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Konami Corp – ‘20-F’ for 3/31/06

On:  Monday, 7/24/06, at 6:35am ET   ·   For:  3/31/06   ·   Accession #:  1193125-6-151326   ·   File #:  1-31452

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 7/24/06  Konami Corp                       20-F        3/31/06   10:2.8M                                   RR Donnelley/FA

Annual Report of a Foreign Private Issuer   —   Form 20-F
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 20-F        Annual Report                                       HTML   2.35M 
 2: EX-1.1      Articles of Incorporation                           HTML     53K 
 3: EX-1.2      Share Handling Regulations                          HTML     50K 
 4: EX-1.3      Regulations of the Board of Directors               HTML     40K 
 5: EX-1.4      Regulations of the Board of Corporate Auditors      HTML     43K 
 6: EX-8.1      List of Subsidiaries                                HTML     12K 
 7: EX-12.1     Certification of the Cheif Executive Officer        HTML     14K 
                          Required by Rule 13A-14(A)                             
 8: EX-12.2     Certification of the Cheif Financial Officer        HTML     14K 
                          Required by Rule 13A-14(A)                             
 9: EX-13.1     Certification of the Cheif Executive Officer        HTML      8K 
                          Required by Rule 13A-14(B)                             
10: EX-13.2     Certification of the Cheif Financial Officer        HTML      8K 
                          Required by Rule 13A-14(B)                             


20-F   —   Annual Report
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Table of Contents
"Identity of Directors, Senior Management and Advisers
"Offer Statistics and Expected Timetable
"Key Information
"Information on the Company
"Unresolved Staff Comments
"Operating and Financial Review and Prospects
"Directors, Senior Management and Employees
"Major Shareholders and Related Party Transactions
"Financial Information
"The Offer and Listing
"Additional Information
"Quantitative and Qualitative Disclosures about Market Risk
"Description of Securities Other Than Equity Securities
"Defaults, Dividend Arrearages and Delinquencies
"Material Modifications to the Rights of Security Holders and Use of Proceeds
"Controls and Procedures
"Audit Committee Financial Expert
"Code of Ethics
"Principal Accountant Fees and Services
"Exemption from the Listing Standards for Audit Committees
"Purchases of Equity Securities by the Issuer and Affiliated Purchasers
"Financial Statements
"Exhibits
"Index to Consolidated Financial Statements and Financial Statement Schedule
"Report of Independent Registered Public Accounting Firm
"Consolidated balance sheets as March 31, 2005 and 2006
"Consolidated statements of income for the years ended March 31, 2004, 2005 and 2006
"Consolidated statements of stockholders' equity for the years ended March 31, 2004, 2005 and 2006
"Consolidated statements of cash flows for the year ended March 31, 2004, 2005 and 2006
"Notes to consolidated financial statements
"Schedule II-Valuation and qualifying accounts

This is an HTML Document rendered as filed.  [ Alternative Formats ]



  Annual report  
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 20-F

 


 

¨   REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR 12(G) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended March 31, 2006

 

OR

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

¨   SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Date of event requiring this shell company report . . . . . . . . . . . . . . . . . . .

 

For the transition period from             to             

 

Commission file number: 1-31452

 


 

Konami Kabushiki Kaisha

(Exact name of registrant as specified in its charter)

 

KONAMI CORPORATION

(Translation of registrant’s name into English)

 


 

    4-1, Marunouchi 2-chome, Chiyoda-ku,
Tokyo 100-6330
Japan   Japan
(Jurisdiction of incorporation or organization)   (Address of principal executive offices)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of Each Class


 

Name of Each Exchange On Which Registered


Common Stock1   New York Stock Exchange

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

(Title of Class)

 


 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

As of March 31, 2006, 137,152,347 shares of common stock were outstanding, including 920,500 shares represented by 920,500 American Depositary Shares.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer    x                 Accelerated filer    ¨            Non-accelerated filer    ¨

 

Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17  ¨    Item 18  x

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 


1   Not for trading, but only in connection with the listing of American Depositary Shares, each representing one share of common stock.


Table of Contents

TABLE OF CONTENTS

 

          Page

PART I

Item 1.

   Identity of Directors, Senior Management and Advisers.    1

Item 2.

   Offer Statistics and Expected Timetable.    1

Item 3.

   Key Information.    1

Item 4.

   Information on the Company.    18

Item 4A.

   Unresolved Staff Comments    62

Item 5.

   Operating and Financial Review and Prospects.    62

Item 6.

   Directors, Senior Management and Employees.    90

Item 7.

   Major Shareholders and Related Party Transactions.    95

Item 8.

   Financial Information.    97

Item 9.

   The Offer and Listing.    98

Item 10.

   Additional Information.    99

Item 11.

   Quantitative and Qualitative Disclosures about Market Risk    114

Item 12.

   Description of Securities Other Than Equity Securities    116
PART II

Item 13.

   Defaults, Dividend Arrearages and Delinquencies.    117

Item 14.

   Material Modifications to the Rights of Security Holders and Use of Proceeds.    117

Item 15.

   Controls and Procedures.    117

Item 16A.

   Audit Committee Financial Expert.    117

Item 16B.

   Code of Ethics.    117

Item 16C.

   Principal Accountant Fees and Services.    117

Item 16D.

   Exemption from the Listing Standards for Audit Committees.    118

Item 16E.

   Purchases of Equity Securities by the Issuer and Affiliated Purchasers.    119
PART III

Item 17.

   Financial Statements.    120

Item 18.

   Financial Statements.    120

Item 19.

   Exhibits.    120

Index to Consolidated Financial Statements and Financial Statement Schedule

   F-1

 

As used in this annual report, references to “Konami” are to KONAMI CORPORATION and references to “we”, “our” and “us” are to KONAMI CORPORATION and its subsidiaries except as the context otherwise requires.

 

As used in this annual report, “fiscal 2006” refers to our fiscal year ended March 31, 2006, and other fiscal years are referred to in a corresponding manner.

 

As used in this annual report, “U.S. dollar” or “$” means the lawful currency of the United States of America, and “yen” or “¥” means the lawful currency of Japan.

 

As used in this annual report, “U.S. GAAP” means accounting principles generally accepted in the United States, and “Japanese GAAP” means accounting principles generally accepted in Japan.

 

As used in this annual report, “ADS” means an American Depositary Share, and “ADR” means an American Depositary Receipt.


Table of Contents

PART I

 

Item 1.   Identity of Directors, Senior Management and Advisers.

 

Not applicable.

 

Item 2.   Offer Statistics and Expected Timetable.

 

Not applicable.

 

Item 3.   Key Information.

 

A.    Selected Financial Data.

 

The following tables include selected historical financial data as of and for the fiscal years ended March 31, 2002 through 2006, derived from our audited consolidated financial statements prepared in accordance with U.S. GAAP. You should read the selected financial data below in conjunction with Item 5 of this annual report and our audited consolidated financial statements and information prepared in accordance with U.S. GAAP which are included in this annual report.

 

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

 

     Fiscal year ended/as of March 31,

 
     2002

   2003

    2004

    2005

    2006

    2006

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

Income Statement Data:

                                               

Net revenues

   ¥ 225,580    ¥ 253,657     ¥ 273,412     ¥ 260,691     ¥ 262,137     $ 2,231,523  

Cost of revenues

     154,651      174,879       179,182       180,363       184,744       1,572,691  

Impairment of goodwill, other intangible assets and long-lived assets (1)(2)

     —        47,599       —         —         19,713       167,813  

Selling, general and administrative expenses

     52,842      53,049       53,517       52,192       55,199       469,899  
    

  


 


 


 


 


Operating income (loss)

     18,087      (21,870 )     40,713       28,136       2,481       21,120  
    

  


 


 


 


 


Other income (expenses), net

     4,591      (226 )     (606 )     (694 )     5,957       50,711  
    

  


 


 


 


 


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

     22,678      (22,096 )     40,107       27,442       8,438       71,831  

Income taxes

     11,667      6,186       18,035       7,902       (10,270 )     (87,427 )

Minority interest in income (loss) of consolidated subsidiaries

     364      (1,051 )     2,220       2,761       (4,267 )     (36,324 )

Equity in net income (loss) of affiliated companies

     755      (1,288 )     252       (6,293 )     33       281  
    

  


 


 


 


 


Net income (loss)

   ¥ 11,402    ¥ (28,519 )   ¥ 20,104     ¥ 10,486     ¥ 23,008     $ 195,863  
    

  


 


 


 


 


Basic net income (loss) per share

   ¥ 89.32    ¥ (234.58 )   ¥ 166.86     ¥ 87.41     ¥ 175.86     $ 1.49  

Diluted net income (loss) per share

   ¥ 89.32    ¥ (234.58 )   ¥ 166.86     ¥ 87.41     ¥ 175.80     $ 1.49  

Cash dividends per share (3)

   ¥ 54.00    ¥ 54.00     ¥ 54.00     ¥ 54.00     ¥ 54.00     $ 0.46  

Balance Sheet Data:

                                               

Total current assets

   ¥ 142,055    ¥ 136,705     ¥ 152,766     ¥ 161,938     ¥ 144,327     $ 1,228,629  

Total assets

     328,091      278,250       294,497       304,321       302,637       2,576,292  

Total current liabilities

     79,548      71,774       72,799       99,827       81,224       691,445  

Total long-term liabilities

     77,637      87,215       92,160       73,150       55,477       472,265  

Total stockholders’ equity

     134,990      90,406       102,129       105,857       163,815       1,394,526  

 

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(1)   Following the impairment review for fiscal 2003, we recognized impairment losses of ¥47,599 million with respect to our investment in Konami Sports Corporation (the current operations of which are included in the Health & Fitness reporting unit). Approximately ¥36,717 million of this loss related to the write-off of goodwill and the remaining ¥10,882 million related to the impairment of identifiable intangible assets such as trademarks and franchise contracts.
(2)   During fiscal 2006, we determined that the fair value of long-lived assets and identifiable intangible assets related to the Health & Fitness reporting unit was lower than their carrying value as a result of a review based on independent valuations. Accordingly, impairment of long-lived assets and identifiable intangible assets of ¥10,533 million and ¥9,180 million were recorded in operating expenses respectively.
(3)   Cash dividends per share consist of interim dividends paid during the fiscal year and year-end dividends paid after the fiscal year-end.

 

Exchange Rate Data

 

Fluctuations in exchange rates between the Japanese yen and U.S. dollar and other currencies will affect the U.S. dollar and other currency equivalent of the yen price of our shares and ADSs and the U.S. dollar amounts received on conversion of cash dividends. We have translated some Japanese yen amounts presented in this annual report into U.S. dollars solely for your convenience. Unless otherwise noted, the rate used for the translations was ¥117.47 per $1.00 which was 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, the last business day on or prior to the date of our most recent annual consolidated financial statements. The translation should not be construed as a representation that the yen amounts have been, could have been, or could in the future be converted into U.S. dollars at the above or any other rate.

 

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

 

Fiscal year ended March 31,


   High

   Low

   Average (1)

   Period-end

2001

   125.54    104.19    111.65    125.54

2002

   134.77    115.89    125.64    132.70

2003

   133.40    115.71    121.10    118.07

2004

   120.55    104.18    112.75    104.18

2005

   114.30    102.26    107.28    107.22

2006

   120.93    104.41    113.67    117.48

Calendar year 2006


                   

January

   117.55    113.96    115.48    116.88

February

   118.95    115.82    117.86    115.82

March

   119.07    115.89    117.28    117.48

April

   118.66    113.79    117.07    113.79

May

   113.46    110.07    111.73    112.26

June

   116.42    111.66    114.63    114.51

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

 

As of July 19, 2006, the noon buying rate was ¥116.37 per $1.00.

 

B.    Capitalization and Indebtedness.

 

Not applicable.

 

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C.    Reasons for the Offer and Use of Proceeds.

 

Not applicable.

 

D.    Risk Factors.

 

Special Note Regarding Forward-looking Statements.

 

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

 

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

 

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

 

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

 

    our ability to successfully expand internationally with a focus on our Digital Entertainment segment and Gaming & System segment;

 

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

 

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

 

    our ability to successfully integrate current acquisitions and realize expected synergies and business benefits to recover the acquisition investment, including goodwill and separately identifiable intangible assets; and

 

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

 

Risks Relating to Our Overall Business

 

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

 

The market for video game software, toy & hobby products, amusement arcade games, token-operated games that belong to Digital Entertainment segment and gaming machines that belong to Gaming & System segment is “hits” driven. “Hit” products account for a substantial portion of our net revenues and of the revenues in each of these markets. For example, the fast growth of our toy & hobby products in recent years resulted from, and was heavily dependent on, the sales of our Yu-Gi-Oh! Trading Card Game. Similarly, hit video game software titles such as the Yu-Gi-Oh! series, the WORLD SOCCER Winning Eleven series and the METAL GEAR

 

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SOLID series, as well as our e-AMUSEMENT products for our amusement facilities, have contributed significantly to our recent results. If we do not develop, publish and distribute “hit” products in the future, our financial condition, results of operations and profitability in these segments could be negatively affected. The most important factor in developing hit products is to respond quickly to public tastes and preferences that change rapidly and are hard to predict. Therefore, if we fail to accurately anticipate and promptly respond to changing tastes and preferences, our business, revenues and profits in these segments could be harmed.

 

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

 

Our success depends on generating revenue from the timely introduction and shipment of new products. The majority of sales of a new video game software generally occurs in the first thirty to one hundred and twenty days after release. The sales occurrence for toy & hobby products including mainly card games, amusement arcade games, token-operated games that belong to Digital Entertainment segment and gaming machines that belong to Gaming & System segment also tends to be limited. We are constantly required to introduce new products in order to generate revenues and/or to replace declining revenues from older products. Also, because revenues earned during the early life of a product generally constitute a relatively high percentage of the total revenues earned from a product, a significant delay in the introduction of one or more new products, or the inability to ship in sufficient quantities to meet demand, could negatively affect sales and have a negative impact on our financial condition and results of operations. Unanticipated delays could also cause us to miss an important selling season such as the year-end holiday buying season or summer vacation. Moreover, our products may not achieve and sustain market acceptance during the short life cycle sufficient to generate revenue to recover our investment in developing the products and to cover our other costs.

 

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

 

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

 

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

 

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

 

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

 

Our product sales are affected by customer’s ability and desire to spend disposable income on the purchase of our products. Any significant downturn in general economic conditions which results in a reduction in

 

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consumers’ discretionary spending could reduce demand especially for entertainment and health-oriented products and services like ours and may harm our business. Such industry downturns have been, and may continue to be, characterized by diminished product demand and subsequent erosion of average selling prices.

 

Our performance may be vulnerable to rapidly changing consumer preferences.

 

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

 

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

 

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

 

Our quarterly operating results also may be materially impacted by other factors, including the level of market acceptance or demand for video game software, the timing of hardware platform introductions, the level of development and/or promotion expenses for a video game title. Also, many of our products are in the greatest demand from November to January, particularly at the end and beginning of the year and, to a lesser extent, in August (summer vacation) and in March (spring vacation), in decreasing order. This trend is explained as these months correspond to the periods of children’s school holidays and it is customary in Japan to buy such products as Christmas and New Year presents in December and January. In addition, in the U.S. demand is highest from November, starting with Thanksgiving and through the Christmas season. Moreover, in a platform transition period, sales of video game software products can be significantly affected by the timeliness of introduction of video game systems by the manufacturers of those platforms, such as Sony Corporation (“Sony”), Nintendo Co., Ltd. (“Nintendo”) and Microsoft Corporation (“Microsoft”).

 

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

 

We focus our development and publishing activities principally on products that are, or have the potential to become, franchise brand properties. Many of our products are based on intellectual property and other character or story rights acquired or licensed from third parties. For example, our products often embody trademarks, trade names, logos, or copyrights licensed by third parties, such as Major League Baseball Properties, Inc., and Major League Baseball Players Association. We have also acquired content licenses from sports organizations such as FIFPro Commercial Enterprises BV, the Japan Professional Baseball League, the Japan Professional Soccer League, or J-League, and the Japan Football Association. In addition, we have obtained content licenses from various companies, including NIHON AD SYSTEMS Inc., Kodansha Ltd., and Shogakukan Production Inc.

 

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

 

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

 

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

 

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

 

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

 

Existing or future infringement claims against us may result in costly litigation or require us to obtain a license for the proprietary rights of third parties, which could have a negative impact on our results of operations. As the number of our products increases there is an increased possibility of the contents and features of these products overlapping with the products of other companies, and we become subject to an increasing possibility of infringement claims. Although we are making efforts to ensure that our products do not violate the intellectual property rights of others, it is possible that third parties still may claim infringement.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

In order to develop and market our products and services competitively, we are seeking opportunities in and outside Japan to make acquisitions of controlling or significant stakes in other businesses that will grow our current businesses. Some of these transactions could be material in size and scope. Our acquisitions strategy requires that we effectively coordinate and integrate our activities with those of the companies in which we invest or which we acquire. In the event we make such acquisitions or investments, we will face additional financial and operational risks, including:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Approximately 78.7% of our net revenues during fiscal 2002, 71.9% of our net revenues during fiscal 2003, 64.5% of our net revenues during fiscal 2004, 67.7% of our net revenues during fiscal 2005 and 73.7% of our net revenues during fiscal 2006 were derived from sales in Japan. Although we expect that domestic sales will continue to account for a significant portion of our revenues in future periods, we plan to expand our international operations, particularly with respect to video game software, gaming machines and toy & hobby products, including through alliances or investments. Sales in foreign countries may involve expenses incurred to customize products to comply with local laws, especially in the case of gaming machines. In addition, products that are successful in the domestic Japanese market may not be successful in foreign markets due to different consumer preferences. In addition, our costs will increase as a result of the need to conduct market research to discover local preferences and tastes and to develop foreign language versions or make product modifications in order to tailor our products to various local markets. In the case of video game software, we may have to grant price concessions to or accept returns from major retailers that control market access to consumers. International trade is also subject to general country risks, including suspension of currency exchange by governments, increases in tariffs, and forfeiture of property through expropriation by governments. International trade is also exposed to fluctuating exchange rates. We may become exposed to increased litigation risks or unexpected bankruptcy risks through product liabilities, facility liabilities, product defect or labor issues in the course of further expanding our business, enhancing our international network and increasing our vendors and customers. These and other factors specific to international trade may result in increased costs or reduced revenues.

 

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

 

The Japanese population of people in their teens and twenties, the traditional target market for our products and services including computer & video games products and arcade games, is expected to decline. Accordingly, we may not be able to increase or maintain revenues if we are unable to enter new markets such as fitness clubs and expand our customer base and product offerings to overseas markets. Life expectancy in Japan is among the highest of the developed countries. However, as a result of a decline in fertility rates, Japan’s population is expected to begin declining after 2007 and its demographic makeup is already aging considerably. According to government estimates released in June 2006, as of calendar year 2005, 21% of Japan’s population was aged 65 or over and this percentage is expected to reach 26.0% by 2015 and 35.7% by 2050.

 

Risks Relating to Our Digital Entertainment Segment

 

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

 

The life cycle of existing game consoles and the market acceptance and popularity of new game consoles significantly affect the success of our products. The introduction of new technologies could render our current products or products in development obsolete or unmarketable. In addition, we cannot guarantee that we will be successful in developing and publishing video game software for new game consoles on a timely basis. Further, the release dates of new game platforms or the number of units that will be shipped upon such release are beyond the scope of our control.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Since major manufactures such as Sony and Nintendo are also publishers of games for their own hardware platforms and manufacture products for all of their other licensees, such manufacturers may give priority to their own products or those of our competitors in the event of insufficient manufacturing capacity. Our business and financial results could be materially harmed by unanticipated delays in the manufacturing and delivery of our products by Sony or Nintendo, which has occurred in the past. In addition, our business and financial results

 

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could be materially harmed if Sony or Nintendo used their rights under these agreements to delay the manufacture or delivery of our products, limit the costs recoverable by us to manufacture video game software for their consoles, or elect to manufacture video game software themselves or use developers other than us.

