Factors Affecting Our Results of Operations

Factors Affecting Combined Results of Operations

A number of factors affect revenues and expenses across several of our segments, and therefore have a substantial impact on our combined results of operations. These factors include the importance of “hit products” that respond to trends in popular culture, intellectual property licensing, seasonal fluctuations, investments and acquisitions.

Hit Products

Most of our non-fitness related revenues come from sales of interactive entertainment software and devices and are dependent on our ability to anticipate or influence the kinds of games and products that are popular with consumers. Revenues for our Computer & Video Games, Toy & Hobby, Amusement and Gaming segments are strongly affected by whether individual products or a series of products become “hits” with consumers. A single hit product can generate very substantial revenues, which can continue over an extended period through the release of sequel products and through extension of the concept or characters from a popular game from one business segment to another business segment.

For example, our Toy & Hobby net revenues, including intersegment revenues, increased 79.5% from ¥25,601 million in fiscal 2002 to ¥45,948 million in fiscal 2003 due mainly to robust sales of the Yu-Gi-Oh! Trading Card Game in the U.S., which coincided with the popularity of the Yu-Gi-Oh! television cartoon among U.S. adolescents. Our Computer & Video Games net revenues, including intersegment revenues, decreased 2.9% from ¥90,129 million in fiscal 2002 to ¥87,476 million in fiscal 2003 due in part to the waning sales of our Metal Gear Solid 2, Sons of Liberty title for PlayStation 2, which was a major hit in fiscal 2002, with over 5 million units sold.

It is difficult to predict whether any particular product will become a hit. We seek to reduce the volatility of our net revenues by developing a large number of new titles each year in various categories and for various platforms. We have steadily increased the number of titles published by our home and handheld video game software business from 58 titles in fiscal 1998 to 120 titles in fiscal 2003. We have also decreased the volatility of our net revenues by entering the fitness club business, which we believe will provide a more stable base of revenue.

Intellectual Property Licensing

One means we use to increase the likelihood that our products will succeed is licensing the right to utilize ideas and images from popular culture, such as comic book characters, sports and entertainment personalities and high visibility events. Thus, to some extent our revenues are dependent on successful identification and acquisition of rights to popular ideas and images. We have steadily increased the number of intellectual property licenses we hold from 13 licenses for 26 products in fiscal 1999 to 66 licenses for 115 products in fiscal 2003.

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These licenses typically require a guarantee of minimum future royalties. We may experience losses if sales based on licensed intellectual property do not produce sufficient revenues to cover our royalties expenses. In addition, games that are based on licensed ideas have lower margins than games that we develop independently.

In recent years, the entertainment industry has seen an acceleration in crossovers with other industries such as toys, films, music, comics, publishing and communications. When we are able to use intellectual property licenses in multiple segments, we are able to produce higher revenues. For example, our Yu-Gi-Oh! card game originated from the popular Yu-Gi-Oh! comic in a prominent Japanese weekly magazine. Following our “media-mix strategy”, we made good use of the license for the game, making substantial sales of our Yu-Gi-Oh! card game for our Toy & Hobby segment and as a video game for our Computer & Video Games segment.

Seasonal Fluctuations

Many of our products are in the greatest demand in December and January, particularly at the end and beginning of the year and, to a lesser extent, in August (summer vacation) and in March (spring vacation), in decreasing order. These months correspond to the periods of children’s school holidays, and it is customary in Japan to buy toys as Christmas and New Year presents in December and January. However, our earnings may not necessarily reflect the seasonal patterns of the industry as a whole as a result of increased sales due to the occurrence of special events such as the Olympic Games, World Cup Soccer Tournament or the release of “hit” titles.

Investments and Acquisitions

As discussed in Item 4.B, “ Business Overview ”, of this annual report, in the last three years we have sought growth and diversification through investments and acquisitions in sectors that promise increased revenue stability and increased revenue growth. In particular, we have made investments in video game software production companies for our Computer & Video Games segment and we have acquired new consolidated subsidiaries for our Exercise Entertainment and Gaming segments. These investments and acquisitions have made substantial changes in the composition of our assets, in particular increasing the amount of goodwill and intangibles in our consolidated balance sheet for fiscal 2001 and fiscal 2002.

We have made the following investments in equity method affiliates in fiscal 2001 and fiscal 2002:

Our investments allow us to develop closer ties with companies doing business in areas that we consider growth areas for our business, including sales of Toy & Hobby products and mobile and on-line video game software. Because these companies are equity method affiliates, our financial results are affected by our pro rata share of their net income or losses. As a result of our fiscal 2003 year-end annual examination of these investments, we recognized a net-of-tax impairment charge of ¥2,438 million with respect to the investment in Hudson Soft Co., Ltd, due to a significant decline in its share value in the market. For fiscal 2003, our income statement included ¥1,288 million in equity in loss of affiliated companies.

We spent an aggregate of ¥76,139 million on the following acquisitions of consolidated subsidiaries in the last three fiscal years:

Exercise Entertainment:

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Gaming:

In connection with our acquisition of majority ownership of new consolidated subsidiaries in fiscal 2001, 2002 and 2003, we recognized an aggregate amount of goodwill of ¥39,021 million and acquired an aggregate amount of intangibles of ¥64,809 million, mostly related to the trademarks and other intangible property associated with our fitness club business. Our acquisition related goodwill and other intangible assets were originally amortized over various periods. However, a recent change in U.S. GAAP means that such amortization for goodwill and indefinite lived intangibles ceased beginning on April 1, 2002 and that the remaining balances will be tested for impairment at least on an annual basis. Following the impairment review for fiscal 2003, we recognized impairment losses of ¥47,599 million with respect to our investment in Konami Sports Corporation. Approximately ¥36,717 million of this impairment related to the write-off of goodwill and the remaining ¥10,882 million related to the impairment of identifiable intangible assets such as trademarks and franchise contracts. This impairment was recognized as a component of our operating loss during fiscal 2003. For further information regarding this impairment, see “ Critical Accounting Policies—Valuation of Intangible Assets and Goodwill” on page 86. Intangibles with finite lives will continue to be amortized.

Foreign Currency Fluctuations

An increasing portion of our business is conducted in currencies other than yen—most significantly, U.S. dollars, as we increase our sales overseas. Our business is thus becoming sensitive to fluctuations in foreign currency exchange rates, especially the yen-U.S. dollar exchange rate. Our consolidated financial statements are increasingly becoming subject to both translation risk and transaction risk. Translation risk arises from the fact that our foreign subsidiaries have different functional currencies than we do. Changes in the value of the Japanese yen relative to the functional currencies of these subsidiaries create translation gains and losses on our equity investments in foreign subsidiaries which are recorded as foreign currency translation adjustments on our consolidated statements of shareholders’ equity and accumulated other comprehensive income until we dispose of, liquidate or take an impairment charge with respect to, the relevant subsidiaries.

Transaction risk arises when the currency structure of our costs and liabilities deviates from the currency structure of our sales proceeds and assets. A substantial portion of our overseas sales are made in U.S. dollars and Euros. Our sales denominated in U.S. dollars are, to a significant extent, offset by U.S. dollar denominated costs. Transaction risk remains for products sold in U.S. dollars to the extent that we must purchase parts for our products from Japan, the costs for which are denominated in yen.

We use foreign exchange forward contracts to manage foreign exchange exposure associated with short-term movements in exchange rates applicable to our payables commitments and receivables that we expect to pay or receive in foreign currencies. Changes in the fair values of our foreign exchange forward contracts are recognized as gains or losses on derivative instruments in our income statement. For a more detailed discussion of these instruments, you should read Item 11 herein and Note 18 to our consolidated financial statements included in this annual report.

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Factors Affecting Results of Business Segments

In addition to the factors affecting our combined results of operations through several segments, there are other factors that affect the results of each of our segments independently. The factors affecting results in each of our business segments are as follows:

Computer & Video Games

Net Revenues .    We develop, publish and distribute video game software for use in home and handheld video game consoles and, to a limited extent, for personal computers, mobile phones and on-line games. We refer to this segment as our “Computer & Video Games” segment. Our video game software is sold mainly in the form of DVD-ROMs or proprietary discs for home video game platforms such as Sony PlayStation2, Nintendo GameCube and Microsoft Xbox and ROM-cartridges for handheld video game platforms such as the Game Boy Advance.

In fiscal 2003, net revenues from the Computer & Video Games segment, including intersegment revenues, were ¥87,476 million, accounting for 34.5% of consolidated net revenues excluding intersegment revenues. This was derived primarily from strong sales of soccer titles such as World Soccer Winning Eleven 6 Final Evolution in Japan and Pro Evolution Soccer 2 in Europe , reflecting the popularity of soccer due to the 2002 World Cup Soccer Tournament. In the U.S., we achieved strong sales of Yu-Gi-Oh! titles, including Yu-Gi-Oh! The Eternal Duelist Soul for Game Boy Advance, Yu-Gi-Oh! Forbidden Memories for PlayStation and Yu-Gi-Oh! Dark Duel Stories for Game Boy Color, each of which recorded sales of over one million copies, reflecting a synergy effect of the popularity of the Yu-Gi-Oh! cartoon on television and the Yu-Gi-Oh! Trading Card Game. As a result, the operating margin for the Computer & Video Games segment, including intersegment revenues, for fiscal 2003 was 16.0%.

