative headquarters were unallocable and included in “Eliminations/corporate” of operating expenses with the aggregate amount of ¥3,883 million ($32,355 thousand) and ¥3,689 million for the years ended December 31, 2002 and 2001, respectively. Notes: 2. Total corporate assets of ¥133 billion ($1,106 million) and ¥152 billion included in “Eliminations/corporate” of total assets as of December 31, 2002 and 2001, respectively, mainly consisted of surplus operating funds, such as cash, cash equivalents, shortterm investments and marketable securities, held by the Company and assets used in the Company’s administrative headquarters. (2) Geographical Segment Information Net sales and identifiable assets of consolidated foreign subsidiaries are not significant, therefore, geographical segment information is not presented herein. (3) Sales to Foreign Customers Sales to foreign customers are not significant, therefore, information regarding sales to foreign customers is not presented herein. 14. SUBSEQUENT EVENTS (1) At the general shareholders meeting held on March 27, 2003, the Company’s shareholders approved the following: a. Purchase of Treasury Stock The Company was authorized to repurchase, at management discretion, up to 2 million shares of the Company’s common stock (an aggregate repurchase amount of ¥5 billion ($42 million)) up until the next general shareholders meeting. b. Appropriations of Retained Earnings Millions of Yen Year-end cash dividends, ¥12.5 ($0.10) per share Bonuses to directors and corporate auditors ¥ 1,443 172 Thousands of U.S. Dollars $ 12,023 1,431 (2) The Company repurchased a total of 339 thousand shares of the Company’s common stock at the aggregate repurchase amount of ¥581 million ($4,839 thousand) during the period from February 14, 2003 to March 10, 2003 and a total of 600 thousand shares at the aggregate repurchase amount of ¥1,052 million ($8,769 thousand) during the period from January 7, 2003 to February 14, 2003, respectively, through the Tokyo Stock Exchange. As of March 10, 2003, the accumulated number and the aggregate repurchase amount of the Company’s treasury stock were 1,262 thousand shares and ¥2,144 million ($17,866 thousand), respectively. In addition, upon resolution and approval of the Board of Directors on January 6, 2003, the Company was authorized to repurchase the Company’s common stock with no par value at an upper limit of 2 million shares or ¥4,000 million ($33,333 thousand). 27 Independent Auditors’ Report To the Board of Directors and Shareholders of Heiwa Corporation: We have examined the consolidated balance sheets of Heiwa Corporation and consolidated subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholders’ equity, and cash flows for the years then ended, all expressed in Japanese yen. Our examinations were made in accordance with auditing standards, procedures and practices generally accepted and applied in Japan and, accordingly, included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. In our opinion, the consolidated financial statements referred to above present fairly the financial position of Heiwa Corporation and consolidated subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles and practices generally accepted in Japan applied on a consistent basis. Our examinations also comprehended the translation of Japanese yen amounts into U.S. dollar amounts and, in our opinion, such translation has been made in conformity with the basis stated in Note 1 to the consolidated financial statements. Such U.S. dollar amounts are presented solely for the convenience of readers outside Japan. March 27, 2003 13. SEGMENT INFORMATION The Group operates in the following business segments: (1) Pachinko machines—Pachinko machines and gauge boards of pachinko machines (2) Supply machines—Pachinko ball replenishing systems and computers for pachinko parlors (3) Pachislo machines—Pachislo machines (4) Amusement parlors— Operation of amusement parlors (5) Other———————Leasing, reinsurance, investments and other Information about business segments, geographical segments and sales to foreign customers of the Group for the years ended December 31, 2002 and 2001, is as follows: (1) Business Segment Information 28 Network and Subsidiaries Head Office: 2-3014-8 Hirosawa-cho, Kiryu, Gunma 376-8588, Japan Sales Headquarters: 2-22-9 Higashi Ueno, Taito-ku, Tokyo 110-0015, Japan Subsidiaries: Shinko Co., Ltd., Amtex Co., Ltd. and Heiwa Insurance, Inc. Nagoya Hakodate Sapporo Sales Office Branch Office Kyoto Niigata Kushiro Sales Office Sales Office Sales Office Osaka Takasaki Aomori Branch Office Branch Office Sales Office Kobe Kanazawa Sendai Sales Office Branch Office Branch Office Sales Office Koriyama Okayama Sales Office Sales Office Utsunomiya Takamatsu Sales Office Sales Office Tsukuba Hiroshima Sales Office Branch Office Kiryu Yamaguchi Sales Office Head Office Fukuoka Saitama Sales Office Branch Office Chiba Oita Sales Office Sales Office Tokyo Kumamoto Sales Office Sales Headquarters・ Branch Office Kagoshima Yokohama Sales Office Sales Office Miyazaki Shizuoka Sales Office Sales Office Board of Directors (As of March 27, 2003) President Vice President Senior Managing Director Managing Directors Directors Senior Corporate Auditor Corporate Auditors Jun Nakajima Yasuhiko Ishibashi Kazuyoshi Horie Toru Machida Takeo Jozen Toshikatsu Imoto Isao Ueki Isao Hoshiyama Toshio Kamiyama Masahiro Hirano Hiroji Arai Masaaki Kishimoto Corporate Data (As of April 30, 2003) Heiwa Corporation Head Office: Transfer Agent and Registrar: Common Stock: Number of Shareholders: Listing: 2-3014-8 Hirosawa-cho, Kiryu, Gunma 376-8588, Japan Tel: 81-277-52-0121 The Chuo Mitsui Trust and Banking Co., Ltd. 3-33-1, Shiba, Minato-ku, Tokyo 105-8574, Japan Authorized: 228,903 thousand shares Issued: 115,743 thousand shares 14,668 (As of December 31, 2002) Tokyo Stock Exchange First Section Head Office 29 HEIWA Corporation 2-3014-8 Hirosawa-cho, Kiryu, Gunma 376-8588, Japan Tel: 81-277-52-0121 URL http://www.heiwanet.co.jp/ Printed in Japan on recycled paper
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