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The following is an excerpt from a 20-F SEC Filing, filed by KONAMI CORP on 7/24/2006.
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KONAMI CORP - 20-F - 20060724 - NOTES_TO_FINANCIAL_STATEMENT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006

 

1.    Business and Organization, Basis of Presentation and Summary of Significant Accounting Policies

 

Business and Organization

 

KONAMI CORPORATION (the “Company”) was founded in 1969 and was incorporated under the laws of Japan in March 1973. The Company and its subsidiaries (collectively “Konami”) engage in production and sale of video game software for home video game systems, game machines for installation in amusement arcades and other entertainment venues and other amusement-related products, and operation of health and fitness club facilities. The principal markets for Konami’s products are Japan, North America, Europe, Asia and Australia while all of its health and fitness club facility operation is in Japan.

 

Substantially all of Konami’s revenues from video game software have historically been derived from sales of software for use on proprietary game platforms developed and manufactured by other manufacturers. Konami may only publish its games for use on the manufacturers’ game platforms if it receives a platform license from them, which is generally for an initial term of several years and may be extended for additional one-year terms. If Konami cannot obtain licenses to develop video game software from manufacturers of popular game platforms or if any of its existing license agreements are terminated, it will not be able to release software for those platforms, which may have a negative impact on its results of operations and profitability. To date, Konami has successfully obtained extensions or new agreements with the platform manufacturers each time it has attempted to do so. These licenses include other provisions such as approval rights by the manufacturers of all products and related promotional materials which could have an effect on Konami’s costs and the timing of release of new game titles.

 

In the United States, Canada and Australia, the manufacture and distribution of Konami’s gaming machines are subject to numerous federal, state and local regulations. In addition, Konami may be subject to regulation as a gaming operator if it enters into lease participation agreements under which it shares 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 Konami can generate revenues. Konami and its key personnel are subject to an extensive investigation before each jurisdictional gaming license is issued. Also, Konami’s gaming machines are subjected to independent testing and evaluation prior to approval from each jurisdiction. Generally, regulatory authorities have broad discretion when granting, renewing or revoking these game approvals and licenses.

 

Basis of Accounting

 

The Company and its domestic subsidiaries maintain their books and records in conformity with accounting principles and practices generally accepted in Japan (“Japanese GAAP”), and its foreign subsidiaries in conformity with those of the country of their domicile. The consolidated financial statements presented herein have been prepared in a manner and reflect certain adjustments, which are necessary to conform with U.S. generally accepted accounting principles (“U.S. GAAP”).

 

For the year ended March 31, 2006, Konami changed the presentation of “Purchases of treasury stock by subsidiaries” from net cash used in financing activities to net cash used in investing activities in the consolidated statements of cash flows. In addition, Konami revised the corresponding prior year presentation. The revision increased net cash used in financing activities and decreased net cash used in investing activities by ¥2,456 million and ¥3,593 million for the year ended March 31, 2004 and 2005, respectively.

 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Translation into U.S. Dollars

 

The accompanying consolidated financial statements are stated in Japanese yen, the functional currency of the country in which the Company is incorporated and principally operates. The U.S. dollar amounts included herein represent a translation using the mid price for telegraphic transfer of U.S. dollars for yen quoted by The Bank of Tokyo-Mitsubishi UFJ, Ltd. as of March 31, 2006 of ¥117.47 to $1 and are included solely for the convenience of the reader. 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.

 

Summary of Significant Accounting Policies

 

(a) Consolidation Policy

 

The accompanying consolidated financial statements include the accounts of the Company and all of its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

(b) Cash and Cash Equivalents

 

Cash and cash equivalents include all highly liquid investments with an initial maturity of three months or less.

 

(c) Marketable Securities

 

Konami classifies its debt and marketable equity securities into one of three categories: trading, available-for-sale, or held-to-maturity securities. Trading securities are bought and held primarily for the purpose of selling them in the near term. Held-to-maturity securities are those securities in which Konami has the ability and intent to hold them until maturity. All securities not included in trading or held-to-maturity categories are classified as available-for-sale. Trading and available-for-sale securities whose fair values are readily determinable are recorded at fair value. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Unrealized gains and losses on trading securities are included in earnings. Unrealized gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of accumulated other comprehensive income until realized. Realized gains and losses from sale of available-for-sale securities are determined based on the average cost method. A decline in the market value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Dividend income is recognized when received. As of March 31, 2005 and 2006, all equity securities held by Konami are classified as available-for-sale.

 

On a continuous basis, but no less frequently than at the end of each semi-annual period, Konami evaluates the cost basis of an available-for-sale security for possible other-than-temporary impairment. Factors considered in assessing whether an indication of other-than-temporary impairment exists include: the degree of change in ratio of market prices per share to book value per share at date of evaluation compared to that at date of acquisition, the financial condition and prospects of each investee company, industry conditions in which the investee company operates, the fair value of an available-for-sale security relative to the cost basis of the investment, the period of time the fair value of an available-for-sale security has been below the cost basis of the investment and other relevant factors.

 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Konami evaluates the cost basis of a held-to-maturity debt security for possible other-than-temporary impairment by taking into consideration the financial condition, business prospects and credit worthiness of the issuer. The published credit ratings of investee companies that are “BB” or lower are considered an indication of other-than-temporary impairment.

 

Impairment to be recognized is measured based on the amount by which the carrying amount of the investment exceeds the fair value of the investment. Fair value is determined based on quoted market prices, projected discounted cash flows or other valuation techniques as appropriate.

 

(d) Investments in Affiliates

 

For those investments in affiliates in which the Company has the ability to exercise significant influence over the affiliate’s operations (generally when its voting interest is between 20% and 50%), the equity-method of accounting is used. Under this method, the investment is initially recorded at cost and is adjusted to recognize the Company’s share of the net earnings or losses of the affiliates. All significant intercompany profits from these affiliates have been eliminated.

 

Investments in non-marketable equity securities in which the Company’s ownership is less than 20% are carried at cost. On a continuous basis, but no less frequently than at the end of each semi-annual period, the Company evaluates the carrying amount of its ownership interests in investee companies for possible impairment. Factors considered in assessing whether an indication of other-than-temporary impairment exists include the achievement of business plan objectives and milestones including cash flow projections and the results of planned financing activities, the financial condition and prospects of each investee company, the fair value of the ownership interest relative to the carrying amount of the investment, the period of time the fair value of the ownership interest has been below the carrying amount of the investment and other relevant factors. Impairment to be recognized is measured based on the amount by which the carrying amount of the investment exceeds the fair value of the investment. Fair value is determined based on quoted market prices, projected discounted cash flows or other valuation techniques as appropriate. A decline in the value of a non-marketable equity security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established.

 

(e) Inventories

 

Inventories, consisting of merchandise for resale, finished products, work-in-process, raw materials and supplies, are stated at the lower of cost or market. Cost is determined by the first-in, first-out method for merchandise, by the specific identification method for software products, and by the average method for others.

 

(f) Property and Equipment

 

Property and equipment are carried at cost. Depreciation is computed on the declining-balance method using estimated useful lives ranging from 10 to 50 years for buildings and structures and from 2 to 20 years for tools, furniture and fixtures. Equipment under capital leases is stated at the lower of the present value of minimum lease payments or the fair value of the leased equipment at the inception of the lease and is amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset, which range from 3 to 8 years.

 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Ordinary maintenance and repairs are expensed as incurred. Major replacements and improvements are capitalized. When properties are retired or otherwise disposed of, the property and related accumulated depreciation accounts are relieved of the applicable amounts and any differences are included in operating income or expenses.

 

In June 2001, the FASB issued Statements of Financial Accounting Standards (“ 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. Konami adopted SFAS No. 143 on April 1, 2003.

 

In March 2005, the FASB issued FASB Interpretation No.47, “Accounting for Conditional Asset Retirement Obligations” which requires conditional asset retirement obligations to be recognized if a legal obligation exists to perform asset retirement activities and a reasonable estimate of the fair value of the obligation can be made. FIN 47 also provides guidance as to when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Company adopted the provisions of FIN 47 on March 31, 2006. No conditional asset retirement obligations were recognized and, accordingly, the adoption of FIN 47 had no effect on the Company’s financial statements.

 

(g) Software for Internal Use

 

Under the provisions of Statement of Position (“SOP”) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” Konami has capitalized costs associated with software systems for internal use, that have reached the application stage and meet recoverability tests as capitalized computer software in the accompanying consolidated balance sheets. Such capitalized costs primarily include external direct costs utilized in developing or obtaining the applications. Capitalization of such costs ceases at the point in which the project is substantially complete and ready for its intended use, and the costs capitalized are amortized on a straight-line basis over the estimated useful life of each application, ranging from 2 to 5 years. Konami expenses costs incurred during the preliminary project stage which include costs for making strategic decisions about the project, and determining performance and system requirements. Konami also expenses costs incurred for internal-use software in the post-implementation stage such as training and maintenance costs.

 

(h) Business Combination

 

Konami has used the purchase method of accounting for its acquisitions and, accordingly, has allocated the purchase price based on the estimated fair value of net assets of the acquired companies in accordance with SFAS No. 141 “Business combinations”. The excess purchase price over the fair value of net assets acquired is recorded as goodwill.

 

(i) Goodwill and Other Identifiable Intangible Assets

 

Goodwill represents the difference between the cost of acquired companies and amounts allocated to the estimated fair value of their net assets. Identifiable intangible assets represent intangible assets related to trademarks, membership lists, gaming licenses, existing technology, customer relationships and franchise and other contracts acquired in connection with acquisitions of subsidiaries.

 

F-11


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Konami performs an assessment of goodwill for impairment at least annually, and more frequently if an indicator of impairment has occurred, using a two-step process under SFAS No. 142, “Goodwill and Other Intangible Assets”. The first step requires identification of reporting units and determination of the fair value for each individual reporting unit. Konami has determined its reporting units to be the same as its reportable segments. The fair value of each reporting unit is then compared to the reporting unit’s carrying amount including assigned goodwill. To the extent a reporting unit’s carrying amount exceeds its fair value, the second step of the impairment test is performed by comparing the implied fair value of the reporting unit’s goodwill to its carrying amount. If the implied fair value of a reporting unit’s goodwill is less than its carrying amount, an impairment loss is recorded.

 

Intangible assets determined to have an indefinite useful life have been also tested for impairment based on fair value under SFAS No. 142. Konami reassesses such determination periodically for each asset based on the factors prescribed in SFAS No. 142.

 

Intangible assets with finite useful lives have been amortized over their estimated useful lives. Konami assesses the recoverability of these intangible assets according to SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

 

In the fourth quarter of the fiscal year ended March 31, 2006, Konami performed an annual assessment of goodwill and other intangible assets with an indefinite life for impairment under SFAS No. 142 and recorded an aggregate non-cash impairment charge of ¥9,180 million ($78,148 thousand). See Note 7 for a description of impairment charges recorded for intangible assets for the year ended March 31, 2006.

 

(j) Impairment or Disposal of Long-Lived Assets

 

Konami’s long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Factors Konami considers important which could trigger an impairment review include: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of the use of the acquired assets or the strategy for overall business; significant negative industry or economic trends; significant decline in the stock price of the acquired entity for a sustained period; and market capitalization of the acquired entity relative to its net book value. When it is determined that the carrying amount of assets to be held and used may not be recoverable based upon the existence of one or more of these indicators of impairment, recoverability is measured by a comparison of the carrying amount of an asset to future net cash flows (undiscounted and without interest charges) expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Impairment charges to reduce the carrying value of long-lived assets are presented in the accompanying consolidated statements of income as a separate line item within operating costs and expenses. See Note 6 for a description of impairment charges recorded for long-lived assets for the year ended March 31, 2006.

 

(k) Derivative Financial Instruments

 

From time to time, Konami uses certain derivative financial instruments to manage its foreign currency risks. Konami may enter into forward contracts to reduce its exposure to short-term (generally no more than one year) movements in exchange rates applicable to firm funding commitments that are denominated in currencies other than the Japanese yen.

