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The following is an excerpt from a 20-F SEC Filing, filed by KONAMI CORP on 7/22/2004.
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Item 3.   Key Information.


A.    Selected Financial Data.


The following tables include selected historical financial data as of and for the fiscal years ended March 31, 2000 through 2004. The data for the fiscal years ended March 31, 2001 through 2004 in the first table is derived from our audited consolidated financial statements prepared in accordance with U.S. GAAP. The data for the fiscal years ended March 31, 2000 through 2002 in the second table is derived from our audited consolidated financial statements prepared in accordance with Japanese GAAP. We have not prepared consolidated financial statements in accordance with Japanese GAAP for any period after March 31, 2002. You should read the selected financial data below in conjunction with Item 5 of this annual report and our audited consolidated financial statements and information prepared in accordance with U.S. GAAP which are included in this annual report.


Selected Financial Data Prepared in Accordance with U.S. GAAP


     Fiscal year ended/as of March 31,

     2001 (1)





     (Yen in millions and U.S. dollars in thousands, except per share data)  

Income Statement Data:


Net revenues

   ¥ 171,481    ¥ 225,580    ¥ 253,657     ¥ 273,412     $ 2,586,924  

Cost of revenues

     103,068      154,651      174,879       179,182       1,695,355  

Impairment charge for goodwill and other intangible assets (2)

     —        —        47,599       —         —    

Selling, general and administrative expenses

     30,502      52,842      53,049       53,517       506,358  





Operating income (loss)

     37,911      18,087      (21,870 )     40,713       385,211  





Other income (expenses), net

     2,924      4,591      (226 )     (606 )     (5,733 )





Income (loss) before income taxes, minority interest and equity in net income (loss) of affiliated companies

     40,835      22,678      (22,096 )     40,107       379,478  

Income taxes

     19,203      11,667      6,186       18,035       170,641  

Minority interest in income (loss) of consolidated Subsidiaries

     420      364      (1,051 )     2,220       21,004  

Equity in net income (loss) of affiliated companies

     356      755      (1,288 )     252       2,384  





Net income (loss)

   ¥ 21,568    ¥ 11,402    ¥ (28,519 )   ¥ 20,104     $ 190,217  





Basic and diluted net income (loss) per share

   ¥ 189.04    ¥ 89.32    ¥ (234.58 )   ¥ 166.86     $ 1.58  

Cash dividends per share

   ¥ 54.00    ¥ 54.00    ¥ 46.00     ¥ 62.00     $ 0.59  

Balance Sheet Data:


Total current assets

   ¥ 124,852    ¥ 142,055    ¥ 136,705     ¥ 152,766     $ 1,445,416  

Total assets

     293,830      328,091      278,250       294,497       2,786,423  

Total current liabilities

     80,350      79,548      71,774       72,799       688,798  

Total long-term liabilities

     36,754      77,637      87,215       92,160       871,984  

Total shareholders’ equity

     145,151      134,990      90,406       102,129       966,308  


In February 2001, we acquired 54.64% of the issued and outstanding shares of PEOPLE CO., LTD.., a health and sports club operator in Japan, for total cash consideration of ¥69,415 million. The acquired



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company was then renamed Konami Sports Corporation. The assets, liabilities and results of operations of Konami Sports Corporation have been included in our consolidated financial statements since the acquisition date.

(2)   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 loss 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. Under U.S. GAAP, impairment loss is treated as an operating expense.


Selected Financial Data Prepared in Accordance with Japanese GAAP


     Fiscal year ended/as of March 31,


   2001 (1)




(Yen in millions and U.S. dollars in thousands,

except per share data)

Income Statement Data:


Net revenues

   ¥ 146,667    ¥ 171,481    ¥ 225,580    $ 1,692,908

Cost of revenues

     90,755      103,210      154,371      1,158,507

Selling, general and administrative Expenses

     24,973      29,625      44,332      332,698




Operating income

     30,939      38,646      26,877      201,703




Other income (expenses), net

     3,471      946      2,322      17,426




Income before income taxes minority interest (2)

     34,410      39,592      29,199      219,129

Income taxes

     15,650      17,307      13,248      99,422

Minority interest in income of consolidated subsidiaries

     415      503      2,378      17,846




Net income

   ¥ 18,345    ¥ 21,782    ¥ 13,573    $ 101,861




Net income per share—basic (3)

   ¥ 164.26    ¥ 190.91    ¥ 107.24    $ 0.80

Net income per share—diluted (3)

   ¥ 163.33    ¥ 190.91    ¥ 107.24    $ 0.80

Cash dividends per share

   ¥ 97.00    ¥ 54.00    ¥ 54.00    $ 0.41

Balance Sheet Data:


Total current assets

   ¥ 102,953    ¥ 125,278    ¥ 142,133    $ 1,066,664

Total assets

     136,081      250,023      290,148      2,177,471

Total current liabilities

     46,647      77,571      75,645      567,692

Total long-term liabilities

     16,348      8,554      53,111      398,582

Total shareholders’ equity

     70,844      149,875      141,298      1,060,398

(1)   In February 2001, we acquired 54.64% of the issued and outstanding shares of PEOPLE CO., LTD.., a health and sports club operator in Japan, for total cash consideration of ¥69,415 million. The acquired company was then renamed Konami Sports Corporation. The assets, liabilities and results of operations of Konami Sports Corporation have been included in our consolidated financial statements since the acquisition date.
(2)   Under Japanese GAAP, income before income taxes includes equity in net income/losses of affiliated companies.
(3)   Net income per share information is calculated by dividing net income by the weighted average number of shares outstanding during the relevant period after adjusting to reflect the stock splits by way of free distributions made on May 20, 1999 and May 19, 2000.


There are certain significant differences between U.S. GAAP and Japanese GAAP. These differences relate to, among other things, disclosure of segment information, the scope of consolidation, accounting for derivatives, deferred income taxes, accounting for investments in certain equity securities, accounting for capital leases, accrued compensated absences, accounting for employee retirement and severance benefits, accounting for business combinations, intangible assets and impairment of long-lived assets, the presentation of the cash flows and the statement of comprehensive income. Also, under Japanese GAAP, a restatement of prior years’ financial statements reflecting the effect of a change in accounting principles is not required.