 

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

 

Legislation is periodically introduced at the local, state and federal levels in the United States and in other countries to establish a system for providing consumers with information about graphic violence and sexually explicit material contained in software products. In 2005, legislation was also introduced in Japan to establish a system for local authorities to restrict the provision of products containing graphic violence. In addition, many countries have laws that permit governmental entities to censor the content and advertising of software. Although there are no mandatory government-run rating systems in Japan, North America, Europe and Asian countries except China that are significant markets or potential markets for our products, governmental approval is required for software sales in China and such rating systems may be adopted elsewhere. We may be required to modify our products or alter our marketing strategies to comply with new regulations, which could delay the release of our products in those countries. Due to the uncertainties regarding these rating systems, confusion in the marketplace may occur, and we are unable to predict what effect, if any, such rating systems would have on our business.

 

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

 

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

 

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

 

Amusement arcades are the primary venue for video game machines and token-operated game machines in Japan. Amusement arcade revenues and the sales of arcade games have been declining over the past several years, however, these have recently been bottoming out and recovering. However, due to the development of full-scale home video game systems that can rival amusement arcade games in play quality and the introduction of advanced mobile telephones equipped with network and game functions, consumers now have increasing leisure alternatives outside of amusement arcades. As customer preferences diversify, fewer people may visit frequently the amusement arcades on which we depend for sales of our amusement arcade game software, amusement arcade games and token-operated game machines and this could have a negative impact on our results of operations if amusement arcade operators reduce purchases of our products as a result.

 

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

 

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

 

Our business could be harmed if there is any substantial decline in the popularity of interactive Internet-based games or if our Internet-based games are not received favorably in the market.

 

In recent years, the rapid growth of the Internet has resulted in the development of interactive software games for play over networks and on mobile phones. Although we are marketing mobile phone-based games as well as games for PlayStation 2 and Xbox, games downloadable using the Xbox 360 or personal computers and games for play over networks, games have diversified over recent years and consumers now have expanded choices. If there is any substantial decline in the popularity of our network-based games, our business, revenues and profits could be harmed.

 

In addition, the development and operation of Internet-based games require a long period for development and a substantial amount of initial investment, including for example numerous test operations of facilities such as servers. If our Internet-based games are not received favorably in the market, we may be unable to recoup our initial investment or operating expenses, and may have to recognize an impairment with respect to the servers and software assets associated with such games.

 

Information processing failures in the operation of our Internet-based games may adversely affect our revenues and income.

 

As our Internet-based games require servers that process a heavy volume of information, the computers we use as servers must be equipped with high processing capacity. Although we attempt to prevent troubles by performing maintenance for our servers, we may be unable to operate our Internet-based games if the information processing capacity of a server becomes suddenly overloaded or is unexpectedly attacked by external computer viruses. If the recovery of processing capacity requires a long period of time, thus driving customers away, or if such technical errors and interruptions occur repeatedly and cause our customers to lose confidence in our services, our net revenues and operating income may decrease.

 

Abuses of network-based credit card billing authorization may adversely affect our revenues and profits.

 

We collect charges for our network-based games based on consumers’ credit card information, through a credit card authorization agent. Although our credit card authorization agent takes all possible measures to ensure the privacy of customer information during billing transactions, if the credit card information of our customers is obtained by unauthorized third parties and used for unauthorized transactions, we may be required to make repayments of the unauthorized amounts out of the sales we made to such customers. In addition, if numerous abuses occur, a credit card authorization agent might cancel billing collection services with us, and our net revenues and operating income may be adversely affected.

 

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Risks Relating to Our Health & Fitness Segment

 

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

 

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

 

    obtain financing;

 

    locate suitable sites for clubs;

 

    successfully negotiate lease agreements and meet construction schedules and budgets;

 

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

 

    hire, train and retain qualified personnel;

 

    attract new members; and

 

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

 

If we are not able to achieve success with respect to the factors outlined above, the growth of our health & fitness segment may be limited. We cannot assure you that we will be able to implement our growth strategy, open new clubs in a timely and cost-efficient basis or operate our new clubs profitably. Upon opening a new fitness club, we often experience an initial period of operating losses with respect to that club for the first year. However, this period can vary depending on the individual club, and may be substantially longer than a year. If we are unable to enhance the performance of our new fitness clubs, our operating income may be adversely affected. In fiscal 2006, we recognized ¥19,713 million in impairment losses in our Health & Fitness segment partly as a result of the segment’s failure to meet previous growth expectations, and we may still incur future impairment charges against goodwill or other intangible assets.

 

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

 

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

 

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

 

The fitness club industry is highly competitive. We compete with other fitness clubs, physical fitness and recreational facilities established by local governments, hospitals and businesses for their employees, amenity and condominium clubs and, to a certain extent, with racquet and tennis and other athletic clubs, country clubs, weight reducing salons and the home-use fitness equipment industry. We also compete with other entertainment and retail businesses for the discretionary income of our target markets. We cannot assure you that we will be able to compete effectively in the future in the markets in which we operate. In addition, we may face new

 

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competitors in the market that may be larger and have greater resources than us. These competitive conditions may limit our ability to increase dues without a material loss in membership, attract new members and attract and retain qualified personnel. Additionally, consolidation in the fitness club industry could result in increased competition among participants, particularly as large multi-facility operators are better able to compete for attractive acquisition candidates, thereby increasing costs associated with expansion through acquisitions, as well as negotiation of leases and the availability of real estate.

 

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

 

Use of our fitness clubs and equipment poses some potential health risks to members or guests through exertion from use of our services and facilities including exercise equipment. As a result, we may be subject to claims against us for death or injury suffered by members while exercising at our fitness clubs, and we may not be able to successfully defend any such claims. In addition, any such claims may harm our reputation. We currently maintain general liability coverage but there can be no assurance that we will be able to maintain such liability insurance on acceptable terms in the future or that such insurance will provide adequate coverage against potential claims. Any liability claim in excess of our insurance coverage may adversely affect our results of operations.

 

We are subject to various governmental regulations, any con-compliance with which could result in temporary closings and negative publicity.

 

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

 

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

 

In many cases, we rent land and buildings when we open new fitness clubs. Under the lease agreements that we enter into with landowners, we are often required to make deposits and to provide guarantee money in case we default in payment of rent or neglect to restore the property to its original state upon termination of the lease agreement. Under such lease agreements, if we pay our rent and restore the property as stipulated, we are entitled to obtain refund of such deposits and guarantee money. However, if the owner of the property faces financial difficulty or is otherwise unable or unwilling to return these funds, we may not be able to obtain full refunds of such deposits and guarantee money. As of March 31, 2006, such deposits and guarantee money accounted for over 8% of our total assets.

 

Risks Relating to Our Gaming & System Segment

 

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

 

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

 

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In order to diversify and expand sales, we have obtained licenses in every state in Australia, the main states in the United States and some provinces in Canada, and are marketing and selling gaming machines. If our games fail to be accepted by the market for gaming machines and we are otherwise unable to develop gaming machines that offer technological advantages or unique entertainment features, we will be unable to generate the revenues necessary to compete effectively in the competitive gaming machine market. Consequently, the results of our operations could suffer.

 

If our technologies for gaming products are subject to claims they infringe on competitors’ patents, trademark rights and design rights, we may be unable to market our products as planned, thus adversely affecting our profits.

 

As technological capabilities and an ability to develop effective business plans are constantly becoming more crucial for success in the gaming business, it has become a critical business strategy for companies, especially in the United States, to ensure an advantage over competitors by filing and acquiring their own intellectual property rights such as patents, trademark rights and design rights in advance of their competitors. In this competitive business environment, we strive to commercialize our products only after carefully examining the intellectual property rights status of the products. However, if the contents of our new products and services are deemed to infringe on the intellectual property rights of competitors, we may be unable to bring such products or services to market or be forced to cease selling such products or services.

 

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

 

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

 

    the pace of market expansion;

 

    changes in gaming regulation;

 

    fluctuations in popularity of casino gaming; and

 

    changes in casino gaming tax rates for instituted by national, state or province governments.

 

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

 

Our failure to obtain or retain required licenses for our Gaming & System segment could prevent us from expanding our market and prohibit us from generating revenue in certain jurisdictions.

 

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

 

Together with our key personnel, we undergo extensive investigation before each jurisdictional license is issued. Our gaming machines are subjected to independent testing and evaluation prior to approval from each

 

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jurisdiction in which we do business. Generally, regulatory authorities have broad discretion when granting, renewing or revoking these game approvals and licenses. Our failure to obtain or retain a required license or approval in one jurisdiction could negatively impact our ability to obtain or retain required licenses and approvals in other jurisdictions. The failure to obtain or retain a required license or approval in any jurisdiction would decrease the geographic areas where we may operate and generate revenues, decrease our share in the gaming marketplace and put us at a disadvantage compared with our competitors. Consequently, the market price of our common stock may suffer.

 

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

 

The future revenue growth of our Gaming & System segment depends on our ability to strengthen our research and development departments and improve the effectiveness of our sales organizations and service departments.

 

In order to increase market awareness and sales of our gaming products, it is important for us to develop hit products that are received favorably in our markets and for us to maintain technology that allows for future innovation and adaptations to changes in customer preferences. If we fail to assess market needs or be technologically innovative, our net revenues and operating income may be adversely affected.

 

In addition, it is important for us to improve the effectiveness of our sales operations and service departments internationally. Our gaming business is expanding from sales of slot machines to sales of casino management systems, which connect gaming machines under a single accounting, marketing and customer management system and reinforcement of security. Casino management systems provide for relatively stable revenues, as proceeds from the initial sale are supplemented by subsequent connection fees. However, gaming products require sophisticated sales efforts targeted at selected people within the gaming industry and quality post-sale servicing. Competition for qualified sales personnel is intense, and we might not be able to hire the kind and number of sales personnel we are targeting. In addition, we will need to effectively train and educate our sales force and strengthen our service departments to ensure trust in our products if we are to be successful in selling into the gaming machine market.

 

If our new manufacturing plant in the United States has operational difficulties, and we have problems with manufacturing capacity and quality control, our business growth may be adversely affected.

 

In June 2005, we started operation of a new manufacturing plant to strengthen production capacity and customer service and expand development and sales in the U.S. market. We depend our new manufacturing capacity for substantially all of our sales in the U.S. market. If natural disasters or operational troubles occur in this plant, we may be unable to maintain sufficient manufacturing capacity to meet increases in orders, and our financial performance may be adversely affected.

 

Natural disasters such as hurricanes Katrina in August 2005 and Rita in September 2005, which caused a tremendous amount of damage to the southern part of the United States, could have a material adverse effect on our Gaming & System segment.

 

In summer 2005, hurricanes caused a tremendous amount of damage to the gaming business in the southern part of the United States, where we ship some of our products. The hurricanes resulted in loss of gaming equipment and a decrease in and cancellation of purchase orders. We also faced losses of gaming devices inventory, although to a lesser degree. Our results of operations may be adversely affected if similar natural disasters occur in the future.

 

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Risks Relating to Our Other Operations—LCDs for Pachinko machines

 

As we do not manufacture LCDs for Pachinko machines, any delay or disruption in shipments from outside sources or incorporation of our software into the LCDs by subcontractors may adversely affect our profits.

 

Our revenues and profits from sales of our pachinko LCDs business come from sales of software that is integrated into LCDs. The manufacturing of LCDs is a complicated process which we entrust to third parties through agreements with certain suppliers who specialize in LCD commercial production. While we believe that we currently enjoy good relations with these suppliers, we cannot ensure that they will be able to provide us with the quality and quantity of LCDs which we may require in the future. We also rely on subcontractors to incorporate our software into the LCDs, which makes it possible that we will suffer profitability losses in the event of complications or delay. In addition, if any of the manufacturers or subcontractors discontinue their operations and we cannot find suitable replacements in a timely manner, we may face delays in introducing new products into the market and a decreased capacity for supplying software that is integrated into LCDs, adversely affecting our results of operations.

 

Risks Relating to the Shares and the ADSs

 

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

 

Disclosures of our operating results (particularly if below the estimates of securities industry analysts), announcements of various events by us or by our competitors or other industry participants or the development and marketing of new products, as well as other factors, may cause the market price of our common stock to change significantly over short periods of time. The price of our common stock has been and is likely to continue to be highly volatile, and shareholders may not be able to recoup their investment. For example, the closing highs and lows of price per share of our common stock ranged from ¥2,115 to ¥3,110 during fiscal 2006.

 

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

 

As of May 31, 2006, there were 137,152,347 shares of our common stock outstanding including 35,006,949 shares, representing 25.52% of our outstanding shares, beneficially owned by Kagemasa Kozuki, our founder, Representative Director, Chairman of the Board, President and Chief Executive Officer, and his affiliate holders Yoko Kozuki, Kozuki Holding B.V., Kozuki Foundation for Sports and Higher Education, and Kozuki Capital Corporation. These shares and, generally, the shares owned by other shareholders, can be disposed of on the Tokyo Stock Exchange or otherwise in Japan without any legal restriction. Additionally, under our Articles of Incorporation, our board of directors is authorized to issue 306,444,214 additional shares of common stock generally without any shareholder approval. In addition, as of May 31, 2006, we held 6,403,439 shares of treasury stock which our board of directors may sell without any shareholder approval.

 

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

 

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

 

Pursuant to the Corporate Law of Japan relating to joint stock corporations and other related legislation, our Articles of Incorporation provide that 100 shares of common stock constitute one “unit”. The Corporate Law imposes significant restrictions and limitations on holdings of shares that do not constitute whole units. In general, holders of shares constituting less than one unit do not have the right to vote or to examine our books

 

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and records. The transferability of our shares of common stock constituting less than one unit is significantly limited. For a more complete description of the unit share system and its effect on the rights of holders of our shares, see Item 10.B “Unit Share System” below.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We are a limited liability, joint-stock corporation incorporated under the laws of Japan. Most of our directors, executive officers and corporate auditors reside in Japan. All or substantially all of our assets and the

 

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assets of these persons are located in Japan and elsewhere outside the United States. It may not be possible, therefore, for U.S. investors to effect service of process within the United States upon us or these persons or to enforce against us or these persons judgments obtained in U.S. courts predicated upon the civil liability provisions of the federal securities laws of the United States. There is doubt as to the enforceability in Japan, in original actions or in actions for enforcement of judgment of U.S. courts, of liabilities predicated solely upon the federal securities laws of the United States.

 

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

 

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

 

Item 4.   Information on the Company.

 

A.    History and Development of the Company.

 

Our business was founded by our current Representative Director, Chairman of the Board and Chief Executive Officer, Kagemasa Kozuki, in Osaka on March 21, 1969. Konami was incorporated as a joint stock corporation under the laws of Japan on March 19, 1973 under the name Konami Industries Co., Ltd.

 

We originally were established to produce amusement arcade games and since that time have expanded the range of our products. We began to produce and market microcomputer-equipped video game machines in 1978, video game software for personal computers in 1982, game software for a home video game system in 1985 and software for LCDs for pachinko machines in 1992. We began our Toy & Hobby business in 1996. We obtained a license to manufacture and sell gaming machines in Nevada, and entered the gaming business in the United States in 2000. We entered the fitness club and equipment business through our acquisition of PEOPLE CO., LTD., which was renamed Konami Sports Corporation, in February 2001.

 

We initiated overseas operations by exporting amusement arcade games in 1979. We established our U.S. sales and manufacturing subsidiary, Konami of America, Inc. (the predecessor of Konami Digital Entertainment, Inc.) in 1982. Later, we established sales and manufacturing subsidiaries in a number of foreign countries.

 

We listed our shares on the Osaka Securities Exchange in 1984 (subsequently delisted in December 2002), on the Tokyo Stock Exchange in 1988, on the Singapore Exchange in 1997, on the London Stock Exchange in 1999 and on the New York Stock Exchange in September 2002.

 

In 1991, we changed our name to Konami Co., Ltd. and subsequently changed our name to KONAMI CORPORATION in 2000. In August 2002, we moved our principal head office to 4-1, Marunouchi 2-chome, Chiyoda-ku, Tokyo 100-6330, Japan. Our telephone number is 81-3-5220-0573.

 

In 2006, we made Konami Sports Corporation (the predecessor of Konami Sports & Life Co., Ltd.) a wholly-owned subsidiary by issuing Konami shares to the minority shareholders of Konami Sports after Konami Sports Corporation merged with Konami Sports Life Corporation. In addition, we newly established Konami Digital Entertainment Co., Ltd. through a company separation to succeed to our digital entertainment business and we changed our group structure so that we act as a holding company.

 

For a discussion of recent and current capital expenditures, please see “Capital Expenditures” at the end of Item 5.A. We have had no recent significant divestitures nor are any significant divestitures currently being made.

 

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B.    Business Overview.

 

Overview

 

We develop, publish, market and distribute video game software products globally for Sony PlayStation and PlayStation 2, Nintendo GameCube, Microsoft Xbox, Microsoft Xbox 360 console systems, Sony PlayStation Portable, Nintendo Game Boy Advance and Nintendo DS handheld systems as well as for use on personal computers. In addition, we plan, produce, operate and distribute entertainment content for mobile phone online games.

 

We also produce card games, character goods, toys & hobbies, publications, CDs and DVDs and other merchandize products, many of which use popular characters seen in movies, television, comic books, video games, advertising or other media. We also publish, produce and provide post-sale service for software and hardware for amusement arcade games. In addition, we produce software for LCDs used in pachinko machines, and produce video games and token-operated games installed in amusement arcades and other entertainment venues in Japan as well as gaming machines for casinos in the United States, Australia and other overseas jurisdictions.

 

In addition, we believe that we are the leading operator of health and fitness clubs in Japan, in terms of revenues, members and the total number of facilities. As of March 31, 2006, our nationwide network of 209 directly operated health and fitness club facilities and 67 sports facilities whose operations are outsourced to us, cater to all age groups, from children through senior citizens. Moreover, Konami Sports Corporation merged with Konami Sports Life Corporation to establish Konami Sports & Life Co., Ltd. as of February 28, 2006 with the aim of creating new markets and providing various health-related services through the operation of fitness club facilities and the development and manufacturing of heath-related equipment and supplements.

 

Because our sales are affected by changes in how consumers, particularly children and young adults, spend their leisure time, we seek to meet consumers’ needs and preferences by developing products that can be used in a number of environments, including home video games, card games and games for amusement arcades, casinos and pachinko parlors. We also recognize that borders that separate product categories such as games, movies, music, toys, books and television programs are blurring. We seek to capitalize on this trend by projecting successful concepts across different types of leisure environments and product categories.

 

Many of our successful products have resulted from diversified use of strong contents. For example:

 

    We first sold Dance Dance Revolution one of our popular products in November 1998 as an amusement arcade game. We launched Dance Dance Revolution in the form of home video game software in April 1999 and have sold over one million units. We also extended this product’s range of targeted customers through the new “work-out” version for home use which is targeted mainly at women.

 

    We launched beatmania as an amusement arcade game in December 1997. We began selling beatmania in the form of home video game software in October 1998 and have sold over one million units.

 

    We sold Yu-Gi-Oh! as video game software for Game Boy in July 1998; we subsequently introduced our hit Yu-Gi-Oh! Trading Card Game in February 1999. From April 2006, we created Yu-Gi-Oh! ONLINE, an online version of the Yu-Gi-Oh! Trading Card Game.