 

F-12


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Konami accounts for its derivative financial instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended. SFAS No. 133, as amended, requires that all derivative instruments be reported on the balance sheet as either assets or liabilities measured at fair value. For derivative instruments designated and effective as fair value hedges, changes in the fair value of the derivative instrument and of the hedged item attributable to the hedged risk are recognized in earnings. For derivative instruments designated as cash flow hedges, the effective portion of any hedge is reported in accumulated other comprehensive income until it is recognized in earnings in the same period in which the hedged item affects earnings. Any amounts excluded from the assessment of hedge effectiveness as well as the ineffective portion of all hedges are reported in current earnings each period. Changes in fair value of derivative instruments that are not designated as a hedge are recorded each period in current earnings. If a derivative instrument is not designated as a hedge, the gain or loss is recognized in earnings in the period of change. To date, Konami has not designated any derivative instrument as a hedge.

 

(l) Income Taxes

 

Konami accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, deferred income taxes are recognized by the asset and liability method for the estimated future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards, using enacted tax rates in effect for the years in which those temporary differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date.

 

(m) Revenue Recognition

 

Konami derives revenue from primarily three sources: (i) product revenue, which includes packaged game software and other products, game machines and related equipment and components, (ii) membership fee revenue from health and fitness club members, and (iii) sales and subscription fee revenue from mobile game contents.

 

Konami’s revenue recognition criteria are as follows:

 

Persuasive Evidence of an Arrangement.

 

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

 

For Konami’s health and fitness clubs, members are required to sign a standard monthly membership agreement upon admission, which is automatically renewed unless the member provides 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.

 

For mobile game contents, Konami enters into distribution agreements with mobile phone carriers for the sale or subscription of mobile game contents by the carriers to their subscribers. Konami recognizes as revenues the net amount the mobile phone carrier pays to Konami upon the sale of Konami’s game contents, net of any service or other fees earned and deducted by the carrier.

 

F-13


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KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Delivery Has Occurred.

 

Packaged game software and other products are physically delivered to customers. Also, Konami’s game machines and related equipment are physically delivered to customers as a fully-assembled, ready to be installed unit. Accordingly, Konami recognizes revenue from product sales upon delivery and acceptance since title and risk of loss transfer to the customer based on freight on board (“FOB”) destination. Generally, Konami does not permit exchanges or accept returns of unsold merchandise except in the case of obvious defects. In certain limited circumstances Konami may allow returns, for which Konami estimates the related allowances based upon management’s evaluation of historical experience, the nature of the software titles and other factors. These estimates are deducted from gross sales.

 

Revenue from health and fitness club membership is derived primarily from monthly membership fees from club members. Revenue for those fees is recognized as monthly charges are generally made to the members’ accounts in advance, at the end of each month, with respect to the following month’s membership. This policy requires Konami to defer the applicable membership fee revenue for one month.

 

Revenue from mobile game contents is derived from monthly subscription fees. Under the distribution agreements, the mobile phone carriers are responsible for billing, collection and remittance of those subscription fees to Konami. The carriers generally report the final sales data to Konami within 60 days following the end of each month. When final sales data is not available in a timely manner for reporting purposes, Konami estimates its revenues based on available sales data, which is then adjusted to actual revenues in the following reporting period once the actual amounts are determined.

 

The Price is Fixed or Determinable.

 

The price customers pay for Konami’s 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. Konami’s membership fee for health and fitness clubs is fixed at the time of admission of the member. Also, monthly subscription fees for mobile game contents are based on a fixed rate per end customer subscriber.

 

Collection is Probable.

 

Probability of collection is assessed on a customer-by-customer basis. Konami typically sells to customers with whom Konami has 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 Konami’s health and fitness clubs, the collectibility of membership fees is assured as it generally charges members’ accounts one-month in advance. Also, for mobile game contents, the collectibility of subscription fees is assured by the distribution agreements with the mobile phone carriers.

 

(n) Software Development Costs

 

Research and development expenses are charged to income as incurred. Research and development expenses included in selling, general and administrative expenses amounted to ¥1,382 million, ¥1,813 million and ¥2,446 million ($20,822 thousand) for the years ended March 31, 2004, 2005 and 2006, respectively, in the accompanying consolidated statements of income.

 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed”, provides for the capitalization of certain software development costs incurred after technological feasibility is established or for development costs that have alternative future uses. Under Konami’s current practice of developing new game software products, technological feasibility is not established until substantially all development activities are complete, which generally include the development of a working template and the related tools. For game products where a proven game engine technology exists and other criteria supporting the technological feasibility of the game title in development have been met, which include coding and testing of unique or unproven functions and features, Konami capitalizes these costs and begins to expense them upon release of the product through cost of revenues or they are written-off when they are deemed unrecoverable.

 

(o) Royalties and License Fees

 

Konami pays royalties and license fees to professional sports organizations and certain other third parties for use of their trade names. Minimum portions of such royalties and license fees paid up-front are recorded as prepaid royalties and are expensed to costs of products sold over the contractual terms ranging primarily from 4 to 12 months. Variable portions of such royalties and license fees, which are generally determined based on the number of copies shipped at the predetermined royalty rates, are expensed to cost of products sold based on actual shipment. Management periodically evaluates the future realizability of prepaid royalties and charges to income any amounts deemed unlikely to be realized. Prepaid royalties amounted to ¥301 million and ¥454 million ($3,865 thousand) at March 31, 2005 and 2006, respectively, and were included in Prepaid expenses and other current assets in the accompanying consolidated balance sheets.

 

(p) Shipping and Handling Expenses

 

Shipping and Handling expenses are charged to earnings as incurred and are included in Selling, general and administrative expenses in the accompanying consolidated statements of income. Shipping and Handling expenses amounted to ¥952 million, ¥1,069 million and ¥811 million ($20,150 thousand) for the years ended March 31, 2004, 2005 and 2006, respectively.

 

(q) Advertising Expenses

 

Advertising expenses are charged to earnings as incurred and are included in Selling, general and administrative expenses in the accompanying consolidated statements of income. Advertising expenses amounted to ¥11,957 million, ¥12,667 million and ¥10,836 million ($92,245 thousand) for the years ended March 31, 2004, 2005 and 2006, respectively.

 

(r) Stock-based Compensation

 

Konami accounts for its stock-based compensation plan to directors and employees using the intrinsic value based method prescribed by Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” and FIN No. 44, “Accounting for Certain Transactions Involving Stock Compensation an Interpretation of APB No. 25”. As such, compensation expense is recorded on the date of grant only if the current fair value of the underlying stock exceeds the exercise price. SFAS No. 123, “Accounting for Stock-Based Compensation,” allows companies to continue to apply the provisions of APB No. 25, where applicable, and provide pro forma disclosure for employee stock option grants as if the fair value based method defined in SFAS No. 123 had been applied. Konami has elected to continue to apply the provisions of APB No. 25 for their stock-based compensation plans to directors and employees.

 

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KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Had Konami determined compensation expense based on the fair value at the grant date for rights of stock-based compensation plans under SFAS No. 123, Konami’s net income and net income per share would have been adjusted to the pro forma amounts indicated below;

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

Reported net income

   ¥ 20,104     ¥ 10,486     ¥ 23,008     $ 195,863  

Add back: stock-based compensation expense under intrinsic-value-based method, net of tax

     —         —         97       826  

Deduct: stock-based compensation expense under fair-value-based method, net of tax

     (664 )     (589 )     (539 )     (4,588 )
    


 


 


 


Pro forma net income

   ¥ 19,440     ¥ 9,897     ¥ 22,566     $ 192,100  
    


 


 


 


     Yen

    U.S. Dollars

 

Per share data:

                                

Reported net income per share, basic

   ¥ 166.86     ¥ 87.41     ¥ 175.86     $ 1.49  

Reported net income per share, diluted

   ¥ 166.86     ¥ 87.41       175.80       1.49  

Add back: stock-based compensation expense under intrinsic-value-based method, net of tax

     —         —         0.74       0.01  

Deduct: stock-based compensation expense under fair-value-based method, net of tax

     (5.51 )     (4.92 )     (4.12 )     (0.04 )
    


 


 


 


Pro forma net income per share, basic

   ¥ 161.35     ¥ 82.49     ¥ 172.48     $ 1.46  
    


 


 


 


Pro forma net income per share, diluted

   ¥ 161.35     ¥ 82.49     ¥ 172.42     $ 1.46  
    


 


 


 


 

(s) Comprehensive Income

 

SFAS No. 130, “Reporting Comprehensive Income,” requires classification of other comprehensive income in a financial statement and display of other comprehensive income separately from retained earnings and additional paid-in capital. Other comprehensive income primarily includes foreign currency translation adjustments, unrealized gains (losses) from marketable securities considered available-for-sale and adjustment for minimum pension liability as well as the income tax effects thereof.

 

(t) Translation of Foreign Currencies

 

Transactions denominated in foreign currencies are recorded using the exchange rates in effect as of the transaction dates. The related foreign currency asset and liability balances are translated based on exchange rates prevailing at each balance sheet date with the resulting gain or loss charged to income.

 

Assets and liabilities of a foreign subsidiary where the functional currency is other than Japanese yen are translated into Japanese yen at the exchange rates in effect at the balance sheet date. Revenue and expense accounts are translated at average exchange rates during the current year. The resulting translation adjustments are included in accumulated other comprehensive income.

 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

(u) Net Income Per Share

 

Net income per share is presented in accordance with the provisions of SFAS No. 128, “Earnings Per Share.” Under SFAS No. 128, basic net income per share excludes dilution for potential common stock and is computed by dividing consolidated net income (loss) by the weighted-average number of common shares outstanding. Diluted net income per share reflects the effect of potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted net income per share is calculated by dividing net income by the sum of the weighted-average number of shares plus additional shares that would be outstanding if potential dilutive shares had been issued. The components of basic and diluted net income per share are as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     2004

   2005

   2006

   2006

Net income available for common stockholders

   ¥ 20,104    ¥ 10,486    ¥ 23,008    $ 195,863
     Shares

    

Weighted-average common shares outstanding

     120,483,869      119,970,052      130,835,422       

Dilutive effect of employee stock options

     —        —        42,014       
    

  

  

      

Common stock and common stock equivalents

     120,483,869      119,970,052      130,877,436       
    

  

  

      
     Yen

   U.S. Dollars

Net income per share:

                           

Basic

   ¥ 166.86    ¥ 87.41    ¥ 175.86    $ 1.49
    

  

  

  

Diluted

   ¥ 166.86    ¥ 87.41    ¥ 175.80    $ 1.49
    

  

  

  

 

For the years ended March 31, 2004, 2005 and 2006, 1,657,600, 1,618,700 and 2,572,280 shares attributable to outstanding stock options were excluded from the calculation of diluted earnings per share because the exercise prices of the stock options were greater than or equal to the average price of the common shares, and therefore their inclusion would have been anti-dilutive.

 

(v) Use of Estimates

 

Preparation of these consolidated financial statements requires management of Konami to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of financial statements, and the reported amounts of revenue and expenses during the reporting periods. There can be no assurance that actual results will not differ from those estimates.

 

Konami has identified four areas where it believes assumptions and estimates are particularly critical to the consolidated financial statements. These are revenue recognition, accounting for software development costs, impairment on long-lived and intangible assets, and realizability of deferred tax assets.

 

(w) Recent Accounting Pronouncements

 

In November 2004, the FASB issued SFAS No.151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and

 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

wasted material. Among other provisions, the new rule requires that items such as excessive spoilage, double freight, and re-transportation charge be recognized as current period charges regardless of whether they meet the criterion of so abnormal as stated in Accounting Research Bulletins (“ARB”) No. 43. In addition, SFAS No.151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. Konami is required to adopt SFAS No.151 for fiscal years beginning after June 15, 2005. Konami does not expect the adoption of this statement will have a material effect on its consolidated financial statements.

 

In December 2004, the FASB issued a revision to SFAS No.123, “Accounting for Stock-Based Compensation” (“SFAS No.123R”). SFAS No.123R focuses on the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments that may be settled by the issuance of such equity instruments. The statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No.25, “Accounting for Stock Issued to Employees”, and generally would require instead that such transactions be accounted for using a fair-value-based method. Konami will be required to adopt SFAS No.123R at the beginning of the first annual period beginning after June 15, 2005. Konami does not expect the adoption of this statement will have a material effect on its consolidated financial statements.