Sales of video game software are significantly affected by sales volumes of video game consoles. The potential market for a software product designed for a particular video game system is determined by the total number of such video game consoles purchased by consumers, a number which is sometimes referred to as the “installed base” of such video game consoles. When new hardware systems are introduced, we often experience a temporary decline in net sales attributable to video game software until we are able to produce one or more hit products that utilize the increased capabilities of the new hardware.

The home video game industry is characterized by rapid technological changes, which have resulted in successive introductions of increasingly advanced game consoles. As a result of the rapid technological shifts, no single game console has achieved long-term dominance in the home video game and computer games market, although Nintendo has continued as a major publisher and game console manufacturer since the introduction of the Nintendo Entertainment System during the Christmas season of 1983 and Sony has been a major publisher and game console manufacturer since the introduction of PlayStation in 1994. These rapid shifts in video game hardware technology force us to continually anticipate game console cycles, time our product pipeline so that we do not publish games for hardware that is no longer popular, and develop software programming tools necessary for emerging hardware systems. The home video game and computer games industry began to shift systems with the introduction of Sega’s Dreamcast in 1999, and the introduction of Sony’s 128-bit console, PlayStation2, in the spring of 2000. By March 2001, Sega had exited the hardware manufacturing market, and in September 2001, Nintendo introduced its next-generation game console, GameCube, and Microsoft introduced its first game console, Xbox. The rapid technological advances in game consoles have significantly changed the software development process. The process of developing software for the new 128-bit consoles is extremely complex and we expect the process to become even more complex and expensive with the advent of more powerful future game consoles. According to our estimates, it currently takes between 6 and 24 months to develop a new title and the average development cost per title is generally between ¥100 million and ¥700 million.

Expenses .    A majority of our software titles are developed by our development subsidiaries. Costs and expenses that we incur in the development of new video game software titles are expensed as research and

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development fees until such games reach technological feasibility, at which point we begin to capitalize the expenses. We expense capitalized costs to cost of revenues upon commercial release of the resulting game, as the commercial life of our consumer software is of short duration.

Our cost of revenues for video game software also includes the costs of licenses from contents licensors. While some of our contents licenses include prepaid or guaranteed royalties, most of the royalties we pay are on a sales basis. We amortize the cost of prepaid royalties over the expected life of the associated products. We evaluate the future recoverability of any prepaid royalties and capitalized software costs on a regular basis based on actual title performance. We expense as part of product development costs those capitalized costs that we deem unrecoverable.

Exercise Entertainment

Net Revenues.     We believe that we are the largest fitness club operator in Japan based on the Leisure Paper issued by Institute for Free Time Design. We also design, manufacture and sell fitness-related games and exercise machines. As of March 31, 2003, we operated 238 club facilities that collectively served approximately 850,000 members. Our Exercise Entertainment segment had ¥78,525 million in net revenues, including intersegment revenues, in fiscal 2003.

The majority of our Exercise Entertainment revenues come from membership fees. Our membership fee structure generally includes virtually no initial membership fee. We do not have financing plans for new members. A lack of financing plans and the fact that almost all of our members pay their monthly dues by credit card mean that we have a comparatively low risk of losses from uncollectible receivables.

Our fitness clubs also collect additional revenues from ancillary sales and services, sales of consumables including meals in our in-club restaurants and nutritional products in our in-club stores, and fees for services such as jazzercise and other fitness classes, massage, fitness counseling, diet programs and personal trainers.

Although we have not achieved the expected growth due to unfavorable market conditions, we expect to continue to increase revenues through club and membership growth. We currently serve many, but not all, of the major cities in Japan. We plan to extend our reach into new geographic markets until we cover all of Japan. We believe that we are well positioned, being twice as large as the second largest operator according to the Leisure Paper, to identify opportunities to selectively acquire existing operators and facilities at attractive prices due to our dominant position in a fragmented market. During fiscal 2003, we increased the aggregate number of fitness clubs we directly operate by 11 clubs and the aggregate number of fitness clubs under our franchise by 8 clubs. Also, as a result of our acquisition of all the shares of Konami Athletic Inc. as of March 24, 2003, we added 5 directly-managed fitness clubs. We also worked to improve customer satisfaction by moving five existing club facilities to better facilities in the same neighborhood by creating new facilities or acquiring facilities that had been operated by other companies.

We introduced a new “Undo-Jyuku” brand on October 1, 2002 after integrating our Freizeit and Sele clubs into the Eg-zas brand, thereby strengthening brand recognition and providing more sophisticated facility services, as part of our continuous efforts to improve the retention rate of current customers. Improving the retention rate of customers of existing clubs is one of our major objectives as revenue growth of existing clubs is lower than newly opened clubs. In a move to improve customer convenience, we introduced new services and products such as a personal trainer system where an instructor with specialized knowledge provides individualized lessons for each customer. Finally, we launched the first official i-mode (internet enabled cellular phone) site in the fitness industry, which provides various club facility information and health related information.

Our Exercise Entertainment segment sells fitness-oriented games to consumers and entertainment-oriented exercise machines to health and fitness facilities. We derive revenues from the distribution of equipment manufactured by other parties and from the production and distribution of our own equipment. We intend to

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increase the percentage of our exercise game and equipment sales derived from our own products. As of March 31, 2003, we have developed 4 exercise entertainment machines under EZ series brand and these machines are now introduced in our Konami Sports fitness clubs. We also have several new machines in various stages of the development pipeline.

In fiscal 2003, our fitness-related games and exercise machines business released new home fitness products such as MARTIAL BEAT II , which is a popular martial arts fitness action game that uses video game software and can measure physical strength, and Aerobics Revolution , which allows players to enjoy realistic aerobics activity at home.

Expenses .    Operating expenses for our Exercise Entertainment segment include, for our health and fitness club business, leases for facilities, salaries for trainers and other club employees, costs of exercise machines and other equipment, utilities charges, marketing expenses, costs for maintaining the facilities and depreciation. Upon opening a new fitness club, we often experience an initial period of club operating losses for the first twelve months, but this period can vary substantially depending on the individual club. Initial membership levels tend not to generate sufficient revenue for the club to generate positive earnings in its first full year of operation and substantially lower margins in its second full year of operations than a mature club. However, because most of our expenses are fixed, operating margins tend to improve with respect to each club as membership increases. Expenses for our fitness-related games and exercise machines business are largely related to cost of parts and raw materials, manufacturing costs and research and development expenses.

In fiscal 2003, we had substantial additional operating expenses in our Exercise Entertainment segment because we recognized impairment losses of ¥47,599 million with respect to our investment in Konami Sports Corporation. Under U.S. GAAP, impairment loss is treated as an operating expense. Approximately ¥36,717 million of this impairment related to the write-off of goodwill and the remaining ¥10,882 million related to identifiable intangible assets such as trademarks and franchise contracts. These impairment losses were attributed to the fact that the growth of this segment did not meet our expectations as a result of negative trends in general economic conditions in Japan.

Toy & Hobby

Net Revenues.     In fiscal 2003, net revenues from the Toy & Hobby segment, including intersegment revenues, were ¥45,948 million, accounting for 18.1% of consolidated net revenues. This was derived primarily from robust sales of our popular Yu-Gi-Oh! card game series and firm sales of our new MICROiR series, small and high-tech toys using infra-red remote control. The operating margin for the Toy & Hobby segment, including intersegment revenues, for fiscal 2003 was 36.2%.

The Toy & Hobby segment generates revenues principally from the sales of card games. Net revenues for the Toy & Hobby segment are affected principally by our ability to identify and acquire the rights to popular comic book and television characters and apply them to creative games, as well as the population of children, timing of product introductions, competition within the market, product life cycles and general economic trends.

The card game industry in Japan has been declining since fiscal 2000 when total retail sales peaked at approximately ¥120 billion, and dropped to ¥60 billion in fiscal 2003 according to The Japan Toy Association. The aggregate market size reflects the dominance of our Yu-Gi-Oh! card game for the years in question, with approximately 50% market share, and the shifting interests in toys among the lower elementary school children. We believe that the size of the overall Japanese toy market has also shrunk due to the declining number of children from reduced birth rates, however, expenditures per child has increased which has maintained the market scale in terms of retail sales.

In 2002, we entered into a distribution agreement with a retail partner in the United States, The Upper Deck Company, LLC, which has begun selling our Yu-Gi-Oh! Trading Card Game in the North American card market.

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The animated Yu-Gi-Oh! television program in the United States was the most popular cartoon on television among 6-11 years-old boys in May 2003 and sales of the card game reflected the popularity of the television cartoon. We have been globally standardizing the cards aimed for international use.