 

    METAL GEAR SOLID, initially sold in 1998, and Tokimeki Memorial, a teenage romance game first introduced in 1994, have been hit video game software products and have also generated substantial sales of related character goods.

 

    We began selling the Winning Eleven series, a soccer game, in the form of home video game software in Japan in July 1995, and later expanded its compatibility to several home video game platforms. We have also introduced the series in overseas markets, particularly Europe and North America. In addition, we sell books, a music CD with a theme song, amusement game software and mobile contents related to the Winning Eleven series.

 

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    We have used our expertise in video game software and hardware for the development of our gaming machine and fitness equipment products.

 

We have built a company with a portfolio of products and services that spans a range of categories and target markets. We have created, licensed and acquired a group of recognizable brands that we market to a growing variety of consumer demographics.

 

For the fiscal year ended March 31, 2006, we had consolidated net revenues and net income of ¥262,137 million and ¥23,008 million, respectively, compared with net revenues and net income of ¥260,691 million and ¥10,486 million, respectively, for the fiscal year ended March 31, 2005.

 

Products and Services

 

We reclassified our businesses into three segments: Digital Entertainment, Health & Fitness and Gaming & System, during the fiscal year ended March 31, 2006, each of which is operated on a separate basis. The net revenue figures for each business segment described below are before elimination of intersegment revenues.

 

Digital Entertainment Segment

 

Operating in a business environment with lowering barriers to entry in the digital entertainment industry, we decided to reposition our existing three major business segments—video game software, toy & hobby and amusement, into one Digital Entertainment Segment from April 2005 to create a business structure where we can achieve maximum synergies. During fiscal 2006, this segment had net revenues of ¥165,276 million, which accounted for 63.0% of our consolidated net revenues, before elimination of intersegment revenues. Our Digital Entertainment Segment consists of the five businesses as follows:

 

    Computer & Video Games business:    We produce, manufacture and sell video game software, purchase and distribute video game software for home use.

 

    Toy & Hobby business:    We plan, produce, manufacture and sell card games, electronic toys, boys’ toy products, toys that come with a confectionary, figures and character goods.

 

    Amusement business:    We produce, manufacture and sell video games for amusement facilities and content for token-operated games.

 

    Online business:    We build computer systems related to online gaming, maintain and operate online servers , produce and distribute content for mobile phones, and produce online games.

 

    Multimedia business:    We plan, produce and sell music and video package products, books and magazines.

 

Health & Fitness Segment

 

We are the leading health and fitness club operator in Japan. We believe that we had approximately 21% of the market as measured by revenues based on the Leisure White Paper issued by Institute for Free Time Design and data made publicly available by Nihon Keizai Shimbun, Inc. for fiscal 2005. During fiscal 2006, this segment had net revenues of ¥81,209 million, which accounted for 31% of our consolidated net revenues, before elimination of intersegment revenues.

 

Gaming & System Segment

 

This segment is involved in developing content and hardware for gaming machines for casinos outside of Japan. During fiscal 2006, our net revenues from this segment were ¥10,623 million, which accounted for 4.1% of our consolidated net revenues, before elimination of intersegment revenues.

 

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In addition, as part of our shift to a holding company structure, we transferred our research and development center for gaming machines to Konami Gaming, Inc., our U.S. subsidiary in March 2006, to become Konami Gaming’s Japanese branch and research and development hub.

 

We also changed the segment name from Gaming to Gaming & System during fiscal 2006.

 

The following table presents net revenues in each of our historical business segments, before elimination of intersegment revenues, for each of the three years ended March 31, 2006.

 

Segment Revenues

 

     Year ended March 31,

     2004

   2005

   2006

   2006

     (yen in millions, dollar in thousands)

Net Revenues:

                           

Digital Entertainment

   ¥ 176,444    ¥ 163,671    ¥ 165,276    $ 1,406,963

Health & Fitness

     78,899      79,106      81,209      691,317

Gaming & System

     10,947      11,643      10,623      90,432

Other, Corporate and Eliminations

     7,122      6,271      5,029      42,811
    

  

  

  

Consolidated net revenues

   ¥ 273,412    ¥ 260,691    ¥ 262,137    $ 2,231,523
    

  

  

  


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 Konami.

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

 

Digital Entertainment Segment

 

Consolidated net revenues generated by our Digital Entertainment Segment, before elimination of intersegment revenues, amounted to ¥163,671 million in fiscal 2005 and to ¥165,276 million in fiscal 2006, an increase of ¥1,605 million.

 

Computer & Video Games business

 

Industry Overview

 

The video game industry is comprised of video game hardware manufacturers and video game software publishers. Game hardware systems, frequently referred to as platforms, include home game consoles, handheld platforms and personal computers. In Japan, mobile phones are yet another platform for which there is an emerging demand for video game software applications.

 

A new generation of more technologically advanced game consoles has been introduced every several years. The first platform was Nintendo Entertainment System introduced by Nintendo in 1983 with its central processing unit, or CPU, using 8-bit 1.78 MHz technology. The CPU is a chip on which the software operates, with a “bite” indicating capacity to process data and clock frequency (MHz) indicating the processing speed. Subsequent advances in technology have resulted in continuous increases in the processing power of the chips that power both the consoles and PCs. With the advancement of hardware technology, software has also advanced, with faster and more complex images, more lifelike animation and sound effects and more intricate scenarios.

 

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Each new generation, or cycle, of hardware has resulted in larger numbers of consoles being purchased, referred to in the industry as a larger “installed base”. At the beginning of each cycle, during the period of rapid growth in the installed base of the new generation of consoles, the video game software industry has experienced rapid periods of expansion, as buyers purchase video games for their new consoles. Shortly before and after the release of a new generation of game consoles, sales of the current generation of platforms and games generally diminish, as consumers defer purchases in anticipation of the new platforms and games.

 

Platform manufacturers license publishers to publish games for their platforms and retain a degree of control over the quality and manufacturing of these games. The publishers, subject to the approval of the platform manufacturers, determine the types of games they will create. Software publishers either create their games in-house, through their own development teams, or outsource this function to independent developers.

 

The following table illustrates the evolution of the principal platforms of both video game system and handheld system.

 

Manufacturer


   Platform Name

   Year of
Introduction


   Media Format

   Technology

      Japan

   U.S.

     

Home Game Consoles:

                        

Nintendo

   NES    1983    1985    Cartridge    8-bit

Sega

   Genesis    1988    1989    Cartridge    16-bit

Nintendo

   SNES    1990    1991    Cartridge    16-bit

Sega

   Saturn    1994    1995    CD-ROM Disc    32-bit

Sony

   PlayStation    1994    1995    CD-ROM Disc    32-bit

Nintendo

   Nintendo 64    1996    1996    Cartridge    64-bit

Sega

   Dreamcast    1999    1999    Proprietary Disc    128-bit

Sony

   PlayStation 2    2000    2000    DVD-ROM Disc/
CD-ROM Disc
   128-bit

Nintendo

   GameCube    2001    2001    Proprietary Disc    128-bit

Microsoft

   Xbox    2002    2001    DVD-ROM Disc/
CD-ROM Disc
   128-bit

Microsoft

   Xbox360    2005    2005    DVD-ROM Disc/
CD-ROM Disc
   128-bit

Handheld systems:

                        

Nintendo

   Game Boy    1989    1989    Cartridge    8-bit

Nintendo

   Game Boy Color    1998    1998    Cartridge    8-bit

Nintendo

   Game Boy Advance    2001    2001    Cartridge    32-bit

Nintendo

   Game Boy Advance
SP
   2003    2003    Cartridge    32-bit

Nintendo

   Nintendo DS    2004    2004    Cartridge    ARM9/ARM7

Sony

   PSP    2004    2005    UMD    1~333MHz

(1)   Game Boy Advance SP is an updated version of the Game Boy Advance platform and the same software may be used on both devices.

 

The increase in home game consoles among consumers has tapered off in the last couple of years as users await the transition to next-generation game consoles. On the other hand, handheld systems are already experiencing a transition to new model gaming devices such as Nintendo DS and Sony PSP, and in Japan in particular, there is a trend towards new gaming devices, evidenced by strong sales of Nintendo DS. The popularity of Nintendo DS is attributable in part to its tapping a market of new users who were not yet familiar with such games. We believe its success is a positive sign for the future of the Japanese video game software market.

 

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Starting with Microsoft Xbox 360 released in December 2005 in Japan and November 2005 in North America and the expected launch of next-generation console such as Sony PLAYSTATION3 and Nintendo Wii toward the end of calendar 2006 and the first half of calendar 2007, game consoles have become more highly sophisticated in their ability to show expressiveness when playing games. Moreover, because this competition among platforms also involves competition among new large-capacity media, we believe the game consoles will attract a great deal of interest even from those who usually do not purchase video game software.

 

World Video Game Software Markets

 

According to data by the Computer Entertainment Supplier’s Association, or CESA, the number of shipment of video game software was 64,825 units in Japan, 208,200 units in North America and 99,360 units in Europe in 2004. The North American market, the largest market for video game software in the world, and European markets have been growing steadily, while the Japanese market has been flattening.

 

Our Computer & Video Games Software Business

 

Our Computer & Video Games business develops, publishes, distributes and markets software for video game systems and, to a lesser extent, personal computers. Most of our software consists of video games designed for use with video game platforms, including Sony PlayStation and PlayStation 2, PSP, Nintendo GameCube, Nintendo DS, Game Boy and Game Boy Advance, Microsoft Xbox and Xbox 360, and PCs.

 

By developing video game software for each of the leading home and handheld video game platforms, we are able to limit our dependence on individual platforms, capitalize on the popularity of successful platforms from time to time and sell to a more diverse group of consumers since the target age group for each major platform differs. For example, the primary target consumers for Nintendo Game Boy, Color Game Boy, Game Boy Advance and GameCube are elementary school students. Sony PlayStation and PlayStation 2, and Microsoft Xbox and Xbox 360 cover a wider range of user age groups, including customers in their thirties.

 

The market for video game software is substantially affected by sales of the various video game platforms. For example, during fiscal 2002 the launches of the Nintendo GameCube and Microsoft’s Xbox were a significant development in this market, and we and our competitors devoted resources to developing software for these platforms. Our sales of video game software are inevitably affected to a substantial degree by the cyclical nature of the industry generally as platforms change, but through diversification we seek to limit this effect.

 

Software Titles

 

We publish approximately more than 100 new titles of video game software each year, almost all of which are designed for use with leading platforms. We publish software titles in a variety of genres, including sports, action, role playing and music simulation.

 

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The following two tables indicate the major software titles that we have either published, or anticipate publishing, during fiscal years 2006 and 2007 in each geographic market indicating for each title (i) the category of the game, (ii) the platform on which the game can be played, (iii) the date of release or anticipated release, and (iv) the market in which the product is sold. We cannot assure you that each of the titles anticipated for release in fiscal 2007 will be released when scheduled, if ever.

 

Titles Released In Fiscal 2006

 

Title


  

Genre


  

Platform


   Release Date

   Market

PROYAKYU SPIRITS 2

  

Sports (Baseball)

  

PlayStation 2

   April 2005    Japan

YU-GI-OH! ONLINE

  

Card Battle

  

PC

   April 2005    Japan

JIKKYO PAWAFURU PUROYAKYU 12

  

Sports (Baseball)

  

Nintendo GameCube

   July 2005    Japan

SHIN BOKURANO TAIYO -GYAKUSYU NO SABATA-

  

Action Adventure

  

Game Boy Advance

   July 2005    Japan

PAWAPOKE KOSHIEN

  

Sports (Baseball)

  

Nintendo DS

   August 2005    Japan

WORLD SOCCER Winning Eleven 9

  

Sports (Soccer)

  

PlayStation 2

   August 2005    Japan

METAL GEAR ACID 2

  

Action

  

PlayStation Portable

   December 2005    Japan

METAL GEAR SOLID 3 SUBSISTENCE

  

Action

  

PlayStation 2

   December 2005    Japan

Enthusia

  

Racing

  

PlayStation 2

   May 2005    North America

CODED ARMS

  

Shooting

  

PlayStation Portable

   July 2005    North America

Yu-Gi-Oh! Nightmare Troubadour

  

Card Battle

  

Nintendo DS

   August 2005    North America

Dance Dance Revolution EXTREME2

  

Music Game

  

PlayStation 2

   August 2005    North America

Castlevania Dawn of Sorrow

  

Action

  

Nintendo DS

   October 2005    North America

METAL GEAR ACID 2

  

Action

  

PlayStation Portable

   March 2006    North America

METAL GEAR SOLID 3 SUBSISTENCE

  

Action

  

PlayStation 2

   March 2006    North America

ENTHUSIA

  

Racing

  

PlayStation 2

   May 2005    Europe

bokutai 2 Solar Boy Django

  

Action Adventure

  

Game Boy Advance

   June 2005    Europe

METAL GEAR ACID

  

Action

  

PlayStation Portable

   September 2005    Europe

CODED ARMS

  

Shooting

  

PlayStation Portable

   September 2005    Europe

Pro Evolution Soccer 5

  

Sports (Soccer)

  

PlayStation 2/PC/

Xbox/PSP

   Oct-Nov 2005    Europe

Yu-Gi-Oh! Nightmare Troubadour

  

Card Battle

  

Nintendo DS

   November 2005    Europe

 

Titles Released and Anticipated To Be Released In Fiscal 2007 (1)

 

Title


  

Category


  

Platform


  

Release Date


  

Market


WORLD SOCCER Winning Eleven 10

  

Sports (Soccer)

  

PlayStation 2

  

April 2006

  

Japan

PROYAKYU SPIRITS 3

  

Sports (Baseball)

   PlayStation 2/Xbox360   

April 2006

  

Japan

JIKKYOU PAWAFURU PUROYAKYU

  

Sports (Baseball)

  

PlayStation Portable

  

April 2006

  

Japan

beatmania IIDX 11 IIDX RED

  

Music Game

  

PlayStation 2

  

May 2006

  

Japan

 

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Title


  

Category


  

Platform


  

Release Date


  

Market


JIKKYOU PAWAFURU MAJOR LEAGUE

  

Sports (Baseball)

  

PlayStation 2/
Nintendo GameCube

  

May 2006

  

Japan

JIKKYOU PAWAFURU PUROYAKYU 13

  

Sports (Baseball)

  

PlayStation 2

  

July 2006

  

Japan

GuitarFreaks & DrumMania MASTERPIECE SILVER

  

Music Game

  

PlayStation 2

  

August 2006

  

Japan

Tokimeki Memorial Girl’s Side 2nd Kiss

  

romance game

Sports (Baseball)

  

PlayStation 2

Nintendo DS

  

August 2006

August 2006

  

Japan

Japan

Pop’n music 13 Carnival

  

Music Game

   PlayStation 2   

September 2006

  

Japan

Yu-Gi-Oh! Duel Monsters GX TAG FORCE

  

Card Battle

  

PlayStation Portable

  

September 2006

  

Japan

BOMBERMAN

  

Action

   PlayStation Portable   

Summer 2006

  

North America

BOMBERMAN Act:Zero

  

Action

   Xbox360   

Summer 2006

  

North America

Dance Dance Revolution SuperNOVA

  

Music Game

  

PlayStation 2

  

Fall 2006

  

North America

Dance Dance Revolution ULTRAMIX4

  

Music Game

  

Xbox

  

Fall 2006

  

North America

Dance Dance Revolution UNIVERCE

  

Music Game

  

Xbox360

  

Fall 2006

  

North America

GoPets: Vacation Island

  

Virtual Comic

   Nintendo DS   

Fall 2006

  

North America

ELEBITS

  

Action

   Wii   

Fall 2006

  

North America

Silent Hill Experience

  

Digital Comic

   PlayStation Portable   

April 2006

  

Europe

Rumble Roses XX

  

Wrestling

   Xbox360   

May 2006

  

Europe

Yu-Gi-Oh! GX Duel Academy

  

Card Battle

   Game Boy Advance   

July 2006

  

Europe

Pro Evolution Soccer 6

  

Sports (Soccer)

   PlayStation 2/
PlayStation Portable/
Xbox360/Nintendo DS/PC
  

Fall 2006

  

Europe

METAL GEAR SOLID 3 SUBSISTENCE

  

Action Adventure

  

PlayStation 2

  

Fall 2006

  

Europe

Suikoden V

  

RPG

   PlayStation 2   

Fall 2006

  

Europe


(1)   Excluding titles that are scheduled but have not yet been publicly announced to be released.

 

The primary home video game software products on which we rely as revenue sources have been our hit titles, which include the following:

 

    METAL GEAR SOLID. We have sold a total of over 18 million units of our METAL GEAR SOLID series, including over seven million units of METAL GEAR SOLID, the original action game that we introduced in 1999 and seven million units of the sequel, METAL GEAR SOLID 2 SONS OF LIBERTY. The most recent series launched during fiscal 2005, METAL GEAR SOLID 3 SNAKE EATER, sold more than 3.6 million units. Products derived from METAL GEAR SOLID, such as METAL GEAR ACID, have also been launched, increasing our total series sales to over 20 million units as of March 31, 2006.

 

    Soccer titles.    We have sold a total of over 28 million units of Winning Eleven series (also known as Pro Evolution Soccer series in Europe) in worldwide since the initial title was released during the year ended March 31, 1996.

 

 

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    Baseball titles.    We have sold a total of more than 14 million units of baseball titles in Japan since we began releasing titles in the original title was released during the year ended March 31, 1994.

 

The following table illustrates the number of units that we have sold by platform for the periods indicated on a consolidated basis. This table indicates where we have concentrated our development efforts as well as changes in the relative significance of individual platforms.

 

     Year ended March 31,

     2002

   2003

   2004

   2005

   2006

Platforms


   Units

   Units

   Units

   Units

   Units

     (sales units in thousands)

PlayStation

   2,920    4,100    1,350    300    90

PlayStation 2

   11,490    8,900    10,750    15,250    11,620

PSP

   —      —      —      330    3,090

Game Boy

   290    1,400    250    20    0

Game Boy Advance

   4,750    4,800    6,700    3,160    1,880

Nintendo GameCube

   150    800    1,450    630    360

Nintendo DS

   —      —      —      60    1,480

Xbox

   630    800    550    1,500    1,220

PC

   10    200    550    850    500

Other

   60    —      —      —      120
    
  
  
  
  

Total

   20,300    21,000    21,600    22,100    20,360
    
  
  
  
  

 

Software Development

 

We seek to develop video game software that is fun and exciting, and which provide sufficient challenges at various levels of proficiency to encourage repeated play. We also develop and release titles with comic, cartoon and movie contents and achieve synergy with media. We develop most of our own video game software.

 

Because the popularity of successful titles fades quickly, we are constantly working to develop new titles and sequels to existing titles. The life span for video game software titles depends on the type of title. Sports titles, which are updated frequently, may last indefinitely. Other titles usually have short life spans, generally six months to one year.

 

Most of our video game software development, including titles designed for overseas markets, is conducted by our group companies in Japan and the U.S. We subcontract part of the development to a subsidiary in China, Konami Software Shanghai, Inc. We expect that this subsidiary will be able to create and develop sophisticated video game software for both the Japanese market and the international market as it gradually acquires additional expertise and know-how.

 

We have conducted video game software development on a consolidated basis since the merger of our three game software production subsidiaries in April 2005.

 

In April 2006, we founded Konami Digital Entertainment Co., Ltd. through a transfer of our digital entertainment operations including our video game software business, in the form of corporate separation and, as a result, we shifted to a holding company structure. We presently provide substantial discretion to our subsidiaries to achieve timely decision-making processes while the parent company develops group strategies and distributes management resources among group companies.

 

Hiring and retaining talented creative staff is key to developing successful content. To do this, we have introduced equity-based incentives and remuneration packages for creative staffs and developers that reflect the financial results of their work. We believe that this compensation structure that rewards creators for the success of their games and our policy of providing creators substantial independence and flexibility, enables us to attract and retain game creators that are among the best in the industry.

