MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATION AND FINANCIAL POSITION

Analysis of Income

SUMMARY

Robust Growth in Gas Sales Reflected in
Sustained Expansion of Both Net Sales andOperating Income● Consolidated sales reached an all-time high, reflecting sustained growth in gas sales.
● This sales growth has been paralleled by a steady reduction in operating expenses, resulting in a 23.5% increase in operating income.
● Net income was lower because of decisions to take a lump-sum write-off of actuarial differences in retirement benefits, and to bring forward the application of impairment accounting to fixed assets. These measures will help to reduce the future cost burden.

The result was operating income of ¥189.4 billion representing an 18.2% year-on-year increase.

■ Gas Appliance Sales● Without these extraordinary items, free cash flow * would have been substantially above the initial target. For this reason, the annual dividend has been increased by one yen per share.

Despite reduced sales in some segments, such as gas appliance

Strong Sales of Products Designed to Compete with Electrical Appliances

sales and related construction, total sales rose ¥24.1 billion, orTokyo Gas recorded buoyant sales of products developed to* Tokyo Gas uses free cash flow as a key management indicator: Free cash flow = net income + depreciation* - capital expenditures**2.1%, to a new record of ¥1,151.8 billion. The rise was attributa-

compete with electrical appliances. However, sales of this seg-ble to healthy 4.9% growth in gas sales.

ment declined due to static total sales volumes and reduced sell-*including amortization of long-term prepayments**purchases of tangible fixed assets + purchases of intangible fixed assets + long-term prepayments (accounting basis)

Although feedstock costs increased in step with growth in theing prices, amid strong competition. Despite the resulting

volume of gas sales, operating expenses were minimized throughdecline in segment sales, lower procurement prices and success-further measures to improve operating efficiency. This wasful efforts to reduce fixed costs and other operating expenses■ Industrial Sector

reflected in operating income, which rose ¥29.0 billion, or 23.5%,

brought higher operating income.

In addition to an increase in demand for use in existing facilities,to ¥152.3 billion. Operating income increased in all segments.

Trends in Core Profit Source of Gas Sales Volume
Note: All graph data for year ended March 31

Steady Increase in the Volume of Sales,
Conspicuous Growth in Industrial Gas Sales

especially cogeneration systems, there was also a rise in demand

Segment sales fell 6.4%, or ¥9.0 billion, to ¥132.3 billion,
while operating expenses were reduced 6.5%, or ¥8.8 billion, toBusiness results by segment (¥ Million)■ Residential Sector

for gas used specifically for power generation. These factors

Temperatures at the start of the fiscal year and during thebrought substantial sales growth of 569 million m , or 15.7%,

Years ended March 31

2002

2003

2004

summer were lower than in the previous year. This was reflect-over the previous year’s level to 4,201 million m3. There was a

Gas Sales

750,439

789,688826,567

ed in increased demand for hot water in the first half of theparticularly steep increase in demand from electric power com-

Gas Appliance Sales

148,271

141,225

132,254

year. Temperatures in the winter were higher than in the year

panies and independent power producers (IPPs) for gas used

Related Construction

67,63367,04564,944■ Related Construction

before, with the result that demand for hot water and heating

solely for power generation. Sales in this area rose 35.3%, or 434

Real Estate Rental Business

15,685

14,944

14,151

Cost Savings Allow Income Growth Despite Slow Sales

remained static. Overall, sales declined 10 million m3, or 0.3%,

million m3. This growth resulted in part from increased utiliza-

Other115,561

114,732

113,909

There were declines in the number of new installations and safe-

at 3,292 million m . There was growth of 55 million m broughttion of natural gas in thermal generation facilities when nuclear

Operating income

on by an increase in the number of customers, and a decline of

power plant operations were suspended. For other uses in theYears ended March 31

2002

2003

2004

149,210160,224

189,366

Gas Appliance Sales

7,243

7,842

7,904

Related Construction

3,650

4,175

4,456

Real Estate Rental Business

6,091

7,623

7,883

Other

10,7999,626

11,2703

3

3

52 million m resulting from temperature-related factors.

industrial sector (mainly for cogeneration systems), there was a

Declines due to other factors, such as reduced sales per house-

133 million m3, or 5.6%, increase, amounting to 2,503 million m3.