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Our results of operations for the fiscal years ended March 31, 2001 and 2002 as reported in our U.S. GAAP and Japanese GAAP consolidated financial statements differ principally because of accounting for the effects of business combinations, impairment of long-lived assets, impairment of prepaid assets and deferred taxes.


Exchange Rate Data


Fluctuations in exchange rates between the Japanese yen and U.S. dollar and other currencies will affect the U.S. dollar and other currency equivalent of the yen price of our shares and ADSs and the U.S. dollar amounts received on conversion of cash dividends. We have translated some Japanese yen amounts presented in this annual report into U.S. dollars solely for your convenience. Unless otherwise noted, the rate used for the translations was ¥105.69 per $1.00 which was the mid price for telegraphic transfer of U.S. dollars for yen quoted by The Bank of Tokyo-Mitsubishi, Ltd. as of March 31, 2004, the last business day prior to the date of our most recent annual consolidated financial statements. The translation should not be construed as a representation that the yen amounts have been, could have been, or could in the future be converted into U.S. dollars at the above or any other rate.


The following table presents the noon buying rates for Japanese yen per $1.00 in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York for and as of the end of each period indicated.


Fiscal year ended March 31,



   Average (1)



   124.45    101.53    110.02    102.73


   125.54    104.19    111.65    125.54


   134.77    115.89    125.64    132.70


   133.40    115.71    121.10    118.07


   120.55    104.18    112.75    104.18

Calendar year 2004



   107.17    105.52    106.27    105.84


   109.59    105.36    106.71    109.26


   112.12    104.18    108.52    104.18


   110.37    103.70    107.66    110.37


   114.30    108.50    112.20    110.18


   111.27    107.10    109.43    109.43

(1)   Calculated from the average of the exchange rates on the last day of each month during the period with respect to fiscal years and from the average of daily noon buying rate with respect to calendar years.


As of July 12, 2004, the noon buying rate was ¥108.24 per $1.00.


B.    Capitalization and Indebtedness.


Not applicable.


C.    Reasons for the Offer and Use of Proceeds.


Not applicable.


D.    Risk Factors.


Special Note Regarding Forward-looking Statements.


This annual report contains forward-looking statements about our industry, our business, our plans and objectives, our financial condition and our results of operations that are based on our current expectations,



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assumptions, estimates and projections. These forward-looking statements are subject to various risks and uncertainties. Generally, these forward-looking statements can be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “anticipate”, “estimate”, “plan” or similar words. These statements discuss future expectations, identify strategies, discuss market trends, contain projections of results of operations or of financial condition, or state other forward-looking information. Known and unknown risks, uncertainties and other factors could cause our actual results to differ materially from and worse than those contained in or suggested by any forward-looking statement. We cannot promise that our expectations, projections, anticipated estimates or other information expressed in or underlying these forward-looking statements will turn out to be correct. We do not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.


Important risks and factors that could cause our actual results to be materially different from as described in the forward-looking statements are set forth in this Item 3.D or elsewhere in this annual report and include, without limitation:


    our ability to continue to win acceptance of our products, which are offered in highly competitive markets characterized by the continuous introduction of new products, rapid developments in technology and subjective and changing consumer preferences;


    changes in economic conditions affecting our operations or the way that individuals choose to spend their leisure time;


    our ability to successfully expand internationally with a focus on our Computer & Video Games business, Toy & Hobby business and Gaming business;


    our ability to successfully expand the scope of our business and broaden our customer base through our Health & Fitness business;


    regulatory developments and changes, in particular in the gaming industry, and our ability to respond and adapt to those changes; and


    our expectations with regard to further acquisitions and the integration of any companies we may acquire.


Risks Relating to Our Overall Business


Our future success is dependent on our ability to release “hit” products.


The market for video game software, Toy & Hobby products, amusement arcade games, token-operated games and gaming machines is “hits” driven. “Hit” products account for a substantial portion of our net revenues and of the revenues in each of these markets. For example, the fast growth of our Toy & Hobby segment in recent years resulted from, and was heavily dependent on, the sales of our Yu-Gi-Oh! card games. Similarly, hit video game software titles such as the Yu-Gi-Oh! series, the WORLD SOCCER WINNING ELEVEN series and the METAL GEAR SOLID series have contributed significantly to the recent results of our Computer & Video Games segment. If we do not develop, publish and distribute “hit” products in the future, our financial condition, results of operations and profitability could be negatively affected. The most important factor in developing hit products is to respond quickly to public tastes and preferences that change rapidly and are hard to predict. Therefore, if we fail to accurately anticipate and promptly respond to changing tastes and preferences, our business, revenues and profits could be harmed.


Our revenues are dependent on timely introduction of popular new products.


Our success depends on generating revenue from the timely introduction and shipment of new products. The average life cycle of a new software title generally ranges from less than three months to twelve to eighteen months, with the majority of sales occurring in the first thirty to one hundred and twenty days after release. The life cycle for Toy & Hobby products including mainly card games, amusement arcade games, token-operated games and gaming machines also tends to be limited. We are constantly required to introduce new products in



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order to generate revenues and/or to replace declining revenues from older products. Also, because revenues earned during the early life of a product generally constitute a relatively high percentage of the total revenues earned from a product, a significant delay in the introduction of one or more new products, or the inability to ship in sufficient quantities to meet demand, could negatively affect sales and have a negative impact on our financial condition and results of operations. Unanticipated delays could also cause us to miss an important selling season such as the year-end holiday buying season or summer vacation. Moreover, our products may not achieve and sustain market acceptance during the short life cycle sufficient to generate revenue to recover our investment in developing the products and to cover our other costs.


The timely shipment of a new product depends on various factors, including the development process, approval by third-party licensors, production capacity and other factors such as debugging and approval by hardware licensors, in the case of software. It is possible that some of our products will not be released or shipped in a timely fashion in accordance with our plans.


Competition for market acceptance and pricing competition affect our revenue and profitability.