 

Through our long experience in developing software, we have developed significant in-house expertise and many proprietary development tools—such as game engines, three-dimensional models and texture maps that can

 

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be used to control the diffuse color of a surface on a pixel-by-pixel basis—that streamline the development process, allowing members of our development teams to focus their efforts on the play and simulation aspects of the product under development. We believe our accumulated know-how and proprietary development tools enable our software designers to develop compelling, graphically sophisticated games quickly and efficiently, which may give us an advantage over competitors.

 

Manufacturing

 

Our video game softwares are manufactured upon acceptance by Sony, Nintendo and Microsoft as required by the applicable platform license. We believe that this is the most desirable arrangement for both parties because we avoid the costs associated with the construction and maintenance of manufacturing facilities while the hardware manufacturers collect per unit royalties for each game they manufacture. The manufacturing process begins with our placing a purchase order with a manufacturer. Hardware manufacturers or their authorized vendors typically ship the first order to us within two to six weeks and additional orders for the same title within three days to four weeks.

 

We maintain both the proprietary rights and risks associated with each game title. In addition, at the time our product unit orders are filled by the manufacturer, we become responsible for the costs of manufacturing and/or the applicable per unit royalty on such units, even if the units do not ultimately sell. We provide a standard defective product warranty on all of the products sold. We are responsible in most cases for resolving, at our expense, any applicable warranty or repair claim. To date, we have not experienced any material costs from warranty or repair claims.

 

Platform Licenses

 

Our video game software business is dependent on our license agreements with the manufacturers of hardware platforms. All of these licenses are non-exclusive with fixed terms although these contracts are usually extended for additional terms. Each license grants us the right to develop, publish and distribute titles for use on the manufacturer’s platforms. Manufacturers typically have the right to approve the titles to be released and embodied in products that are manufactured solely by the manufacturer or its authorized vendor.

 

The following table sets forth information with respect to our platform licenses. In some instances, we have more than one platform license for a particular platform.

 

Manufacturer


 

Platform


  Territory

  Initial Contract Date

  Expiration Date

Nintendo

 

Game Boy Color

  Japan   March 8, 1999   March 7, 2007

Nintendo

 

Game Boy Advance

  Japan   January 9, 2001   January 8, 2007

Nintendo

 

Game Boy Advance

  United States and Canada   July 6, 2001   July 5, 2007

Nintendo

 

Game Boy Advance

  Europe   April 1, 2001   December 7, 2007

Nintendo

 

GameCube

  Japan   November 1, 2001   October 31, 2007

Nintendo

 

GameCube

  United States and Canada   January 10, 2002   January 9, 2008

Nintendo

 

GameCube

  Europe   March 1, 2002   December 7, 2007

Nintendo

 

Nintendo DS

  Japan   October 1, 2004   September 30, 2006

Nintendo

 

Nintendo DS

  Europe   June 24, 2005   June 23, 2008

Sony

 

PlayStation

  Japan   April 8, 1994   April 7, 2007

Sony

 

PlayStation

  Europe   November 13, 1995   December 31, 2006

Sony

 

PlayStation 2

  Japan   April 1, 2003   March 31, 2007

Sony

 

PlayStation 2

  Asia   April 1, 2003   March 31, 2007

Sony

 

PlayStation 2

  United States and Canada   October 25, 2001   March 31, 2007

Sony

 

PSP

  Japan   November 19, 2004   March 31, 2007

Sony

 

PSP

  United States and Canada   February 11, 2005   March 31, 2007

Microsoft

 

Xbox

  Worldwide   November 15, 2001   November 15, 2007

Microsoft

 

Xbox360

  Worldwide   November 19, 2004   March 31, 2007

 

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Nintendo charges us an amount for each Game Boy Advance, Game Boy Color and Nintendo DS. This amount varies based, in part, on the memory capacity of the cartridges. Nintendo GameCube, Sony and Microsoft contracts include a charge for every disc manufactured. The amounts charged by the manufacturers include a royalty for the use of the manufacturer’s name, proprietary information and technology, and are subject to adjustment by the manufacturers at their discretion. The manufacturers have the right to review, evaluate and approve a demo-disc of each title and the title’s packaging.

 

Marketing, Sales and Distribution

 

We believe that we benefit from a strong positive perception in Japan of the Konami brand name. We are focusing on further enhancing the Konami brand name by aggressively advertising and promoting ourselves and our products and services. To continue to increase our brand name recognition, we advertise on television, the radio and through various magazines and newspapers.

 

In October 2005, we merged with Konami Marketing Japan, Inc., a wholly-owned subsidiary for our marketing, sales and distribution businesses. As a result, we believe we are able to operate our digital entertainment business in a more consistent manner, from planning and production to advertisement and sales, and operate more efficiently.

 

Our video game software products are sold in Japan primarily through our sales distribution network, which we coordinate, and offices throughout Japan. Each of these sales offices focuses its efforts on a specific area within Japan. We bear inventory risk until the product is sold to the retailer. However, once products are sold to a retailer, they cannot be returned unless they are defective. We believe that our distribution network is a major asset of our business.

 

As for overseas marketing, we sell our products through our subsidiaries, principally those in the United States, Germany and Hong Kong.

 

Toy & Hobby Business

 

Toy Industry Overview

 

Consumption Trends—Declining Child Population and Enlarging the Age Brackets of Consumers

 

The Japanese toy industry is being forced to restructure as a result of a declining child population, the growing number of alternative options for play, changes in distribution systems and the bankruptcy of major toy wholesalers. Furthermore, companies must develop toys with original ideas so children will play with toys to a more advanced age than at present.

 

Since the population of children (those aged 0-14 years old) has been steadily declining and since the number of live births has also tended to decline (owing to women getting married and bearing children later in life and to the increasing number of unmarried women), the child population is expected to continue to decline slightly in the future. According to the National Institute of Population and Social Security Research, the number of births in Japan has declined from 2.09 million in 1973 to 1.06 million in 2005. Consequently, the population of this age group has decreased from 27 million in the beginning of the 1980s to 17.7 million in the population census of 2005. The children’s population is expected to fall below 16 million in 2016.

 

The phenomenon of children abandoning toys at a younger age is due to the changing pattern of children’s lives. A large number of children go to music classes (piano classes, etc.), fitness clubs (swimming schools, etc.) and cram schools (educational institutions to help enter kindergartens, primary schools and junior and senior high schools) from infancy and thus they spend less of their leisure time playing with toys than previous generations did. Moreover, electronic toys such as PlayStation2 and Game Boy Advance now occupy an important position in the toy market. These toys are also used by younger people. The popularity of electronic games contributes much to the decreasing demand for general toys.

 

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Trends and Characteristics of Toy Demand

 

According to the market research conducted by the Japan Toy Association, total revenues of toys sold domestically, including home video game systems and video game software, have been stable at a level of around ¥700 billion in the past five years. In light of the long-term demographic trends, this industry is not expected to grow. Toy demand fluctuates sharply from season to season. Toys are in the greatest demand in Japan in December and January, and in the U.S. in November, particularly at the end and beginning of the year, and, to a lesser extent, in August and in March (in decreasing order). This trend is explained as these months correspond to the periods of children’s school holidays and it is customary in Japan to buy toys as Christmas and New Year presents in December and January.

 

According to a market survey conducted by the Japan Toy Association in, July, 2005 sales of girls’ toys, such as dress-up dolls, decreased while sales of hobby products such as plastic models, radio-controlled toys and model railroads indicated strong growth. As to card games, according to the Toy Industry White Papers, card games’ retail sales grew dramatically from ¥30 billion in fiscal 1996 to ¥120 billion in fiscal 2001. However, sales of card games in fiscal 2006 remained almost the same level as the previous fiscal two years at ¥60 billion ($511 million). We believe that this is due principally to slowed-down popularity of our Yu-Gi-Oh! Trading Card Game which have dominated the market.

 

Popular goods reflect contemporary social conditions. We believe that the changing market environment has led to certain goods being introduced and produced, as mentioned below.

 

    computers have been used in all aspects of social life, as electronic technology advances and, as a result, toys that were adapted from office automation equipment for children have attracted consumers;

 

    more and more parents have attached importance to education and they tend to buy expensive products for their children in the category of educational/preschool toys; and

 

    hobby items, such as radio controlled products and games, have sold well due to an increasing amount of leisure time caused by the spread of the five-day workweek.

 

The distribution of toys has greatly changed owing to the entry of the large U.S. chain toy store Toys”R”Us into the Japanese market and to the increased sales made by suburban toy chain stores. The sales share of specialty toy shops has decreased and wholesalers, which act as intermediaries for manufacturers and retailers, have been affected by the change of distribution routes and the shortened distribution channels, which have caused them difficulties. The system of fixed retail price sales, which is the traditional business practices in the toy market, has begun to collapse, and even department stores have sold toys at discount prices.

 

According to the research conducted by the NPD Group, the toy market in North America has a size of $2 billion in annual sales, accounting for approximately 37% of the world toy market. The toy market in North America is expected to expand gradually and to not be affected significantly by general economic conditions.

 

Costs for product development and marketing in European markets are generally higher than other markets due primarily to costs for translation in several languages and different distribution system in each country.

 

The average amount spent on each child has been increasing due to the declining birth rate in North America. Also, the age group of consumers of toy products has been lowered, reflecting the fact that children tend to abandon toys at a younger age due to the accelerating pace of children’s growth.

 

In North America, sales of licensed products accounted for 25% to 30% of total toy products sales and toys relating to Japanese cartoon contents have been especially popular.

 

Our Toy & Hobby Business

 

We produce, develop, design and sell a range of toys and brand-related goods, including card games, figures, toys with confectionery capsule toys, game prizes for amusement arcade games and other accessories.

 

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These original toys and brand-related goods are based on well-known characters, brands and images, or content, that we either produce on our own or license from third parties. Because of our strong reputation in the industry, we are able to acquire licenses to use popular characters and images such as those contained in Yu-Gi-Oh!. Most sports-related licenses, which give us the right to use team or organization logos and trademarks, are non-exclusive. In other cases, we typically obtain exclusive rights. Although each product is different, in most cases, we produce, develop and design the product around popular content and subcontract the manufacturing to a third party.

 

Our Toy & Hobby business is divided into two divisions: (i) card games; (ii) toys. More than 80% of our revenues from our Toy & Hobby business has been derived from worldwide sales of card games, and changes in the revenues and income of our Toy & Hobby business have depended primarily on changes in our worldwide sales of card games, principally our Yu-Gi-Oh! Trading Card Game. We believe we have the largest share of the worldwide card game market according to data available from the Japan Toy Association and the Toy Industry Association, Inc. In February 1999, we launched our Yu-Gi-Oh! Trading Card Game in Japan. Yu-Gi-Oh! is the story of a shy young boy who overcomes rivals with the help of an ancient deck of cards. The Yu-Gi-Oh! Trading Card Game is based on the comic by Kazuki Takahashi that was originally serialized in Shonen Jump, one of Japan’s most popular comic magazines. Yu-Gi-Oh! features frightening monsters and dark fantasy storylines, which have a strong appeal to preteens.

 

Yu-Gi-Oh! was launched as a television cartoon series in the United States in September 2001, and has been keeping high audience ratings on the Kids’ WB! Network. Reflecting the popularity of the Yu-Gi-Oh! television cartoon, we still kept solid sales of card games including the Yu-Gi-Oh! Trading Card Game in the United States. The Yu-Gi-Oh! Trading Card Game was launched in the United Kingdom in December 2002, in France in March 2003 and in other European countries in April 2003.

 

We are working to diversify the range of our toy products in order to reduce our dependency on card games. Our toy business mainly develops (i) boy’s toys that are licensed from television and comic cartoons or figures based on characters of our home game software and amusement games, etc.; (ii) educational toys with sounds for infants; (iii) toys with confectionery; (iv) capsule toys; and (v) bath and toiletry items.

 

In our main boy’s toy business, we have obtained an exclusive license to develop a major series of boy’s toy products based on GRANSAZERS, a science fiction action hero in a TV show produced by Toho and had been broadcasted by 26 TV stations including six stations affiliated with TV Tokyo for one year starting in October 2003. We have received favorable responses for our lineup of toys and merchandize carrying heroes and robots appearing on the show. Also, a new robot hero animation television program, Get Ride! AMDRIVER, started in April 2004 and we introduced a lineup of toy products using the characters from this television program. We introduced toys using characters appearing in the popular science fiction action hero series, such as THE JUSTIRISERS in October 2004 and SAZER X in October 2005, which followed GRANSAZERS and recorded solid sales.

 

Production

 

Our Toy & Hobby products are produced both overseas and in Japan by various third-party manufacturers. We are not dependent on any single manufacturer for the production of our toy & hobby products.

 

Marketing, Sales and Distribution

 

Marketing and sales in Japan are conducted through our sales network in the Konami group through which we sell directly to retailers such as Toys”R”Us. In July 2001, we opened the Konami Card Game Center in Tokyo as a customer service base for our card game business. Our retail partner, The Upper Deck Company, LLC., acts as our distributor in the U.S. and retains the inventory and return risks for the Yu-Gi-Oh! Trading Card Game there. In Europe, we conducted sales of Yu-Gi-Oh! Trading Card Game either directly or through our

 

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retail partners, including The Upper Deck Company, LLC until March 2004. We currently distribute our products through The Upper Deck Company, LLC’s European entity employing the scheme used in the U.S.

 

Amusement Business

 

Our Amusement business produces and sells video game machines and token-operated game machines for amusement arcades.

 

Amusement Arcade Games—Industry Overview

 

According to the most recent industry statistics, the domestic amusement arcade industry had total revenues of ¥829.8 billion during 2005. The breakdown by category is shown in the following table.

 

Amusement Arcades—Japanese Industry Revenues

 

Industry


   2001

   2002

   2003

   2004

   2005

     (billions of yen)

Amusement arcade operations

   ¥ 596.4    ¥ 590.3    ¥ 605.5    ¥ 637.7    ¥ 649.2

Amusement arcade games (domestic)

                                  

Video game machines

     28.3      24.5      22.7      35.0      39.6

Token-operated game machines

     24.3      22.3      27.1      37.4      37.0

Prize machines

     11.2      10.7      12.3      16.8      14.6

Vending machines

     13.1      18.0      18.8      18.5      19.5

Music simulation game machines

     6.6      4.9      3.4      3.4      3.3

*Card games

     —        —        —        —        5.5

Other

     36.6      39.7      50.2      52.9      48.2
    

  

  

  

  

Sub-total

     120.2      120.2      134.5      164.0      167.7

Amusement arcade games (exports)

     22.4      20.6      20.0      13.9      12.9
    

  

  

  

  

Total

   ¥ 739.0    ¥ 731.1    ¥ 760.0    ¥ 815.6    ¥ 829.8
    

  

  

  

  


     * Sales amounts related to the Card games Industry was very minor and was included in the Vending machine Industry for the previous years.

 

Source:   “Amusement Industry Survey, Fiscal 2006” (September, 2005), Japan Amusement Machinery Manufacturers Association, All Nippon Amusement Machine Operators’ Union and Nippon SC Amusement Park Association.

 

Due to the development of powerful home game consoles that can rival amusement arcade games in play quality and the introduction of advanced mobile telephones equipped with Internet and game functions, consumers now have competitive leisure alternatives. However, revenues from the operation of amusement arcades increased to ¥605.5 billion in 2003, ¥637.7 billion in 2004 and, for the third consecutive year, to ¥649.2 billion in 2005, due primarily to progress in the restructuring of the amusement industry, including the closing of unprofitable small sized amusement arcades and the efficient development of large-scale amusement arcades that attract customers, and increased sales at department stores that target families.

 

Our Amusement Business—Video Game Machines

 

Our Amusement business develops, produces and sells video game machines for amusement arcades, many of which use sophisticated computer graphics technology. In fiscal year 2005, we introduced approximately 12 new titles for video game machines for amusement arcades, half of which were sequel titles. Such titles typically have life spans of six to 18 months, although popular titles may have a longer life and are sometimes developed into a series of titles, which together constitute a recognized brand such as Dance Dance Revolution.

 

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The main purchasers of our video game machines are amusement arcades. We have sought to respond to market trends by introducing low price products and products that involve the type of play that cannot be replicated easily by home video game systems. In this regard, our music simulation games have been successful. These games evolved from beatmania, a disc jockey simulation game developed in our Amusement business. Hit music simulation games have included Dance Dance Revolution, beatmania, pop’n music, GuitarFreaks & DrumMania. These music-simulation game machines are relatively expensive, but can accommodate relatively inexpensive software updates for sequel games. Because the price of new software generally is substantially less expensive as compared to the price of a new amusement arcade machine, software upgrades tend to be more attractive to our customers.

 

In March 2003, our Amusement business introduced the “e-AMUSEMENT” service that connects amusement arcades all over Japan through a computer network run by Konami, creating a new amusement arcade market. This service allows multiple players to participate in the same game from different locations simultaneously. Our MAH-JONG FIGHT CLUB, which is our first “e-AMUSEMENT” title, is retaining its popularity in part due to events such as national conventions where players can try their skills in a tournament.

 

Our “e-AMUSEMENT” titles include:

 

    MAH-JONG FIGHT CLUB, a Mah-jong game that allows multiple players to participate simultaneously from different locations;

 

    QUIZ MAGIC ACADEMY, an online quiz game participated by many players from all over the country;

 

    DrumMania, a drum simulation game that corresponds to “e-AMUSEMENT”; and

 

    BASEBALL HEROS, an online baseball game that allows multiple players to participate by using baseball player cards.

 

Video Game Machines—Production

 

Our video game machines for amusement arcades designed for both the Japanese and the overseas markets are developed in Kobe and Tokyo. We also produce our amusement arcade games designed for the Japanese market at our production facilities in Kobe. We export our developed software content to the United Kingdom and the United States, where we produce the amusement arcade video games for those markets. Local production and assembly allows us to reduce costs and to limit our exposure to exchange rate fluctuations.

 

Video Game Machines—Marketing, Sales and Distribution

 

Our video game machines for amusement arcades used to be marketed, sold and distributed by Konami Marketing Japan, Inc., a wholly owned subsidiary. However, in October 2005, we merged it into Konami Corporation assuming its marketing and sales operations and founded Konami Logistics & Services, Inc. to operate our distribution business. As a result, we believe we have become able to provide more efficient and timely services in our marketing, sales and distribution activities. In overseas markets, our foreign sales subsidiaries are responsible for marketing, sales and distribution of our video game machines for amusement arcades.

 

Amusement Business—Overview of Token-Operated Game Machines Business

 

Token-operated game machines in Japan

 

As indicated in the following table, as of fiscal 2005, sales of token-operated game machines amounted to ¥37.0 billion, comprising approximately 22.1% of the ¥167.7 billion Japanese amusement arcade game market. As indicated in the following table, revenues from amusement arcade operations had been declining, but showed an increase for three consecutive years after fiscal 2003. Revenues from the operation of token-operated game

 

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machines increased in every year from 2001 through 2005. We believe that the sale of medium- and large-sized token-operated game machines, which provide the type of entertainment that cannot be replicated on home video game systems, is largely responsible for this trend.

 

Token-Operated Game Machines—Japanese Industry Revenues

 

     2001

    2002

    2003

    2004

    2005

 
     (billions of yen except for percentages)  

Revenues from the sale of token-operated game machines

   ¥ 24.3     ¥ 22.3     ¥ 27.1     ¥ 37.4     ¥ 37.0  

Revenues from amusement arcade operations

     596.4       590.3       605.5       637.7       649.2  

Revenues from token-operated game machines

     129.5       137.4       152.6       163.1       176.2  

Token-operated game machine revenues as a percentage of amusement arcade revenues

     21.7 %     23.3 %     25.2 %     25.6 %     27.1 %

Source:   “Amusement Industry Survey, Fiscal 2005” (September 2005), Japan Amusement Machinery Manufacturers Association, All Nippon Amusement Machine Operators’ Union and Nippon SC Amusement Park Association.