3hold, amounted to 13 million m3.

■ Wholesaling to Other Gas Companies■ Commercial Sector

Sales expanded 9.1%, or 86 million m , to 1,030 million m with

Demand for air conditioning stagnated because of low summer

increases in the volume taken by the gas companies to which

temperatures and mild winter temperatures. However, total

gas is supplied.

3

million m . Contributing factors included steady flow of newly
commissioned facilities in new properties, including urban

Total sales amounted to 11,218 million m , an increase of 747
3

million m3, or 7.1%, over the previous year’s level.

redevelopment schemes.
Gas sales volume by sector

Gas Sales

Gas sales volume for power generation

er at ¥7.9 billion. This segment’s contribution to total sales
declined marginally from 12.5% to 11.5%.

ty upgrades. Despite the slowdown, operating income was higher

3

sales in this sector increased 4.0%, or 103 million m3, to 2,695
3¥126.0 billion. Operating income was ¥0.06 billion, or 0.8%, high-Sales to outside customers

Note: Segment sales are sales to outside customers, while operating income is thesum of sales to outside customers and intra-group transactions minus theoperating expenses of outside and inside transactions.

thanks to reductions in fixed costs and other expenses.
At ¥64.9 billion, sales were ¥2.1 billion, or 3.1%, lower thanin the previous year. Operating expenses were reduced 4.2%, or¥2.8 billion, to ¥63.6 billion, with the result that operating
income rose 6.7%, or ¥0.3 billion, to ¥4.5 billion. This segment’s
contribution to total sales was slightly lower at 5.6%, comparedwith 5.9% in the previous year.

■ Gas Sales■ Real Estate Rental Business

Higher Volumes Bring Sustained Growth in Both Sales and Income

Cost Cutting Offsets Reduced Rent Revenue

There was a 7.1% increase in gas sales volumes, led by strong

Segment sales declined, in part because of rent reductions todemand from power generation, in which unit prices are lower.

reflect the state of the real estate market, falling 5.3%, or ¥0.8

The unit price also rose under the “sliding rate” system, whichbillion, to ¥14.1 billion. Despite this, operating income improved

adjusts for fluctuations in gas resource costs. These factors helped

because of lower depreciation and the reduction of selling, gen-

Million m3

Million m3

12,0003,500

to boost sales in this segment by ¥36.9 billion, or 4.7%, to ¥826.6

eral and administrative expenses.

3,000

billion. Nonconsolidated sales increased 4.9%, or ¥38.4 billion.

Operating expenses were reduced 4.0%, or ¥0.2 billion, toRising sales volumes contributed ¥21.8 billion and price adjust-¥27.6 billion, and operating income rose 3.4%, or ¥0.3 billion, to

10,0002,500

ments under the “sliding rate” system added ¥18.0 billion, while¥7.9 billion. This segment’s contribution to total sales declined

2,000

other factors had an adverse effect amounting to ¥1.3 billion. This

from 1.3% in the previous year to 1.2%.

1,500

segment’s contribution to total sales rose from 70.0% to 71.8%.