The markets for Toy & Hobby products, video game software, arcade games, token-operated games, gaming machines and most of our other products are intensely competitive and new products and platforms are regularly introduced. Only a small percentage of products introduced in the market achieve any degree of sustained market acceptance. In the case of software for handheld and home game consoles, amusement arcade games, token-operated games and gaming machines, significant price competition and reduced profit margins may result as the hardware product cycle matures. In addition, competition from new technologies such as video game software for play over the Internet or mobile phones may reduce demand in markets in which we have traditionally competed. As a result of prolonged price competition and reduced demand due to competing technologies, our operations in the past have been, and in the future could continue to be, negatively impacted.


Our competitors vary in size from small companies to very large corporations, some of which have significantly greater financial, marketing and product development resources than we have. Due to these greater resources, certain of our competitors can undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors of desirable motion picture, television, sports and character properties and pay more to third party software developers than we can. It is also possible that some of our domestic competitors will form alliances or enter into exclusive business arrangements with key creators, distributors or retailers overseas which could hinder our ability to expand into international markets.


A decline in consumer spending due to unfavorable economic conditions could hinder sales of our products.


Our product sales are affected by customer’s ability and desire to spend disposable income on the purchase of our products. Any significant downturn in general economic conditions which results in a reduction in consumers’ discretionary spending could reduce demand especially for entertainment and health-oriented products and services like ours and may harm our business. Such industry downturns have been, and may continue to be, characterized by diminished product demand and subsequent erosion of average selling prices.


Our performance may be vulnerable to rapidly changing consumer preferences.


Sales of our products depend substantially on how consumers decide to spend their money. Many of our markets are characterized by rapidly changing trends and fads, and frequent innovations and improvements are necessary to maintain consumer interest. We compete with other forms of entertainment and leisure activities. For example, we believe that the overall growth in the use of the Internet and online services by consumers may pose a competitive threat if customers and potential customers spend less of their available time using video game software, Toy & Hobby products, amusement arcade games, token-operated games and gaming machines and more time using the Internet or otherwise choose to engage in other forms of entertainment and leisure activities. Our financial performance may be harmed if we are unable to successfully adapt our products and services to these changing trends and fads.



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Fluctuations in our quarterly operating results make our quarterly revenues and income difficult to predict.


The timing of release of new products can cause material quarterly revenue and earnings fluctuations. A significant portion of revenues in any quarter is often derived from sales of new products introduced in that quarter or in the immediately preceding quarter. If we are unable to begin volume shipments of a significant new product during the scheduled quarter, our revenues and earnings will be negatively affected in that period. In addition, because a majority of the unit sales for many of our products typically occur in the first thirty to one hundred and twenty days following their introduction, revenues and earnings may increase significantly in a period in which a major product is introduced and may decline in the following period or in periods in which there are no major product introductions.


Our quarterly operating results also may be materially impacted by other factors, including the level of market acceptance or demand for video game software, the timing of hardware platform introductions, the level of development and/or promotion expenses for a video game title. Also, 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. This trend is explained as 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. Additionally, in a platform transition period, sales of video game software products can be significantly affected by the timeliness of introduction of game console platforms by the manufacturers of those platforms, such as Sony, Nintendo and Microsoft.


Inability to procure commercially valuable intellectual property licenses may prevent product releases or result in reduced product sales.


We focus our development and publishing activities principally on products that are, or have the potential to become, franchise brand properties. Many of our products are based on intellectual property and other character or story rights acquired or licensed from third parties. For example, our products often embody trademarks, trade names, logos, or copyrights licensed by third parties, such as FIFPro Foundation. We have also acquired content licenses from Japanese sports organizations such as the Japan Professional Baseball League, the Japan Professional Soccer League, or J-League, and the Japan Football Association. In addition, we have obtained content licenses from various companies, including Disney Interactive, Inc., Vivendi Universal Games, Inc. Nihon Ad Systems Inc., Kodansha, Shogakukan Production Co., Ltd., Mirage Licensing, Inc. and 4KIDS Entertainment Inc.


These license and distribution agreements are limited in scope and time, and we may not be able to acquire new licenses, renew licenses when they expire or include new products in existing licenses. License agreements relating to these rights generally extend for an initial term of two to three years. The agreements are terminable upon the occurrence of a number of factors, including our material breach of the agreement, failure to pay amounts due to the licensor in a timely manner, or a bankruptcy or insolvency. The loss of a significant number of our intellectual property licenses or of our relationships with licensors could have a material adverse effect on our ability to develop new products and therefore on our business and financial results.


Inadequate intellectual property protections could prevent us from enforcing or defending our proprietary technology.


We regard our products as proprietary and rely on a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure agreements and other methods to protect our proprietary rights. We own or license various patents, copyrights and trademarks. We are aware that some unauthorized copying occurs within the trading card game, video game software and arcade machine industries. For example, unauthorized copies of the Yu-Gi-Oh! card games have been found in the United States, France, China, Taiwan and the Netherlands. If a significant volume of unauthorized copying of our trading card games and other products were to occur, it could cause material harm to our business and financial results.



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Policing unauthorized use of our products is difficult and can be a persistent problem, especially in some international markets. Further, the laws of some countries where our products are or may be distributed either do not protect our products and intellectual property rights to the same extent as the laws of Japan and the United States, or are poorly enforced. Legal protection of our rights may be ineffective in such countries, and our ability to protect our intellectual property rights and to avoid infringing intellectual property rights of others may diminish, particularly as we pursue new and emerging technologies. We cannot assure you that existing intellectual property laws will provide adequate protection for our products in connection with these emerging technologies.


Infringement of intellectual property rights could lead to costly litigation and/or the need to enter into license agreements, which may result in increased operating expenses.


Existing or future infringement claims against us may result in costly litigation or require us to obtain a license for the proprietary rights of third parties, which could have a negative impact on our results of operations. As the number of our products increases and the features and content of these products continue to overlap, we increasingly become subject to infringement claims. Although we believe that we make reasonable efforts to ensure that our products do not violate the intellectual property rights of others, it is possible that third parties still may claim infringement.