Expenses .    Our Toy & Hobby segment has been a comparatively high margin segment because the costs of producing some of the goods marketed by the segment are comparatively low. In particular, card games have historically shown a higher margin than other toy products due to their relatively low manufacturing expenses. Costs include raw material costs, manufacturing outsourcing, licensing, research and development and administrative costs. Furthermore, because the Toy & Hobby products are typically based on previously developed intellectual property, research and development costs for the segment are comparatively low.

Amusement

Net Revenues .    In fiscal 2003, net revenues from the Amusement segment, including intersegment revenues, were ¥34,305 million, accounting for 13.5% of consolidated net revenues excluding intersegment revenues. This was derived primarily from sales of popular video arcade games such as MAH-JONG FIGHT CLUB and WORLDCOMBAT and token-operated game machines such as GI-TURFWILD and FORTUNE ORB and sales of LCD screen software for pachinko machines. The operating margin for the Amusement segment, including intersegment revenues, for fiscal 2003 was 21.2%.

The majority of revenues for the Amusement segment are derived from the sales of amusement arcade games and token-operated game machines. Especially, we maintained the favorable market acceptance of e-AMUSEMENT products for amusement arcades such as the MAH-JONG FIGHT CLUB series, which are video games that allow players to compete directly with players in other arcade game locations via an on-line amusement connection. Revenues for the Amusement segment are affected by market acceptance, introduction of hit titles and general economic trends. We have found that we are able to elongate the life-cycle of our arcade games and increase our Amusement segment margins by creating new software packages for our existing arcade games in addition to creating new games.

We derive sustained revenues from our token-operated machines in Japan. We believe that we are one of the leading companies in the Japanese token-operated game machine industry with revenues of ¥7.4 billion in fiscal 2003.

The arcade operations industry in Japan has been consolidating, with the number of amusement arcades declining and the average size of each arcade increasing. Arcade game sales have been declining since the appearance of advanced interactive entertainment products such as sophisticated video game consoles and mobile phones which offered competing entertainment options. It is now possible to play on a mobile phone games that one could only play in an amusement arcade about twenty years ago.

The Amusement segment also generates revenues from the sale of software for LCD units in pachinko games machines. Revenues from pachinko LCDs are affected by the maturation of the market, consumer preference, regulatory standards, supply-demand balance of liquid crystal display units, competition within the market, product life cycles and general economic trends. In recognition that all software have a finite life-cycle, pachinko parlors systematically replace legacy software experiencing declining pay levels with new software incorporating enhanced entertainment value and improved player appeal generally every two months to one year. We recorded a decline in sales of LCD units in fiscal 2003, due primarily to our inability to introduce new products matching changing customers’ needs in a timely manner.

Also, the pachinko machine market has shown a slight decline due to the overall effects of recession in the past several years. The pachinko industry still remains highly regulated which restricts rapid development of our operations. All pachinko manufacturers in Japan are required to get approval from The Security Electronics and Communication Technology Association, supervised by National Police Agency, in order to engage in sales

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activities. The manufacturers of pachinko machines must also register with The Japan Crime Prevention Association. Licensing requirements can delay the development and release of new pachinko machine products. Changes in rules or regulations governing pachinko machines may adversely affect our sales of software for LCD units.

Expenses .    Expenses for our Amusement segment are largely related to cost of parts and raw materials, particularly with respect to pachinko LCDs, LCDs, which are sometimes scarce and priced accordingly, manufacturing costs and research and development expenses. We are currently working on improving margins in our Amusement segment through the introduction of less expensive Internet-linked amusement arcade games “ e-AMUSEMENT ” and other measures to decrease production costs.

Gaming

Net Revenues.     In fiscal 2003, net revenues from the Gaming segment, including intersegment revenues, were ¥8,215 million, accounting for 3.2% of consolidated net revenues excluding intersegment revenues. This was derived primarily from sales of 6,100 casino gaming machines in Australia through Konami Australia Pty Ltd, which had licenses for sales and manufacturing of gaming machines in all Australian states. Although the dominance of the largest player in the Australian gaming markets has made it difficult for us to become a market leader quickly, we have made substantial in-roads and believe we are one of the largest sellers of gaming machines in the Australian market.

In the United States, the largest casino gaming machines market in the world, we currently hold licenses to manufacture and sell casino gaming machines in 19 states and to 82 tribes. We participated in the world’s largest gaming show held in Las Vegas in September 2002 with 26 titles of our products, thereby showing that we improved our line-up of gaming machines both in quantity and quality. As a result, Konami Gaming, Inc., our U.S. subsidiary for casino gaming machines, increased its sales to 2,200 machines in fiscal 2003 from 1,100 machines in fiscal 2002.

The main revenue source for the Gaming segment is the sale of video slot machines and software contents in Australia and the United States. Revenues for the Gaming segment are affected by the timing of product introductions, timing of regulatory approvals in various markets, ability to penetrate into foreign casino markets, number of casino players, competition within the market, normal product life cycles and general economic trends.

Our sales of casino gaming machines are conducted overseas, primarily in North America and in Australia. Casinos are authorized to operate in more than 110 countries and the number of countries authorizing casinos has been increasing each year according to Tokyo Metropolitan Government, Bureau of Industrial and Labor Affairs. We believe that the world-wide sales (including leasing and others) of casino gaming machines for the year 2004 will be over ¥300 billion and the market will grow continuously. In Australia, the second largest market for casino gaming machines, sales have been increasing moderately due to limits on the number of gaming machines in major states. On the other hand, in the United States, the largest market for casino gaming machines, continuous and stable growth of the market is expected due to an increase in demand for switching to newly introduced gaming machines corresponding to the new cashless system. We believe that we have a competitive advantage in gaming machines market, especially in Australia where video slot games using game software are popular, as gaming machines are becoming more high-tech, with increased entertainment and game value.

Expenses .    Expenses in our Gaming segment are largely related to cost of parts and raw materials, manufacturing costs and research and development expenses. In recent years, we have attempted to decrease our cost of revenues for our Gaming segment by acquiring parts and producing our machines sold abroad in the markets in which they are sold, thereby reducing shipping costs and foreign exchange risks.

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Comparison of Fiscal 2003 with Fiscal 2002

Net Revenues

Net revenues increased ¥28,077 million, or 12.4%, to ¥253,657 million in fiscal 2003 from ¥225,580 million in fiscal 2002 due primarily to robust sales of our Yu-Gi-Oh! Trading Card Game in the U.S. and the addition of a full year of revenues from a subsidiary that operates fitness club businesses, Konami Olympic Sports Club, which was acquired in February 2002, and subsequently merged into Konami Sports Corporation in October 2002.

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Cost of Revenues

Cost of revenues increased ¥20,228 million, or 13.1%, to ¥174,879 million in fiscal 2003 from ¥154,651 million in fiscal 2002, mirroring the rise in sales, and the inclusion of a full year of cost of revenues from Konami Olympic Sports Club.

Impairment Charge for Goodwill and Other Intangible Assets

An impairment charge of ¥47,599 million for goodwill and other intangible assets was recorded in fiscal 2003 as a result of a significant decline in the value of goodwill and other intangible assets relating to our health and fitness club business. These impairment losses were attributed to the fact that the growth of this business did not meet our expectations as a result of negative trends in general economic conditions in Japan.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased ¥207 million, or 0.4%, to ¥53,049 million in fiscal 2003 from ¥52,842 million in fiscal 2002. The increase in expenses was due primarily to the inclusion of a full year of such expenses incurred by the health and fitness club business of Konami Olympic Sports Club and a ¥3,311 million increase in advertising expenses. However, the increase in such expenses was mostly offset by a ¥3,948 million decrease in bad debt expense and a ¥3,532 million decrease in amortization of goodwill and identifiable intangible assets due to the adoption of SFAS No. 142, which ended the amortization of goodwill and indefinite lived intangible assets.

Operating Income (Loss)

As a result of the foregoing, our operating income (loss) decreased ¥39,957 million to ¥(21,870) million in fiscal 2003 from ¥18,087 million in fiscal 2002. As a percentage of net revenues, operating income decreased 16.6% to (8.6)% in fiscal 2003 from 8.0% in fiscal 2002.

Other Income (Expenses), net

Other income (expenses), net decreased ¥4,817 million to ¥(226) million in fiscal 2003 from ¥4,591 million in fiscal 2002 due primarily to a ¥3,751 million decrease in gains on the sale of subsidiary shares. The decrease in gains resulted from the fact that we had a ¥3,526 million gain in connection with an initial public offering by Konami Computer Entertainment Japan, Inc. and a ¥1,129 million gain in connection with the sale of shares of Konami Computer Entertainment Tokyo, Inc. in the market during fiscal 2002, while we did not sell any shares of any of our public subsidiaries during fiscal 2003.

Income (Loss) Before Income Taxes, Minority Interest and Equity in Net Income (Loss) of Affiliated

Companies

As a result of the foregoing, our income (loss) before income taxes, minority interest and equity in net income (loss) of affiliated companies decreased ¥44,774 million to ¥(22,096) million in fiscal 2003 from ¥22,678 million in fiscal 2002.