8,000

6,000

Operating expenses were affected by a rise in gas resource

4,000
1,000

WholesaleIndustrial sector
Commercial sector
Residential sector

2,000

0

’00

[ 27 ]’01’02

TOKYO GAS ANNUAL REPORT 2004

’03

’04

Power generation only
Cogeneration (Industrial sector)
Cogeneration (Commercial sector)

500
0

’00

’01

’02

’03

’04

■ Othercosts in step with volume growth in gas sales. However, meas-

Steady Expansion of Energy Service Businessures to reduce selling, general and administrative expenses

Business areas in this segment include district heating and cool-allowed Tokyo Gas to hold its operating expenses to ¥641.7 bil-ing systems, energy services and LPG sales. Despite positive fac-

lion, an increase of just 1.5% over the previous year’s level.

tors, including sustained growth in energy service operations,TOKYO GAS ANNUAL REPORT 2004

[ 28 ]

Free cash flow

As a consequence, other expenses, net amounted to ¥79.2

segment sales declined 0.7%, or ¥0.8 billion, to ¥113.9 billion.
Reasons for the lower result include a drop in orders for large-

billion, compared with ¥27.4 billion in the previous year. Net

scale general engineering projects, and withdrawal from theincome declined ¥14.4 billion, or 24.3%, below the previous

coke business. This segment accounted for 9.9% of net sales,

year’s level to ¥44.8 billion.

down from 10.2% in the previous year.

Net income and net income per share

80

Increased Sales, Lower Operating Income,and Higher Net Income Projected for the
New Fiscal Year60

Gas sales volumes in the year ending March 31, 2005 are expect-¥ Billion100

ed to increase 2.6% to 11.5 billion m3. Sales to the residential sec-

Segment operating expenses were ¥12.2 billion, or 8.2%,
higher than in the previous year at ¥160.9 billion. Segment oper-¥ Billion

¥

60

30

40

50

25

20

40

20

tor are expected to increase 0.9%, from aggressive marketing offloor-heating systems and products developed to compete withating income increased 17.1%, or ¥1.6 billion, to ¥11.3 billion.

Temporary Decline in Net Income from
Lump-sum Write-off of Actuarial Differencesin Retirement Benefits

electrical appliances. Sales to the commercial sector are to grow
6.9%, driven by stepped-up demand for gas air conditioning.

0
30

15

20

10

10

5

’00

’01

’02

’03

’04

Sales to the industrial sector are estimated to decline 0.4% due tothe leveling of special demand for use in power generation, which

Decision to Increase Annual Dividend

increased dramatically in fiscal 2003. However, wholesale gas
sales are projected to rise 8.3%, reflecting an increase in the vol-Other income totaled ¥17.5 billion, a year-on-year increase of¥1.4 billion. This is mainly attributable to a ¥5.7 billion gain fromthe liquidation of excess allowances for retirement benefits

0

0

’00

’01

’02

’03

Net income
Net income per share’04

resulting from reform of the corporate pension plan, and thereceipt of ¥2.2 billion in proceeds from the sale of fixed assets.
Total other expenses increased ¥53.1 billion to ¥96.7 billion.
The increase is attributable to the write off in this fiscal year of
the entire amount of actuarial differences in retirement benefits,
totaling ¥59.0 billion, taken on the occasion of the reform of thecorporate pension plan. Another factor that increased expenses
was the decision to bring forward the application of impairment
accounting to fixed assets in order to strengthen the financial
structure. There were impairment losses of ¥3.3 billion on certain assets, including a once planned site for branch offices.
On the other hand, there were no environmental conditioning
costs, which were recorded as an extraordinary expenditure item

Although gas sales will increase in volume terms, unit pricesof about ¥480 billion generated over the five-year period from fiscal

are expected to fall under the “sliding rate” system, which
adjusts for fluctuations in gas resource costs. Tokyo Gas is there-

in free cash flow in this term, and if this factor is discounted, freefore projecting a decline of 0.6% in revenues from its gas sales

Following the enforcement of the Defined Benefit Corporate Pension Law, Tokyo
Gas undertook major reforms of its pension plan by switching from a tax-qualified
pension plan to a contract-type corporate pension plan and by introducing a cash
balance plan in fiscal 2003. This resulted in a reduction in the benefit rate, and¥5.7 billion in profit as a gain from reducing the retirement benefit reserve wasrecorded in the accounts as a result.
Further to the reform of the pension plan, the Company decided to change thenumber of years over which the unrecognized actuarial differences are written off
from ten years to one year. The full amount of unrecognized actuarial differencesfrom past years was recorded as a loss totaling ¥59.0 billion in this fiscal year. Thischange allows the status of the retirement benefit obligations to be reflected in the
Company’s financial statements in a timely manner. It also reduces the future burden and strengthens the Company’s financial structure.