From time to time, third parties have asserted that some of our products infringed their proprietary rights. These infringement claims have sometimes resulted in litigation against us. For example, in game software featuring sports such as baseball and soccer, we use individual names and images of professional players, team names, logos and uniforms. Although we have obtained licenses to use them from organizations and agents which manage the rights of the professional players and the teams, in the event agreements change or any disputes arise among the professional players, the teams and organizations or agents which manage their rights, it is possible that such professional players, teams, organizations or agents might bring a lawsuit against us to suspend manufacturing and sales of the relevant game software. Such a lawsuit may be time consuming and expensive to defend.


Intellectual property litigation or claims could force us to do one or more of the following:


    cease selling, incorporating or using products or services that incorporate the challenged intellectual property;


    obtain a license from the holder of the infringed intellectual property, which if available at all, may not be available on commercially favorable terms; or


    redesign our products, which could cause us to incur additional costs, delay introduction and possibly reduce commercial appeal of our products.


Any of these actions may cause material harm to our business and financial results.


If our products contain defects, our business could be harmed significantly.


Our video game software products, amusement arcade games, token-operated games, gaming machines, pachinko liquid crystal display, and exercise equipment are complex and may contain undetected errors when first introduced or when new versions are released. We cannot assure you that, despite extensive testing prior to release, errors will not be found in new products or releases after shipment, resulting in loss of or delay in market acceptance. This loss or delay could significantly harm our business and financial results.


We may face limitations on our ability to find suitable acquisition opportunities and integrate acquired businesses.


In order to develop and market our products and services competitively, we are seeking opportunities in and outside Japan to make acquisitions of controlling or significant stakes in other businesses that will grow our



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current businesses. Some of these transactions could be material in size and scope. Our acquisitions strategy requires that we effectively coordinate and integrate our activities with those of the companies in which we invest or which we acquire. In the event we make such acquisitions or investments, we will face additional financial and operational risks, including:


    difficulty in assimilating the operations, technology and personnel of acquired companies;


    disruption in our business because of the allocation of financial and human resources to consummate the acquisitions;


    difficulty in retaining key technical and managerial personnel from acquired companies;


    dilution of our current shareholders if we issue equity to fund one or more of these acquisitions or investments; and


    assumption of operating losses and increased expenses, charges and liabilities in connection with acquisitions.


While we will continually be searching for additional acquisition opportunities, we may not be successful in identifying suitable acquisitions. As the video game software, amusement arcade machine, gaming machine and sports club industries continue to consolidate, we face significant competition in seeking and consummating acquisition opportunities. We may not be able to consummate potential acquisitions or investments on terms acceptable to us or such an acquisition or investment may not enhance our business or may decrease rather than increase our earnings. Our shareholders may not have the opportunity to review, vote on or evaluate future acquisitions.


Our business and financial results could be negatively impacted if we are unable to attract additional qualified employees or retain the services of key employees, the loss of whom could have a material adverse effect on our business.


Our continued growth and success depend to a significant extent on the continued service of our senior management and other key employees and the hiring of new qualified employees. The software industry in particular is characterized by a high level of employee mobility and aggressive recruiting among competitors for personnel with technical, marketing, sales, product development and management skills. We may not be able to attract and retain skilled personnel or may incur significant costs in order to do so that may not be offset through either improved productivity or higher prices.


Factors specific to international trade may result in reduced revenues and/or increased costs.


Approximately 78.7% of our net revenues during fiscal 2002, 71.9% of our net revenues during fiscal 2003 and 64.5% of our net revenues during fiscal 2004 were derived from sales in Japan. Although we expect that domestic sales will continue to account for a significant portion of our revenues in future periods, we plan to expand our international operations, particularly with respect to video game software, gaming machines and Toy & Hobby business, including through alliances or investments. Sales in foreign countries may involve expenses incurred to customize products to comply with local laws, especially in the case of gaming machines. In addition, products that are successful in the domestic Japanese market may not be successful in foreign markets due to different consumer preferences. In addition, our costs will increase as a result of the need to conduct market research to discover local preferences and tastes and to develop foreign language versions or make product modifications in order to tailor our products to various local markets. In the case of video game software, we may have to grant price concessions to or accept returns from major retailers that control market access to consumers. International trade is also subject to general country risks, including suspension of currency exchange by



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governments, increases in tariffs, and forfeiture of property through expropriation by governments. International trade is also exposed to fluctuating exchange rates. We may become exposed to increased litigation risks or unexpected bankruptcy risks through product liabilities, facility liabilities, product defect or labor issues in the course of further expanding our business, enhancing our international network and increasing our vendors and customers. These and other factors specific to international trade may result in increased costs or reduced revenues.


Demographic trends may have an adverse effect on our target market and our ability to increase revenues.


The Japanese population of people in their teens and 20s, the traditional target market for our products and services including Computer & Video Games products and arcade games, is expected to decline. Accordingly, we may not be able to increase or maintain revenues if we are unable to enter new markets such as sports clubs and expand our customer base and product offerings to overseas markets. Life expectancy in Japan is among the highest of the developed countries. However, as a result of a decline in fertility rates, Japan’s population is expected to begin declining after 2007 and its demographic makeup is already aging considerably. According to government estimates released in March 2002, as of calendar year 2000, 17.4% of Japan’s population was aged 65 or over and this percentage is expected to reach 26.0% by 2015.


Risks Relating to Our Computer & Video Games Business


Transitions in game console platforms and technological change have a material impact on the market for video game software and may adversely affect our revenues and profitability.


The life cycle of existing game console platforms and the market acceptance and popularity of new game console platforms significantly affects the success of our products. The introduction of new technologies could render our current products or products in development obsolete or unmarketable. In addition, we cannot guarantee that we will be successful in developing and publishing software for new game console platforms on a timely basis. Further, we have no control over the release dates of new game platforms or the number of units that will be shipped upon such release.


Also, when new game console platforms are announced or introduced into the market, consumers typically reduce their purchases of video game software products for current console platforms in anticipation of new platforms becoming available. During these periods, sales of our video game software products can be expected to slow down or even decline until new platforms have been introduced and have achieved wide consumer acceptance. For example, sales of some of our products for the previous PlayStation and Nintendo 64 platforms were negatively affected by the platform transition from 32-bit and 64-bit to 128-bit game consoles such as Sony’s PlayStation 2, Nintendo’s GameCube and Microsoft’s Xbox. Also, if fewer than expected units of a new game platform are manufactured or shipped, or the introduction of a new platform is significantly delayed, as occurred with Microsoft’s Xbox, we may experience lower-than-expected sales.