Income Taxes

Income taxes decreased by ¥5,481 million, or 47.0%, to ¥6,186 million in fiscal 2003 from ¥11,667 million in fiscal 2002. This decrease in income taxes was primarily due to a decrease in the effective income tax rate. The effective tax rate decreased by 79.5% to (28.0%) in fiscal 2003 from 51.5% in fiscal 2002. This 79.5% decrease in the effective tax rate was attributable to the recognition of an impairment charge for goodwill, which provides no tax benefit. As a result, the effective tax rate was significantly different from the statutory tax rate of 42.0%.

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Minority Interest in Income (Loss) of Consolidated Subsidiaries

Minority interest in income (loss) of consolidated subsidiaries decreased ¥1,415 million to ¥(1,051) million in fiscal 2003 from ¥364 million in fiscal 2002 due primarily to a ¥2,632 million minority interest in the impairment charge related to goodwill and identifiable intangible assets incurred by Konami Sports Corporation, which more than offset an overall increase in income of consolidated subsidiaries.

Equity in Net Income (Loss) of Affiliated Companies

Equity in net income (loss) of affiliated companies decreased ¥2,043 million to ¥(1,288) million in fiscal 2003 from ¥755 million in fiscal 2002 due primarily to a ¥2,438 million other-than-temporary decline in the value of our investment in Hudson Soft Co., Ltd.

Net Income (Loss)

As a result of the foregoing, our net income (loss) decreased ¥39,921 million to ¥(28,519) million in fiscal 2003 from ¥11,402 million in fiscal 2002.

Comparison of Fiscal 2002 with Fiscal 2001

Net Revenues

Net revenues increased ¥54,099 million, or 31.5%, to ¥225,580 million in fiscal 2002 from ¥171,481 million in fiscal 2001 due primarily to robust sales of action and sports related video game software and the addition of a full year of revenues from our new fitness club business.

Cost of Revenues

Cost of revenues increased ¥51,583 million, or 50.0%, to ¥154,651 million in fiscal 2002 from ¥103,068 million in fiscal 2001, mirroring the rise in sales, and the inclusion of a full year of cost of revenues from our new health and fitness club business.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased ¥22,340 million, or 73.2%, to ¥52,842 million in fiscal 2002 from ¥30,502 million in fiscal 2001 due primarily to a write-off of lease deposits amounting to ¥4,137 million owed to us by a fitness club facility lessor that entered corporate reorganization proceedings in fiscal 2002, a ¥5,732 million increase in amortization of goodwill and identifiable intangible assets, ¥5,556 million of which was associated with the acquisition of Konami Sports Corporation, and a ¥4,995 million increase in directors’ compensation and employees’ salaries.

Operating Income (Loss)

As a result of the foregoing, our operating income decreased ¥19,824 million, or 52.3%, to ¥18,087 million in fiscal 2002 from ¥37,911 million in fiscal 2001. As a percentage of net revenues, operating income decreased 14.1% to 8.0% in fiscal 2002 from 22.1% in fiscal 2001.

Other Income (Expenses), net

Other income (expenses), net increased ¥1,667 million, or 57.0%, to ¥4,591 million in fiscal 2002 from ¥2,924 million in fiscal 2001 due primarily to gains on the sale of subsidiary shares which increased by ¥707 million. We had a ¥3,526 million gain in connection with an initial public offering by Konami Computer

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Entertainment Japan, Inc. during fiscal 2002 as compared to a gain of ¥3,948 million in connection with an initial public offering of Konami Computer Entertainment Tokyo, Inc. in fiscal 2001. Interest expense decreased by ¥499 million during fiscal 2002 reflecting repayment of long-term debt.

Income (Loss) Before Income Taxes, Minority Interest and Equity in Net Income (Loss) of Affiliated

Companies

As a result of the foregoing, our income before income taxes and minority interest decreased ¥18,157 million, or 44.5%, to ¥22,678 million in fiscal 2002 from ¥40,835 million in fiscal 2001.

Income Taxes

In spite of an increase in our effective income tax rate from 47.0% to 51.5% resulting primarily from non-deductible amortization of goodwill, income taxes decreased ¥7,536 million, or 39.2%, to ¥11,667 million in fiscal 2002 from ¥19,203 million in fiscal 2001 due primarily to the 52.3% decrease in operating income.

Minority Interest in Income (Loss) of Consolidated Subsidiaries

Minority interest in income of consolidated subsidiaries decreased ¥56 million, or 13.3%, to ¥364 million in fiscal 2002 from ¥420 million in fiscal 2001 due primarily to a write-off of lease deposits by Konami Sports Corporation discussed in Selling, General and Administrative Expenses above, which more than offset an overall increase in income of consolidated subsidiaries.

Equity in Net Income (Loss) of Affiliated Companies

Equity in net income of affiliated companies increased ¥399 million, or 112.1%, to ¥755 million in fiscal 2002 from ¥356 million in fiscal 2001. Our share of the improved net income of Takara Co., Ltd. accounted for ¥442 million of this increase.

Net Income (Loss)

As a result of the foregoing, our net income decreased ¥10,166 million, or 47.1%, to ¥11,402 million in fiscal 2002 from ¥21,568 million in fiscal 2001.

Segment Information

Based on the applicable criteria set forth in Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information”, or SFAS 131, we have five reportable operating segments for which separate financial information is available and reported in our consolidated financial statements. Our chief operating decision maker regularly evaluates this data in deciding how to allocate resources and in assessing performance. The operating segments are managed separately as each segment represents a strategic business unit that offers different products and serves different markets. As required by SFAS No. 131, we present our business segment information in the accompanying consolidated financial statements as it is presented in reports to our management, derived from our U.S. GAAP financial statements in fiscal 2003. Such reports were previously prepared based on Japanese GAAP and accordingly, results for fiscal 2001 and fiscal 2002 have been restated to be based on U.S. GAAP.

During fiscal 2003, we renamed each of our business segments in order to clarify the operations of each segment. Former “Consumer Software” became “Computer & Video Games”, former “Health and Fitness” became “Exercise Entertainment”, former “Character Products” became “Toy & Hobby”, former “Amusement Content” became “Amusement” and former “Gaming Content” became “Gaming”.

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In May 2002, Konami sold its amusement facility operation business, which was a part of the Other segment, to a third-party purchaser.

In the fourth quarter of fiscal 2003, Konami transferred its fitness-related games and exercise machines equipment business from the Amusement segment to the Exercise Entertainment segment and its token-operated game machine business from the Gaming segment to the Amusement segment. In accordance with these changes, results for fiscal 2001 and fiscal 2002 have been reclassified to conform to the presentation for fiscal 2003.

The following tables present net revenues, both including and excluding intersegment revenues, operating expenses and operating income (loss) for fiscal 2001, 2002 and 2003, by segment, which are the primary measures used by our chief operating decision makers to measure our operating results and to measure segment profitability and performance. The year-to-year comparisons following the tables discuss comparisons of net revenues, including intersegment revenues, operating expenses and operating income (loss) for each year.

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Comparison of Fiscal 2003 with Fiscal 2002

Computer & Video Games

Net revenues of our Computer & Video Games segment decreased ¥2,653 million, or 2.9%, to ¥87,476 million in fiscal 2003 from ¥90,129 million in fiscal 2002, despite a record year in terms of units sold. This decrease was due primarily to a shift in our product mix from products with higher unit prices such as the Metal Gear Solid 2, Sons of Liberty game for PlayStation 2, which recorded sales of more than five million copies worldwide in fiscal 2002, to products with lower unit prices and an increase in unit sales to North America, which generated less revenues than a similar increase in unit sales in Japan would have, due to different market conditions. World Soccer Winning Eleven 6 Final Evolution and Pro Evolution Soccer 2 for PlayStation 2 each recorded over one million sales in Japan and in Europe, respectively, reflecting worldwide popularity of soccer due to the 2002 World Cup Soccer Tournament. Also the Yu-Gi-Oh! titles including Yu-Gi-Oh! The Eternal Duelist Soul for Game Boy Advance, Yu-Gi-Oh! Forbidden Memories for PlayStation and Yu-Gi-Oh! Dark Duel Stories for Game Boy Color, recorded total sales of 4.6 million copies in the U.S. As a result, we recorded an increase in sales to 23.7 million copies in fiscal 2003, including 21.0 million copies of our titles and 2.7 million copies of titles from other third party companies, from 22.8 million copies in fiscal 2002, including 20.3 million copies of our titles and 2.5 million copies of titles from other third party companies.

Operating expenses increased ¥1,712 million, or 2.4%, to ¥73,489 million in fiscal 2003 from ¥71,777 million in fiscal 2002. Such increase includes a ¥269 million decrease in cost of revenues and a ¥1,981 increase in selling, general and administrative costs including advertisement costs relating to the Yu-Gi-Oh! titles.

Operating income decreased ¥4,365 million, or 23.8%, to ¥13,987 million in fiscal 2003 from ¥18,352 million in fiscal 2002, reflecting the fact that revenues decreased while costs increased.