cash flow would be substantially higher than the target. On thebusiness. An increase in the scope of consolidation from 18 com-completion of the first year of Frontier 2007, business projections

panies to about 50 in the new fiscal year is expected to lift total

now strongly indicate that the targets for the final year of the plan

net sales to ¥1,197 billion, a year-on-year increase of 3.9%.

will be exceeded. For this reason, it was decided to allocate part of

Expenses will also increase, however, and operating income isthe free cash flow in excess of the targets to dividends, in order toprojected to decline 4.8% to ¥145 billion. In the absence of thepass on the rewards to shareholders. The annual dividend per

extraordinary losses that affected earnings in fiscal 2003, net

share has been increased from ¥6 to ¥7 per share.

income is expected to rise 92.0% to ¥86 billion.

Cash Flows and Financial Position

Free Cash Flow of ¥84.2 Billion

Operating Cash Flows Increased, but Yearend Net Cash Declined because of Bond
Redemptions and the Acquisition ofTreasury Stock

Tokyo Gas has made free cash flow a key management indicator,■ Cash Flows from Operating Activities

which is calculated by adding depreciation* to net income and sub-Income before income taxes and minority interests declined

tracting capital expenditures**. One of the goals set down inbecause of the write-off of reserve obligations for retirement

Frontier 2007 is the achievement of free cash flow averaging ¥97

benefits and the early application of impairment accounting.

billion per annum and totaling ¥480 billion over a five-year period.

However, there was a large inflow of ¥143.1 billion for deprecia-

The result for this term fell short of this target at ¥84.2 billion, ation of fixed assets, including special depreciation of the newly

year-on-year decline of ¥4 billion, or 4.5%. Depreciation increased

completed LNG tank facilities at the Ohgishima LNG Terminal,

4.2% to ¥146.8 billion, while capital expenditures were reduced

as well as the aforementioned write-off of retirement benefit

4.1% to ¥107.4 billion. Though both of these factors had the effectreserve obligations. Subsequently, net cash provided by operat-of increasing free cash flow, net income declined 24.3% to ¥44.8

ing activities increased ¥4.1 billion year on year to ¥217.6 billion.

est-bearing debt.

12

to shareholders as dividends, nearly 17% of the total free cash flow
2003 to fiscal 2007. Transient factors caused a year-on-year decline

were reduced ¥2.6 billion through aggressive repayment of inter-Times

ume taken by gas companies to which gas was supplied.

REFORMS OF THE PENSION PLAN

amounting to ¥5.7 billion in the previous year. Interest expenses

Interest coverage ratio

Frontier 2007 established a basic policy of distributing ¥81 billion

year’s level of ¥110.1 billion. Capital expenditures, which are
the sum of acquisitions of tangible fixed assets and intangible
fixed assets, increased ¥6.0 billion to ¥113.2 billion. Major
investments included gas pipelines.
Capital expenditures and depreciation¥ Billion
200

10

8

6

4

2

0

’00

’01

’02

’03

’04

Interest coverage ratio = (operating income + interest and dividend income) /interest expense[ 29 ]TOKYO GAS ANNUAL REPORT 2004

billion because of measures to improve the Company’s financial

150

100

50

Capital expenditures
Depreciation

0

structure, as described above. The decline in free cash flow result-■ Cash Flows from Investing Activities

ed from this lower net income figure.

Net cash used in investing activities amounted to ¥126.0 bil-*including amortization of long-term prepayments**purchases of tangible fixed assets + purchases of intangible fixed assets + long-term prepayments (accounting basis)

lion, an outflow increase of ¥15.9 billion from the previous

’00

’01

’02

TOKYO GAS
’03
’04 ANNUAL REPORT 2004

[ 30 ]

Capital expenditures represent the amount of payments for fixed assets in the relevant fiscal year.