 

Our Amusement Business—Overview of Token-Operated Game Machines Business

 

We develop, produce and sell token-operated game machines that we sell primarily to amusement arcade operators in Japan.

 

All token-operated game machines that we sell in Japan are played by purchasing tokens that are inserted into the machine, the object being for the player to win more tokens to extend the playing time. Our most popular token-operated game machines, GI-HORSEPARK, GI-TURFWILD series and Fantastic Fever 2, accounted for a substantial majority of our net revenues of token-operated game machines in fiscal 2006. GI-HORSEPARK and GI-TURFWILD series are large-scale horse race games where users can bet tokens on horses in racing games as well as breed horses, and where nationwide tournaments can be enjoyed using “e-AMUSEMENT”. Fantasic Fever 2 features slot machine games such as Fantasic Chance, featuring sound and light combined with slot, where chance balls are collected and aimed at targets.

 

Medium- and large-sized game machines, which sell for as much as approximately ¥20 million and attract older children and adults, are supplied mainly to amusement arcades. In addition to GI-HORSEPARK, GI-TURFWILD series and Fantasic Fever 2, our principal machines include WingFantasia, a game featuring a “party”-like scene, where a token-operated game is combined with a Japanese backgammon function and a roulette wheel, and the FORTUNE ORB series, a slot machine game where a user can win prizes in a super jackpot. Such large-sized token operated game machines have a typical commercial life span of four to five years and we typically introduce a few new types of large-sized token-operated game machines each year. We also sell small-sized token-operated game machines.

 

Token Operated Game Machines—Production

 

Our domestic token-operated game machines are developed and produced at our production facilities in Zama, Kanagawa, Japan.

 

Token Operated Game Machines—Marketing, Sales and Distribution

 

Our token-operated game machines for amusement arcades are marketed, sold and distributed through our sales distribution network.

 

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Online Business

 

Online Business Overview

 

Growth of broadband, online games and mobile phones as a platform

 

Internet technology for high speed broadband enables customers to have a more enhanced and interactive online experience. Going forward, we expect the spread of broadband services and continued competition among broadband providers to lead to further growth in the market for online games. With the rapid spread of broadband infrastructure, many game console manufacturers and video game software publishers are entering the online game business. For example, Sony Computer Entertainment started a broadband online service for PlayStation 2 in the spring of 2002 through which users can play games online and download software as well as enjoy broadband contents such as movies and music at home. In August 2002, Sony Computer Entertainment America Inc. started selling online adaptors and software for PlayStation 2 in the U.S. In the fall of 2002, Nintendo started an online service for GameCube in Japan and the U.S., Microsoft started online service for Xbox in November 2002 in the U.S. and in Japan in January 2003. Some of our competitors have already started operating web sites where players can download a game and play it on the Internet. We expect that with the spread of broadband and faster services, investment into and interest in online games will expand significantly.

 

We also expect mobile phones to become a new platform for home video game software. In Japan, mobile phones are not just phones, but wireless Internet handsets loaded with digital cameras and multi-media processors. As of March 31, 2006, over 79 million mobile Internet subscribers in Japan downloaded share price information, reviewed news, sent out pictures and played games. Although usage rates for personal computers and the Internet is higher in the U.S. than in Japan, comparatively more people access the Internet via mobile phones in Japan and mobile phones are increasingly becoming a popular way to access the Internet.

 

Companies such as NTT DoCoMo, Inc. (DoCoMo) have developed a cutting-edge third-generation mobile phone technology enabling 24-hour access to the Internet at low cost from mobile phones for Japanese subscribers. One of the most popular services, i-mode, has been developed by DoCoMo and enables subscribers to view specified websites and to receive e-mails from mobile phones. In addition to accessing the Internet and e-mails, i-mode provides access to financial information (including share prices and net banking), travel information, news and entertainment information. Additional contents such as games are usually provided for an additional subscription of ¥100 to ¥300 per month. Other online mobile phone services, such as Vodafone Live! and Ezweb by au, provide similar functions. These third-generation services not only enable efficient access to e-mails, faster viewing for websites and e-commerce application, but also provide necessary speed and volume to support innovative multimedia applications such as more enhanced online games, downloading of music and video images.

 

Our Online Business

 

We develop, publish, distribute and sell software for home video game systems, personal computers, mobile phones and online networks. We plan to actively enter the mobile phone and online game software business in light of the recent growth of the online and mobile phone game markets, and we believe there may be new opportunities for profits with our software titles.

 

In October 2001, we established Konami Mobile Online, Inc. as our principal subsidiary developing games for mobile phones. In September 2003, we renamed it Konami Online, Inc., and added online game business to its existing businesses to manage online game infrastructures, Konami Online, Inc. later merged into Konami Corporation in April 2005. At the same time, we also merged our game software production subsidiaries into Konami Corporation to further enable us to focus on the online game business. We develop and distribute various contents for all domestic mobile network services, including i-mode, Vodafone Live! and Ezweb. In 2003, we started distribution of various game contents in North America, Europe and Asia. In Japan, we provide a download service for ringer melodies and wallpapers for mobile phones. Most of our games for mobile phones

 

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are mobile phone versions of our popular home video game software. Depending on the type of service, the subscription fee for users is ¥70 to ¥300 per month.

 

Multimedia Business

 

Our multimedia business

 

Our multimedia business includes the planning, production and sales of music, videos, books and magazines, and operates in the publishing, music and video industries. The distribution of publications between publishing companies and bookstores goes through distributors, or publishing brokers, who are engaged in the collection, delivery and return of goods.

 

We distribute our publications both through publishing brokers as well as, with respect to our music and video products, through contractual arrangements with market leaders, utilizing their distribution channels. We also enter into contracts to extend our license agreements with the Japanese publisher on a yearly basis, as appropriate.

 

We plan, produce and sell CDs and DVDs of music, videos, books that are containing clues and strategies for playing popular games, and magazines derived from our contents such as game software. In some cases, owners of popular content such as comic book publishers or animation companies approach us and ask us to use their content in our products. In other cases, we approach the owners of content that we believe has potential customer appeal in order to obtain the rights to use and develop that content into products.

 

In April 2005, in our efforts to create a new content, we started broadcasting our original cartoon “GOKUJO SEITOKAI” on television and released related products such as a DVD and a music CD. We plan to actively introduce more multi-faceted private label products, such as animations, books and music CDs, to further enhance our brand name.

 

Health & Fitness Segment

 

Our Health & Fitness segment is comprised of the operation of fitness clubs and the design, manufacture and sales of fitness machines and fitness-related products. Consolidated net revenues generated by our Health & Fitness segment, before elimination of intersegment revenues, amounted to ¥79,106 million in fiscal 2005 and to ¥81,209 million in fiscal 2006, an increase of ¥2,103 million.

 

Fitness club business

 

Industry Overview

 

According to “Club Business Trends in Japan, 2004” a report available at Fitness Online, private fitness club revenues in Japan have leveled off at a compound annual rate of increase of approximately 1.0% over a five year period, from ¥364.8 billion in 2000 to ¥379.6 billion in 2004. On the other hand, over the same period, the number of private fitness clubs has grown at a compound annual rate of approximately 2.2% from 1,788 in 2000 to 1,951 in 2004. However, fitness club membership has increased over the same period at a compound annual rate of 0.3%, from 3.74 million in 2000 to 3.78 million in 2004, which implies that the number of fitness clubs increased at a higher level than the number of fitness club membership and thus average revenue per member increased only at a low compound annual rate of 0.25%. We believe that fitness clubs, on average, are experiencing excess capacity together with discounted membership fees. Surviving in the current fitness club market is relatively difficult, and only those who do experience the level of membership and revenue to realize the benefits of the inherent operating leverage in the industry will survive.

 

We believe that the expected growth in fitness club memberships will be attributable to several factors. Japanese are becoming increasingly focused on achieving healthier, more active and less stressful lives. Of the

 

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factors that members consider very important in their decision to join a fitness club, the most commonly mentioned are shaping up, appearance related factors including muscle tone and looking better, relief of stress, weight control and general health maintenance. Other factors that are taken into account when selecting fitness clubs include the distance from home, quality of facilities and price. We believe that interest in fitness clubs has heightened due to the efforts of club owners to renew facilities, reduce membership fees, offer more diverse membership options, extend club hours, increase group exercise programs such as aerobics and jazzercise, and enhance marketing and sales activities. We also believe that fitness clubs provide a more convenient venue for exercise than outdoor activities, particularly in densely populated metropolitan areas.

 

According to published industry sources, the major trends that are driving changes in the health and fitness industry include:

 

    the aging of the Japanese population is creating an awareness of and a need for healthy living and physical fitness;

 

    capital investment by large operators who are renewing or expanding facilities is generating greater consumer demand;

 

    greater availability of membership program options, such as weekend or after-hours memberships, are attracting greater numbers of members;

 

    an increase in non-dues revenue from the sale of beverages and other products is providing revenue diversification for club operators; and

 

    large operators are acquiring small- and medium-sized fitness clubs in an effort to build national platforms.

 

We believe that we had approximately 21% of the Japanese fitness club market, as measured by revenues, for the year ended March 31, 2005 based on the Leisure White Paper issued by Institute for Free Time Design and data made publicly available by Nihon Keizai Shimbun, Inc. We have several other competitors in an otherwise fragmented market but, as noted above, the industry is undergoing consolidation which may result in the creation of additional significant competitors.

 

Our Fitness club Business

 

Through our acquisition of a majority of the outstanding common stock of PEOPLE CO., LTD. in February 2001, which we renamed Konami Sports Corporation, we have become the leading operator of health and fitness clubs in Japan in terms of revenues, members and total number of facilities. Since our acquisition of PEOPLE CO., LTD., we have grown our fitness club business through acquisitions of other fitness clubs. We increased our presence in this market even further through the acquisition in February 2002 of a majority of the shares of the Daiei Olympic Sports Club, Inc., one of the major fitness club operators in Japan in terms of revenues, which was subsequently taken over by Konami Sports Corporation in October 2002. These acquisitions were part of our strategy to diversify our revenues and decrease our reliance on the video game industry. Fitness club revenues tend to be more stable than other segments in revenues, which can fluctuate widely depending on the release of hit products. Fitness clubs also tend to have a more diverse consumer base across both gender and age. Finally, we expect that our fitness clubs will provide demand for our fitness machine business.

 

The environment surrounding the fitness club business has changed significantly due to the rapid aging of Japanese population. This change has included a shift in fitness needs toward senior members of the society.

 

In the current year, in response to this change in the operating environment, we renewed the management of our fitness club business in an attempt to fundamentally change our fitness club business model and business plan.

 

In prior years, our operating strategy was based on the concept of being the largest nation-wide fitness club, with our focus on increased geographic area coverage and market share. Thus, we continuously increased the

 

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number of clubs by opening new clubs, and clubs were viewed to a certain extent as groups of facilities in the same or neighboring areas as opposed to individually operated clubs. Therefore, improving the performance of unprofitable clubs was considered within a long time frame and in conjunction with the performance of neighboring clubs.

 

Under our current management policy, however, the strategic focus is on the profitability of individual clubs. Our business plan was revised to reflect the particular situation at the individual club level, to critically assess and determine the need for the closing of unprofitable clubs in a much shorter time frame than before.

 

As of March 31, 2006, we directly owned and operated a nationwide network of 209 fitness clubs and operated an additional 67 sports facilities outsourced to us. These clubs collectively served approximately 960,000 members as of March 31, 2006. We offer a wide variety of health and fitness related services, including traditional membership-based clubs with swimming, gymnastics and tennis school programs, aerobics programs, combat-type exercise programs and health and advisory services to people of all ages. In addition to our facility-based operations, we also provide health and fitness advisory services to corporations and to public sector entities. Our non-facility business includes franchising of fitness clubs and the licensing of specific products and programs, such as diet programs. We are also engaged in other activities incidental to our core Health & Fitness segment, including travel agency operations and publishing a magazine for club members.

 

We principally sell month-to-month membership payment plans that are generally cancelable by members at the end of any month provided that they give advance notice by the tenth day of that month. We believe that members generally prefer this non-commit membership plan over long term commitments. The non-commit membership plan also provides us with an incentive to deliver high quality programs and services in order to retain members.

 

We have experienced significant growth through a combination of (i) acquiring existing single and multi-club businesses, and (ii) developing and opening new club locations. We believe that there are further opportunities to grow our business profitably. While Japan’s population is growing very slowly, is aging rapidly, and is projected to begin contracting in the future, the percentage of the population that are members of fitness clubs is significantly lower in Japan than it is in the United States. First, we plan to carefully continue opening of new fitness club facilities focusing on their profitability in a short to medium term, while critically assessing the profitability of existing facilities. Second, we believe that we can increase our market penetration by adding services and facilities that will attract new members from all age groups. We plan to differentiate us from our competitors by introducing fitness machines that include an entertainment element and by expanding our business into value-added services that can meet the evolving needs of consumers such as cafeterias, acupressure and other body-work clinics, and by adding other entertainment-oriented facilities, such as bicycle or running equipment with video game features, in our clubs that will help to differentiate us from our competitors. In September 2005, we set up a booth at the 32nd International Home Care & Rehabilitation Exhibition H.C.R 2005 to introduce our original equipment, programs and services developed in response to an ageing society.

 

Club Formats and Location

 

Our clubs generally have relatively high “retail” visibility, and close proximity to subway, train and bus stations in urban areas and commuter suburbs in accordance with our operating strategy of offering our target members the convenience of multiple locations close to where they live and work, reciprocal use privileges and standardized facilities and services.

 

In addition, we are making efforts to provide safe, clean and comfortable facilities from the viewpoint of our customers. We plan to further improve the safeness of our facilities and provide quality services to our customers, through introducing Automated External Defibrillators or AEDs in all of Konami Fitness club facilities as well as renovating older buildings. We aim to respond to various customer needs by providing a broad range of services that meet all age groups and to operate fitness club facilities that can contribute to the enhancement of the health of our community members.

 

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We operate the following three types of service businesses at various locations in Japan.

 

    Operation of our fitness clubs. In an effort to expand the network of our fitness club facilities, we opened nine new club facilities, including those relocated and reconstructed in fiscal 2006, such as in Nishinomiya in Hyogo, Myoden in Chiba, Fukuoka-Kashii in Fukuoka, Suzuka in Mie and Asahikawa in Hokkaido. As a result, we had a total of 209 fitness clubs as of March 31, 2006. In particular, we opened a facility in Nishinomiya in February 2006 that is one of the largest fitness club facilities in Japan, furnished with a 50-meter swimming pool, a training gym equipped with approximately 100 training machines, and advanced equipment using information technology and the expertise of our group, such as e-XAX, our health management system. We are also engaged in the consolidation, relocation and reconstruction of our facilities in places such as Nishikasai in Tokyo and Suzuka in Mie for the purposes of streamlining our facility locations to improve the profitability of individual facilities while providing safer and more comfortable clubs and services to our members. We provide three services at Konami Sports Club: Egzas, through which we provide various programs combining studio fitness programs, machine exercises and swimming exercises targeting a broad range of age groups; Undo-Jyuku for children up to high school students, with various fitness schools including swimming and gymnastics schools; and GRANCISE, furnished with top-level services and facilities for business people. Additionally, since 2002 we have expanded member services such as personal training, fitness counseling, acupuncture and massage, muscle toning training, diet programs, lifestyle diseases prevention programs, scuba diving classes and golf training, for additional fees. The income generated from operation of our fitness club facilities accounted for 86.3% of the total operating income of our Health & Fitness segment in fiscal 2006.

 

    Operation of sports facilities outsourced to us. We operate sports facilities of private companies and of local governments by contract upon obtaining the approval of relevant boards or councils. We actively utilize our expertise and experience in the health enhancement of community members. We operated 67 such facilities as at the end of March 2006, including 30 new facilities, such as public athletic facilities in Itabashi ward in Tokyo and Osaka, compared to 28 facilities as of March 31, 2005. We added 34 additional facilities in April, for a total of 101 facilities as of May 17, 2006. Our operating income generate from operation of facilities by contract accounted for 4.6% of total income of our Health & Fitness segment for the fiscal 2006. In addition to the outsourcing business, we have franchise contracts under which we receive a royalty or advertising fees from franchised fitness clubs for use of our brand names and to be licensed for our specific products and programs. In fiscal 2006, we reviewed our existing franchise contracts and determined that fewer franchise stores were desirable for our brands. As a result, a majority of the existing 28 franchise contracts was not renewed and we recognized impairment losses for intangible assets related to those franchise contracts terminated in 2006.

 

    Other. Our other businesses include, in particular, providing tours relating to sports and leisure mainly to adults, as well as extracurricular activities for children. For example, on December 11, 2005, we conducted a tour to the Honolulu Marathon held as a part of the Hawaii Project that we promote, as well as an experience-oriented camp called “NEICHILD CAMP” allowing children to get closer to nature. We also generated additional income through sales of products at our stores. Our operating income generate from other operation accounted for 9.1% of total income of our Health & Fitness segment for the fiscal 2006.

 

Marketing

 

Our marketing campaigns are directed by our in-house Publicity Unit of Facility Operation Department. This team conveys each of our nationally branded fitness clubs as the premier network of fitness clubs in that region. Advertisements are designed to highlight the consistent quality and high value-to-price ratio that we believe we provide through a combination of our membership programs, club facilities and personnel. Our goal is to achieve broad awareness of our brand names primarily through television, newspaper, and magazine and our web site.

 

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During the second half of the year ended March 31, 2004, we eliminated the initiation fees for individual memberships for our Egzas and Undo-Jyuku facilities to encourage enrollment.

 

We also engage in public relations and special events to promote our image in surrounding local communities. We believe that these public relations efforts enhance our image and the image of our brand names in the communities in which we operate.

 

Sales

 

Sales of new memberships are generally handled at the club level. In making a sales presentation, we emphasize: (i) the proximity of our clubs to concentrated commercial and residential areas convenient to where target members live and work; (ii) the advantages of a membership with a club that has an extensive nationwide network; (iii) the lack of a long-term obligation on the part of the enrollee; (iv) the price value relationship of a membership; and (v) access to value-added services.

 

We generally offer five principal types of memberships: (i) GRANCISE Regular Membership, which entitles members to use all facilities of GRANCISE and Egzas for no charge; (ii) GRANCISE Branch Membership, which enables members to use one GRANCISE facility and all Egzas facilities for no charge; (iii) Egzas Special Membership, which allows members to use all Egzas facilities nationwide for no charge; (iv) Egzas Regular Membership, which entitles members to use one Egzas facility for no charge and all other Egzas facilities nationwide on a per-use charge; and (v) Egzas Branch Membership, which enables members to use one Egzas facility during certain hours on weekdays or any time during the operation hours of Saturdays, Sundays and holidays. We introduced this new membership system on September 1, 2003, and we allowed existing members to choose whether to continue with the previous membership system or to switch to the new membership system.

 

In joining a club, a new member signs a membership agreement which obligates the member to pay monthly dues on an ongoing basis. We collect most of all monthly membership dues through automatic payments based on credit card or bank account debit authorization contained in the membership agreement. Most membership dues are paid one month in advance. Members can generally cancel their membership at the end of any month provided that they give advance notice by the tenth day of that month. We believe that our program of monthly dues collection provides a predictable and stable cash flow for us, eliminates the traditional accounts receivable function, and minimizes bad-debt write-offs while providing a significant competitive advantage in terms of the sales process, dues collection, working capital management and membership retention. During the first week of each month, we receive the dues for that month initiated by third party processors such as JACCS, OMC or Pocket Card, three Japanese credit card companies. Discrepancies and insufficient funds incidents are researched and resolved by in-house staff.