 

In December 2004, the FASB issued SFAS No.153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No.29”. SFAS No.153 focuses on the measurement of exchanges nonmonetary assets and redefines the scope of transaction that should be measured based on the fair value of the assets exchanged. Konami will be required to adopt SFAS No.153 for fiscal year beginning after June 15, 2005. Konami does not expect the adoption of this statement will have a material effect on its consolidated financial statements.

 

In May 2005, the FASB issued SFAS No.154, “Accounting Changes and Error Corrections—a Replacement of APB Opinion No.20 and FASB Statement No.3” focuses on the guidelines of procedures and reporting of accounting changes or error corrections. In addition, SFAS No.154 requires to re-state retroactively from the possible earliest period on the business practice when accounting changes and error corrections are reported. Konami will be required to adopt SFAS No.154 for fiscal year beginning after December 15, 2005. Konami does not expect the adoption of this statement will have a material effect on its consolidated financial statements.

 

In June 2005, the FASB issued FASB Staff Position (“FSP”) SFAS No.143-1, “Accounting for Electronic Equipment Waste Obligations”. SFAS No.143-1 focuses on accounting for certain liabilities of waste electrical and electronic equipment based on a guidance approved by European Union (“EU”). Business owners are required to assume obligations respect to the waste of electric equipment sold before August 13, 2005. Konami will be required to adopt SFAS No.143-1 on the later of (1) the fiscal year beginning after June 8, 2005, or (2) the date that guidance is approved by the EU. Konami does not expect the adoption of this statement will have a material effect on its consolidated financial statements.

 

In September 2005, the Emerging Issues Task Force (“EITF”) issued EITF issue No. 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty”. EITF 04-13 provides guidance as to when purchases and sales of inventory with the same counterparty should be accounted for as a single exchange transaction. EITF 04-13 also provides guidance as to when a nonmonetary exchange of inventory should be accounted for at fair value. EITF 04-13 is effective for new arrangements entered into in reporting periods beginning after March 15, 2006 with early application permitted. Konami does not expect the adoption of this consensus will have a material effect on its consolidated financial statements.

 

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KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

In November 2005, the FASB issued SFAS No.115-1 and No.124-1, “The Meaning of Other-Than- Temporary Impairment and Its Application to Certain Investments” (SFAS No.115-1). SFAS No.115-1 focuses on the determination as to when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. SFAS No.115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. Konami will be required to adopt SFAS No.115-1 for fiscal year beginning after December 16, 2005. Konami does not expect the adoption of this statement will have a material effect on its consolidated financial statements.

 

2.    Merger and Acquisition

 

On December 16, 2004, the Company entered into a plan of merger agreement with three of its consolidated subsidiaries, Konami Computer Entertainment Studios, Inc. (“Konami STUDIO”), Konami Computer Entertainment Tokyo, Inc. (“Konami TYO”), and Konami Computer Entertainment Japan, Inc., (“Konami JPN”). Under the terms of the agreement, 0.42, 1.00, and 0.81 of one share of the Company’s common stock was exchanged for each common share of Konami STUDIO, Konami TYO and Konami JPN, respectively. The merger ratios were determined based on the independent valuations. The Company consummated the mergers on April 1, 2005, by issuing 10,794,142 new common shares to minority shareholders of those merged companies.

 

Konami accounted for the acquisitions of additional equity interests in the merged companies as a step-acquisition and, accordingly, the total purchase price of ¥24,373 million ($207,483 thousand), consisted of the fair value of new common shares issued to minority shareholders of the merged companies and the direct cost of the acquisition, has been allocated based on the estimated fair value of assets and liabilities of Konami STUDIO, Konami TYO and Konami JPN. The excess of the purchase price over the estimated fair value of the net assets acquired of ¥13,348 million ($113,629 thousand) has been recorded as goodwill in the accompanying consolidated balance sheets. Goodwill arising from these acquisitions has all been allocated to the Digital Entertainment segment of Konami. In connection with the purchase price allocation, Konami identified in-process research and development (“IP R&D”) which included the value of products in the development stage that were not considered to have reached technological feasibility or to have alternative future use. Accordingly, IP R&D of ¥225 million ($1,915 thousand) was charged to R&D expense in the consolidated statements of income upon consummation of the acquisition.

 

On April 27, 2005, the Company acquired an additional 3,000,000 shares of HUDSON SOFT CO., LTD. (“Hudson”), an equity-method affiliate, by acquiring newly issued shares for total consideration of ¥1,434 million ($12,207 thousand). Accordingly, the Company’s equity ownership interest in Hudson increased from 45.5% to 54.0% and, as a result, Hudson became a consolidated subsidiary. Financial results of Hudson have been included in the consolidated financial statements from the acquisition date.

 

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KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

The following table reflects the April 27, 2005, condensed balance sheet of Hudson, as adjusted to give effect to the purchase method accounting adjustments:

 

     Millions of Yen

   Thousands of
U.S. Dollars


Current assets

   ¥ 8,309    $ 70,733

Property and equipment

     1,130      9,619

Goodwill

     1,266      10,777

Other assets

     477      4,061

In-process research & development

     42      358
    

  

Total assets acquired

     11,224      95,548
    

  

Current liabilities

     7,455      63,463

Long-term liabilities

     500      4,256
    

  

Total liabilities assumed

     7,955      67,719
    

  

Minority interest

     924      7,866
    

  

Net assets acquired

   ¥ 2,345    $ 19,963
    

  

 

Goodwill related to acquisition of Hudson shares is allocated to the Digital Entertainment segment of Konami. In connection with the purchase price allocation, IP R&D of ¥42 million ($358 thousand) was charged to R&D expense in the consolidated statements of income upon consummation of the acquisition.

 

On November 7, 2005, the Company, Konami Sports Corporation (a consolidated subsidiary, “KSP”), and Konami Sports Life Corporation (a wholly owned subsidiary, “KSL”) entered into a basic agreement for a merger between KSP and KSL with KSP as the surviving entity, and a share exchange between KSP and the Company so that KSP become a wholly owned subsidiary of the Company. A public announcement of the terms of the share exchange was made on that day. The plan of merger and share exchange was approved in the shareholders’ meeting held on January 26, 2006. KSL and KSP merger was closed on February 28, 2006, and the share exchange between the Company and KSP was executed on March 1, 2006. KSP and KSL merger was made via share exchange with the exchange ratio of 1.00 to 3.99 which was determined based on an independent valuation. The Company and KSP share exchange was made with the exchange ratio of 1.00 to 0.79 which was determined based on an independent valuation. A total of 9,898,911 shares of the Company’s common stock, including 4,024,078 newly issued shares and 5,874,833 shares held as treasury stock, was issued to the minority shareholders of KSP in the share exchange. Upon completion of the merger, KSP changed its trade name to Konami Sports & Life Co., Ltd.

 

Konami accounted for the acquisition of additional equity interests in KSP as a step-acquisition and, accordingly, the total purchase price of ¥16,194 million ($137,856 thousand), consisted of the fair value of common shares issued to minority shareholders of KSP and the direct cost of the acquisition, has been allocated using the preliminary estimates of fair value of assets and liabilities of KSP based on the valuation by third parties which is in process. The excess purchase price over the estimated fair value of the net assets acquired of ¥6,596 million ($56,151 thousand) has been recorded as goodwill in the accompanying consolidated balance sheets. Goodwill arising from the acquisition of additional equity interest in KSP has all been allocated to the Health & Fitness segment of Konami. The identifiable intangible asset of KSP recognized in connection with the step acquisition included ¥12,542 million ($106,768 thousand) for trademarks, ¥727 million ($6,189 thousand) for membership list and ¥1,557 million ($13,254 thousand) for franchise and other contracts.

 

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KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

3.    Investments in Affiliates

 

The carrying amount of investments in affiliates as of March 31, 2005 and 2006 was ¥5,184 million and ¥6,050 million ($51,503 thousand), respectively, and includes ¥2,059 million and ¥5,040 million ($42,905 thousand), respectively, of the excess cost of investments over the Company’s equity in net assets of the affiliates (“equity-method goodwill”).

 

Under SFAS No. 142, equity-method goodwill is not amortized but continues to be reviewed for impairment in accordance with APB No. 18, which requires other-than-temporary decline in value of an equity-method investment to be recognized as an impairment loss. All significant intercompany profits from these affiliates have been eliminated according to the equity-method of accounting.

 

At March 31, 2005 and 2006, Konami held investments in the equity-method affiliates as follows:

 

    Description of business

  Acquisition Date

  Ownership %

 
                2005    

        2006    

 

TAKARA Co., Ltd.

  Toy manufacturer   July 2000   23.0 %   —    

HUDSON SOFT CO., LTD.

  Game software producer   August 2001   45.5 %   —    

Resort Solution Co., Ltd.

  Management on resort facilities   March 2006   —       20.0 %

 

On March 31, 2005, the Company sold its entire equity interest in Genki Co., Ltd. (“Genki”), previously an equity-method affiliate, and terminated its equity relationship with Genki. In connection with the sale, ¥563 million of gain on sales of an affiliated company was recognized in the accompanying consolidated statements of income for the year ended March 31, 2005.

 

On April 25, 2005, the Company sold its entire equity interest in TAKARA Co., Ltd. (“Takara”), previously an equity-method affiliate and terminated its equity relationship with Takara. As a result, gain on sales of ¥6,917 million ($58,883 thousand) was recognized in the accompanying consolidated statements of income for the year ended March 31, 2006.

 

As discussed in Note 2, the Company acquired additional newly issued shares by Hudson, previously an equity-method affiliate, on April 27, 2005 and Hudson became a 54.0% owned consolidated subsidiary of the Company.

 

On March 10, 2006, the Company acquired 20.0% of the total outstanding common stock of Resort Solution Co., Ltd. (“Resort Solution”), a company engaged in management and development of golf courses, hotels and resort facilities, for a total consideration of ¥5,993 million ($51,017 thousand). The acquisition was aimed at achieving a business alliance with Resort Solution in the area of Konami’s health and fitness business. The excess of the purchase price over the Company’s equity in net assets of the investee amounted to ¥5,040 million ($42,905 thousand) and was recognized as the equity-method goodwill based on the currently available information and certain assumptions that management believes are reasonable. The equity in net income of the investee has been included in the accompanying consolidated statements of income form the acquisition date.

 

At March 31, 2005 and 2006, Konami evaluated the recoverability of its investments in affiliates and concluded that there was no impairment in the carrying value of those investments.

 

The Company’s share of undistributed earnings of affiliated companies included in consolidated retained earnings was ¥57 million ($485 thousand) at March 31, 2006. There was no undistributed earnings of affiliated companies as of March 31, 2005.

 

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KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Affiliated companies accounted for under the equity-method with an aggregate carrying amount of ¥5,184 million and ¥6,050 million ($51,503 thousand) as of March 31, 2005 and 2006, respectively, were traded on established markets and were quoted at an aggregate market value of ¥14,757 million and ¥6,593 million ($56,125 thousand) as of March 31, 2005 and 2006, respectively.

 

Condensed combined financial information of the Company’s unconsolidated affiliates at March 31, 2005 and 2006 and for each of the three years ended March 31, 2006 are as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     2005

   2006

   2006

Combined Financial Position:

                    

Property and equipment, net

   ¥ 13,046    ¥ 15,541    $ 132,298

Other assets, net

     78,712      14,767      125,708
    

  

  

Total assets

   ¥ 91,758    ¥ 30,308    $ 258,006
    

  

  

Debt

     42,363      1,585      13,493

Other liabilities

     29,664      23,675      201,541

Minority interest

     9,716      10      85

Stockholders’ equity

     10,015      5,038      42,887
    

  

  

Total liabilities and equity

   ¥ 91,758    ¥ 30,308    $ 258,006
    

  

  

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

Combined Operations:

                                

Sales

   ¥ 124,136     ¥ 108,979     ¥ 24,783     $ 210,973  

Cost of revenues

     89,058       83,936       12,977       110,471  

Selling, general and administrative expenses

     33,367       41,820       10,512       89,487  
    


 


 


 


Operating income (loss)

     1,711       (16,777 )     1,294       11,015  

Interest income (expense), net

     (526 )     (476 )     (56 )     (477 )

Other, net

     (72 )     (3,285 )     (91 )     (774 )
    


 


 


 


Net income (loss)

   ¥ 1,113     ¥ (20,538 )   ¥ 1,147     $ 9,764  
    


 


 


 


 

4.    Inventories

 

Inventories at March 31, 2005 and 2006 consisted of the following:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     2005

   2006

   2006

Finished products

   ¥ 6,117    ¥ 7,321    $ 62,322

Work in process

     7,504      8,938      76,088

Raw materials and supplies

     1,867      3,850      32,774
    

  

  

Total

   ¥ 15,488    ¥ 20,109    $ 171,184
    

  

  

 

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KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

5.    Investment in Marketable Securities

 

Investment in marketable securities at March 31, 2005 and 2006 consisted of the following:

 

     Millions of Yen

     March 31, 2005

     Cost

   Gross
unrealized
gains


   Gross
unrealized
losses


   Fair value

Available-for-sale:

                           

Marketable equity securities

   ¥ 76    ¥ 89    ¥ —      ¥ 165
    

  

  

  

Total

   ¥ 76    ¥ 89    ¥ —      ¥ 165
    

  

  

  

 

There were no gross unrealized holding losses on available-for-sale securities and the fair value of the related securities in a continuous unrealized loss position for less than 12 months on March 31, 2005, and 2006.