TOKYO GAS ANNUAL REPORT 2004

[ 30 ]Steady Reduction of Interest-bearing Debt

■ Cash Flows from Financing Activities
Net cash used in financing activities rose ¥21.2 billion, from ¥78.5

vent dilution caused by the conversion of convertible bonds

35.9%. However, the return on equity (ROE*) declined from

into shares, Frontier 2007 calls for the allocation of about 20%

10.4% to 7.6% because of the lower net income result. An

billion in the previous year to ¥99.7 billion. Though bond issues

Efforts to strengthen the Company’s financial structure broughtof free cash flow (¥100 billion) to the continuing repurchase of

improvement to 13.8% is predicted for fiscal 2004.

raised ¥50.0 billion, there was an overall reduction in cash and cash

a significant reduction in interest-bearing debt. The total at thestock. Tokyo Gas will continue to implement this policy.

equivalents because of outflows of ¥78.8 billion for bond redemp-

end of the year was ¥682.7 billion, a year-on-year decline of* ROE=Net income/shareholders’ equity (average of position at start and end of
fiscal year)

tions and ¥28.0 billion for the repurchase of common stock.

¥48.6 billion. This resulted mainly from the redemption of(¥ Million)

straight bonds through debt assumption contracts, retirement by

2002

2003

2004

purchase of straight bonds, and the redemption of convertible

Net cash provided byoperating activities

191,676

213,533

217,608

bonds. The ratio of interest-bearing debt to total assets

Net cash used ininvesting activities(111,821)(110,144)(126,038)

Years ended March

improved from 43.6% to 41.0%.
Interest-bearing debt and ratio of interest-bearing debt to total assets

Net cash used infinancing activities(117,176)(78,517)(99,744)

1,000

%
60

800

55

600

50

400

45

¥ Billion

The changes noted above had the effect of reducing cash andcash equivalents at the year-end by ¥8.2 billion to ¥44.0 billion.

The shareholders’ equity ratio improved from 34.6% toExternal Risks Affecting Business Activities■ Gas Rate Decline Risk

■ Gas Resource Cost Fluctuation Risk

Progress in deregulation has caused competition to intensify

City gas supplied by Tokyo Gas is produced mainly from import-

among energy suppliers. There is a risk that the price of gas will

ed LNG. Since contracts are denominated in U.S. dollars, earn-need to be reduced to attract and retain customers in the face ofings are at risk from fluctuations in the yen-dollar exchange rate.

price reductions by the Tokyo Electric Power Company, which is

Also, the dollar-denominated LNG prices are linked to crude oil

the greatest competitor of Tokyo Gas.

prices on a sliding scale, which exposes the Company to risk

Tokyo Gas recognizes this risk and has allocated capital

Despite Business Expansion, Fixed Assets to
be Reduced through Capital Expenditure
Focusing on Asset Efficiency
Total assets at the end of the year under review amounted to

The extent to which these fluctuations affect gas resource
costs over a year is as follows.

Frontier 2007 to cover price reductions.

■ Temperature Fluctuation Risk

40

200

35

0

’00

’01

’02

’03

Interest-bearing debt
Ratio of interest-bearing
debt to total assets’04

Interest-bearing debt = long-term debt due after one year + long-term debt due
within one year + bank loans

a year-end total of ¥1,170.4 billion through ongoing depreciation.
Investments and other non-current assets grew ¥45.0 billion to¥218.4 billion. This resulted from an increase in unrealized gains

from changes in the international market price for crude oil.