Exercise Entertainment

Net revenues of our Exercise Entertainment segment increased ¥12,875 million, or 19.6%, to ¥78,525 million in fiscal 2003 from ¥65,650 million in fiscal 2002. This increase was due primarily to the expansion of our network of fitness clubs by acquiring our competitors, the opening of 16 new fitness clubs and entering into new franchise relationships, and the addition of a full year of revenues from Konami Olympic Sports Club Corporation, which was acquired in February 2002 and subsequently merged into Konami Sports Corporation in October 2002. In addition, we added five new directly-managed club facilities by the acquisition of all of the outstanding shares of Konami Athletics Inc. in March 2003.

Operating expenses increased ¥57,664 million, or 82%, to ¥127,937 million in fiscal 2003 from ¥70,273 million in fiscal 2002 due primarily to a charge taken in connection with the impairment of goodwill and other

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intangible assets relating to this segment of ¥47,599 million, the inclusion of a full year of operating expenses incurred by Konami Olympic Sports Club Corporation and costs of opening 16 new fitness clubs.

Operating loss increased ¥44,789 million to ¥49,412 million in fiscal 2003 from ¥4,623 million in fiscal 2002, reflecting the impairment of goodwill and other intangible assets.

Toy & Hobby

Net revenues of our Toy & Hobby segment increased ¥20,347 million, or 79.5%, to ¥45,948 million in fiscal 2003 from ¥25,601 million in fiscal 2002. This increase was due primarily to an increase in sales of the Yu-Gi-Oh! Trading Card Game series in the U.S. to approximately ¥24,000 million in fiscal 2003 from approximately ¥300 million in fiscal 2002. Since its release in the U.S. in March 2002, sales of the Yu-Gi-Oh! Trading Card Game series grew dramatically from summer vacation until the Christmas season, reflecting the popularity of the Yu-Gi-Oh! childrens cartoon on television and the Yu-Gi-Oh! video game series. A new series of the Yu-Gi-Oh! card game also maintained high levels of sales in Japan and other Asian countries of approximately ¥13,500 million. As a result, worldwide total sales of Yu-Gi-Oh! card games were approximately ¥38,000 million in fiscal 2003, increased from approximately ¥19,200 million in fiscal 2002. We also recorded stable sales in M ICRO iR series products.

Operating expenses increased ¥10,919 million, or 59.3%, to ¥29,319 million in fiscal 2003 from ¥18,400 million in fiscal 2002. The increase consists primarily of an increase in cost of revenues of ¥9,124 million due mainly to an increase in cost of revenues for the Yu-Gi-Oh! card games and an increase in selling, general and administrative costs due mainly to an increase in advertisement costs for TV commercials in the United States.

Operating income increased ¥9,428 million, or 130.9%, to ¥16,629 million in fiscal 2003 from ¥7,201 million in fiscal 2002, reflecting the fact that revenues increased more than costs.

Amusement

Net revenues of our Amusement segment decreased ¥3,613 million, or 9.5%, to ¥34,305 million in fiscal 2003 from ¥37,918 million in fiscal 2002. This decrease was due primarily to the decline in sales of pachinko LCD units to approximately ¥7,200 million in fiscal 2003 from approximately ¥15,400 million in fiscal 2002, resulting from our inability to introduce new products meeting rapidly changing market needs in a timely manner. On the other hand, sales of amusement arcade game products increased to approximately ¥17,900 million in fiscal 2003 from approximately ¥11,800 million in fiscal 2002, reflecting the favorable market acceptance of e - AMUSEMENT products for amusement arcades such as the M AH -J ONG FIGHT CLUB series and the expansion of the line-up of simulation games that can be played by more than one person such as W ORLD C OMBAT , a gun shooting game, as well as music simulation games such as pop ’ n music , GUIT A RF REAKS and d rummania . Token-operated products also contributed approximately ¥7,400 million to revenues for fiscal 2003. Token-operated game sales were led by the continuously popular GI-WINNING SIRE and GI-TURFWILD , the latest large-scale token-operated horse racing games in the GI series, which have a realistic “right there in he midst of it” feel, FORTUNE ORB , a large-sized “penny-falls” game machine popular for its entertaining stage effects and OVALARENA , a new large-scale token-operated bingo game machine with a player match-up function.

Operating expenses decreased ¥2,283 million, or 7.8%, to ¥27,035 million in fiscal 2003 from ¥29,318 million in fiscal 2002 due primarily to the decrease in cost of revenues and selling, general and administrative expenses accompanying the decrease in revenues.

Operating income decreased ¥1,330 million, or 15.5%, to ¥7,270 million in fiscal 2003 from ¥8,600 million in fiscal 2002, reflecting the fact that revenue decreased more quickly than costs.

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Gaming

Net revenues of our Gaming segment increased ¥5,152 million, or 168.2%, to ¥8,215 million in fiscal 2003 from ¥3,063 million in fiscal 2002. This increase was due primarily to an increase in revenues from sales of casino gaming machines by our Australian subsidiary, Konami Australia Pty Ltd., to 6,100 machines in fiscal 2003 from 1,700 machines in fiscal 2002, reflecting both growth in sales by Konami Australia Pty Ltd. and an additional six months of revenues from Konami Australia Pty Ltd. in fiscal 2003, since it was acquired in October 2001. Revenue growth also reflects an increase in sales of casino gaming machines through our U.S. subsidiary, Konami Gaming, Inc., to 2,200 machines in fiscal 2003 from 1,100 machines in fiscal 2002.

Operating expenses increased ¥2,595 million, or 44.8%, to ¥8,384 million in fiscal 2003 from ¥5,789 million in fiscal 2002 due primarily to an increase in revenues and the fact that we recognized only 6 months of operating expenses of Konami Australia Pty Ltd. in fiscal 2002.

Operating loss decreased ¥2,557 million to ¥169 million in fiscal 2003 from ¥2,726 million in fiscal 2002, reflecting that revenues increased more than costs.

Other

Net revenues of our Other segment decreased ¥3,377 million, or 38.0%, to ¥5,520 million in fiscal 2003 from ¥8,897 million in fiscal 2002. This decrease was due primarily to the sale of our amusement arcade operation business to AmLead Co., Ltd. as of May 13, 2002. After the sale of our amusement arcade operation business, the segment includes real estate management services for our group companies and delivery and maintenance services that we provide with respect to products of our Amusement segment.

Operating expenses decreased ¥2,911 million, or 31.5%, to ¥6,330 million in fiscal 2003 from ¥9,241 million in fiscal 2002 due primarily to the sale of our amusement arcade operation business.

Operating loss increased ¥466 million, or 135.5%, to ¥810 million in fiscal 2003 from ¥344 million in fiscal 2002, reflecting the fact that revenues decreased more than costs.

Comparison of Fiscal 2002 with Fiscal 2001

Computer & Video Games

Net revenues of our Computer & Video Games segment increased ¥29,242 million, or 48.0%, to ¥90,129 million in fiscal 2002 from ¥60,887 million in fiscal 2001. This increase was due primarily to an increase of approximately ¥28,600 million in sales of video game software including hit titles such as Metal Gear Solid 2: Sons of Liberty of which five million units were shipped worldwide, Silent Hill 2 and World Soccer Winning Eleven 5 Final Evolution for the PlayStation2 and Yu-Gi-Oh! Duelmonsters 5 Expert 1 for Game Boy Advance. The active global hardware systems market contributed to this increase as the release of Nintendo GameCube and Microsoft Xbox together with the rapid increase in sales of PlayStation2 stimulated the software market. Revenues from other products and services such as tuition fees for the Konami School increased by approximately ¥1,100 million.

Operating expenses increased ¥18,003 million, or 33.5%, to ¥71,777 million in fiscal 2002 from ¥53,774 million in fiscal 2001. The majority of this increase in operating expenses, or ¥15,383 million, was due to cost of revenues and the remaining ¥2,620 million increase was due to a rise in selling, general and administrative expenses, both of which rose in line with the increase in revenues.

Operating income increased ¥11,239 million, or 158.0%, to ¥18,352 million in fiscal 2002 from ¥7,113 million in fiscal 2001, reflecting the fact that revenues grew more quickly than expenses.

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Exercise Entertainment

Net revenues of our Exercise Entertainment segment increased ¥60,466 million to ¥65,650 million in fiscal 2002 from ¥5,184 million in fiscal 2001. This increase was due primarily to the fact that only one full month of revenues of Konami Sports Corporation, which we acquired in February 2001, was recorded for the segment in fiscal 2001 and the segment experienced substantial growth in fiscal 2002 through the acquisition of various competitors. The addition of revenues from Konami Sports Corporation was responsible for approximately ¥53,300 million of this increase in revenues in fiscal 2002.

Operating expenses increased ¥64,849 million to ¥70,273 million in fiscal 2002 from ¥5,424 million in fiscal 2001. Cost of revenues increased by ¥51,040 million and selling general and administrative expenses increased by ¥13,809 million due mainly to the addition of Konami Sports Corporation to our consolidated results and a write-off of lease deposits amounting to ¥4,137 million owed to us by a fitness club facility lessor that entered corporate reorganization proceedings in fiscal 2002.