 

    Millions of Yen

  Thousands of U.S. Dollars

    March 31, 2006

  March 31, 2006

    Cost

  Gross
unrealized
gains


  Gross
unrealized
losses


  Fair value

  Cost

  Gross
unrealized
gains


  Gross
unrealized
losses


  Fair value

Available-for-sale:

                                           

Marketable equity securities

  ¥ 460   ¥ 112   —     ¥ 572   $ 3,916   $ 953   —     $ 4,869

Total

  ¥ 460   ¥ 112   —     ¥ 572   $ 3,916   $ 953   —     $ 4,869

 

6.    Property and Equipment

 

Property and equipment at March 31, 2005 and 2006 consisted of the following:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

Property and equipment, at cost:

                        

Land

   ¥ 11,515     ¥ 10,362     $ 88,210  

Buildings and structures

     56,708       44,169       376,002  

Tools, furniture and fixtures

     25,584       21,922       186,618  

Construction in progress

     738       1,244       10,590  
    


 


 


Total

     94,545       77,697       661,420  

Less-Accumulated depreciation and amortization

     (47,950 )     (35,245 )     (300,034 )
    


 


 


Net property and equipment

   ¥ 46,595     ¥ 42,452     $ 361,386  
    


 


 


 

Depreciation and amortization expense for the years ended March 31, 2004, 2005 and 2006 amounted to ¥6,933 million, ¥7,592 million and ¥9,209 million ($78,394 thousand), respectively.

 

In accordance with SFAS No. 144, all long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In the prior years,

 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Konami performed such reviews for its Health & Fitness operations based on certain grouping of clubs in the same geographic area where interdependencies of club operations existed such as sharing of costs and expenses. However, in fiscal 2006, in connection with changes in management of KSP and in its operating structure of clubs, which eliminated interdependencies among clubs, Konami reassessed its asset grouping for Health & Fitness operations and changed to an individual club operation level which is considered to be the lowest level at which identifiable cash flows are largely independent of the cash flows of other assets under the new operating structure. The carrying amount of the club assets is compared to the expected undiscounted future cash flows to be generated by those assets over the estimated remaining useful life of the club. Cash flows are projected for each club based on historical results and expectations. In cases where the expected future cash flows are less than the carrying amount of the assets, those clubs are considered impaired and the assets are written down to fair value. For purposes of estimating fair value, the Company has utilized the third-party appraisals, which were based on the projected future cash flows of the impaired clubs discounted at a weighted average cost of capital. The Company recorded a pre-tax impairment charge of ¥10,533 million ($89,665 thousand) in operating expenses in the accompanying consolidated statements of income for the year ended March 31, 2006. The impairment charges related to club locations with operating performance that deteriorated subsequent to the 2005 review or which had additions during the subsequent period that were found to be impaired. The impairment charges related primarily to the carrying values of buildings, leasehold improvements and other tangible club facility assets that will continue to be operated by the Company.

 

7.    Goodwill and Identifiable Intangible Assets

 

Konami evaluates the recoverability of the carrying value of goodwill under SFAS No.142. Konami engages an independent appraiser to assist management in its determination of the fair values of its reporting units. In its determination of the fair values, the appraiser primarily utilizes 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 1) expected future revenue growth rates, profit margins and working capital levels of the reporting units, 2) a discount rate, and 3) a terminal value multiples. The revenue growth rates, profit margins and working capital levels of the reporting units are based on management’s expectation of future results. In evaluating the recoverability of other intangible assets which were allocated to the reporting units, Konami primarily utilizes a discounted cash flow analysis as well as other applicable valuation approaches, and if applicable, independent valuations.

 

At March 31, 2005, Konami evaluated the recoverability of goodwill and intangible assets and concluded that there was no impairment in the carrying value of such assets for any of its reporting units.

 

However, in the fourth quarter of the fiscal year ended March 31, 2006, Konami determined that the fair value of indefinite lived assets related to trademarks and franchise contracts recognized in the Health & Fitness reporting unit was lower than their carrying value as a result of review based on the independent valuations. Accordingly, an aggregate non-cash impairment charge of ¥9,180 million ($78,148 thousand) was recorded in operating expenses in the accompanying consolidated statements of income for the year ended March 31, 2006. The impairment charge consisted of ¥3,478 million ($29,608 thousand) for trademarks and ¥5,702 million ($48,540 thousand) for franchise contracts. These impairment losses were attributed to the reporting unit’s failure to meet previous growth expectations and the cancellation of certain franchise contracts during fiscal 2006.

 

F-24


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

The changes in the carrying amount of goodwill by operating segment for the years ended March 31, 2005 and 2006 are as follows:

 

     Millions of Yen

     Digital
Entertainment


   Health &
Fitness


   Gaming &
System


   Total

Balance at March 31, 2004

   ¥ 339      —      ¥ 125    ¥ 464

Additional acquisitions during year

     —      ¥ 385      —        385

Balance at March 31, 2005

   ¥ 339    ¥ 385    ¥ 125    ¥ 849

Additional acquisitions during year

     14,657      6,596      —        21,253
    

  

  

  

Balance at March 31, 2006

   ¥ 14,996    ¥ 6,981    ¥ 125    ¥ 22,102
    

  

  

  

     Thousands of U.S. Dollars

     Digital
Entertainment


   Health &
Fitness


   Gaming &
System


   Total

Balance at March 31, 2005

   $ 2,886    $ 3,278    $ 1,064    $ 7,228

Additional acquisitions during year

     124,771      56,151      —        180,922
    

  

  

  

Balance at March 31, 2006

   $ 127,657    $ 59,429    $ 1,064    $ 188,150
    

  

  

  

 

Additional goodwill in the Health & Fitness segment of ¥385 million ($3,277 thousand) was acquired during the year ended March 31, 2005 in connection with the acquisition of treasury stock by KSP which increased the Company’s equity interest from 60.5% to 64.1%.

 

As discussed in Note 2, additional acquisitions of equity interests in its subsidiaries in Digital Entertainment segment resulted in the increase of goodwill for the year ended March 31, 2006. In addition, the Company acquired the remaining interest in KSP and made it a wholly owned subsidiary, which resulted in recognition of goodwill in the Health & Fitness segment for the year ended March 31, 2006.

 

Identifiable intangible assets at March 31, 2005 and 2006 primarily representing intangible assets acquired in connection with acquisitions of subsidiaries consisted of the following:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

Identifiable intangible assets subject to amortization:

                        

Existing technology

   ¥ 644     ¥ 705     $ 6,002  

Franchise and other contracts

     —         2,202       18,745  

Membership lists

     —         727       6,189  

Less-Accumulated amortization

     (472 )     (701 )     (5,968 )
    


 


 


Net amortized identifiable intangible assets

     172       2,933       24,968  

Identifiable intangible assets with an indefinite life:

                        

Trademarks

     38,818       35,340       300,843  

Franchise contracts

     6,703       —         —    

Gaming licenses

     298       302       2,571  
    


 


 


Total unamortized identifiable intangible assets

     45,819       35,642       303,414  
    


 


 


Total identifiable intangible assets

   ¥ 45,991     ¥ 38,575     $ 328,382  
    


 


 


 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Intangible assets determined to have an indefinite useful life have been reassessed periodically based on the factors prescribed in SFAS No. 142 including, but not limited to, the expected use of the asset by the Company, legal or contractual provisions that may affect the useful life or renewal or extension of the asset’s contractual life without substantial cost, and the effects of demand, competition and other economic factors. As a result of reassessment in 2006, intangible assets related to franchise contracts which were previously determined to have an indefinite life have been determined to have a finite life of 14 years. After 2006 reassessment, intangible assets with an indefinite life included trademarks and gaming licenses.

 

Intangible assets related to existing technology, customer relationships, membership lists and franchise and other contracts have been amortized over their estimated useful lives of 2 to 15 years.

 

The aggregate amortization expense for identifiable intangible assets for the years ended March 31, 2004, 2005 and 2006 was ¥546 million, ¥129 million and ¥ 179 million ($1,524 thousand), respectively.

 

The estimated amortization expense for the following years is as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


Year ending March 31,

             

2007

   ¥ 568    $ 4,835

2008

     491      4,180

2009

     158      1,345

2010

     158      1,345

2011

     158      1,345

 

8.    Other Assets

 

Other assets at March 31, 2005 and 2006, consisted of the following:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     2005

   2006

   2006

Capitalized computer software, net

   ¥ 11,875    ¥ 11,831    $ 100,715

Investments in non-marketable securities

     574      391      3,329

Other

     6,934      7,881      67,089
    

  

  

Total other assets

   ¥ 19,383    ¥ 20,103    $ 171,133
    

  

  

 

Konami acquired computer software, principally for ERP implementation, of ¥9,781 million and ¥5,599 million ($47,663 thousand) in fiscal years 2005 and 2006, respectively.

 

Capitalized computer software at March 31, 2005 and 2006 consisted of the following:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

Capitalized computer software, at cost

   ¥ 15,294     ¥ 18,887     $ 160,781  

Less—Accumulated amortization

     (3,419 )     (7,056 )     (60,066 )
    


 


 


Capitalized computer software, net

   ¥ 11,875     ¥ 11,831     $ 100,715  
    


 


 


 

F-26


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Amortization expense of computer software for the years ended March 31, 2004, 2005 and 2006 amounted to ¥887 million, ¥1,329 million and ¥4,007 million ($34,111 thousand), respectively.

 

Estimated amortization expense of computer software for the following years is as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


Year ending March 31,

             

2007

   ¥ 2,899    $ 24,679

2008

     2,826      24,057

2009

     2,708      23,053

2010

     2,409      20,507

2011

     990      8,428

 

Amortization expense of other intangible assets for the years ended March 31, 2004, 2005 and 2006 amounted to ¥162 million, ¥310 million and ¥387 million ($3,294 thousand), respectively.

 

9.    Related Party Transactions

 

Konami engages in sale and purchase transactions in the normal course of business with its equity-method affiliates. Such transactions for the years ended March 31, 2004, 2005 and 2006 are summarized as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     2004

   2005

   2006

   2006

Sales to Takara

   ¥ 80    ¥ 0    ¥ —      $ —  

Purchases from Takara

     2,187      1,151      5      43

Sales to Hudson

     18      6      —        —  

Purchases from Hudson

     5,328      4,244      1,047      8,913

Sales to Genki

     —        5      —        —  

Purchases from Genki

     3,041      1,277      —        —  

 

There was no related notes and accounts receivable balance from Takara at March 31, 2005. The related notes and accounts payable to Takara were ¥42 million at 2005, and were included in Trade notes and accounts payable in the accompanying consolidated balance sheets. The Company sold its entire shares of Takara, an equity-method affiliate, and dissolved its equity relationship on April 25, 2005.

 

The related accounts receivable from Hudson were ¥2 million at March 31, 2005, and were included in Trade notes and accounts receivable in the accompanying consolidated balance sheets. The related accounts payable to Hudson was ¥14 million at March 31, 2005, and were included in Trade notes and accounts payable in the accompanying consolidated balance sheets. As a result of the Company’s acceptance of a third party allotment of additional shares on April 27, 2005, Hudson, an equity-method affiliate, became a 54.0% owned consolidated subsidiary of the Company.