 

We also respond to the needs of various companies by establishing differentiated prices for corporate membership plans. We have also developed corporate fitness programs, fitness evaluations and health clinics allowing corporations to use our fitness club facilities as part of their employee benefits plans.

 

The Fitness Product business

 

Industry Overview—Consumer Trends

 

We believe that the domestic market for fitness equipment has potential for growth due to a number of demographic and market trends that we expect will continue, including:

 

    growing consumer awareness of positive benefits of good nutrition and fitness;

 

    expanding media attention on health and fitness;

 

    an aging population that is maintaining a more active lifestyle;

 

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    continued attention to appearance and weight by consumers; and

 

    expansion of the market for sophisticated high-quality fitness equipment due to consumers’ continued demand for higher levels of efficiency in their workout regimes.

 

Our Fitness Product Business

 

Our fitness equipment business is primarily comprised of procurement and sales, manufacturing and marketing of fitness equipment and related products. We believe that we can leverage our know-how gained from years of creating entertainment software and hardware to create exciting new fitness products that offer users entertainment as well as a healthy workout. In addition, we believe that such equipment will stimulate additional demand for fitness club memberships, thereby benefiting our fitness club business.

 

We also plan to expand into the home fitness equipment market. In particular, we plan to grow our operations by developing high quality, branded entertainment-oriented fitness equipment that better meets the needs of our customers and retailers.

 

Production, Marketing, Sales and Distribution

 

Fitness Equipment

 

We have developed and introduced the “EZ Series” as “Exertainment” equipment which adds entertainment aspects to traditional fitness machines and combines exercising and entertainment. For example, the EZRUNNER and EZBIKE products are treadmills and exercise bicycles with a built-in video monitor on which the user can enjoy TV programs and other forms of entertainment. These products have been introduced to some of Konami Sports facilities as the next-generation machines to meet the demand of the users who wish to become healthy while having fun. In addition to home fitness products that allow users to enjoy exercising at home, such as Refreshment Bike, a home fitness machine with a built-in generator of high amounts of concentrated oxygen and negative ions, as well as Kenshin Keikaku, a software which displays and manages physical activity data stored in e-walkeylife, a multi-functioned pedometer.

 

Supplements

 

We have developed original supplements such as FLAVANGENOL, which is high in polyphenol and helps improve blood flow and burn off body fat, Konami Sports Club BLACKCURRANT, which is high in anthocyanin and controls active enzymes, and EXERDIET, which helps to burn off body fat efficiently during workouts. We also introduced a service called “Supplement Member”, a delivery service of popular supplements for our club members to their home addresses.

 

Our fitness equipment and entertainment health related products are designed, produced, developed, manufactured, marketed, sold and distributed by Konami Sports Life Corporation, our wholly owned subsidiary. However, Konami Sports Life Corporation merged with Konami Sports Corporation and became Konami Sports & Life Co., Ltd. as of February 28, 2006, to operate fitness club facilities and develop and manufacture heath-related equipment and supplement products with the aim of creating new markets and providing various health-related services.

 

Gaming & System Segment

 

Our Gaming & System segment develops, produces and sells gaming machines such as video and mechanical slot machines and management systems to gaming operators in the United States, Australia and other overseas markets. Net revenues generated by our Gaming business, before elimination of intersegment revenues, amounted to approximately ¥11,643 million in fiscal 2005 and approximately ¥10,623 million in fiscal 2006, a decrease of approximately ¥1,020 million, or 8.8%. We develop, produce and sell gaming machines for international markets, primarily in North America and Australia, and sell casino management systems in North America.

 

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Gaming Industry Overview

 

Global Gaming Industry

 

The North American market is the world’s largest gaming market, followed by the Oceania and Russian markets. Other major gaming markets include South America, Africa and Asia. The North American gaming market has been growing every year, with the number of major players in this market growing significantly.

 

Gaming in the United States

 

The gaming industry in the United States, has generally experienced substantial growth in the last decade. Prior to 1979, gaming was limited to Nevada. In 1979, gaming was legalized in New Jersey. Between 1979 and 1988, gaming activities by various Native American tribes developed, leading to the enactment of the federal Indian Gaming Regulatory Act. The growth of Native American gaming served as a catalyst for certain jurisdictions to consider non-Native American gaming because of its potential as a source of government revenue. Since 1989, various forms of gaming have been legalized in numerous states including but not limited to Colorado, Illinois, Indiana, Iowa, Louisiana, Michigan, Mississippi and Missouri. In addition, gaming facilities operate at casino hotels, river boat casinos and on cruise ships sailing out of numerous ports in and around the United States. Several other states have approved or are considering approval of some form of gaming.

 

Gaming in Australia

 

In Australia, the gaming industry is characterized by intense competition between manufacturers over a limited total market share due to an increase in the gaming tax rate and restrictions on the numbers of gaming machines permitted to be installed in larger states, as part of the Gambling Harm Minimization Policies implemented by the Australian government. Australia is the largest and most established market for gaming products outside of North America and is primarily oriented towards the video slot machine market.

 

Our Gaming Business

 

We have expanded our gaming machines business in international markets. This expansion, initiated in March 1998 by exporting components of video slot machines to Australia, was followed by the launch of video slot machine sales in the United States in late 2000. In August 2001, we acquired Paradigm Gaming Systems, Inc., through our American subsidiary, Konami Gaming, Inc., and integrated it into the Systems Division of Konami Gaming, Inc. Paradigm Gaming Systems, Inc. is a developer of casino management systems. Our casino management system product enables simultaneous accounting, marketing management, customer management and security enhancement by connecting all of the gaming machines to a casino in a unified management system. We expect that our sales of casino management systems will contribute to more stable revenues in our gaming business, as we earn connection fees on an ongoing basis after installation, as well as revenues from sales that are realized at the time of installation. Due to the acquisition of Paradigm Gaming Systems, Inc., we are further expanding our opportunities in the gaming machine market in North America and are steadily expanding our client list. We have received licenses to manufacture and/or sell gaming machines in almost all of the major states and provinces in North America and Canada that permit gaming. For example, we acquired licenses from New Jersey in 2004 and Oklahoma and Alberta, Canada in 2005. In September 2005, we participated in the Global Gaming Expo to introduce our new model K2V series and casino management systems to demonstrate the expanded scope of our products. Additionally, in October 2005, we entered into an agreement for a large-scale installation of the Casino Management System in Quebec, Canada.

 

We originally started our Gaming & System segment with sales of video slot machines in Australia and later introduced our video slot machine products into the North American market. We are currently focused on the development of new models, including mechanical slot machines, to secure revenues generated in the North American market, where the market share of mechanical slot machines accounted for more than half of the entire market in 2003, according to data from the State Gaming Commissions, and a substantial portion of the demand for gaming machines is attributed to mechanical slot machines.

 

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Production

 

Our gaming machines and casino management system, sold in North America are assembled at our production facility in Las Vegas, Nevada. Gaming machines sold in Australia are assembled at our production facility in Sydney, Australia. Our products are assembled utilizing various parts and components from a large base of local vendors. A Japanese branch of our North American subsidiary supplies certain software and electronic components to our overseas production facilities. We have also identified alternate sources of supply for significant parts and components in the event any of our current vendors fail to meet order requirements.

 

We completed the construction of a new building in Las Vegas in June 2005. Almost half of our worldwide sales are derived from the U.S. market, and products sold in the U.S. market are built solely in the facility in Las Vegas. We believe we have thus achieved more efficient operations through increased production capacity compared to our previous building and an enhanced training facility for customers of our casino management system.

 

Marketing, Sales and Distribution

 

Our gaming machines are marketed, sold and distributed overseas through our local subsidiaries directly to casino operators. Currently, in Las Vegas, which is representative of the North American market, there is substantial management integration of gaming facilities.

 

Other Operations

 

Pachinko

 

Pachinko—Overview of Merchandise and Industry

 

The pinball-like game of pachinko is a national pastime in Japan. Players purchase a supply of tiny metal pinballs that they then propel with a motorized trigger at a maximum permitted rate of 100 times a minute through a vertically mounted pinball-like maze in a pachinko machine. As the balls bounce through a maze of pins, they either hit jackpots to produce more balls or fall into the gutter at the bottom of the machine. The board face, which has moving images on a LCD panels and flashing lights is designed to attract potential players and is the most important component. Our LCDs are installed in the board face of machines.

 

The number of pachinko outlets in Japan has decreased in the last few years. According to the National Police Agency released on April 2006, the number of nationwide pachinko outlets has decreased 452, by 2.9%, to 15,165 for the year end of 2005. However, the number of pachinko machines per outlet has increased 323.1 or 1.5% from the previous year, which is attributable to the progress in the upsized growth in floor area of outlets, resulting from increases in the number of machines per outlet, and to easing of regulations on pachinko.

 

Our Pachinko LCD Operations

 

We develop software that is incorporated into and sold together with LCDs for pachinko machines. The life cycle of such software for LCDs is approximately several months to one year.

 

Currently, we typically introduce between five and ten new pachinko software installed in LCDs each year. Pachinko machines must be inspected by The Security Electronics and Communications Technology Association, an extra-governmental organization associated with the Metropolitan Police Department, before being marketed in Japan. This process exposes us to possible delays in our introduction of new software installed in LCDs because we may be required to change software content.

 

To attract a wider customer base, we have expanded the type of pachinko game machine titles we develop to focus software development to a great extent on entertainment and game value. We believe that the pachinko game machine manufacturing market in Japan is mature and is unlikely to grow significantly, if at all. However, we plan to expand our market share by increasing the volume of software we sell.

 

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Development, Production and Components Supply

 

We develop software for LCDs used in pachinko machines and, in a few limited cases, we have begun to outsource a portion of the software production to various third parties who produce our software to our circuit design specifications. We also work with third-party contractors who integrate the software with LCDs, semi-conductors and printed circuit boards that we order from major electrical manufacturers in Japan. We have encountered difficulties in the past in procuring LCDs in sufficient quantities, although less 50 currently due to the increasing production capabilities of LCD makers. However, there is also increasing demand for semiconductors due to advanced LCD technologies and, in order to avoid future procurement problems, we place orders in advance to meet the requirements. We have not encountered, and do not expect to encounter, any difficulty in procuring printed circuit boards for our use. After our contractors have integrated the software and hardware, we then supply the bundled unit to the pachinko hardware manufacturer for the relevant pachinko machines.

 

Marketing and Sales

 

We sell our LCDs directly to pachinko machine manufacturers. Some of the larger manufacturers publish their own software for pachinko machines, but most manufacturers purchase software from third parties, including us. We commenced sales in 1992 and currently have basic product and sales agreements with over seven companies with which we try to strengthen business relations.

 

Other—Konami School

 

In order to bring talent to each of our business areas, we established Konami School, Inc. in August 2003 and opened Konami School in April 2004. We are fostering talents for our various business areas, including game creators and fitness club staffs.

 

Brand Sourcing

 

A significant portion of our products include content (brands) such as characters, images, trademarks and logos, to which we have been granted licenses from a broad range of licensors. The success of our business depends to a significant extent on our ability to create or license content with strong consumer appeal and a high level of recognition or acceptance. To do so, we must identify and respond rapidly to new and emerging consumer trends.

 

Content is one of our most valuable assets. Accordingly, we actively seek to obtain licenses of prominent brands for our video game software, amusement arcade games, gaming machines, card games, toys, music CDs and other consumer merchandise. Our most important source for licensed brands has been sports organizations. Use of the names of actual players in our games is a relatively new phenomenon in response to the demand for greater reality in game software content and as such, securing necessary licenses is critical to success of our sports titles. Increasingly, we also seek to license brands from film makers, comics publishers, and animation and TV program producers.

 

Our significant brand licensing activities include the following:

 

    We have obtained licenses from Major League Baseball Properties, Inc., and Major League Baseball Players Association, FIFPro Commercial Enterprises BV and Japanese sports organizations such as the Professional Baseball Organization of Japan, the Japan Professional Soccer League, or J-League, and the Japan Football Association.

 

    We have obtained licenses from film makers, comics publishers and animation companies, including Nihon Ad Systems Inc., Kodansha and Shogakukan Production Co., Ltd.

 

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Overseas Activities

 

The following tables show net revenues, operating expenses and operating income (loss) by geographic area for the fiscal years ended March 31, 2004, 2005 and 2006:

 

Year Ended March 31, 2004


  Japan

  United
States


  Europe

  Asia/
Oceania


  Total

  Eliminations (2)

    Consolidated

    (Millions of Yen)

Net revenues:

                                           

Customers

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

Intersegment (1)

    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 (loss)

  ¥ 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 (2)

    Consolidated

    (Millions of Yen)

Net revenues:

                                           

Customers

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

Intersegment (1)

    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 (2)

    Consolidated

    (Millions of Yen)

Net revenues:

                                             

Customers

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

Intersegment (1)

    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

 

Year Ended March 31, 2006


  Japan

  Americas

    Europe

  Asia/
Oceania


  Total

  Eliminations (2)

    Consolidated

    (Thousands of U.S. Dollars)

Net revenues:

                                             

Customers

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

Intersegment (1)

    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

(1)   Intersegment means transactions between geographic areas.
(2)   Eliminations means elimination of intersegment transactions and operating expenses not allocated to a specific geographic region.

 

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One of our principal strategies is to significantly increase our overseas revenues in absolute terms and as a percentage of our overall revenues.

 

Our present overseas activities consist principally of sales of video game software, toy & hobby products, amusement arcade games and gaming machines and revenues from charges on mobile games. During fiscal 2004, our net revenues increased by ¥6,652 million in the United States due primarily to the continuous popularity of the Yu-Gi-Oh! game software and the Yu-Gi-Oh! Trading Card Game, and by ¥19,532 million in Europe due primarily to an increase in sales of the Yu-Gi-Oh! game software, the Yu-Gi-Oh! Trading Card Game and soccer titles. During fiscal 2005, our net revenues in the United States and Europe decreased ¥12,113 million and ¥528 million, respectively, due principally to slowed-down sales of the Yu-Gi-Oh! game software and the Yu-Gi-Oh! Trading Card Game, which offset growth in sales of gaming machines and METAL GEAR SOLID series in the United States and the METAL GEAR SOLID series in Europe.

 

In fiscal 2006, our net revenues decreased ¥7,731 million in the United States and ¥7,039 million in Europe, respectively, resulting mainly from a decline in sales of video game software in the United States, as well as a decline in our net revenues from the Gaming & System segment due to a transition period toward new gaming machines in the United States during the fiscal year. In Europe, we experienced decreased sales of the Yu-Gi-Oh! Trading Card Game.

 

We initiated overseas operations by exporting amusement arcade games in 1979, and in 1982 we established a sales subsidiary in the United States. In subsequent years, we established additional sales subsidiaries in Germany, the United Kingdom, Korea, Singapore and Hong Kong, and a software game development subsidiary in Shanghai. In February 1997 we established Konami Gaming, Inc. to manufacture and distribute gaming machines in Nevada. Having received all licenses required by the state and county officials in Nevada, we began distributing gaming machines in Nevada beginning in fiscal 2001. Since then, we have received similar licenses and/or permission to operate in major states in North America. In addition, we have been licensed by Native American tribes in California, Arizona, New Mexico, Minnesota and Michigan. We have obtained licenses in a number of other gaming jurisdictions in North America. Konami Australia Pty Ltd., which became our consolidated subsidiary in October 2001, have obtained licenses to manufacture and sell gaming machines in all states in Australia, and exports gaming machines to overseas markets.

 

During the fiscal year ended March 31, 2001, the gaming machines we sold in the United States and two video slot machine components we exported to Australia were produced in Japan. Later, our production facility in Las Vegas, Nevada, which houses the headquarters and principal manufacturing facility of our U.S. gaming machine business, began operations in September 2001 and built a new building and started full production operations in June 2005.

 

In October 2003, Konami of America, Inc., our sales subsidiary in the United States, added a new function of overseas business administration to its existing sales business and changed its name to Konami Digital Entertainment, Inc. It established a new administrative office in Los Angeles in order to conduct various activities responding to local market needs for expanding shares of our Computer & Video Games business overseas. Subsequent to the introduction of this regional autonomy system, all overseas offices in our Digital Entertainment business changed their names to Konami Digital Entertainment.

 

Recently we launched sales of our video game software in China with the release of WORLD SOCCER Winning Eleven 7 INTERNATIONAL for PlayStation 2. We are committed to build our market share in China by localizing our popular products for the Chinese market. Additionally, in Korea, we released the PC online-game version of WORLD SOCCER Winning Eleven 9 in March 2006 following the online-game version of Yu-Gi-Oh. We plan to start full operation in other Internet-developed countries in Asia.

 

In line with our strategy to expand our international business, we are investigating acquisition and investment opportunities outside Japan for businesses that will grow or complement our current businesses.

 

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Research and Development

 

An important requirement for success in the highly competitive markets in which we operate is the ability to create quality products that attract public attention. We are also working to expand into new markets such as fitness equipment. The following three tables show our primary research and development activities, during each of the last three fiscal years.

 

Year Ended March 31, 2004


Segment


  

Focus of R&D Activity


Digital Entertainment

   Software such as WORLD SOCCER Winning Eleven 7 and JIKKYOU PAWAFURU PUROYAKYU SERIES.
     Card games such as the Yu-Gi-Oh! Trading Card Game series, boys’ toy products and infants such as GRANSAZERS and bath and toiletry products.
     Video games such as MAH-JONG FIGHT CLUB and QUIZ MAGIC ACADEMY, new software for music simulation games such as DrumMania and pop’n music, “e-AMUSEMENT” system which connects above video games through the Internet, medium- and large-sized token operated games such as Fantasic Fever, FORTUNE ORB and GI series, as well as software for pachinko LCDs.

Health & Fitness

   Fitness machines such as EZ Series”.

Gaming

   Gaming machines and software for North America and Australia.

 

Year Ended March 31, 2005


Segment


  

Focus of R&D Activity


Digital Entertainment

   Video Game Software such as METAL GEAR SOLID 3 SNAKE EATER and WORLD SOCCER Winning Eleven 8, online-game version of WORLD SOCCER Winning Eleven Series and Yu-Gi-Oh! series and game content for mobile telephones.
     Arcade games such as the Yu-Gi-Oh! Trading Card Game series and toys such as THE JUSTIRIZERS.
     Video games such as MAH-JONG FIGHT CLUB and QUIZ MAGIC ACADEMY, new software for music simulation games such as DrumMania and pop’n music, medium- and large-sized token-operated games such as WingFantasia and GI-TURF WILD, game software for pachinko LCDs, and amusement software compatible with “e-AMUSEMENT

Health & Fitness

   Fitness machines such as EZ Series” and supplements such as FLAVANGENOL.

Gaming

   Gaming machines, software and casino management systems for North America and Australia.

 

Year Ended March 31, 2006


Segment


  

Focus of R&D Activity


Digital Entertainment

   Software such as GENSOSUIKODEN V and WORLD SOCCER Winning Eleven 9, online-game version of WORLD SOCCER Winning Eleven Series and Yu-Gi-Oh! Series and game content for mobile telephones.
     Card games such as the Yu-Gi-Oh! Trading Card Game series and toys such as SAZER X.
     Video games such as MAH-JONG FIGHT CLUB and QUIZ MAGIC ACADEMY, new software for music simulation games such as DrumMania and pop’n music, medium- and large-sized token-operated games such as FORTUNE ORB 3 and GI series and amusement software compatible with “e-AMUSEMENT

Health & Fitness

   Fitness machines such as EZ Series” and supplements such as FLAVANGENOL.