Operating loss increased ¥4,383 million to ¥4,623 million in fiscal 2002 from ¥240 million in fiscal 2001 due primarily to the addition of Konami Sports Corporation to our consolidated results.

Toy & Hobby

Net revenues of our Toy & Hobby segment decreased ¥34,989 million, or 57.7%, to ¥25,601 million in fiscal 2002 from ¥60,590 million in fiscal 2001. This decrease was due primarily to a decline of approximately ¥34,600 million in sales of card games such as the Yu-Gi-Oh! card game from its peak during fiscal 2001. However, the series still generated approximately ¥20,400 million in sales during fiscal 2002. Sales of other Toy & Hobby products decreased by approximately ¥700 million on a net basis although we experienced an increase in sales of our new DigiQ remote controlled cars which were sold through Takara Co., Ltd.

Operating expenses decreased ¥11,830 million, or 39.1%, to ¥18,400 million in fiscal 2002 from ¥30,230 million in fiscal 2001. Almost all of this decline in operating expenses, or ¥11,789 million, was due to decreased cost of revenues in line with the decline in revenues.

Operating income decreased ¥23,159 million, or 76.3%, to ¥7,201 million in fiscal 2002 from ¥30,360 million in fiscal 2001, reflecting the fact that revenues decreased more than costs.

Amusement

Net revenues of our Amusement segment decreased ¥2,583 million, or 6.4%, to ¥37,918 million in fiscal 2002 from ¥40,501 million in fiscal 2001. This decrease was due primarily to a decline in the sales of our music-related amusement arcade games such as Dance Dance Revolution and GUITARFREAKS , which experienced very high sales in previous fiscal years. The decrease was offset in part by the sales of new amusement arcade games such as Celebrity Studio , an automatic photo machine and HieHie Penta , the first prize-awarding machine to provide frozen prizes. Overall, while revenues from amusement arcade games declined by approximately ¥6,100 million to ¥11,000 million, revenues from pachinko LCD units increased by approximately ¥700 million to approximately ¥15,400 million.

Operating expenses decreased ¥1,157 million, or 3.8%, to ¥29,318 million in fiscal 2002 from ¥30,475 million in fiscal 2001, reflecting the decrease in revenues.

Operating income decreased ¥1,426 million, or 14.2%, to ¥8,600 million in fiscal 2002 from ¥10,026 million in fiscal 2001, reflecting the fact that revenues decreased more than costs.

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Gaming

Net revenues of our Gaming segment increased ¥2,638 million to ¥3,063 million in fiscal 2002 from ¥425 million in fiscal 2001 due primarily to the acquisition of Konami Australia Pty. Ltd., our Australian sales agent and producer of gaming machines, which became a consolidated subsidiary in October 2001.

Operating expenses increased ¥2,626 million, or 83.0%, to ¥5,789 million in fiscal 2002 from ¥3,163 million in fiscal 2001. This increase was due primarily to increased sales and the addition of Konami Australia Pty. Ltd. to our consolidated results. The consolidation resulted in a ¥654 million increase in cost of revenues and a ¥1,972 million increase in selling, general and administrative expenses.

Operating loss decreased ¥12 million, or 0.4%, to ¥2,726 million in fiscal 2002 from ¥2,738 million in fiscal 2001, reflecting the fact that revenues increased more than operating expenses.

Other

Net revenues of our Other segment increased ¥20 million, or 0.2%, to ¥8,897 million in fiscal 2002 from ¥8,877 million in fiscal 2001. This increase was due primarily to an increase in intersegment sales related to real estate management services provided to our subsidiaries, which offset a decrease in revenues of approximately ¥300 million from the operation of amusement arcade centers.

Operating expenses increased ¥345 million, or 3.9%, to ¥9,241 million in fiscal 2002 from ¥8,896 million in fiscal 2001 due to a ¥111 million increase in selling, general and administrative expenses and a ¥234 million increase in cost of revenues.

Operating loss increased ¥325 million to ¥344 million in fiscal 2002 reflecting the fact that operating expenses increased more than revenues.

Critical Accounting Policies

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make assumptions and estimates about expected future cash flows and other matters that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Note 1 of the notes to our consolidated financial statements includes a summary of the significant accounting policies used in the preparation of our consolidated financial statements. We consider some of our significant accounting policies to be critical to our reported results because they require our management to make complex judgments in making assumptions and estimates about the effects of matters that are inherently uncertain and therefore subject to change. Changes in such assumptions and estimates could have a material effect on the amounts reported in our financial statements. We believe that among our significant accounting policies, the following policies may involve a higher degree of judgment or complexity.

Acquisitions

In the past two fiscal years, we have made a number of business acquisitions, which have been accounted for using the purchase method of accounting. The purchase method requires that the net assets—tangible and identifiable intangible assets less liabilities—of the acquired company be recorded at fair value, with the difference between the cost of an acquired company and the fair value of the acquired net assets recorded as goodwill. Application of the purchase method requires us to make complex judgments about the allocation of the purchase price to the fair value of the net assets we acquired, and estimated useful lives of such assets.

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With respect to intangible assets acquired in the course of our acquisitions, we have estimated the useful lives of various intangible assets based on our internal expertise as well as assistance from independent valuation experts. We determined that our acquired intangible assets related to trademarks, franchise contracts and gaming licenses have an indefinite useful life. Our intangible assets related to membership lists, existing technology and customer relationships are estimated to have useful lives of two to five years.

Valuation of Intangible Assets and Goodwill

As of April 1, 2002, we adopted Statement of Financial Accounting Standards, or SFAS, No. 142, “Goodwill and Other Intangible Assets.” Under SFAS No. 142, we are required to perform an initial impairment test of our indefinite-lived intangible assets and goodwill at the transition and an annual impairment test thereafter. We also assess the impairment of intangible assets and goodwill whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

When we determine that the carrying amount of intangible assets and goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we evaluate the carrying amount of the assets based on their fair value. If the fair value is less than the carrying amount of the assets, we record an impairment loss based on the difference between the carrying amount and the fair value of the assets.

We evaluated the recoverability of goodwill on our books under SFAS No. 142 at its adoption on April 1, 2002 and again in the fourth quarter of fiscal 2003. In both instances, we engaged an independent appraiser to assist us in our determination of the fair values of our reporting units. In its determination of the fair values, the appraiser primarily utilized a discounted cash flow analysis as well as other valuation approaches including the stock price and market capitalization of the acquired entity and asset and liability structure of the reporting units. Significant assumptions used in this analysis included: (i) expected future revenue growth rates, profit margins and working capital levels of the reporting units; (ii) a discount rate; and (iii) a terminal value multiples. The revenue growth rates, profit margins and working capital levels of the reporting units were based on our expectation of future results. In evaluating the recoverability of other intangible assets which were allocated to the reporting units, we primarily utilized a discounted cash flow analysis as well as other applicable valuation approaches, and if applicable, independent valuations.

At the adoption of SFAS No. 142 on April 1, 2002, we completed our transitional impairment assessment for goodwill and other intangible assets based on their fair value. Based on our assessment of the circumstances, considering the independent appraiser’s findings, we concluded that there was no impairment in the carrying value of our goodwill and intangible assets with an indefinite life.

In the fourth quarter of fiscal 2003, however, using the same methodologies and again considering the independent appraiser’s findings, we determined that the fair value of our Exercise Entertainment segment was lower than the carrying value. As a result of the subsequent reassessment of fair values of goodwill and other intangible assets which were allocated to the segment, an aggregate non-cash impairment charge of ¥47,599 million was recognized for these intangible assets as a component of operating loss for fiscal 2003. The impairment charge consisted of ¥36,717 million for goodwill and ¥10,882 million for trademarks. These

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impairment losses were attributed to the segment’s failure to meet previous growth expectations as a result of a significant slow-down in the growth rate of the industry in which it operated as well as negative trends in general economic conditions in Japan that accelerated in the later half of fiscal 2003.

If our expectations of future operating results change, or if there are changes to other assumptions, the estimate of the fair value of our identifiable intangible assets could change significantly. Such a change could result in additional impairment charges in future periods, which could have a significant impact on our consolidated financial statements.

Software Development

We utilize our internal development teams to develop our software. We account for software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed”. We capitalize software development costs once technological feasibility is established and such costs are determined to be recoverable against future revenues. We expense software development costs incurred prior to technological feasibility to research and development. We evaluate the technological feasibility of our software in development on a product-by-product basis, based on our historical experience, whether the software is closely related to previously marketed software or uses existing technology, and other factors. For products where proven game engine technology exists, technological feasibility may occur early in the development cycle. Our technological feasibility decisions affect the timing of our recognition of the costs associated with developing our products.

Revenue Recognition

We derive revenue from primarily two sources: (i) product revenue, which includes packaged game software and other products, game machines and related equipment and components; and (ii) membership fee revenue from health and fitness club members.

Our revenue recognition criteria are as follows:

Persuasive Evidence of an Arrangement.

For our product sales, it is our customary practice to have a written contract, which is signed by both the customer and us, or a purchase order or amendment to the written contract from those customers that have previously negotiated a standard purchase agreement.