 

The related accounts receivable from Genki was ¥5 million at March 31, 2005 and was included in Trade notes and accounts receivable in the accompanying consolidated balance sheets. The related accounts payable to Genki were and ¥246 million at March 31, 2005, and were included in Trade notes and accounts payable in the accompanying consolidated balance sheets. The Company sold its entire shares of Genki, an equity-method affiliate, and dissolved its equity relationship on March 31, 2005.

 

F-27


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

During fiscal 2005, Konami Corporation of America, a consolidated subsidiary, acquired 100,000 shares of Konami Computer Entertainment Hawaii, Inc. for ¥ 129 million from Takuya Kozuki who is a director of Konami Corporation of America and an immediate family member of senior management team and major shareholders of the Company. The transaction price was determined based on the third party appraisal.

 

During fiscal 2005, Konami Real Estate, Inc., a consolidated subsidiary, transferred certain fixed assets to Kozuki Capital Corporation at ¥162 million. During fiscal 2006, Konami Real Estate, Inc. acquired certain fixed assets from Kozuki Capital Corporation at ¥1,582 million ($13,467 thousand). Kozuki Capital Corporation is a company owned by senior management shareholders of the Company and their immediate family members and operates in the business of securities, investments and real estates. The transaction price was determined based on fair market value.

 

Konami Real Estate, Inc. paid a rent of ¥4 million and ¥14 million ($119 thousand) during fiscal 2005 and 2006 and a lease deposit of ¥4 million during 2005 to Kozuki Capital Corporation in accordance with rent agreements entered into in December 2004, for the lease of certain office spaces.

 

10.    Short-term Borrowings and Long-term Debt

 

A summary of short-term borrowings at March 31, 2005 and 2006 is as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     2005

   2006

   2006

Unsecured bank loans consisting of notes to banks and bank overdrafts with interest rates ranging from 0.56% to 1.375% and from 0.59% to 5.59% per annum at March 31, 2005 and 2006

   ¥ 8,582    ¥ 958    $ 8,155
    

  

  

Total

   ¥ 8,582    ¥ 958    $ 8,155
    

  

  

 

Weighted-average interest rate on short-term borrowings was 0.581% and 2.458% at March 31, 2005 and 2006, respectively. Those unsecured short-term bank loans included loans denominated in foreign currencies amounting to US$3,000 thousand (¥352 million) at March 31, 2006.

 

A summary of long-term debt at March 31, 2005 and 2006 is as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     2005

   2006

   2006

Unsecured 0.70% per annum bonds due in September 2005

   ¥ 15,000    ¥ —      $ —  

Unsecured 0.92% per annum bonds due in September 2006

     15,000      15,000      127,692

Unsecured 1.05% per annum bonds due in September 2007

     15,000      15,000      127,692

Unsecured 1.18% per annum bonds issued by Konami Sports due in December 2006

     5,000      5,000      42,564

Unsecured 1.25% per annum bonds issued by Konami Sports due in December 2007

     5,000      5,000      42,564

Unsecured 1.39% per annum bonds issued by Konami Sports due in December 2008

     5,000      5,000      42,564

 

F-28


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

Unsecured loans from banks due serially from 2005 to 2011 with interest rates ranging from 0.87% to 2.462% and from 0.87% to 2.9% per annum at March 31, 2005 and 2006

   ¥ 4,912     ¥ 3,975     ¥ 33,839  
    


 


 


Total long-term debt

     64,912       48,975       416,915  

Less: current portion

     (15,317 )     (21,992 )     (187,214 )
    


 


 


Long-term debt, non-current portion

   ¥ 49,595     ¥ 26,983     $ 229,701  
    


 


 


 

Unsecured long-term loans from banks included loans denominated in foreign currencies at March 31, 2006 were US$25 thousand (¥3 million) and none at March 31, 2005. At March 31, 2005 and 2006, Konami did not have any assets that were pledged as collateral for any of the debt obligations.

 

The Company had unused committed lines of credit available for immediate borrowings amounting to ¥12,000 million with certain financial institutions which were terminated on March 30, 2005. The aggregate commitment fee paid for such credit line agreements for the years ended March 31, 2005 amounted to ¥18 million.

 

The aggregate annual maturities of long-term debt outstanding at March 31, 2006 are as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


Year ending March 31,

             

2007

   ¥ 21,992    $ 187,214

2008

     20,593      175,304

2009

     5,593      47,612

2010

     592      5,039

2011

     205      1,746

 

11.    Leases

 

Konami is obligated under various capital leases and noncancelable operating leases which expire at various dates during the next 25 years.

 

At March 31, 2005 and 2006, the amounts of assets and related accumulated amortization included in property and equipment on the consolidated balance sheet recorded under capital leases were as follows:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

Building and structures, at cost

     —         5,067     $ 43,134  

Tools, furniture and fixtures, at cost

   ¥ 8,839     ¥ 4,704       40,044  

Accumulated amortization

     (5,114 )     (2,971 )     (25,291 )
    


 


 


Net leased property

   ¥ 3,725     ¥ 6,800     $ 57,887  
    


 


 


 

Amortization of capitalized leases is included in depreciation expense.

 

F-29


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Future minimum lease payments under capital leases and noncancelable operating leases as of March 31, 2006 are as follows:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     Capital
Leases


   Operating
Leases


   Capital
Leases


   Operating
Leases


Year ending March 31,

                   

2007

   2,751    2,982    23,419    25,385

2008

   2,099    2,981    17,868    25,377

2009

   1,498    2,977    12,752    25,343

2010

   1,156    2,972    9,841    25,300

2011

   689    2,953    5,865    25,138

Thereafter

   4,872    30,662    41,475    261,020
    
  
  
  

Total minimum lease payments

   13,065    45,527    111,220    387,563
    
  
  
  

Less: amount representing interest
(rates ranging from 1.08% to 7.32% per annum)

   1,917         16,319     
    
       
    

Present value of net minimum lease payments

   11,148         94,901     

Less: current portion

   2,500         21,282     
    
       
    

Non-current portion

   8,648         73,619     
    
       
    

 

Current and non-current portions of minimum leases payments for capital leases are included in current and non-current portions of long-term debt, respectively, in the accompanying consolidated balance sheets.

 

Konami occupies certain offices and lease equipment under cancelable lease arrangements. Rental expenses for all operating leases for the years ended March 31, 2004, 2005 and 2006 totaled ¥20,899 million, ¥18,449 million and ¥19,133 million ($162,876 thousand), respectively, and were included in costs of products sold, costs of services rendered and selling, general and administrative expenses in the accompanying consolidated statements of income.

 

12.    Asset Retirement Obligation

 

Konami has asset retirement obligations arising from the contractual requirements to perform certain asset retirement activities at the time that certain leasehold improvements relating primarily to the health and fitness facilities is disposed of. The liability was initially measured at fair value and subsequently is adjusted for accretion expenses and charges in amount or timing of estimated cash flows. The corresponding asset retirement costs are capitalized as part of the carrying amount of related long-lived asset and depreciated over the asset’s useful life. The following table presents the activity for asset retirement obligations for the year ended March 31, 2005 and 2006:

 

     Millions of Yen

   Thousands of
U.S. Dollars


     2005

   2006

   2006

Beginning balance

   ¥     —      ¥ —      $ —  

Additional liabilities incurred

     —        1,620      13,791

Liabilities settled

     —        —        —  

Revision to estimates

     —        —        —  

Accretion expense

     —        137      1,166
    

  

  

Ending Balance

   ¥ —      ¥ 1,757    $ 14,579
    

  

  

 

F-30


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

13.    Income Taxes

 

The Company and its domestic subsidiaries are subject to a national corporate tax of 30% and the local income taxes net of national tax benefit, which in the aggregate resulted in a statutory income tax rate of approximately 42%, 40.9% and 40.9% for the years ended March 31, 2004, 2005 and 2006, respectively. On March 24, 2003, the Japanese Diet approved Amendments to the Local Tax Law, which reduced the standard tax rates for the income-based business tax, as well as added business tax based on corporate size, effective for the years beginning on or after April 1, 2004. Consequently, the statutory income tax rate was reduced to approximately 40.9% effective April 1, 2004. The income before income taxes and income tax expense (benefit) for the years ended March 31, 2004, 2005 and 2006 consisted of the following:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

Income before income taxes:

                                

Japanese

   ¥ 30,656     ¥ 21,900     ¥ 8,376     $ 71,303  

Foreign

     9,451       5,542       62       528  
    


 


 


 


Total

   ¥ 40,107     ¥ 27,442     ¥ 8,438     $ 71,831  
    


 


 


 


Income taxes—Current:

                                

Japanese

   ¥ 16,214     ¥ 13,674     ¥ (5,747 )   $ (48,923 )

Foreign

     2,472       1,843       962       8,189  
    


 


 


 


Total

   ¥ 18,686     ¥ 15,517     ¥ (4,785 )   $ (40,734 )
    


 


 


 


Income taxes—Deferred:

                                

Japanese

   ¥ (634 )   ¥ (7,540 )   ¥ (5,500 )   $ (46,820 )

Foreign

     (17 )     (75 )     15       127  
    


 


 


 


Total

   ¥ (651 )   ¥ (7,615 )   ¥ (5,485 )   $ (46,693 )
    


 


 


 


 

The significant components of income taxes for the years ended March 31, 2004, 2005 and 2006 are as follows:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2005

 

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

   ¥ 18,035     ¥ 7,902     ¥ (10,270 )   $ (87,427 )

Income tax expense (benefit) reported on other comprehensive income related to:

                                

Net unrealized gains (losses) on available-for-sale securities

     189       (14 )     (52 )     (443 )

Foreign currency translation adjustments

     —         (27 )     27       230  

Minimum pension liability adjustment

     (49 )     49       —         —    
    


 


 


 


Total income taxes

   ¥ 18,175     ¥ 7,910     ¥ (10,295 )   $ (87,640 )
    


 


 


 


 

F-31


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Reconciliations of the differences between the statutory tax rates and the effective tax rates are as follows:

 

     2004

    2005

    2006

 

Statutory tax rate

   42.0 %   40.9 %   40.9 %

Increase (reduction) in taxes resulting from:

                  

Non-deductible expenses

   3.9     5.9     21.2  

Change in valuation allowance

   (2.1 )   (1.1 )   15.3  

Reversal of accrued income taxes

   —       —       (196.9 )

Change in income tax rate

   0.5     —       —    

Investments in affiliates

   0.4     (4.8 )   —    

Gain on sales of subsidiaries shares

   —       (12.7 )   —    

Dividend of overseas subsidiaries

   —       4.5     3.3  

Investment tax credits

   —       (3.1 )   (10.2 )

Other, net

   0.3     (0.8 )   4.7  
    

 

 

Effective income tax rate

   45.0 %   28.8 %   (121.7 )%
    

 

 

 

In March 2006, The Company recognized the tax benefit as a result of the reversal of ¥17,051 million of accrued income taxes, which had been provided due to the uncertainty as to deductibility of the capital loss incurred in the year ended March 31, 2003 in connection with its plan to reorganize the Konami group into a holding company structure, a necessary condition for such loss to be deductible, which was delayed and was not expected to complete as originally planned. The reorganization to a holding company structure was completed and finalized in the fiscal year ended March 31, 2006 and, accordingly, the Company reversed the accrued taxes and recognized the tax deduction of the capital loss, which resulted in a decrease in the effective income tax rate by 196.9 %.

 

The effects of temporary differences that give rise to deferred tax assets and liabilities at March 31, 2005 and 2006 are as follows:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

Deferred tax assets:

                        

Accrued enterprise taxes

   ¥ 2,004     ¥ 1,109     $ 9,441  

Accrued expenses

     3,071       3,634       30,935  

Accrued pension and severance costs

     1,330       1,433       12,199  

Allowance for doubtful accounts

     1,127       869       7,397  

Inventories

     11,854       12,814       109,083  

Net operating loss carryforwards

     5,609       7,437       63,310  

Property and equipment basis differences

     701       4,009       34,128  

Investments in affiliates

     483       —         —    

Asset retirement obligation

     —         719       6,121  

Other

     1,760       4,097       34,877  
    


 


 


Gross deferred tax assets

     27,939       36,121       307,491  

Less valuation allowance

     (6,496 )     (11,641 )     (99,098 )
    


 


 


Total deferred tax assets

     21,443       24,480       208,393  

Deferred tax liabilities:

                        

Intangible assets

     (18,320 )     (15,718 )     (133,804 )

Investments in affiliates

     —         (23 )     (196 )

Other

     (878 )     (1,106 )     (9,415 )
    


 


 


Gross deferred tax liabilities

     (19,198 )     (16,847 )     (143,415 )
    


 


 


Net deferred tax assets

   ¥ 2,245     ¥ 7,633     $ 64,978  
    


 


 


 

F-32


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and tax carryforwards are utilizable. Management considered the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not that Konami will realize the benefits of these deductible differences, net of the existing valuation allowances at March 31, 2005 and 2006.