Approximately ¥2.1 billion for each ¥1 movement in the yen-dollar exchange rate

¥1,666.8 billion, a reduction of ¥9.2 billion from the previous year’slevel. Property, plant and equipment was reduced ¥47.0 billion toresources totaling ¥180.0 billion over the five-year period ofApproximately ¥4.3 billion for each $1 movement in the per-barrel price of crude oil

Temperatures affect the volume of city gas sales, which account

Fluctuations in the cost of gas resources are reflected in gas

for around 70% of consolidated sales and 80% of income. Gas is

rates after approximately six months under the “sliding rate”

used mainly for water heating and space heating especialy insystem*. Under this system, although earnings may be subject toresidential use. Mild winter weather can erode revenues andtemporary increases and decreases, crude oil prices and curren-

income by reducing the volume of gas sold.

cy exchange rates have no net effect on results over the medi-

The average temperatures in fiscal 2003 were 21.7ºC in the

Repurchase of Common Stockon investment securities because of rising share prices. Current

um- to long-term perspective.

first half of the year, 11.0ºC in the second half, and 16.3ºC overIn fiscal 2003, the crude oil price averaged $29.42 per barrel,

the whole year. Forecasts for fiscal 2004 are based on averages

and the average exchange rate was ¥113.19 to one dollar.

assets declined ¥5.4 billion to ¥259.1 billion, in part because of a

Shareholders’ equity at the year-end totaled ¥598.5 billion, anof 22.7ºC in the first half, 10.9ºC in the second half, and 16.8ºC

Forecasts for fiscal 2004 are based on an average crude oil pricereduction in cash and cash equivalents and receivables.

increase of ¥18.7 billion over the year. While there was aover the whole year.

of $30 per barrel and an exchange rate of ¥110 to one dollar.

Impact of 1˚C temperature rise on gas sales volume* Depending on the contract, changes may be reflected without a six-month time lag.
Adjustment has an upper limit (please refer to the accompanying Investors’ Guide
2004, P. 4).

One of the management policies defined in Frontier 2007 calls

decrease of ¥27.9 billion, due mainly to repurchase of our own

for an increase in return on assets (ROA*). This will be achieved

stock, retained earnings was ¥28.3 billion higher, and there wasthrough stringent screening of investment in tangible fixed assets.

a rise of ¥18.7 billion in net unrealized holding gains on securi-

In fiscal 2003, ROA declined from 3.5% in the previous year toties. The repurchase of 2.9 million shares of common stock for

2.7% due to a decrease in net income as a result of transient fac-

¥9.9 billion in the previous year was followed in fiscal 2003 bytors. However, an improvement to 5.1% is projected for fiscal 2004.

the acquisition of 76.6 million shares for ¥27.8 billion. To pre-*ROA = Net income/total assets (average of positions at start and end of fiscal year)

ROA and ROE

Rate of change

Summer (June–September)

0.2%

Winter (December–March)-2.4%

Intervening months (April, May, October, November)-1.9%

Annual-1.5%■ Interest Rate Fluctuation Risk
Tokyo Gas negotiates fixed interest rates for both short-term andlong-term interest-bearing debt, which precludes risk of interest

Monthly gas sales volumes for fiscal 2003 (nonconsolidated)

rate fluctuation during the term of an obligation. However, there

Shareholders’ equity and equity ratio

Million m3%¥ Billion

%

12

6,000

60

10

5,000

50

8

4,000

40

6

3,000

30

4

2,000

20

1,000

10

1,500

may be risk of fluctuation when loans are refinanced.

1,200■ Share Price Fluctuation Risk
Tokyo Gas primarily holds equities to maintain corporate rela-

900

tionships essential to the conduct of its business operations.
Equity of publicly listed companies is subject to market risk.

600

Tokyo Gas has established management policies and rules for

2

ROE
ROA

0

’00

[ 31 ]

’01

’02

’03

TOKYO GAS ANNUAL REPORT 2004

’04

0

0

’00

’01

’02

’03

300

handling of such equities.

0

Shareholders’ equity
Equity ratio

2003.4 5

6

7

Residential sector

8

9

10

11

Commercial sector

12 2004.1 2

3Industrial sector

Wholesale’04
TOKYO GAS ANNUAL REPORT 2004

[ 32 ]