For our fitness clubs, members are required to sign a standard monthly membership agreement upon admission, which is automatically renewed unless the member provides an advance notice of his or her intention to cancel prior to the tenth day of the month at the end of which the membership will terminate.

Delivery Has Occurred.

Our packaged game software and other products are physically delivered to our customers, with standard transfer terms. Also, our game machines and related equipment are physically delivered to our customers as a fully-assembled, ready to be installed unit. Our arrangements generally include acceptance clauses. Acceptance occurs upon the earlier of receipt of a written customer acceptance immediately after delivery or expiration of the acceptance period, which is generally seven days from the delivery date. Accordingly, we recognize revenue from our product sales upon delivery and acceptance. Generally, we do not permit exchanges or accept returns of unsold merchandise except in the case of obvious defects. In certain limited circumstances we may allow returns or provide price protection, for which we estimate the related allowances based upon our management’s evaluation of our historical experience, the nature of the software titles and other factors. These estimates are deducted from gross sales.

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Revenue from fitness club membership is derived primarily from monthly membership fees from club members. Revenue for those fees is recognized as monthly charges are made to the members’ accounts in advance, at the end of each month, with respect to the following month’s membership. This policy requires us to defer the membership fee revenue for one month. Initial membership fee revenue is deferred and recognized over the estimated period of the related membership. Currently, however, the amount of such initial fees is not significant.

The Price is Fixed or Determinable.

The price our customers pay for our products is negotiated at the outset of an arrangement, and is generally determined by the specific volume of product to be delivered. Therefore, the prices are considered to be fixed or determinable at the start of the arrangement. Our membership fee for fitness clubs is fixed at the time of admission of the member.

Collection is Probable.

Probability of collection is assessed on a customer-by-customer basis. We typically sell to customers with whom we have a history of successful collection. New customers are subjected to a credit review process that evaluates the customers’ financial position and ultimately their ability to pay. For our fitness clubs, the collectibility of membership fees is always assured as we charge members’ accounts one-month in advance.

Accounting Developments

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 requires that legal obligations associated with the retirement of tangible long-lived assets be recorded as a liability and measured at fair value when those obligations are incurred if an estimate of fair value is possible. When a company initially recognizes a liability for an asset retirement obligation, it must capitalize the cost by recognizing an increase in the carrying amount of the related long-lived asset. We adopted SFAS No. 143 on April 1, 2003 and the adoption did not have a material effect on our results of operations and financial position.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. SFAS No. 145 provides for the rescission of several previously issued accounting standards, new accounting guidance relating to the accounting for certain lease modifications and various technical corrections to existing pronouncements that are not substantive in nature. We adopted SFAS No. 145 on April 1, 2003, except for the provisions relating to the amendment of SFAS No.13, which was adopted for transactions occurring subsequent to May 15, 2002. The adoption of SFAS No. 145 did not have a material impact on our consolidated financial statements.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity”. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of SFAS No. 146 has not had a material effect on our consolidated financial statements.

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34”. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and

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measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002 and have not had a material effect on our consolidated financial statements. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. We did not have a significant item to be disclosed under such requirements in our consolidated financial statements for fiscal 2003.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51”. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For nonpublic enterprises with a variable interest in a variable interest entity created before February 1, 2003, the Interpretation is applied to the enterprise no later than the end of the first annual reporting period beginning after June 15, 2003. The application of this Interpretation is not expected to have a material effect on our consolidated financial statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that variable interest entities will be consolidated or their information will be disclosed information when the Interpretation becomes effective.

In February 2003, the EITF reached a consensus on Issue No. 03-02 (“EITF 03-02”), “Accounting for the Transfer to the Japanese Government of the Substitutional Portion of Employee Pension Fund Liabilities.” This Issue provides a consensus that Japanese employers should account for the entire separation process as a single settlement event upon completion of the transfer to the Japanese government of the substitutional portion of the benefit obligations and related plan assets. According to this consensus, the transfer is not viewed as a plan amendment unfavorable to employees. Furthermore, accounting recognition is done upon the actual transfer of the substitutional portion of the benefit obligations and the related plan assets. Additionally, the EITF agreed that the resultant gain from the government subsidy which is the difference between the fair value of the substitutional portion of the obligations transferred, computed based on a market discount rate, and the amount of plan assets required to be transferred which the government is to calculate, would be directly recognized as a gain or loss at settlement. The application of EITF 03-02 is not expected to have any effect on our consolidated financial statements as we do not have such substitutional portion of employee pension fund liabilities subject to this consensus.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Except for certain provisions, SFAS No. 149 is to be applied prospectively to contracts entered into or modified after June 30, 2003 and to hedging relationships designated after June 30, 2003. We are in the process of determining the impact, if any, that the adoption of SFAS No. 149 will have on our results of operations and financial position.

In May 2003, the FASB issued SFAS No. 150, “Financial Statement on Certain Financial Instruments with Characteristics of Liabilities and Equity.” SFAS No. 150 changes the accounting for certain financial instruments with characteristics of both liabilities and equity that, under previous guidance, could be classified as equity, by now requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position. Further, SFAS No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives. SFAS No. 150 is generally to be applied to all financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 is not expected to have a material effect on our results of operations and financial position.

Capital Expenditures

Our capital expenditures amounted to ¥77,598 million, ¥20,681million and ¥17,919 million during fiscal 2001, 2002 and 2003, respectively. The major portion of our capital expenditures during fiscal 2001 related to the

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acquisition of intangible assets in the amount of ¥56,759 million recognized in connection with our purchase of Konami Sports Corporation and other subsidiaries. During fiscal 2002, our capital expenditures consisted mainly of purchases and leases of computer and other product development equipment in the amount of ¥9,615 million. During fiscal 2003, our capital expenditures consisted mainly of the acquisition of Konami Super Campus for ¥3,010 million and funds for the opening and repair of fitness clubs in the amount of ¥4,638 million. We expect our capital expenditures for fiscal 2004 to be approximately ¥11,000 million, of which approximately ¥3,000 million will relate to purchases and leases of computer and other product development equipment and ¥2,500 million will relate to the opening and repair of additional fitness clubs.

B.    Liquidity and Capital Resources

Our principal needs for cash are: fees for manufacturing and royalty payments to video game hardware manufacturers who produce our game software; payments to content licensors; purchase of parts and raw materials; selling, general and administrative expenses such as research and development expenses; payments for the acquisition of companies targeted under our acquisitions strategy; employees’ salaries, wages and other payroll costs; lease payments for fitness club facilities; debt service requirements; expenditures to renovate and maintain our properties; payments of dividends to our shareholders; and taxes.

Our principal needs for cash for fiscal 2004 include cash used for ordinary operations of our business. In addition, we consider potential opportunities to expand our current business or enter new areas of business from time to time. Generally, our sources of funds include available cash reserves, cash provided by our current and future operating activities, borrowings from banks and other financial institutions and issuance of debt securities. We believe that available cash reserves and expected cash from operations and future borrowings or issuance of debt capital will provide sufficient financial resources to meet our currently anticipated capital and other expenditure requirements. There are no material contractual or legal restrictions on the ability of our subsidiaries to transfer funds to us in the form of dividends (assuming that they have sufficient distributable net assets or retained earnings as provided under the local law of the relevant jurisdiction), loans or advances. There are no material economic restrictions on payments of dividends, loans or advances to us by our subsidiaries other than general withholding or other taxes calculated at rates determined by the local tax law of the relevant jurisdiction (ordinarily 20% in the case of dividend payments by our Japanese subsidiaries and 10% (or, in certain circumstances, 15%) in the case of dividend payments and 10% in the case of interest payments by our U.S. subsidiaries).

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Comparison of Fiscal 2003 with Fiscal 2002

Net cash provided by operating activities increased ¥16,592 million, or 149.2%, to ¥27,711 million in fiscal 2003 from ¥11,119 million in fiscal 2002. During fiscal 2003, increased collection of payments on trade notes and accounts receivable, which had been at a high level at the end of fiscal 2002, contributed to the improvement of cash flows from operating activities by ¥8,510 million. Our operating cash flows were also improved by ¥4,413 million due to the fact that we used less cash to decrease trade notes and accounts payable as compared to fiscal 2002. In addition, there was a decrease in inventories in fiscal 2003, which contributed to the increase in net operating cash flows by ¥4,150 million since there had been an increase in inventories in fiscal 2002.

Net cash used in investing activities decreased ¥3,782 million, or 23.6%, to ¥12,242 million in fiscal 2003 from ¥16,024 million in fiscal 2002. Improvements in investing cash flows were, in part, due to the fact that we did not use cash for investments in affiliated companies during fiscal 2003 while we made such investments amounting to ¥8,115 million during fiscal 2002. A ¥1,790 million increase in proceeds from sales of property and equipment also contributed to the improvement of cash flows from investing activities in fiscal 2003. However, the decrease in cash used for investments was partly offset by a ¥7,262 million increase in capital expenditures, which was due mainly to active acquisition of property and equipment related to the Exercise Entertainment segment.