Gaming & System

   Gaming machines, software and casino management systems for North America and Australia.

 

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Competition

 

The markets for video game software and most of our other products are intensely competitive and are characterized by the frequent introduction of new hardware systems, software products and other innovations.

 

In addition, the domestic Japanese market is gradually shrinking due partly to the declining birthrate. Japanese game producers are competing to bolster their product lineups and expand their overseas operations. Moreover, the spread of online games due to the expansion of broadband networks and the market growth of cellular phone contents owing to the improvement of cellular phone capabilities have intensified competitions over limited users’ leisure times and made it extremely important for game software producers to develop software for a wide variety of media and outlets in order to maintain growth.

 

Rapid changes in the business environment as mentioned above are also driving reorganization in the game software industry. For example, Enix Co., Ltd. and Square Co., Ltd. merged on April 1, 2003 and the new company, Square Enix Co., Ltd., is expected to focus on strengthening software development and expanding the lineup of online games. Also, in October 2004, Sammy Corporation founded Sega Sammy Holdings Inc., a holding company through which it acquired SEGA Corporation. In addition, Bandai Co., Ltd. and Namco Limited consolidated their operations to establish Namco Bandai Holdings Inc. in September 2005, and later established Namco Bandai Games Inc. through the consolidation of their domestic game businesses in March 2006.

 

We believe that the most significant competitive factors in all of our major business lines are the ability to develop compelling content and bring it to market at the appropriate time to capitalize on ever-changing consumer preferences. We believe our ability to develop content internally, as well as our strong internal distribution network, give us an advantage over many of our competitors. However, our competitors vary in size from small companies to very large corporations which have significantly greater financial, marketing and product development resources than we have. Due to these greater resources, some of our competitors are better able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and pay higher fees to licensors of desirable properties.

 

Our competitors and potential competitors in the video game software industry include the following:

 

    Other Japanese publishers of video game software, including Capcom Co. Ltd., Square Enix Co., Ltd., Namco Bandai Games Inc., and Sega Sammy., as well as overseas publishers such as Acclaim Entertainment, Inc., Activision Inc., Eidos PLC, Electronic Arts Inc., Infogrames SA, Take-Two Interactive Software, Inc., THQ Inc. and Vivendi Universal Publishing.

 

    Integrated video game system hardware/software companies, such as Sony, Microsoft and Nintendo, which compete directly with us in the development and publishing of software titles for their respective platforms.

 

    Large diversified entertainment or software companies, many of which own substantial libraries of available content and have substantially greater financial resources than we have, and which may decide to compete directly with us or to enter into exclusive relationships with our competitors.

 

There are barriers to entry in the video game software market, consisting mainly of the difficulty of developing the technical and creative resources as well as the distribution networks of established competitors. However, the development of the Internet as a medium for the distribution of video game software, the use of the Internet to facilitate the formation of collaborative technical and creative networks, and the proliferation of programming tools and other resources may have the effect of reducing these barriers.

 

Our most significant competitors in the market for toy & hobby products are mainly toy makers, such as Namco Bandai. We believe that the most significant competitive factor in the market for toy & hobby products is the ability to timely develop popular products based on appealing characters and themes. In addition, there have been business reorganizations such as consolidation of the operations of Takara Co., Ltd. and Tomy Co., Ltd. in March 2006 and their establishment of Takara Tomy Co., Ltd.

 

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The market for video game machines and token-operated game machines for amusement arcades in Japan is dominated by a few large manufacturers, including ourselves as well as Sega Sammy and Namco Bandai, and competition in these markets is intense. The principal method of competition in the market for video game machines and token-operated game machines for amusement arcades is new product development.

 

The market for software for LCDs for pachinko machines in Japan is relatively stable, with manufacturers of pachinko machines having close relationships with particular producers of such software. We believe that we have benefited from our ability to provide software with strong entertainment value rather than speculation-oriented software. Competitors that produce entertainment-oriented software may pose a threat to us. We believe that our strong relationships with pachinko machine manufacturers and our reputation for making reliable, appealing products give us a competitive advantage in the market for software for LCDs for pachinko machines.

 

In the fitness club market, we compete with other commercial health and fitness clubs, such as Central Sports Co., Ltd., physical fitness and recreational facilities established by local governments, hospitals, nursing homes, businesses for their employees and similar organizations, and, to a certain extent, with racquet, tennis and other athletic clubs, country clubs, weight-reducing salons and the home-use fitness equipment industry. We also compete, to some extent, with entertainment and retail businesses for the discretionary income of our target markets.

 

However, we believe our brand identity, operating experience, ability to allocate advertising and administration costs over all of our fitness clubs, nationwide operations, purchasing power and account processing and collection infrastructure, provide us with distinct competitive advantages. As the fitness market in Japan still has room for further growth, we expect more companies to enter the market both regionally and nationally and we may not be able to continue to compete effectively in each of our markets in the future.

 

Our principal competitors in overseas gaming machine markets include International Game Technology, Bally Technologies, Inc., Aristocrat Leisure Limited and WMS Industries Inc. A library of strong performing games, the possession of valuable patents and the development of unique products differentiable from those of others can be a significant competitive advantage. Other methods of competition include quality and breadth of sales and service organizations, financial stability of the manufacturer, and pricing.

 

Intellectual Property

 

As of March 31, 2006, we had approximately 3,962 trademarks, 949 patents 4 registration of utility model and 187 registered designs (excluding applications pending) in Japan and we also had approximately 4,934 trademarks, 1,207 patents and 352 registered designs (excluding applications pending) overseas. The trademarks and patents relate to our hardware and software for video game software products, input equipment for home video games, amusement arcade and token-operated games and gaming machines, creative products, LCDs for pachinko machines and pachinko slot machines. The utility models relate to input equipment for home video games, amusement and gaming machines and creative products. The registered designs relate to input equipment for home video game machines, amusement and gaming machines, designs for icons, creative products, pachinko equipment and pachinko slot machines.

 

Intellectual property for video game software is registered to us, our development subsidiaries or to us and our development subsidiaries as joint owners.

 

We believe that our trademarks (which, once registered, are perpetual, subject to use and payment of registration fees) and other intellectual property rights referred to above are important assets. Accordingly, we established divisions to necessary steps to secure and protect such rights, including registration with appropriate authorities and, if necessary, legal proceedings. The non-registration or expiration of registration of some of our intellectual property rights could have a material adverse effect on our business.

 

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Although we use copy-protection devices, an unauthorized person may be able to copy our software or otherwise obtain and use our proprietary information. If a significant amount of illegal copying of software published by us occurs, our product revenues could be adversely affected. Policing illegal use of software is extremely difficult and software piracy is expected to persist. In addition, the laws of some foreign countries in which our software is distributed do not protect us and our intellectual property rights to the same extent as the laws of Japan and the United States. Although illegal copying of our software has not been a major problem for us to date, it could have an adverse effect on our software business if we expand that business into China and Southeast Asia, where protection of intellectual property rights is weak.

 

Each of Nintendo, Sony and Microsoft incorporates security devices in the software and their respective hardware systems in order to prevent unlicensed software from infringing their respective proprietary rights by manufacturing software compatible with their hardware. Under our various license agreements with Nintendo, Sony and Microsoft, we are responsible for protecting our own and our licensors’ intellectual property rights that are used or incorporated in our software.

 

We do not own the trademarks, copyrights or patents covering the proprietary information and technology utilized in the game consoles marketed by Nintendo, Sony, Microsoft or, to the extent licensed from third parties, the brands, concepts and game programs featured in and comprising our software. See Item 4.B Business Overview—Brand Sourcing”. Accordingly, we must rely on the trademarks, copyrights and patents of these third-party licensors for protection of such intellectual property from infringement. Under our license agreements with certain licensors, we may bear the risk of claims of infringement brought by third parties and arising from the sale of software.

 

Regulation

 

Gaming

 

General

 

The manufacture, sale and distribution of gaming devices, equipment and related software is subject to federal, state, tribal and local regulations in the United States and foreign jurisdictions. While the regulatory requirements vary from jurisdiction to jurisdiction, the majority of these jurisdictions require licenses, registrations, permits, findings of suitability, documentation of qualification including evidence of financial stability and/or other required approvals for companies who manufacture and distribute gaming equipment, as well as the individual suitability or licensing of officers, directors, major shareholders and key employees. Laws of the various gaming regulatory agencies generally serve to protect the public and ensure that gaming related activity is conducted honestly, competitively, and free of corruption.

 

Various gaming regulatory agencies have issued licenses allowing us to manufacture and/or distribute our products and operate “wide area progressive” systems, also known as WAP systems. We and our key personnel have obtained or applied for all government licenses, permits, registrations, findings of suitability and approvals necessary allowing for the manufacture, distribution, and where permitted, operation of gaming machines in the jurisdictions where we do business. We have never been denied a gaming related license, nor have our licenses been suspended or revoked.

 

Nevada Regulation

 

The manufacture, sale and distribution of gaming devices in Nevada or for use outside Nevada are subject to the Nevada Gaming Control Act and the regulations of the Nevada Gaming Commission (Commission), and the State Gaming Control Board (GCB), and the local laws, regulations and ordinances of various county and municipal regulatory authorities (collectively referred to as the Nevada gaming authorities). These laws, regulations and ordinances primarily concern the responsibility, financial stability and character of gaming device manufacturers, distributors and operators, as well as persons financially interested or involved in gaming

 

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operations. The manufacture, distribution and operation of gaming devices require separate licenses. The laws, regulations and supervisory procedures of the Nevada gaming authorities seek to (i) prevent unsavory or unsuitable persons from having a direct or indirect involvement with gaming at any time or in any capacity, (ii) establish and maintain responsible accounting practices and procedures, (iii) maintain effective control over the financial practices of licensees, including establishing minimum procedures for internal fiscal affairs and the safeguarding of assets and revenues, providing reliable record keeping and requiring the filing of periodic reports with the Nevada gaming authorities, (iv) prevent cheating and fraudulent practices, and (v) provide a source of state and local revenues through taxation and licensing fees. Changes in these laws, regulations, procedures, and judicial or regulatory interpretations could have an adverse effect on our gaming operations.

 

Our subsidiary that conducts the manufacturer, sale, and distribution of gaming devices in Nevada or for use outside Nevada, as well as the operation of slot machine routes and other gaming activities in Nevada, is required to be licensed by the Nevada gaming authorities. Our licenses require the periodic payment of fees and taxes and are not transferable. Each type of machine we sell in Nevada must first be approved by the Commission and may require subsequent machine modification. Our gaming subsidiary licensed in Nevada must also report substantially all loans, leases, sales of securities and similar financing transactions to the GCB and the Commission, and/or have them approved by the Commission. We believe we have obtained all required licenses and/or approvals necessary to carry on our business in Nevada.

 

We are registered with the Commission as a publicly traded corporation and are required periodically to submit detailed financial and operating reports to the Commission and to furnish any other information that the Commission may require. No person may become a stockholder of or receive any percentage of profits from our licensed gaming subsidiaries, without first obtaining licenses and approvals from the Nevada gaming authorities.

 

Our officers, directors and key employees who are actively engaged in the administration or supervision of gaming and/or directly involved in gaming activities of our licensed gaming subsidiaries may be required to file applications with the Nevada gaming authorities and may be required to be licensed or found suitable by them. Officers, directors and certain key employees of our licensed gaming subsidiaries must file applications with the Nevada gaming authorities and may be required by them to be licensed or found suitable. Our bylaws provide for us to pay all costs of the GCB investigations that are related to our officers, directors or employees.

 

The Nevada gaming authorities may investigate any individual who has a material relationship or involvement with us, or any of our licensed gaming subsidiaries in order to determine whether such individual is suitable or should be licensed as a business associate of a gaming licensee. The Nevada gaming authorities may deny an application for licensure or finding of suitability for any cause deemed reasonable. A finding of suitability is comparable to licensing and both require submission of detailed personal and financial information followed by a thorough background investigation. The applicant for licensing or a finding of suitability must pay all costs of the investigation. We must report changes in licensed positions to the Nevada gaming authorities. The Nevada gaming authorities may disapprove any change in position by one of our officers, directors or key employees, or require us to suspend or dismiss officers, directors or other key employees and sever all relationships with such persons, including those who refuse to file appropriate applications or whom the Nevada gaming authorities find unsuitable to act in such capacities. Determinations of suitability or of questions pertaining to licensing are not subject to judicial review in Nevada.

 

We are required to submit detailed financial and operating reports to the Commission. If it were determined that any Nevada gaming laws were violated by us or any of our licensed gaming subsidiaries, our gaming licenses could be limited, conditioned, suspended or revoked, subject to compliance with certain statutory and regulatory procedures. In addition, we, our licensed gaming subsidiaries and any persons involved may be subject to substantial fines for each separate violation of the Nevada gaming laws at the discretion of the Commission. The Commission also has the power to appoint a supervisor to operate our gaming properties and, under certain circumstances, earnings generated during the supervisor’s appointment could be forfeited to the

 

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State of Nevada. The limitation, conditioning or suspension of our gaming licenses or the appointment of a supervisor could (and revocation of our gaming licenses would) materially and adversely affect our gaming operations.

 

The Commission may require any beneficial holder of our voting securities, regardless of the number of shares owned, to file an application, be investigated, and be found suitable, in which case the applicant would be required to pay all of the costs and fees of the GCB investigation. If the beneficial holder of voting securities who must be found suitable is a corporation, partnership, or trust, it must submit detailed business and financial information including a list of beneficial owners. Any person who acquires more than 5% of our voting securities must report this to the Commission. Any person who becomes a beneficial owner of more than 10% of our voting securities must apply for a finding of suitability within 30 days after the chairman of the GCB mails the written notice requiring this filing.

 

Under certain circumstances, an Institutional Investor, as this term is defined in the Commission regulations, which acquires more than 10%, but not more than 15%, of our voting securities may apply to the Commission for a waiver of these finding of suitability requirements, provided the institutional investor holds the voting securities for investment purposes only. An institutional investor will not be deemed to hold voting securities for investment purposes unless the voting securities were acquired and are held in the ordinary course of its business and not for the purpose of causing, directly or indirectly (i) the election of a majority of our board of directors, (ii) any change in our corporate charter, bylaws, management, policies or operations, or (iii) any other action which the Commission finds to be inconsistent with holding our voting securities for investment purposes only. The Commission considers voting on all matters voted on by shareholders and the making of financial and other informational inquiries of the type normally made by securities analysts, and such other activities as the Commission may determine, to be consistent with holding voting securities for investment purposes only. If the beneficial holder of voting securities who must be found suitable is a corporation, partnership, limited partnership, limited liability company or trust, it must submit detailed business and financial information including a list of beneficial owners. The applicant is required to pay all costs of the GCB investigation.

 

Any person who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Commission or the chairman of the GCB may be found unsuitable. The same restrictions apply to a record owner who fails to identify the beneficial owner, if requested to do so. Any stockholder found unsuitable and who holds, directly or indirectly, any beneficial ownership of our voting securities beyond that period of time as may be prescribed by the Commission may be guilty of a criminal offense. We are subject to disciplinary action, and possible loss of our approvals, if, after we receive notice that a person is unsuitable to be a stockholder or to have any other relationship with us or any of our licensed gaming subsidiaries, we (i) pay that person any dividend or interest upon our voting securities, (ii) allow that person to exercise, directly or indirectly, any voting right conferred through securities held by that person, (iii) give remuneration in any form to that person, for services rendered or otherwise, or (iv) fail to pursue all lawful efforts to require the unsuitable person to relinquish his voting securities for cash at fair market value. Additionally, the Clark County authorities have taken the position that they have the authority to approve all persons owning or controlling the stock of any corporation controlling a gaming licensee.

 

The Commission may, in its discretion, require the holder of any of our debt securities to file an application, be investigated and be found suitable to own any of our debt securities. If the Commission determines that a person is unsuitable to own any of these securities, then pursuant to the Nevada gaming laws, we can be sanctioned, including the loss of our approvals, if without prior Commission approval, we: (i) pay to the unsuitable person any dividend, interest, or any distribution whatsoever; (ii) recognize any voting right by the unsuitable person in connection with these securities; (iii) pay the unsuitable person remuneration in any form; or (iv) make any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation, or similar transaction.

 

We are required to maintain a current stock ledger in Nevada which may be examined by the Nevada gaming authorities at any time. If any of our securities are held in trust by an agent or by a nominee, the record

 

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holder may be required to disclose the identity of the beneficial owner to the Nevada gaming authorities. A failure to make this disclosure may be grounds for finding the record holder unsuitable. We are also required to render maximum assistance in determining the identity of the beneficial owner. The Commission has the power at any time to require our stock certificates to bear a legend indicating that the securities are subject to the Nevada gaming laws and the regulations of the Commission. To date, the Commission has not imposed this requirement on us.

 

We may not make a public offering of our securities without the prior approval of the Commission if the securities or their proceeds are intended to be used to construct, acquire or finance gaming facilities in Nevada, or retire or extend obligations incurred for such purposes. Such approval, if given, does not constitute a finding, recommendation, or approval by the Commission or the GCB as to the accuracy or adequacy of the prospectus or the investment merits of the securities. Any representation to the contrary is unlawful.

 

Changes in control of Konami through merger, consolidation, acquisition of assets or stock, management or consulting agreements or any act or conduct by a person whereby he obtains control, may not occur without the prior investigation of the GCB and approval of the Commission. Entities seeking to acquire control of us must satisfy the GCB and the Commission in a variety of stringent standards prior to assuming control. The Commission may also require controlling shareholders, officers, directors and other persons having a material relationship or involvement with the entity proposing to acquire control, to be investigated and licensed as part of the approval process relating to the transaction.

 

The Nevada legislature has declared that some corporate acquisitions opposed by management, repurchases of voting securities and other corporate defense tactics that affect Nevada gaming licensees, and publicly-traded corporations that are affiliated with those operations, may be injurious to stable and productive corporate gaming. The Commission has established a regulatory scheme to ameliorate the potentially adverse effects of these business practices upon Nevada’s gaming industry and to further Nevada’s policy to (i) assure the financial stability of corporate gaming operators and their affiliates; (ii) preserve the beneficial aspects of conducting business in the corporate form; and (iii) promote a neutral environment for the orderly governance of corporate affairs. Approvals are, in certain circumstances, required from the Commission before we can make exceptional repurchases of voting securities above their current market price and before a corporate acquisition opposed by management can be consummated. Nevada’s gaming laws and regulations also require prior approval by the Commission if we were to adopt a plan of recapitalization proposed by our board of directors in opposition to a tender offer made directly to our shareholders for the purpose of acquiring control of us.

 

License fees and taxes, computed in various ways depending on the type of gaming or activity involved, are payable to the State of Nevada and to the cities and counties where our subsidiaries conduct operations. Depending on the particular fee or tax involved, these fees and taxes are payable either monthly, quarterly or annually. Annual fees are payable to the State of Nevada to renew our licenses as a manufacturer, distributor, and operator of a slot machine route. Nevada gaming law also requires persons providing gaming devices in Nevada to casino customers on a revenue participation basis to pay their proportionate share of the taxes imposed on gaming revenues generated by the participation gaming devices.