 

The net change in the total valuation allowance for the years ended March 31, 2004, 2005 and 2006 was a decrease of ¥1,268 million, ¥224 million and an increase of ¥5,145 million ($43,798 thousand), respectively. Foreign subsidiaries are subject to income taxes of the countries in which they operate.

 

The valuation allowance for deferred tax assets that would be allocated to reduce goodwill or other non-current intangible assets of an acquired company upon subsequent recognition of the related tax benefits amounted to ¥968 million ($8,240 thousand) as of March 31, 2006.

 

Deferred tax liabilities aggregating ¥88 million ($749 thousand) have been recognized for undistributed earnings of certain foreign subsidiaries where dividends are expected with additional tax burden to the Company. At March 31, 2005 and 2006, the Company did not recognize deferred tax liabilities of ¥625 million and ¥694 million ($5,908 thousand), respectively, for undistributed earnings of certain foreign subsidiaries as the Company does not currently intend to repatriate those earnings. At March 31, 2005 and 2006, aggregate undistributed earnings not subject to deferred tax liabilities were ¥10,781 million and ¥11,803 million ($100,477 thousand), respectively.

 

Net deferred tax assets were included in the accompanying consolidated balance sheets as follows:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

Current assets:

                        

Deferred income taxes, net

   ¥ 18,392     ¥ 16,510     $ 140,547  

Investments and other assets:

                        

Deferred income taxes, net

     —         3,179       27,062  

Current liabilities:

                        

Other current liabilities

     —         (132 )     (1,124 )

Long-term liabilities:

                        

Deferred income taxes

     (16,147 )     (11,924 )     (101,507 )
    


 


 


Net deferred tax assets

   ¥ 2,245     ¥ 7,633     $ 64,978  
    


 


 


 

F-33


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

At March 31, 2006, certain domestic subsidiaries had operating loss carry forwards aggregating approximately ¥6,286 million ($53,512 thousand), which expire as follows:

 

     Millions of yen

   Thousands of
U.S. Dollars


Year ending March 31

             

2007

   ¥ —      $ —  

2008

     —        —  

2009

     47      400

2010

     36      306

2011

     1,232      10,488

2012

     4,574      38,938

2013

     397      3,380
    

  

Total

   ¥ 6,286    $ 53,512
    

  

 

U.S. subsidiaries had federal and state tax net operating loss carry forwards of approximately ¥12,279 million ($104,529 thousand) and ¥10,606 million ($90,287 thousand), respectively, which expire in varying amounts through the year 2025. These net operating loss carry forwards which expire within 1 to 5 years, 6 to 10 years, 11 to 15 years and thereafter are ¥13,470 million ($114,668 thousand), ¥1,826 million ($15,544 thousand), ¥779 million ($6,631 thousand) and ¥6,810 million ($57,972 thousand), respectively.

 

14.    Severance and Retirement Plans

 

The Company and its domestic subsidiaries have defined benefit severance and retirement plans covering their employees. The plans provide, under most circumstances, retirement benefits and lump-sum severance payments to the employees that are determined by reference to their rate of pay at the time of termination, years of service and certain other factors. All employees can make an election either to remain in the defined benefit plans or to withdraw from the plans and enroll under such system as receiving all compensation currently during their employment. For those under the fixed annual compensation system, separate severance and retirement benefits are not to be paid upon their termination or retirement.

 

Net periodic cost of the Company and its domestic subsidiaries’ plans accounted for in accordance with SFAS No. 87 for the years ended March 31, 2004, 2005 and 2006 included the following components:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

Service cost—benefits earned during the year

   ¥ 312     ¥ 313     ¥ 236     $ 2,009  

Interest cost on projected benefit obligation

     53       40       24       204  

Expected return on plan assets

     (45 )     (41 )     (41 )     (349 )

Recognized actuarial (gain) loss

     21       (51 )     (68 )     (579 )

Amortization of prior service cost

     (13 )     (14 )     (1 )     (8 )
    


 


 


 


Net periodic cost

   ¥ 328     ¥ 247     ¥ 150     $ 1,277  
    


 


 


 


 

F-34


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

The reconciliation of beginning and ending balances of the benefit obligations of the Company and its domestic subsidiaries’ plans accounted for in accordance with SFAS No. 87 are as follows:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

Change in benefit obligation:

                        

Benefit obligation, beginning of year

   ¥ 3,492     ¥ 2,848     $ 24,244  

Service cost

     313       236       2,009  

Interest cost

     40       24       204  

Effect of acquisition

     —         444       3,780  

Actuarial (gain) loss

     (777 )     164       1,396  

Benefits paid

     (220 )     (272 )     (2,315 )
    


 


 


Benefit obligation, end of year

   ¥ 2,848     ¥ 3,444     $ 29,318  

Change in plan assets:

                        

Fair value of plan assets, beginning of year

   ¥ 2,481     ¥ 2,433     $ 20,712  

Actual return on plan assets

     (10 )     130       1,107  

Employer contribution

     125       190       1,617  

Benefits paid

     (163 )     (157 )     (1,337 )
    


 


 


Fair value of plan assets, end of year

     2,433       2,596       22,099  

Funded status

     (415 )     (848 )     (7,219 )

Unrecognized actuarial (gain)

     (439 )     (382 )     (3,252 )

Unrecognized prior service cost

     (123 )     (66 )     (562 )
    


 


 


Net amount recognized

   ¥ (977 )   ¥ (1,296 )   $ (11,033 )
    


 


 


Amounts recognized in the consolidated balance sheets consist of:

                        

Accrued pension and severance cost

   ¥ (977 )   ¥ (1,296 )   $ (11,033 )

Accumulated other comprehensive (loss)

     —         (29 )     (246 )
    


 


 


Net amount recognized

   ¥ (977 )   ¥ (1,325 )   $ (11,279 )
    


 


 


 

     Millions of Yen

   Thousands of
U.S. Dollars


     2005

   2006

   2006

Pension plans with an accumulated benefit obligation in excess of plan assets:

                    

Projected benefit obligation

   ¥ 1,903    ¥ 2,507    $ 21,342

Accumulated benefit obligation

     1,751      2,223      18,924

Fair value of plan assets

     827      953      8,113

 

The measurement date used to determine pension benefit obligations for all the pension plans was March 31.

 

The accumulated benefit obligation for the pension plans was ¥2,668 million and ¥3,148 million ($26,798 thousand) at March 31, 2005 and 2006, respectively.

 

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Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Weighted-average assumptions used to determine benefit obligations at March 31, 2005 and 2006 were as follows:

 

     2005

    2006

 

Weighted-average assumptions:

            

Discount rate

   1.4 %   1.4 %

Assumed rate of increase in future compensation levels

   2.4 %   1.7 %

 

Weighted-average assumptions used to determine net cost for the years ended March 31, 2004, 2005 and 2006 were as follows:

 

     2004

    2005

    2006

 

Weighted-average assumptions:

                  

Discount rate

   1.9 %   1.4 %   1.4 %

Assumed rate of increase in future compensation levels

   2.7 %   2.7 %   2.3 %

Expected long-term rate of return on plan assets

   2.0 %   1.7 %   1.7 %

 

Konami determines the expected long-term rate of return on plan assets of the various assets categories in which it invests. Konami considers the current expectations for future returns and the actual historical returns of each plan asset category.

 

The benefit plan weighted-average asset allocations for the Company and its domestic subsidiaries for the years ended March 31, 2005 and 2006 by asset category were as follows:

 

     2005

    2006

 

Asset category:

            

Equity securities

   21.4 %   23.9 %

Debt securities

   21.4 %   23.2 %

Guaranteed investment contracts—insurance companies

   44.9 %   40.7 %

Other

   12.3 %   12.2 %
    

 

     100.0 %   100.0 %

 

Konami’s investment goals for the pension benefit plans are to ensure adequate plan assets to provide future payments of pension benefits to eligible participants. Konami addresses diversification by the use of domestic and international equity securities and domestic and international debt securities in order to secure stable return on plan assets subject to specific risk management policies. Konami evaluates the difference between expected return based on expected long-term rate of return on plan assets and actual return on invested plan assets on an annual basis. If the evaluation requires a revision of its formulation of asset allocation, Konami revises the asset allocation.

 

The Company and its domestic subsidiaries have participated in the welfare pension fund for the computer industry association, a multi-employer contributory plan, since its establishment in October 1989. Konami’s contributions to the plan amounted to ¥611 million, ¥624 million and ¥765 million ($6,512 thousand) for the years ended March 31, 2004, 2005 and 2006, respectively, and were recorded as costs and expenses in the consolidated statements of income.

 

F-36


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Konami expects to contribute ¥201 million ($1,711 thousand) and ¥1,038 million ($8,836 thousand) to its domestic defined benefit plan and multi-employer contributory plan, respectively, in the year ending March 31, 2007.

 

Future estimated pension benefit payments, using the defined benefit plan for Konami and its domestic subsidiaries are as follows.

 

     Millions of yen

   Thousands of
U.S. Dollars


Year ending March 31

             

2007

   ¥ 123    $ 1,047

2008

     136      1,158

2009

     151      1,285

2010

     160      1,362

2011

     166      1,413

   2012-2017

     923      7,857

 

The Company and certain of its subsidiaries have accrued the liability for retirement benefits for their directors and corporate auditors in the amount of ¥1,367 million and ¥1,332 million ($11,339 thousand) at March 31, 2005 and 2006, respectively, which is included in Accrued pension and severance costs in the accompanying consolidated balance sheets.

 

15.    Stockholders’ Equity

 

Dividends

 

Under the Japanese Corporate Law (the “Law”), the amount available for dividends is based on retained earnings as recorded on the books of the Company maintained in conformity with Japanese GAAP. Certain adjustments not recorded on the Company’s books are reflected in the consolidated financial statements for reasons described in Note 1. At March 31, 2006, a retained earnings available for dividends determined in accordance with Japanese GAAP recorded on the Company’s books of account was ¥ 68,701 million ($584,839 thousand).

 

The Law provides that an amount equal to at least 10% of the aggregate amount of cash dividends and certain other appropriations of retained earnings associated with cash outlays applicable to each fiscal period shall be appropriated as a legal reserve (a component of retained earnings) until such reserve and additional paid-in-capital equals 25% of common stock. The amount of total additional paid-in-capital and legal reserve that exceeds 25% of common stock may be available for appropriations by resolution of the stockholders. In addition, the Law permits the transfer of a portion of additional paid-in-capital and legal reserve to common stock by resolution of the Board of Directors.

 

Stock-based Compensation Plan

 

The Company and its domestic consolidated subsidiaries maintained certain stock-based compensation plans for grant of stock subscription rights to their directors and employees. Under these plans, the number of ordinary shares issuable will be adjusted for stock splits, reverse stock splits and certain other recapitalizations.

 

F-37


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Subsidiaries that previously maintained such plans included Konami Computer Entertainment Osaka, Inc. (“Konami OSA”), Konami TYO, Konami JPN, Konami STUDIO and KSP. All plans related to Konami OSA, Konami TYO, Konami STUDIO and Konami JPN were canceled by March 31, 2005, in connection with their mergers with the Company. Also, in the year ended March 31, 2006, the exercise price and the number of shares issuable under the KSP’s plan originally established in 2004 were adjusted so that the shares were issuable in the Company’s common shares, in connection with the stock exchange between KSP and the Company as described in Note 2. The adjustment did not result in compensation expense as the fair value of the Company’s common shares exceeded the adjusted exercise price.