Net cash used in financing activities amounted to ¥16,443 million for fiscal 2003 while net cash of ¥12,613 million was provided by financing activities during fiscal 2002. This was due primarily to a ¥29,828 million decrease in proceeds from long-term debt. During fiscal 2003, we had ¥14,902 net proceeds from the issuance of bonds while we had ¥44,681 million of such debt issuance proceeds during fiscal 2002.

Comparison of Fiscal 2002 with Fiscal 2001

Net cash provided by operating activities amounted to ¥22,398 million in fiscal 2001 and ¥11,119 million in fiscal 2002. In fiscal 2002, a ¥10,166 million decrease in net income was offset by a ¥10,353 million increase in depreciation and amortization expenses. Net cash provided by operating activities decreased principally due to a ¥12,377 million decrease in trade notes and accounts payable as compared to fiscal 2001, which was caused in large part by bill payments from the previous year being credited on the first day of fiscal 2002 due to a banking holiday.

Cash used in investing activities in recent periods included acquisitions of several subsidiaries and investments in affiliates, as well as investments in property and equipment. There was a decrease in cash used in investing activities to ¥16,024 million in fiscal 2002, from ¥72,788 in fiscal 2001, due primarily to a substantially smaller amount of expenditures on investments and acquisitions in fiscal 2002 as compared to fiscal 2001. In fiscal 2001, we acquired the business that is now Konami Sports Corporation. In fiscal 2002, we made further acquisitions of smaller fitness clubs and investments in strategic partners in the video game software industry such as Hudson Soft Co., Ltd. and Genki Co., Ltd. During fiscal 2002, we also sold outstanding shares of Konami Computer Entertainment Tokyo, Inc. for ¥1,797 million, which resulted in a gain of ¥1,129 million.

Cash provided by financing activities totaled ¥12,613 million in fiscal 2002 as compared to ¥59,261 in fiscal 2001. During fiscal 2001, cash in the amount of ¥6,013 million was provided by the issuance of shares by Konami Computer Entertainment Tokyo, Inc. in its initial public offering. We also received ¥62,824 million from the issuance of our own shares in a global equity offering. During fiscal 2002, we received cash in the amount of ¥7,035 million in the initial public offering of Konami Computer Entertainment Japan, Inc. As a result, net proceeds from the issuance of common stock decreased ¥61,802 million as compared to fiscal 2001, but this was partially offset by a ¥44,509 increase in proceeds from long-term debt issued during fiscal 2002. Cash provided by financing activities in fiscal 2002 was further reduced by repurchases of treasury stock and repayments of long-term debt.

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Long and Short-term Debt

Our debt includes both long-term debt and short-term borrowings. Our borrowing requirements have not been seasonal. Short-term borrowings consisted entirely of unsecured bank loans totaling ¥10,948 million as of March 31, 2002 and ¥8,308 million as of March 31, 2003. As of March 31, 2003, the non-current portion of our long-term debt consisted mainly of ¥60,000 million of unsecured bonds described in the following paragraphs. It also included ¥540 million of unsecured loans from banks. For information regarding the aggregate annual maturities of our long-term debt outstanding at March 31, 2003, please see the Contractual Obligations table below under “ Other Commitments ” of this Item 5.B. We are able to borrow from financial institutions at local market-based interest rates, which in our case, is mostly market-based rates in Japan, however, approximately 18% of our total outstanding long-term debt, excluding unsecured bonds, and short term borrowings as of March 31, 2003 was denominated in US dollars and based on the local market-based interest rates of the United States. The interest rates of our long-term debt and short-term borrowings ranged from 0.56% to 2.36% during fiscal 2003. We plan to refinance repayment of our debt and borrowings due in one to three years by a combination of all or some of the following funding sources: available cash reserves; cash provided by our operations; borrowings from banks or other financial institutions; and issuance of debt securities.

During fiscal 2003, our consolidated subsidiary, Konami Sports Corporation, issued unsecured domestic bonds series 1, 2 and 3 due 2006, 2007 and 2008, respectively. Each series of the bonds was issued for ¥5,000 million to total an aggregate principal amount of ¥15,000 million. During fiscal 2002, we issued unsecured domestic bonds series 3, 4 and 5 due 2005, 2006, and 2007, respectively. Each series of the bonds was issued for ¥15,000 million to total an aggregate principal amount of ¥45,000 million. The interest rates of these bonds issued by Konami and Konami Sports Corporation range from 0.70% to 1.39%.

In fiscal 2000, we entered into a renewable credit line agreement to provide for borrowings of up to ¥12,000 million in order to increase our financing capabilities. The current line of credit expires on March 31, 2004. We had no outstanding borrowings under the revolving line of credit as of March 31, 2003. We also established a commercial paper program worth ¥10,000 million in fiscal 1996, for which there was no outstanding balance at March 31, 2003. Financing under the commercial paper program is available upon the satisfaction of certain procedural requirements which we believe that it may take us a few weeks to complete.

In connection with our purchases of certain products for distribution in North America and Europe, including Game Boy cartridges and GameCube discs, some of our suppliers require us to provide irrevocable letter of credit prior to accepting our purchase orders. As of March 31, 2003, we had outstanding letters of credit in the amount of €3,545,973 and $4,673,989.

Other Commitments

Licenses .    We have several on-going contractual commitments involving minimum future royalties payments. Under these agreements, we commit to provide specified payments to the intellectual property holders, such as professional sports organizations, based upon contractual arrangements. Assuming all contractual provisions are met, the total future minimum contract commitment for contracts in place as of March 31, 2003 is ¥984 million, substantially all of which has been prepaid and recorded as prepaid royalties and license fees.

Leases.     We lease certain computer and other equipment under capital leases and non-cancelable operating leases. Total future minimum lease payments under capital lease arrangements were ¥5,010 million as of March 31, 2003. Minimum rental commitments under non-cancelable operating leases at March 31, 2003 were ¥30,867 million.

Purchase Obligations.     We have obligations to purchase property, plant, equipment and other assets amounting to approximately ¥607 million as of March 31, 2003.

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The following tables summarize the contractual obligations and other commercial commitments that will affect our liquidity position for the next several years, as of March 31, 2003:

Derivative Transactions

We enter into foreign exchange forward contracts to manage foreign exchange exposure associated with short-term movements in exchange rates applicable to our payables commitments and receivables that we expect to pay or receive in foreign currencies. For a more detailed discussion of these instruments, you should read Item 11 herein and Note 18 to our consolidated financial statements included in this annual report. We do not hold or issue derivatives for speculation purposes. Because the counterparties to those contracts are limited to major international financial institutions, we do not anticipate any material losses arising from credit risk. Our Finance Department executes and controls those contracts. Each contract and its results are to be periodically reported to an officer in charge of the department and the CFO.

We do not designate any derivative financial instruments as hedges and, as a result, they are to be recognized as either assets or liabilities at fair value and the corresponding gains and losses are to be recognized in earnings in the period of change.

C.    Research and Development, Patents and Licenses, etc.

Our research and development activities consist primarily of developing amusement arcade games, video game software, gaming machines and Toy & Hobby products. Research and development expenses are charged to income as incurred. On a consolidated basis, we spent ¥836 million, ¥861 million and ¥855 million on research and development for fiscal 2001, 2002 and 2003, respectively.

See Item 4.B “ Research and Development ” above for further information about our research and development activities and Item 4.B “ Intellectual Property ” above for information on our patents and other intellectual property.

D.    Trend Information.

While our results of operations for fiscal 2004 remain subject to a number of uncertainties, we currently expect that our net revenues for fiscal 2004 will slightly increase from the previous fiscal year and our operating income and the net income will recover substantially without the negative effect of the impairment of goodwill

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and other intangible assets associated with our Exercise Entertainment segment recognized in fiscal 2003. We base our expectations on the following assumptions:

Notwithstanding the loss recorded due to the recognition of impairment of goodwill and other intangible assets relating to our Exercise Entertainment segment in fiscal 2003, our business has grown steadily and we believe that our medium to long-term growth prospects are good as well. We expect consumer demand for video game software to expand, based on the predominance of PlayStation 2 and Game Boy Advance in fiscal 2003. We are also expecting growth in our fitness clubs business, reflecting increased interests in health and beauty, especially among middle-aged and senior people. Our Gaming segment expects to expand its market, including in the U.K., where the deregulation of casino business is scheduled in 2004, and Japan, where such deregulation has been actively promoted.

The discussion above includes forward-looking statements based on management’s assumptions and beliefs as to the factors set forth above, as to market and industry conditions and as to our performance under those conditions and are subject to the qualifications set forth in “ Special Note Regarding Forward-looking Statements ” in “ Risk Factors ” in Item 3.D. Our actual results could vary significantly from these projections and could be influenced by a number of factors including our ability to generate new popular products, our ability to expand overseas, consumer spending patterns and other factors and risks as discussed in the other part of “ Risk Factors ” in Item 3.D.

E.    Off-Balance Sheet Arrangements.

Not applicable.

F.    Tabular Disclosure of Contractual Obligations.

Not applicable.

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