We must make significant expenditures to develop products for new platforms which may not be successful or released when anticipated.


The cyclical nature of the industry requires us to anticipate and assess the emergence and market acceptance of new game console platforms and develop new software well in advance of the time the platform is introduced to consumers. The complexity of next-generation platforms has resulted in higher development expenses which typically range between ¥100 million and ¥700 million per product. If the platforms for which we develop new software products do not attain significant market penetration or our new products fail to gain market acceptance, we may not be able to recover in revenues our development expenses, which could be significant, and our business and financial results could be significantly harmed. We anticipate that our profitability will continue to



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be impacted by the levels of research and development expenses relative to revenues, and by fluctuations relating to the timing of development in anticipation of future platforms.


If we are unable to obtain or renew licenses from hardware manufacturers, we will not be able to release software for popular video game consoles and our revenue and profitability may be negatively impacted.


Substantially all of our revenues from our Computer & Video Games segment have historically been derived from sales of software for use on proprietary game platforms developed and manufactured by other companies. We may only publish our games for play on their game platforms if we receive a platform license from them, which licenses are generally for an initial term of several years and may be extended for additional one-year terms. If we cannot obtain licenses to develop video game software from manufacturers of popular game consoles or if any of our existing license agreements are terminated, we will not be able to release software for those systems, which may have a negative impact on our results of operations and profitability. Although we cannot assure shareholders that we will be able to obtain extensions or that we will be successful in negotiating definitive license agreements with developers of new systems when the term of existing license agreements end, to date we have always obtained extensions or new agreements with the hardware companies. We also depend on hardware manufacturers for the following additional reasons:


    platform manufacturers have considerable control over the prices for their platform licenses;


    we must obtain their prior review and approval to publish games on their platforms;


    if the popularity of a game platform declines, or the manufacturer stops manufacturing or does not meet the demand for a platform, or delays the introduction of a platform in a region important to us, the games that we have published and that we are developing for that platform would likely produce lower sales than we anticipate;


    these manufacturers control the manufacture of, or approval to manufacture, the game discs and cartridges that incorporate our software; and


    these companies have the exclusive right to protect the intellectual property rights to their respective hardware platforms and technology and to discourage others from producing unauthorized software for their platforms that compete with our games.


In addition, we depend on Sony and Nintendo for the manufacture of products that we develop for their hardware platforms. Games for the Xbox must be manufactured by pre-approved manufacturers. Our hardware platform licenses with these platform manufacturers provide that the manufacturer may change prices for the manufacturing of products. These licenses include other provisions such as approval rights of all products and related promotional materials that could have an effect on our costs and the timing of release of new titles.


Since major manufactures such as Sony and Nintendo are also publishers of games for their own hardware platforms and manufacture products for all of their other licensees, such manufacturers may give priority to their own products or those of our competitors in the event of insufficient manufacturing capacity. Our business and financial results could be materially harmed by unanticipated delays in the manufacturing and delivery of our products by Sony or Nintendo, which has occurred in the past. In addition, our business and financial results could be materially harmed if Sony or Nintendo used their rights under these agreements to delay the manufacture or delivery of our products, limit the costs recoverable by us to manufacture video game software for their consoles, or elect to manufacture software themselves or use developers other than us.


Our business, revenues and profits could be harmed if we are not able to respond in a timely manner to the increasing popularity of Internet-based games, including PS2, Xbox and PC games.


In recent years, the rapid growth of the Internet has resulted in the development of interactive software games for play over the Internet and, in Japan, on mobile phones. Although we are marketing mobile



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phone-based games and games downloadable using the online function of PlayStation 2, we are developing and testing but have not yet begun to sell a significant number of games for play over the Internet using either PlayStation 2, Xbox or a PC. If the Internet becomes a popular avenue for interactive software games, we will need to rapidly develop and release games for such media and to establish a profitable business model for these Internet-based games. If we are not able to respond in a timely manner to the increasing popularity of these games, our business, revenues and profits could be harmed.


Our video game software for both game consoles and amusement arcade games may be subject to governmental restrictions, rating systems or to legal claims regarding content.


Legislation is periodically introduced at the local, state and federal levels in the United States and in other countries to establish a system for providing consumers with information about graphic violence and sexually explicit material contained in software products. In addition, many countries have laws that permit governmental entities to censor the content and advertising of software. Although there are no mandatory government-run rating systems in Japan, North America, Europe and Asian countries except China that are significant markets or potential markets for our products, governmental approval is required for software sales in China and such rating systems may be adopted elsewhere. We may be required to modify our products or alter our marketing strategies to comply with new regulations, which could delay the release of our products in those countries. Due to the uncertainties regarding these rating systems, confusion in the marketplace may occur, and we are unable to predict what effect, if any, such rating systems would have on our business.


Within the past several years, at least one lawsuit has been filed in the United States against video game companies, which did not name us as a defendant, by the families of victims who were shot and killed by teenage gunmen. This lawsuit alleged that the video game companies manufactured and/or supplied these teenagers with violent video games, teaching them how to use a gun and causing them to act out in a violent manner. While the plaintiffs’ claims were dismissed, similar lawsuits may be filed in the future which, if decided against us and our insurance carrier does not cover the amounts we are liable for, could have a material adverse effect on our business and financial results. Also payment of significant claims by insurance carriers may make such insurance coverage materially more expensive or unavailable in the future, thereby exposing our business to additional risk.


Although neither the terrorist attacks in the United States of America in September 2001, the late 2001 bio-terrorist attacks on various organizations nor war against Iraq commenced in March 2003 involving terrorist attacks have had a material adverse effect on our business, operations or financial condition, we cannot assure you that future terrorist attacks or the response of governments to any future terrorist actions, would not negatively affect our business by requiring us to modify the content of our game software, which could result in expensive product recalls, reprogramming or delays in the release of future games.