 

Konami has accounted for compensation cost under those plans in accordance with APB No. 25 and FIN No.44. There was no compensation cost recognized for the years ended March 31, 2005 and 2004 as there was no intrinsic value as of the grant date. The compensation cost based on the intrinsic value method of 97 million ($826 thousand) was recognized in the accompanying consolidated statements of income for the year ended March 31, 2006 for options granted during the year.

 

The following table summarizes activity under these plans:

 

     Shares

 
     2004

    2005

    2006

 

Outstanding at beginning of the year

   2,131,650     2,318,650     2, 899,700  

Granted

   304,900     1,358,000     1,344,980  

Exercised

   —       (3,270 )   (11,900 )

Forfeited, canceled or expired

   (117,900 )   (773,680 )   (1,387,100 )

Outstanding at end of the year

   2,318,650     2,899,700     2,845,680  

 

     2004

   2005

   2006

   2006

Weighted average exercise price

   ¥ 3,044    ¥ 3,125    ¥ 3,293    $ 27.66

Weighted average remaining contractual life

     1.04 years      0.86 years      1.95 years      —  

Options exercisable, end of period

     30,000 shares      539,566 shares      1,112,437 shares      —  

Weighted average fair value of options granted during the year

   ¥ 412    ¥ 774    ¥ 489    $ 4.16

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants:

 

     2004

   2005

   2006

Weighted average risk-free interest rate

   0.34%    0.52%    0.09%

Weighted average expected life

   3.82 years    3.42 years    1.67 years

Weighted average expected dividends

   2.14%    2.24%    2.17%

Weighted average expected volatility

   52.80%    52.43%    30.11%

 

F-38


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Treasury Stock Transactions

 

The following table summarizes treasury stock activities for the years ended March 31, 2004, 2005 and 2006:

 

     Change in Treasury stock

 
     Shares

    Millions of yen

 

Balance at March 31, 2004

   8,254,314     ¥ 25,666  

Acquisition through purchase of odd-lot shares

   1,841       4  

Purchase under resolution of the board of directors

   1,000,000       2,601  

Balance at March 31, 2005

   9,256,155       28,271  

Acquisition through purchase of odd-lot shares

   27,936       71  

Issuance in a stock exchange

   (5,917,233 )     (18,064 )

Shares issued to subsidiary in a stock exchange

   3,048,481       8,452  

Issuance upon exercise under stock compensation plan

   (11,900 )     (39 )
    

 


Balance at March 31, 2006

   6,403,439     ¥ 18,691  
    

 


 

     Change in Treasury stock

 
     Thousands of U.S. Dollars

 

Balance at March 31, 2005

   $ 240,666  

Acquisition through purchase of odd-lot shares

     604  

Issuance in a stock exchange

     (153,775 )

Shares issued to subsidiary in a stock exchange

     71,950  

Issuance upon exercise under stock compensation plan

     (332 )
    


Balance at March 31, 2006

   $ 159,113  
    


 

16.    Comprehensive Income (Loss)

 

Accumulated other comprehensive income (loss) at March 31, 2004, 2005 and 2006 is as follows:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

Foreign currency translation adjustments, net of tax:

                                

Balance, beginning of year

   ¥ 842     ¥ (266 )   ¥ 2,019     $ 17,187  

Aggregate adjustment for the year resulting from translation of foreign currency financial statements

     (1,108 )     2,285       1,888       16,072  
    


 


 


 


Balance, end of year

   ¥ (266 )   ¥ 2,019     ¥ 3,907     $ 33,259  
    


 


 


 


Net unrealized gains (losses) on available-for-sale securities, net of tax:

                                

Balance, beginning of year

   ¥ (52 )   ¥ 218     ¥ 198     $ 1,686  

Net change

     270       (20 )     (132 )     (1,124 )
    


 


 


 


Balance, end of year

   ¥ 218     ¥ 198     ¥ 66     $ 562  
    


 


 


 


 

F-39


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

Minimum pension liability adjustment:

                                

Balance, beginning of year

   ¥ —       ¥ (71 )   ¥ —       $ —    

Adjustments for the year

     (71 )     71       (16 )     (136 )
    


 


 


 


Balance, end of year

   ¥ (71 )   ¥ —       ¥ (16 )   $ (136 )
    


 


 


 


Total accumulated other comprehensive income (loss), net of tax:

                                

Balance, beginning of year

   ¥ 790     ¥ (119 )   ¥ 2,217     $ 18,873  

Adjustments for the year

     (909 )     2,336       1,740       14,812  
    


 


 


 


Balance, end of year

   ¥ (119 )   ¥ 2,217     ¥ 3,957     $ 33,685  
    


 


 


 


 

Tax effects allocated to each component of other comprehensive income (loss) and adjustments are as follows:

 

     Millions of Yen

 
     Pretax
amount


    Tax (expense)
or benefit


    Net of tax
amount


 

2004

                        

Foreign currency translation adjustments

   ¥ (1,108 )   ¥ —       ¥ (1,108 )

Net unrealized gains on available-for-sale securities:

                        

Unrealized gains arising during the year

     1,968       (805 )     1,163  

Less: reclassification adjustment for gains included in net income

     (1,509 )     616       (893 )
    


 


 


Net unrealized gains

     459       (189 )     270  
    


 


 


Minimum pension liability adjustment

     (120 )     49       (71 )
    


 


 


Other comprehensive loss

     (769 )     (140 )     (909 )
    


 


 


2005

                        

Foreign currency translation adjustments

   ¥ 2,258     ¥ 27     ¥ 2,285  

Net unrealized losses on available-for-sale securities:

                        

Unrealized gains arising during the year

     216       (88 )     128  

Less: reclassification adjustment for gains included in net income

     (250 )     102       (148 )
    


 


 


Net unrealized losses

     (34 )     14       (20 )
    


 


 


Minimum pension liability adjustment

     120       (49 )     71  
    


 


 


Other comprehensive income (loss)

     2,344       (8 )     2,336  
    


 


 


2006

                        

Foreign currency translation adjustments

   ¥ 1,915     ¥ (27 )   ¥ 1,888  

Net unrealized losses on available-for-sale securities:

                        

Unrealized gains arising during the year

     (518 )     189       (329 )

Less: reclassification adjustment for gains included in net income

     334       (137 )     197  
    


 


 


Net unrealized losses

     (184 )     52       (132 )
    


 


 


Minimum pension liability adjustment

     (16 )     —         (16 )
    


 


 


Other comprehensive income

   ¥ 1,715     ¥ 25     ¥ 1,740  
    


 


 


 

F-40


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

     Thousands of U.S. Dollars

 
     Pretax
amount


    Tax (expense)
or benefit


    Net of tax
amount


 

2006

                        

Foreign currency translation adjustments

   $ 16,302     $ (230 )   $ 16,072  

Net unrealized losses on available-for-sale securities:

                        

Unrealized gains arising during the year

     (4,410 )     1,609       (2,801 )

Less: reclassification adjustment for gains included in net income

     2,843       (1,166 )     1,677  
    


 


 


Net unrealized losses

     (1,567 )     443       (1,124 )
    


 


 


Minimum pension liability adjustment

     (136 )     —         (136 )
    


 


 


Other comprehensive income

   $ 14,599     $ 213     $ 14,812  
    


 


 


 

17.    Derivative Financial Instruments

 

Konami uses foreign exchange forward contracts with terms ranging from 3 to 6 months to reduce its exposure to short-term movements in the exchange rates applicable to firm funding commitments denominated in currencies other than Japanese yen. The aggregate notional amounts of derivative financial instruments outstanding at March 31, 2004, 2005 and 2006 were as follows:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

   2005

    2006

    2006

 

Forward exchange contracts to sell foreign currencies:

                               

Contract amount

   ¥ 3,203    ¥ 9,493     ¥ 3,757     $ 31,983  

Fair value

   ¥ 3,119    ¥ 9,753     ¥ 3,775     $ 32,136  
    

  


 


 


Gain (Loss)

   ¥ 84    ¥ (260 )   ¥ (18 )   $ (153 )
    

  


 


 


 

Konami does not designate the forward exchange contracts as hedges. Accordingly the foreign currency gains and (losses) of ¥84 million, ¥(260) million and ¥(18) million ($153 thousand) arising from these forward exchange contracts at March 31, 2004, 2005 and 2006, respectively, were included in earnings under the caption Other, net in the accompanying consolidated statements of income. Foreign exchange net losses, including those on these forward exchange contracts, for the years ended March 31, 2004, 2005 and 2006 were ¥395 million, ¥826 million and ¥455 million ($3,873 thousand), respectively.

 

Effects of exchange rate changes subsequent to March 31, 2006 on fair value of those forward exchange contracts have not been significant as of the reporting date.

 

18.    Fair Value of Financial Instruments

 

Cash and cash equivalents, Trade notes and accounts receivable, Trade notes and accounts payable, Accrued expenses, and Short-term borrowings

 

The carrying amount approximates fair value because of the short maturity of these instruments.

 

Investments in marketable securities

 

The fair values of Konami’s investments in marketable securities are based on quoted market prices.

 

F-41


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Investments in non-marketable securities

 

For investments in non-marketable securities for which there are no quoted market prices, a reasonable estimate of fair value could not be made without incurring excessive costs. It was not practicable to estimate the fair value of common stock representing certain untraded companies. These investments are carried at cost.

 

Long-term debt

 

The fair values of Konami’s long-term debt instruments are based on the quoted price in the most active market or the present value of future cash flows associated with each instrument discounted using the Company’s current borrowing rate for similar debt instruments of comparable maturity.

 

Derivative financial instruments

 

The fair values of derivative financial instruments, consisting principally of foreign exchange contracts, all of which are used for purposes other than trading, are estimated by obtaining quotes from brokers.

 

The estimated fair values of Konami’s financial instruments at March 31, 2005 and 2006 are as follows:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 
     Carrying
amount


    Estimated
fair value


    Carrying
amount


    Estimated
fair value


    Carrying
amount


    Estimated
fair value


 

Nonderivatives:

                                                

Investment in marketable securities

   ¥ 165     ¥ 165     ¥ 572     ¥ 572     $ 4,869     $ 4,869  

Long-term debt, including current installments

     (64,912 )     (63,794 )     (48,975 )     (47,967 )     (416,915 )     (408,334 )

Derivatives:

                                                

Foreign exchange forward contracts:

                                                

Assets

     —         —         3       3       26       26  

Liabilities

     (260 )     (260 )     (21 )     (21 )     (179 )     (179 )

 

Limitations

 

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instruments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

F-42


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

19.    Supplemental Disclosures to Consolidated Statements of Cash Flows

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

   2006

    2006

 

Cash paid during the year for:

                               

Interest

   ¥ 868     ¥ 974    ¥ (1,137 )   $ (9,679 )

Income taxes

     8,390       9,983      15,581       132,638  

Acquisitions of new subsidiaries:

                               

Fair value of assets acquired

     262       —        6,180       52,609  

Liabilities assumed

     (342 )     —        (7,955 )     (67,719 )

Goodwill

     339       —        1,266       10,777  

Minority interest

     (53 )     —        (924 )     (7,866 )

Cash paid, net of cash acquired

     206       —        (1,433 )     (12,199 )

Property acquired under capital leases during the year

     2,294       1,844      9,079       77,288  

Recognition of tangible fixed assets due to assets retirement obligation

     —         —        1,620       13,791  

 

20.    Segment Information

 

Under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” operating segments are defined as components of an enterprise about which separate financial information is available that is regularly evaluated by the chief operating decision maker 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.

 

In order to better serve a rapidly changing digital entertainment market, the Company combined the related three operating segments, Computer & Video Games, Toy & Hobby and Amusement, which represented operating segments separately managed and reported in the prior years, into the newly established Digital Entertainment segment in 2006. Accordingly, segment information for the years ended March 31, 2004 and 2005 have been restated to conform to the current segment reporting structure.

 

Konami operates on a worldwide basis principally with the following three business segments:

 

1. Digital Entertainment:

   Production and sale of digital contents and related products including Computer & Video Games, Toy & Hobby, Amusement, Online and Multimedia.

2. Health & Fitness:

   Operation of health and fitness clubs, production and sale of health and fitness related goods.

3. Gaming & systems:

   Production, Manufacture and sale of gaming machines for overseas market

 

Notes:

 

“Other” consists of segments which do not meet the quantitative criteria for separate presentation under SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information.”

 

“Corporate” primarily consists of administrative expenses of the Company.

 

F-43


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

“Eliminations” primarily consist of eliminations of intercompany sales and of intercompany profits on inventories.

 

Gaming segment renamed to Gaming & System segment from October 1, 2005.

 

The following table summarizes revenue, operating income (loss), total assets, depreciation and amortization and capital expenditures by operating segment which are the primary measures used by Konami’s chief operating decision maker to measure Konami’s operating results and to measure segment profitability and performance. This information is derived from Konami’s management reports which have been prepared based on U.S. GAAP.

 

a .    Operations in Different Industries

 

(1) Revenue and operating income (loss)

 

Year Ended March 31, 2004


   Digital
Entertainment


   Health &
Fitness


   Gaming &
System


  

Other,
Corporate

and

Eliminations


    Consolidated

     (Millions of Yen)

Net revenue:

                                   

Customers

   ¥ 175,890    ¥ 78,875    ¥ 10,947    ¥ 7,700     ¥ 273,412

Intersegment

     554      24      —        (578 )     —  
    

  

  

  


 

Total

     176,444      78,899      10,947      7,122       273,412

Operating expenses

     128,826      76,128      10,255      17,490       232,699
    

  

  

  


 

Operating income (loss)

   ¥ 47,618    ¥ 2,771    ¥ 692    ¥ (10,368 )   ¥ 40,713
    

  

  

  


 

 

Year Ended March 31, 2005


   Digital
Entertainment


   Health &
Fitness


   Gaming &
System


  

Other,
Corporate

and

Eliminations


    Consolidated

     (Millions of Yen)

Net revenue:

                                   

Customers

   ¥ 162,797    ¥ 78,843    ¥ 11,641    ¥ 7,410     ¥ 260,691

Intersegment

     874      263      2      (1,139 )     —  
    

  

  

  


 

Total

     163,671      79,106      11643      6,271       260,691

Operating expenses

     131,018      77,059      10,201      14,277       232,555
    

  

  

  


 

Operating income (loss)

   ¥ 32,653    ¥ 2,047    ¥ 1,442    ¥ (8,006 )   ¥ 28,136
    

  

  

  


 

 

Year Ended March 31, 2006


   Digital
Entertainment


   Health &
Fitness


    Gaming &
System


  

Other,
Corporate

and

Eliminations


    Consolidated

     (Millions of Yen)

Net revenue:

                                    

Customers

   ¥ 163,624    ¥ 81,117     ¥ 10,621    ¥ 6,775     ¥ 262,137

Intersegment

     1,652      92       2      (1,746 )     —  
    

  


 

  


 

Total

     165,276      81,209       10,623      5,029       262,137

Operating expenses

     131,426      98,268       10,563      19,399       259,656
    

  


 

  


 

Operating income (loss)

   ¥ 33,850    ¥ (17,059 )   ¥ 60    ¥ (14,370 )   ¥ 2,481
    

  


 

  


 

 

F-44


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Year Ended March 31, 2006


   Digital
Entertainment


   Health &
Fitness


    Gaming &
System


  

Other,
Corporate

and

Eliminations


    Consolidated

     (Thousands of U.S. Dollars)

Net revenue:

                                    

Customers

   $ 1,392,900    $ 690,534     $ 90,415    $ 57,674     $ 2,231,523

Intersegment

     14,063      783       17      (14,863 )     —  
    

  


 

  


 

Total

     1,406,963      691,317       90,432      42,811       2,231,523

Operating expenses

     1,118,804      836,537       89,921      165,141       2,210,403
    

  


 

  


 

Operating income (loss)

   $ 288,159    $ (145,220 )   $ 511    $ (122,330 )   $ 21,120
    

  


 

  


 

 

Intersegment revenues primarily consists of Sales of hardware products and parts from Digital Entertainment to Health & Fitness.

 

As discussed in Note 6 and 7, impairment charges of ¥10,533 million ($89,665 thousand) for long-lived assets and ¥9,180 million ($78,148 thousand) for identifiable intangible assets were included in the operating expenses of the Health & Fitness segment for the year ended March 31, 2006.

 

(2) Total assets, depreciation and amortization and capital expenditures

 

Year Ended March 31, 2004


   Digital
Entertainment


   Health &
Fitness


   Gaming &
System


  

Other,
Corporate

and

Eliminations


   Consolidated

     (Millions of Yen)

Assets

   ¥ 110,327    ¥ 104,516    ¥ 9,534    ¥ 70,120    ¥ 294,497

Depreciation and amortization

     2,108      4,963      411      1,046      8,528

Capital expenditures

     1,828      4,724      167      4,843      11,562

 

Year Ended March 31, 2005


   Digital
Entertainment


   Health &
Fitness


   Gaming &
System


  

Other,
Corporate

and

Eliminations


   Consolidated

     (Millions of Yen)

Assets

   ¥ 111,842    ¥ 105,278    ¥ 10,235    ¥ 76,966    ¥ 304,321

Depreciation and amortization

     1,891      4,976      397      2,096      9,360

Capital expenditures

     1,485      5,353      865      10,951      18,654

 

Year Ended March 31, 2006


   Digital
Entertainment


   Health &
Fitness


   Gaming &
System


  

Other,
Corporate

and

Eliminations


   Consolidated

     (Millions of Yen)

Assets

   ¥ 114,654    ¥ 105,533    ¥ 9,627    ¥ 72,823    ¥ 302,637

Depreciation and amortization

     2,286      5,420      517      5,559      13,782

Capital expenditures

     19,785      19,911      661      7,647      48,004

 

F-45


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Year Ended March 31, 2006


   Digital
Entertainment


   Health &
Fitness


   Gaming &
System


  

Other,
Corporate

and

Eliminations


   Consolidated

     (Thousands of Dollars)

Assets

   $ 976,028    $ 898,383    $ 81,953    $ 619,928    $ 2,576,292

Depreciation and amortization

     19,460      46,139      4,401      47,324      117,324

Capital expenditures

     168,426      169,499      5,627      65,097      408,649

 

Eliminations and corporate primarily consist of eliminations of intercompany profits on inventories and assets for corporate headquarters, which primarily consist of cash and financial assets.

 

Capital expenditures include expenditures for acquisitions of tangible and intangible long-lived assets used in operations of each segment, including those acquired in acquisitions of businesses.

 

b.    Operations in Geographic Areas

 

Year Ended March 31, 2004


   Japan

   United
States


   Europe

   Asia/
Oceania


   Total

   Eliminations

    Consolidated

     (Millions of Yen)

Net revenue:

                                                 

Customers

   ¥ 176,401    ¥ 53,670    ¥ 35,551    ¥ 7,790    ¥ 273,412      —       ¥ 273,412

Intersegment

     68,757      1,516      305      260      70,838    ¥ (70,838 )     —  
    

  

  

  

  

  


 

Total

     245,158      55,186      35,856      8,050      344,250      (70,838 )     273,412

Operating expenses

     213,419      51,806      30,915      6,904      303,044      (70,345 )     232,699
    

  

  

  

  

  


 

Operating income

   ¥ 31,739    ¥ 3,380    ¥ 4,941    ¥ 1,146    ¥ 41,206    ¥ (493 )   ¥ 40,713
    

  

  

  

  

  


 

 

Year Ended March 31, 2005


   Japan

   United
States


   Europe

   Asia/
Oceania


   Total

   Eliminations

    Consolidated

     (Millions of Yen)

Net revenue:

                                                 

Customers

   ¥ 176,566    ¥ 41,480    ¥ 34,878    ¥ 7,767    ¥ 260,691      —       ¥ 260,691

Intersegment

     57,123      1,593      450      419      59,585    ¥ (59,585 )     —  
    

  

  

  

  

  


 

Total

     233,689      43,073      35,328      8,186      320,276      (59,585 )     260,691

Operating expenses

     211,500      41,682      32,207      6,684      292,073      (59,518 )     232,555
    

  

  

  

  

  


 

Operating income (loss)

   ¥ 22,189    ¥ 1,391    ¥ 3,121    ¥ 1,502    ¥ 28,203    ¥ (67 )   ¥ 28,136
    

  

  

  

  

  


 

Property and equipment, net

   ¥ 44,775    ¥ 1,018    ¥ 472    ¥ 330    ¥ 46,595      —       ¥ 46,595

 

Year Ended March 31, 2006


   Japan

   United
States


    Europe

   Asia/
Oceania


   Total

   Eliminations

    Consolidated

     (Millions of Yen)

Net revenue:

                                                  

Customers

   ¥ 193,108    ¥ 33,797     ¥ 27,387    ¥ 7,845    ¥ 262,137      —       ¥ 262,137

Intersegment

     31,488      1,545       902      361      34,296    ¥ (34,296 )     —  
    

  


 

  

  

  


 

Total

     224,596      35,342       28,289      8,206      296,433      (34,296 )     262,137

Operating expenses

     222,559      37,688       27,181      6,895      294,323      (34,667 )     259,656
    

  


 

  

  

  


 

Operating income (loss)

   ¥ 2,037    ¥ (2,346 )   ¥ 1,108    ¥ 1,311    ¥ 2,110    ¥ 371     ¥ 2,481
    

  


 

  

  

  


 

Property and equipment, net

   ¥ 39,888    ¥ 1,815     ¥ 454    ¥ 295    ¥ 42,452      —       ¥ 42,452

 

F-46


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

Year Ended March 31, 2006


  Japan

  United
States


    Europe

  Asia/
Oceania


  Total

  Eliminations

    Consolidated

    (Thousands of U.S. Dollars)

Net revenue:

                                             

Customers

  $ 1,643,892   $ 287,707     $ 233,140   $ 66,784   $ 2,231,523     —       $ 2,231,523

Intersegment

    268,051     13,153       7,679     3,072     291,955   $ (291,955 )     —  
   

 


 

 

 

 


 

Total

    1,911,943     300,860       240,819     69,856     2,523,478     (291,955 )     2,231,523

Operating expenses

    1,894,602     320,831       231,387     58,696     2,505,516     (295,113 )     2,210,403
   

 


 

 

 

 


 

Operating income (loss)

  $ 17,341   $ (19,971 )   $ 9,432   $ 11,160   $ 17,962   $ 3,158     $ 21,120
   

 


 

 

 

 


 

Property and equipment, net

  $ 339,559   $ 15,451     $ 3,865   $ 2,511   $ 361,386     —       $ 361,386

 

For the purpose of presenting its operations in geographic areas above, Konami attributes revenues from external customers to individual countries in each area based on where products are sold and services are rendered and attribute assets based on where assets are located.

 

As discussed in Note 6 and 7, impairment charges of ¥10,533 million ($89,665 thousand) for long-lived assets and ¥9,180 million ($78,148 thousand) for identifiable intangible assets were included in the operating expenses of Japan segment for the year ended March 31, 2006.

 

21.    Commitments and Contingencies

 

Konami is subject to pending claims and litigation. Management, after review and consultation with counsel, considers that any liability from the disposition of such lawsuits would not have a material adverse effect on the consolidated financial condition and results of operations of Konami.

 

Konami has placed firm orders for purchases of property, plant and equipment and other assets amounting to approximately ¥8,494 million ($72,308 thousand) as of March 31, 2006.

 

F-47


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended March 31, 2004, 2005, and 2006—(Continued)

 

SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS

 

     Millions of Yen

     Balance
at beginning of
the year


   Additions

   Deductions

   Balance
at end of
the year


2004

                           

Allowance for doubtful accounts

                           

Trade accounts receivable

   ¥ 976    ¥ 83    ¥ 350    ¥ 709

Lease deposits

   ¥ 4,137      —        —      ¥ 4,137

2005

                           

Allowance for doubtful accounts

                           

Trade accounts receivable

   ¥ 709    ¥ 158    ¥ 263    ¥ 604

Lease deposits

   ¥ 4,137      —        4,137    ¥ —  

2006

                           

Allowance for doubtful accounts

                           

Trade accounts receivable

   ¥ 604    ¥ 77    ¥ 140    ¥ 541

 

     Thousands of U.S. Dollars

     Balance
at beginning of
the year


   Additions

   Deductions

   Balance
at end of
the year


2006

                           

Allowance for doubtful accounts

                           

Trade accounts receivable

   $ 5,142    $ 655    $ 1,192    $ 4,605

 

F-48


Table of Contents
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