Risks Relating to Our Video Game Machines, Token-Operated Game Machines and Pachinko LCD Units Business


Our results of operations may suffer if amusement arcade revenues and sales of arcade games and token-operated game machines continue to decline.


Amusement arcades are the primary venue for video game machines and token-operated game machines in Japan. Amusement arcade revenues and the sales of arcade games have been declining over the past several years, however, these have been bottomed out and recovering since last year. However, due to the development of full-scale home video game consoles that can rival amusement arcade games in play quality and the introduction of advanced mobile telephones equipped with Internet and game functions, consumers now have increasing leisure alternatives outside of amusement arcades. As customer preferences diversify, fewer people



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may frequent the amusement arcades on which we depend for sales of our amusement arcade game software, amusement arcade games and token-operated game machines and this could have a negative impact on our results of operations if amusement arcade operators reduce purchases of our products as a result.


If our games are not accepted in the competitive domestic market for video game machines and token-operated game machines for amusement arcades, our results of operations will suffer.


Our success as a manufacturer of video game machines and token-operated game machines is dependent upon numerous factors, including our ability to design, manufacture, market and service video game machines and token-operated game machines that achieve player acceptance while maintaining product quality and acceptable margins. In addition, we must compete against other large and well-established game manufacturers such as Sega Corporation and Namco Ltd. If any of these game manufacturers, or another competitor, develops popular video game machines or token-operated game machines for amusement arcades and installed these game machines in the same arcade floor space as our video games and token-operated game machines, our sales from the amusement arcade game and domestic token-operated game machine markets may decrease significantly.


We do not manufacture our own LCDs for pachinko machines and may not be able to obtain adequate supplies, which could cause delays or reduce profit margins.


Almost all of our revenues and profits from our pachinko LCD units business come from the sale of software that is integrated into LCD units. The manufacturing of LCDs is a complex process. We do not manufacture LCDs and, therefore, we rely on third parties to manufacture these products for us. We work with several contract suppliers who have the capabilities for the commercial manufacture of LCDs. While we believe that the business relations between us and our contract manufacturers are good, we cannot predict whether these manufacturers will meet our requirements for quality, quantity or timeliness for the manufacture of LCDs. Therefore, we may not be able to obtain supplies of LCDs on acceptable terms or in sufficient quantities, if at all.


We also rely on third party subcontractors to integrate our software with the LCDs and other associated hardware, which may also reduce our profit margins and ability to deliver our products with sufficient speed. Also, if any of our existing subcontractors cease operations, we may need to locate and engage another manufacturer. As a result, using a new subcontractor could delay bringing new products to market, disrupt our ability to supply LCD units or reduce our profit margins.


Risks Relating to Our Gaming Business


If our gaming products are not accepted in the competitive market for gaming machines, we may be unable to compete in the gaming machine market.


Our success as a gaming machine manufacturer and supplier in overseas markets is dependent upon numerous factors, including our ability to design, manufacture, market and service gaming machines that achieve player and casino acceptance while maintaining product quality and acceptable margins. In addition, we must compete against gaming equipment companies such as International Game Technology, Alliance Gaming Corporation, Aristocrat Leisure Limited and WMS Industries Inc., which are among the largest and most-established suppliers of gaming machines in the world. Some of our competitors have greater financial resources, name recognition, established service networks and customer relationships than we do and are licensed in more jurisdictions than we are.


In order to diversify and expand sales, we are obtaining licenses and have begun marketing and selling gaming machines to overseas markets such as Australia and the United States. If our games fail to be accepted by



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the market for gaming machines and we are otherwise unable to develop gaming machines that offer technological advantages or unique entertainment features, we will be unable to generate the revenues necessary to compete effectively in the competitive gaming machine market. Consequently, the results of our operations could suffer.


An adverse change affecting the gaming industries, including a change in gaming regulations or in the expansion and popularity of casino gaming, will negatively impact our profitability and our potential for growth.


Our ability to grow our business and operate profitably is substantially dependent upon the expansion of the gaming industry and factors that are beyond our control. These factors include, among others:


    the pace of market expansion;


    changes in gaming regulation; and


    fluctuations in popularity of casino gaming.


An adverse change in any of these political, legal and other factors may negatively impact our results of operations.


Our failure to obtain or retain required gaming licenses could prevent us from expanding our market and prohibit us from generating revenue in certain jurisdictions.


In North America, the manufacture and distribution of gaming machines are subject to numerous federal, state, provincial, tribal, international and local regulations. In particular, we are subject to extensive regulation in Arizona, California, Illinois, Indiana, Iowa, Kansas, Louisiana, Michigan, Minnesota, Mississippi, Nevada, New Mexico, New York, Oregon, West Virginia, Wisconsin, North Dakota, Idaho, Puerto Rico and the Canadian provinces of British Columbia, Ontario, Quebec and Saskatchewan due to our gaming machines business in those jurisdictions. In addition, we may also be subject to regulation as a gaming operator if we keep on developing lease participation agreements under which we share in the revenues generated by gaming machines. These regulations are constantly changing and evolving, and may curtail gaming in various jurisdictions in the future, which would decrease the number of jurisdictions from which we can generate revenues.


Together with our key personnel, we undergo extensive investigation before each jurisdictional license is issued. Our gaming machines are subjected to independent testing and evaluation prior to approval from each jurisdiction in which we do business. Generally, regulatory authorities have broad discretion when granting, renewing or revoking these game approvals and licenses. Our failure to obtain or retain a required license or approval in one jurisdiction could negatively impact our ability to obtain or retain required licenses and approvals in other jurisdictions. The failure to obtain or retain a required license or approval in any jurisdiction would decrease the geographic areas where we may operate and generate revenues, decrease our share in the gaming marketplace and put us at a disadvantage compared with our competitors. Consequently, the market price of our common stock may suffer.


Regulatory authorities may require shareholders to submit to background investigations and respond to questions from regulatory authorities, and may deny a license or revoke our licenses based upon their findings. These licensing procedures and background investigations may inhibit potential investors from becoming significant shareholders.


The future revenue growth of our gaming business depends on our ability to improve the effectiveness and breadth of our sales organizations.


We will need to improve the effectiveness and breadth of our sales operations internationally in order to increase market awareness and sales of our gaming products. Our gaming products require sophisticated sales



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efforts targeted at selected people within the gaming industry. Competition for qualified sales personnel is intense, and we might not be able to hire the kind and number of sales personnel we are targeting. In addition, we will need to effectively train and educate our sales force if we are to be successful in selling into the gaming machine market.


A delay in operation of our new factory in the United States may cause problems in our production capacity and quality control, negatively affecting our revenues and growth.


In order to meet our increasing sales in the U.S. market, we will construct a new factory with increased production capacity in Las Vegas, Nevada and it is currently scheduled to start its operation by the end of fiscal 2005. It is possible that the operation of the new factory will be delayed due to natural disaster or delays in filing various applications concerning the construction and operation of the new factory. If there is a delay in operation of the new factory, we may not be able to maintain sufficient production capacity that can respond to an increase in orders and our performance may be negatively affected as a result.


Risks Relating to Our Health & Fitness Business


Our health & fitness business may not grow as we expect if we are not able to successfully develop and operate new club locations.


Our growth strategy depends in part on our ability to successfully develop and operate new club locations. The successful development of new clubs will depend on various factors, including our ability to:


    obtain financing;


    locate suitable sites for clubs;


    successfully negotiate lease agreements and meet construction schedules and budgets;


    resolve zoning, permitting or other regulatory issues relating to the construction of new clubs;


    hire, train and retain qualified personnel;


    attract new members; and


    effectively address issues raised by other factors, some or all of which may be beyond our control.


If we are not able to achieve success with respect to the factors outlined above, the growth of our health & fitness business may be limited. We cannot assure you that we will be able to implement our growth strategy, open new clubs on a timely and cost-efficient basis or operate our new clubs profitably. Upon opening a new sports 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. These losses and lower margins may negatively impact our future results of operations.


A decline in membership levels of our sports clubs could have a negative effect on our business.


The performance of our sports clubs is dependent on our ability to attract and retain members, and we cannot assure you that we will be successful in these efforts, or that the membership levels at one or more of our clubs will not decline. Our members can cancel their club membership at the end of any month provided that they give advance notice by the tenth day of that month. Because members periodically cancel their membership, our total number of members will decline unless we are able to attract new members each month. There are numerous factors that could lead to a decline in membership levels at established clubs or that could prevent us from increasing our membership at newer clubs, including our reputation, our ability to deliver quality service at a competitive cost, the presence of direct and indirect competition in the areas in which the clubs are located, the



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public’s interest in sports and sports clubs and general economic conditions. As a result of these factors, we cannot assure you that our membership levels will be adequate to maintain or permit the expansion of our operations. In addition, a decline in membership levels may have a material adverse effect on our performance, financial condition and results of operations.


Failure to compete effectively in the sports club industry will have an adverse effect on our results of operations.


The sports club industry is highly competitive. We compete with other sports clubs, physical fitness and recreational facilities established by local governments, hospitals and businesses for their employees, amenity and condominium clubs and, to a certain extent, with racquet and tennis and other athletic clubs, country clubs, weight reducing salons and the home-use fitness equipment industry. We also compete with other entertainment and retail businesses for the discretionary income of our target markets. We cannot assure you that we will be able to compete effectively in the future in the markets in which we operate. Competitors, which may include companies which are larger and have greater resources than us, may enter these markets to our detriment. These competitive conditions may limit our ability to increase dues without a material loss in membership, attract new members and attract and retain qualified personnel. Additionally, consolidation in the sports club industry could result in increased competition among participants, particularly large multi-facility operators that are able to compete for attractive acquisition candidates, thereby increasing costs associated with expansion through both acquisitions, and lease negotiation and real estate availability.


Future claims—we could be subject to claims related to health risks at our clubs.


Use of our sports clubs and equipment poses some potential health risks to members or guests through exertion and use of our services and facilities including exercise equipment. We cannot assure you that a claim against us for death or injury suffered by members or their guests while exercising at a club will not be asserted, or that we would be able to successfully defend any such claim. We currently maintain general liability coverage but we cannot assure you that we will be able to maintain such liability insurance on acceptable terms in the future or that such insurance will provide adequate coverage against potential claims. A liability claim in excess of our insurance coverage would have to be paid out of cash and would harm our reputation in the industry.


We are subject to various governmental regulations, the breach of which could result in temporary closings and negative publicity.


Our operations are subject to national, local and municipal government regulation in the various jurisdictions in which our clubs are located. These regulations include, but are not limited to, health, sanitation and safety regulations with respect to the sale of food and beverages and the operation of swimming pools and baths. Breach of these regulations could result in the temporary suspension or loss of licenses necessary to food service and other operations at any one of our clubs and negative publicity that could have an adverse effect on our reputation and ability to attract and retain club members.


We may be unable to get refunds of deposits and guarantee money relating to leases of land and buildings for the use of our sports club facilities.


We rent land and buildings when we open new sports clubs in many cases. Under lease agreements, we are often required to make deposits and provide guarantee money in order to provide a source of funds to offset owners’ damages if we were to default in payment of rent or to neglect to restore the property to its original state upon termination of the lease agreement. Accordingly, if we pay our rent and perform our restoration obligations as prescribed in the agreement, we are entitled to obtain refund of such deposits and guarantee money. However, if the owner of the property goes bankrupt before returning these funds, or if the owner otherwise is unable or unwilling to return these funds, we may not be able to obtain refunds of such deposits and guarantee money.



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Risks Relating to the Shares and the ADSs


Our share price is volatile and shareholders may not be able to recoup their investment.


Disclosures of our operating results (particularly if below the estimates of securities industry analysts), announcements of various events by us or by our competitors or other industry participants or the development and marketing of new products, as well as other factors, may cause the market price of our common stock to change significantly over short periods of time. The price of our common stock has been and is likely to continue to be highly volatile, and shareholders may not be able to recoup their investment. For example, the closing highs and lows of price per share of our common stock ranged from ¥1,535 to ¥3,980 during fiscal 2004.


A substantial number of our shares of common stock are eligible for future sale, and the sale of these shares may cause the price of our common stock to decline even if our business is performing well.


As of May 31, 2004, there were 120,482,828 shares of our common stock outstanding including 33,824,364 shares, representing 28.07% of our outstanding shares, beneficially owned by Mr. Kagemasa Kozuki, our founder, Representative Director, Chairman of the Board, President and Chief Executive Officer, and his affiliate holders Mrs. Yoko Kozuki, Kozuki Holding B.V., Kozuki Foundation for Higher Education, Kozuki Capital Corporation, Kozuki Foundation for Advanced Information Technology and Kozuki Foundation for Sports and Athletes. These shares and, generally, the shares owned by other shareholders, can be disposed of on the Tokyo Stock Exchange or otherwise in Japan without any legal restriction. Additionally, under our Articles of Incorporation, our board of directors is authorized to issue 321,262,434 additional shares of common stock generally without any shareholder approval. In addition, as of May 31, 2004, we held 8,254,738 shares of treasury stock which our board of directors may sell without any shareholder approval.


Additional sales of a substantial amount of our common stock in the public market, or the perception that such sales may occur, could cause the market price of our common stock to decline. This could also impair our ability to raise additional capital through the sale of our securities. Also, in the future, we may issue common stock to raise cash for additional capital expenditures, working capital, research and development or acquisitions, and we may also pay for additional interests in subsidiaries or affiliated companies by using cash, common stock or both. We may also issue securities convertible into our common stock. Any of these events may dilute your ownership interest in us and have an adverse impact on the price of our common stock.


Investors holding less than a unit of shares will have limited rights as shareholders.


Pursuant to the Commercial Code of Japan relating to joint stock corporations and other related legislation, our Articles of Incorporation provide that 100 shares of common stock constitute one “unit”. The Commercial Code imposes significant restrictions and limitations on holdings of shares that do not constitute whole units. In general, holders of shares constituting less than one unit do not have the right to vote or to examine our books and records. The transferability of our shares of common stock constituting less than one unit is significantly limited. For a more complete description of the unit share system and its effect on the rights of holders of our shares, see Item 10.B “Unit Share System” below.


There are restrictions on your ability to withdraw shares from the depositary receipt facility.


Each ADS represents the right to receive one share of common stock. Each ADR will bear a legend to that effect. Holders of ADSs will be unable to withdraw fractions of shares from the depositary or receive any cash settlement in lieu of withdrawal of fractions of shares. Therefore, pursuant to the terms of the deposit agreement with our depositary, JPMorgan Chase Bank in order to withdraw any shares, a holder of ADSs must surrender for cancellation and withdrawal of shares, ADRs evidencing 100 ADSs or any integral multiple thereof. In addition, although the ADSs themselves may be transferred in any lots pursuant to the deposit agreement, the ability to trade the underlying shares may be limited.



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Holders of ADRs have fewer rights than shareholders and must act through the depositary to exercise those rights.


Holders of ADRs do not have the same rights as shareholders and accordingly cannot exercise rights of shareholders against us. JPMorgan Chase Bank, as depositary, through its custodian agent, is the registered shareholder of the deposited shares underlying the ADSs, and therefore only it can exercise the rights of shareholders in connection with the deposited shares. In certain cases, we may not ask JPMorgan Chase Bank to ask holders of ADSs for instructions as to how they wish their shares voted. Even if we ask JPMorgan Chase Bank to ask holders of ADSs for such instructions, it may not be possible for JPMorgan Chase Bank to obtain these instructions from ADS holders in time for JPMorgan Chase Bank to vote in accordance with such instructions. JPMorgan Chase Bank is only obliged to try, as far as practical, and subject to Japanese law and our Articles of Incorporation, to vote or have its agents vote the deposited shares as holders of ADSs instruct. In your capacity as an ADS holder, you will not be able to bring a derivative action, examine the accounting books and records of the company, or exercise appraisal rights.


Rights of shareholders under Japanese law may be more limited than under the laws of other jurisdictions.


Our Articles of Incorporation, our board of directors’ Regulations and the Commercial Code of Japan govern our corporate affairs. Legal principles relating to such matters as the validity of corporate procedures, directors’ fiduciary duties and liabilities, and shareholders’ rights may be different from those that would apply to a non-Japanese company. Shareholders’ rights under Japanese law may not be as extensive as shareholders’ rights under the laws of other countries or jurisdictions within the United States. You may have more difficulty in asserting your rights as a shareholder than you would as a shareholder of a corporation organized in another jurisdiction.


Because of daily price range limitations under Japanese stock exchange rules, you may not be able to sell your shares of our common stock at a particular price on any particular trading day, or at all.


Stock prices on Japanese stock exchanges are determined on a real-time basis by the equilibrium between bids and offers. These exchanges are order-driven markets without specialists or market makers to guide price formation. To prevent excessive volatility, these exchanges set daily upward and downward price fluctuation limits for each stock, based on the previous day’s closing price. Although transactions may continue at the upward or downward limit price if the limit price is reached on a particular trading day, no transactions may take place outside these limits. Consequently, an investor wishing to sell at a price above or below the relevant daily limit may not be able to sell his or her shares at such price on a particular trading day, or at all.


U.S. investors may have difficulty in serving process or enforcing a judgment against us or our directors, executive officers or corporate auditors.


We are a limited liability, joint-stock corporation incorporated under the laws of Japan. Most of our directors, executive officers and corporate auditors reside in Japan. All or substantially all of our assets and the assets of these persons are located in Japan and elsewhere outside the United States. It may not be possible, therefore, for U.S. investors to effect service of process within the United States upon us or these persons or to enforce against us or these persons judgments obtained in U.S. courts predicated upon the civil liability provisions of the federal securities laws of the United States. There is doubt as to the enforceability in Japan, in original actions or in actions for enforcement of judgment of U.S. courts, of liabilities predicated solely upon the federal securities laws of the United States.


Foreign exchange fluctuations may affect the dollar value of our ADSs and dividends payable to holders of our ADSs.


Market prices for our ADSs may fall if the value of the yen declines against the U.S. dollar. In addition, the U.S. dollar amount of cash dividends and other cash payments made to holders of our ADSs would be reduced if the value of the yen declines against the U.S. dollar.



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