 

Any person who is licensed, required to be licensed, registered, required to be registered, or is under common control with such persons (collectively referred to as licensees), and who proposes to participate in the conduct of gaming operations outside of Nevada is required to deposit with the GCB, and thereafter maintain, a revolving fund in the amount of $10,000 to pay the expenses of investigation by the GCB of the licensee’s participation in foreign gaming. This revolving fund is subject to increase or decrease at the discretion of the Commission. As a licensee, we are required to comply with certain reporting requirements imposed by the Nevada gaming laws. We are also subject to disciplinary action by the Commission if we knowingly violate any laws of the foreign jurisdiction pertaining to our foreign gaming operation, fail to conduct our foreign gaming operations in accordance with the standards of honesty and integrity required of Nevada gaming operations engage in any activity or enter into any association that is unsuitable because it poses an unreasonable threat to

 

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the control of gaming in Nevada, reflects or tends to reflect discredit or disrepute upon the State of Nevada or gaming in Nevada, or is contrary to the gaming policies of Nevada, engage in any activity or enter into any association that interferes with the ability of the State of Nevada to collect gaming taxes and fees, or employ, contract with or associate with any person in the foreign gaming operation who has been denied a license or a finding of suitability in Nevada on the ground of personal unsuitability, or who has been found guilty of cheating at gambling.

 

Mississippi Regulations

 

The manufacture, sale and distribution of gaming machines for use or play in Mississippi or for distribution outside of Mississippi and the operation of wide area progressive gaming devices are subject to the Mississippi Act. Konami Gaming, Inc.’s (KGI) license as a wide area progressive operator permits placement of slot machines and gaming devices on the premises of other licensees on a participation basis. All manufacturing, distribution and wide area progressive operation are subject to licensing and regulatory control of the Mississippi Gaming Commission (the Mississippi Commission).

 

The laws, regulations and supervisory procedures of the Mississippi Commission are based upon declarations of public policy which are concerned with, among other things: (i) the prevention of unsavory or unsuitable persons from having a direct or indirect involvement with gaming at any time or in any capacity; (ii) the establishment and maintenance of responsible accounting practices and procedures; (iii) the maintenance of effective controls over the financial practices of licensees, including the establishment of minimum procedures for internal fiscal affairs and the safeguarding of assets and revenues, providing reliable record keeping and requiring the filing of periodic reports with the Mississippi Commission; (iv) the prevention of cheating and fraudulent practices; (v) providing a source of state and local revenues through taxation and licensing fees; and (vi) the strict regulation of all persons, locations, practices, associations and activities related to the operation of licensed gaming establishments and the manufacture and distribution of gaming devices and associated equipment. Changes in these laws, regulations and procedures could have an adverse effect on our future Mississippi operations.

 

Certain of our subsidiaries that manufacture and distribute gaming devices or operate a slot machine route, or operate wide area progressive gaming, or which hold stock of a subsidiary which does so (a “Gaming Subsidiary”), are required to be licensed or registered by the Mississippi Gaming Commission. The Licenses require the periodic payment of fees and taxes and are not transferable. We are registered by the Mississippi Commission as a publicly-traded corporation (Registered Corporation) and so we are required periodically to submit detailed financial operation reports to the Mississippi Commission and to furnish any other information which the Mississippi Commission may require. We have obtained from the Mississippi Commission the various registrations, finding of suitability, approvals, permits and licenses (collectively, referred to as Licenses) required to engage in manufacturing of gaming devices and for KGI to engage in wide area progressive operations, the manufacture, sale distribution of gaming devices for use or play in Mississippi or for distribution outside of Mississippi. We cannot assure you that these Licenses will not be revoked, suspended, limited or conditioned by the Mississippi Commission.

 

All gaming devices that are manufactured, sold or distributed for use or play in Mississippi, or for distribution outside of Mississippi, must be manufactured by licensed manufacturers and distributed or sold by licensed distributors. All gaming devices manufactured for use or play in Mississippi must be approved by the Mississippi Commission before sales distribution or exposure for play. The approval process for gaming devices includes rigorous testing by the Mississippi Commission, a field trial and a determination as to whether the gaming machine meets strict technical standards that are set forth in the regulations of the Mississippi Commission. Associated equipment (as defined in the Mississippi Act) must be administratively approved by the Chairman of the Mississippi Commission before it is distributed for use in Mississippi.

 

The Mississippi Commission may investigate any individual who has a material relationship or involvement with us in order to determine whether that individual is suitable or should be licensed as a business associate of a

 

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licensee. Officers, directors and certain key employees of our Gaming Subsidiary must file license applications with the Mississippi Commission. Our officers, directors and key employees who are actively and directly involved in activities of our Gaming Subsidiary may be required to be licensed or found suitable by the Mississippi Commission. The Mississippi Commission may deny an application for licensing for any cause which they deem reasonable. A finding of suitability is comparable to licensing, and both require submission of detailed personal financial information followed by a thorough investigation. The applicant for licensing or a finding of suitability must pay all the costs of the investigation. Changes in licensed positions must be reported to the Mississippi Commission and, in addition to their authority to deny an application for a finding of suitability or license, the Mississippi Commission have jurisdiction to disapprove a change in a corporate position.

 

If the Mississippi Commission were to find an officer, director or key employee unsuitable for licensing or unsuitable to continue having a relationship with us, we would have to sever all relationships with that person. In addition, the Mississippi Commission may require us to terminate the employment of any person who refuses to file appropriate applications. Determinations of suitability or of questions pertaining to licensing are not subject to judicial review in Mississippi.

 

We are required to submit detailed financial and operating reports to the Mississippi Commission. Substantially all material loans, leases, sales of securities and similar financing transactions by our Gaming Subsidiary must be reported to, and approved by, the Mississippi Commission.

 

If the Mississippi Commission determines that we violated the Mississippi Act, our Licenses could be limited, conditioned, suspended or revoked subject to compliance with certain statutory and regulatory procedures. In addition, we and the persons involved could be subject to substantial fines for each separate violation of the Mississippi Act at the discretion of the Mississippi Commission. The limitation, conditioning or suspension of any License or the appointment of a supervisor could, and the revocation of any license would, materially adversely affect our future operation in Mississippi.

 

Any beneficial holder of our voting securities, regardless of the number of shares owned, may be required to file applications, be investigated and have his, her or its suitability as a beneficial holder of our voting securities determined if the Mississippi Commission has reason to believe that ownership would otherwise be inconsistent with the declared policies of the State of Mississippi. The applicant must pay all costs of investigation incurred by the Mississippi Commission in conducting any such investigation.

 

The Mississippi Act requires any person who acquires beneficial ownership of more than 5% of our voting securities to report the acquisition to the Mississippi Commission. The Mississippi Act requires that beneficial owners of more than 5% of our voting securities apply to the Mississippi Commission for a finding of suitability within 30 days after the mailing of the written notice by the Executive Director of the Mississippi Commission requiring that filing. Under certain circumstances, an “institutional investor”, as defined in the Mississippi Act, which acquires more than 10%, but not more than 15% or our voting securities may apply to the Mississippi Commission for a waiver of that finding for suitability if the institution investor holds the voting securities for investment purposes only. An institutional investor shall not be deemed to hold voting securities for investment purposes unless the voting securities were acquired and are held in the ordinary course of business as an institutional investor and not for the purpose of causing, directly or indirectly, the election of a majority of the members of our board of directors, any change in our corporate charter, bylaws, management, policies or operations, or those of any of our gaming affiliates, or any other action which the Mississippi Commission finds to be inconsistent with holding our voting securities for invest purposes only. Activities which are not deemed to be inconsistent with holding voting securities for investment purposes only include: (i) voting on all matters voted on by stockholders; (ii) making financial and other inquiries of management of the type normally made by securities analysts for information purposes and not to cause a change in our management policies or operations; and (iii) other activities that the Mississippi Commission may determine to be consistent with investment intent. If the beneficial holder of voting securities who must be found suitable is a corporation, partnership or trust, it must submit detailed business and financial information including a list of beneficial owners. The applicant is required to pay all cost of investigation.

 

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Any person who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Mississippi Commission may be found unsuitable. The same restrictions apply to a record owner who fails to identify the beneficial owner, if requested to do so. Any stockholder found unsuitable and who holds, directly or indirectly, any beneficial ownership of voting securities beyond that period of time as may be prescribed by the Mississippi Commission may be guilty of a criminal offense. We are subject to disciplinary action and possible loss of approvals if, after we receive notice that a person is unsuitable to be a stockholder or to have any other relationship with us or any of our licensed Gaming Subsidiaries, we (i) pay that person any dividend or interest upon our voting securities; (ii) allow that person to exercise, directly or indirectly, any voting rights conferred through securities held by that person; (iii) pay remuneration in any form to that person for services rendered or otherwise; (iv) fail to pursue all lawful efforts to require the unsuitable person to relinquish voting securities including, if necessary, the immediate repurchase of the voting securities for cash at fair market value.

 

The Mississippi Commission may, in its discretion, require the holder of any of our debt security to file an application, be investigated and be found suitable to own any of our debt securities. If the Mississippi Commission determines that a person is unsuitable to own any of our securities, then under the Mississippi Act, we can be sanctioned, including the loss of our approvals, if without the prior approval of the Mississippi Commission we: (i) pay to the unsuitable person any dividend, interest or any distribution whatsoever; (ii) recognize any voting right by the unsuitable person in connection with that security; (iii) pay the unsuitable person remuneration in any form; or (iv) make any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation or similar transaction.

 

We are required to maintain a current stock ledger in the State of Mississippi which may be examined by the Mississippi Commission at any time. If any securities are held in trust by an agent or by a nominee, the record holder may be required to disclose the identity of the beneficial owner to the Mississippi Commission. A failure to make this disclosure may be grounds for finding the record holder unsuitable. We are also required to render maximum assistance in determining the identity of the beneficial owner. The Mississippi Commission requires that stock certificates of Registered Corporation bear a legend indicating that the securities are subject to the Mississippi Act but we have obtained waiver of that requirement.

 

We may not make a public offering of our securities without the prior approval of the Mississippi Commission if the securities or the proceeds are intended to be used to construct, acquire or finance gaming facilities in Mississippi, or to retire or extend obligations incurred for such purposes. Such approval, if given, does not constitute a finding, recommendation, or approval by the Mississippi Commission as to the accuracy or adequacy of the prospectus or the investment merits of the securities. Any representation to the contrary is unlawful. To this end, we received continuous approval of public offerings and/or private placements and related approvals (shelf approval) that are valid for a two (2) year period which can and will be renewed for subsequent 2 year periods.

 

Changes in control of Konami through merger, consolidation, acquisition of assets or stock, management or consulting agreements or any act or conduct by a person whereby he or she obtains control, may not occur without the prior approval of the Mississippi Commission. Entities seeking to acquire control of us must satisfy the Mississippi Commission in a variety of stringent standards prior to assuming control. The Mississippi Commission may also require controlling stockholders, officers, directors and other persons having a material relationship or involvement with the entity proposing to acquire control, to be investigated and licensed as part of the approval process relating to the transaction.

 

The Mississippi legislature has declared that some corporate acquisitions opposed by management, repurchases of voting securities and other corporate defense tactics that affect Mississippi gaming licensees and publicly-traded corporations that are affiliated with those operations may be injurious to stable and productive corporate gaming. The Mississippi Commission has established a regulatory scheme to ameliorate the potentially adverse affects of these business practices upon Mississippi’s gaming industry and to further Mississippi’s policy

 

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to: (i) assure the financial stability of corporate licensees and their affiliates; (ii) preserve the beneficial aspects of conducting business in the corporate form; and (iii) promote a neutral environment for the orderly governance of corporate affairs. Approvals are, in certain circumstances, required from the Mississippi Commission before we can make exceptional repurchases of voting securities above the current market price and before a corporate acquisition opposed by management can be consummated. The Mississippi Act also requires prior approval if we were to adopt a plan of recapitalization proposed by our board of directors in opposition to a tender offer made directly to our shareholders for the purposes of acquiring control of us.

 

License fees and taxes, computed in various ways depending on the type of gaming or activity involved, are payable to the State of Mississippi and to the cities and counties where our subsidiaries conduct operations. Depending on the particular fee or tax involved, these fees and taxes are payable either monthly, quarterly or annually. Annual fees are payable to the State of Mississippi to renew our licenses as a manufacturer, distributor and operator of a slot machine route.

 

Any person who is licensed, required to be licensed, registered, required to be registered, or is under common control with such person, and who proposes to become involved in a gaming venture outside of Mississippi, is required to deposit with the Mississippi Commission, and thereafter maintain, a revolving fund to pay the expenses of investigation by the Mississippi Commission, and thereafter maintain, a $ 10,000 of revolving fund to pay the expenses of investigation by the Mississippi Commission of their participation in foreign gaming operations. This revolving fund is subject to increase or decrease at the discretion of the Mississippi Commission. As a licensee, we are required to comply with certain reporting requirements imposed by the Mississippi Act. The Mississippi Commission may require us to file an application for a finding of suitability concerning an actual or intended activity or association in a foreign gaming operation. A licensee is also subject to disciplinary action by the Mississippi Commission if the licensee knowingly violates any laws of the foreign jurisdiction pertaining to the foreign gaming operation, fails to conduct the foreign gaming operation in accordance with the standards of honesty and integrity required by Mississippi gaming operations, engages in activities that are harmful to the State of Mississippi or its ability to collect gaming taxes and fees, or employs a person in the foreign operation who has been denied a license or finding of suitability in Mississippi on the grounds of personal unsuitability.

 

New Jersey Regulations

 

The manufacture, distribution, and operation of gaming machines, and other aspects of casino gaming in New Jersey, are subject to strict regulation pursuant to the New Jersey Casino Control Act and the regulations promulgated thereunder (collectively, referred to as New Jersey Act). The New Jersey Act created the New Jersey Casino Control Commission (New Jersey Commission) and the New Jersey Division of Gaming Enforcement (the New Jersey Division). The New Jersey Commission is authorized to decide all license applications and other matters and to promulgate regulations. The New Jersey Division is authorized to investigate all license applications, make recommendations to the New Jersey Commission, and to prosecute violations of the New Jersey Act.

 

Under the New Jersey Act, a company must be licensed as a gaming related casino service industry supplier (CSI), or fulfill other requirements, in order to manufacture or distribute gaming devices to New Jersey casinos. In order for a CSI license to be issued, renewed or maintained, certain directors, officers, key employees and owners of a company must be found by the New Jersey Commission to possess by clear and convincing evidence good character, honesty, integrity and financial stability. Concurrent with our subsidiary Konami Gaming, Inc., we got a CSI license in 2004.

 

In its discretion, the New Jersey Commission may permit an unlicensed applicant for a CSI license to transact business with New Jersey casinos prior to licensure. In order to do so, we must maintain a completed application for CSI licensure on file with the New Jersey Commission. In addition, the casino that desires to transact business with us must obtain the approval of the New Jersey Commission for each business transaction

 

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(transactional waiver) by filing a petition with the New Jersey Commission that demonstrates that good cause exists for granting the petition. The New Jersey Commission can not grant such a petition if the New Jersey Division objects to the petition.

 

A CSI license application consists of extensive disclosure forms for the applicant, each of its holding companies, and each individual required to be found qualified by the New Jersey Commission. The persons affiliated with an applicant who must be found qualified by the New Jersey Commission are certain officers, directors and management employees, all beneficial owners of five percent (5%) or more of the applicant, and any other person the New Jersey Commission deems appropriate.

 

With respect to security holders, the New Jersey Commission may waive the qualification requirement for “institutional investors”, as defined in the New Jersey Act, of an applicant if: (i) there is no reason to believe that the institutional investor may be unqualified; (ii) the institutional investor holds less than ten percent of the outstanding securities; (iii) the securities were acquired for investment purposes only, and (iv) the holder has no intention of influencing the affairs of the applicant, other than voting its securities. The New Jersey Act defines an “institutional investor” as (i) any retirement fund administered by a public agency for the exclusive benefit of federal, state or local public employees; (ii) an investment company registered under the Investment Corporate Law of 1940; (iii) a collective investment trust organized by banks under Part Nine of the Rules of the Comptroller of the Currency, (iv) a closed end investment trust; (v) a chartered or licensed life insurance company or property and casualty insurance company; (vi) banking or other licensed or chartered lending institutions; (vii) an investment adviser registered under the Investment Advisers Act of 1940, and (viii) such other persons as the New Jersey Commission may determine for reasons consistent with the policies of the New Jersey Act.

 

In connection with a license application, the New Jersey Division conducts an investigation of the applicant and its individual qualifiers to determine their suitability for licensure. In order for a CSI license to be issued by the New Jersey Commission, the applicant and its individual qualifiers must demonstrate by clear and convincing evidence their good character, honesty and integrity, their financial stability, integrity and responsibility.

 

The application fee for a CSI license consists of a non-refundable deposit of $5,000 and an obligation to pay an additional $5,000 if the processing of the application requires more than 1,000 but less than 2,000 hours and a further $5,000 if the processing of the application exceeds 2,000 hours, plus the expenses of the New Jersey Commission and New Jersey Division. The same fee structure applies to any renewal application.

 

The New Jersey Commission has broad discretion regarding the issuance, renewal, suspension or revocation of CSI licenses. If our CSI license application is denied, we will not be able to transact business with New Jersey casinos. There is no guarantee that we will be granted an initial license or that, following the issuance of an initial CSI license or any renewal thereof, we will continue to be granted renewals of the license. The New Jersey Commission may impose conditions on the issuance of a license. In addition, the New Jersey Commission has the authority to impose fines or suspend or revoke a license for violations of the New Jersey Act, including the failure to satisfy the licensure requirements. A CSI license is issued for an initial period of two (2) years and is thereafter renewable for four (4) year periods.

 

In addition to our required licensure, the gaming equipment manufactured, distributed or sold by us to New Jersey casinos is subject to a technical examination by the New Jersey Division and approval by the New Jersey Commission for, at a minimum, quality, design, integrity, fairness, honesty, suitability and compliance with rigorous technical standards. The approval process includes the submission of a model of the machine to the New Jersey Division for testing, examination and analysis and for comparison with documentation of the schematics, block diagram, circuit analysis and written explanation of the method of operation, odds determination and all other pertinent information. All costs of such testing, examination and analysis are borne by us.

 

As part of this approval process, the New Jersey Commission may require that the manufacturer of any component of the gaming equipment which the New Jersey Commission, in its discretion, determines is essential

 

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to the gaming aspects of the device submit to licensing. Such components would include the computer control circuitry which causes or allows the device to operate as a gambling device. The failure or refusal of such a manufacturer to submit to licensing or the denial of a license by the New Jersey Commission to such manufacturer would result in our inability to distribute and market that gambling device to New Jersey casinos.

 

Prior to a decision by the New Jersey Commission to approve a particular model of machine, it may require a trial period to test the machine in a licensed casino. During the trial period, the manufacturer and distributor of the machine shall not be entitled to receive revenue of any kind whatsoever. Once a model is approved by the New Jersey Commission, all machines of that model placed in operation in licensed casinos shall operate in conformity with the model tested by the New Jersey Division. Any changes in the design, function or operation of the machine are subject to prior approval by the New Jersey Commission in consultation with the New Jersey Division.

 

Other Jurisdictions

 

Each of the other jurisdictions in which we do business requires various licenses, permits and approvals in connection with the manufacture and/or distribution of gaming devices typically involving restrictions similar in many respects to those of Nevada.

 

Federal United States Registration

 

The Federal Gambling Devices Act of 1962 (the Act) makes it unlawful for a person to manufacture, transport, or receive gaming machines, gaming devices or components across interstate lines unless that person has first registered with the Attorney General of the US Department of Justice. We are so registered and must renew our registration annually. In addition, gambling device identification and record keeping requirements are imposed by the Act. Violation of the Act may result in seizure and forfeiture of the equipment, as well as other penalties. We have complied with the registration requirements of the Act.

 

Native American Gaming Regulation

 

Gaming on Native American lands is governed by federal law, tribal-state compacts, and tribal gaming regulations. The Indian Gaming Regulatory Act of 1988, or the IGRA, provides the framework for federal and state control over all gaming on Native American lands and is administered by the National Indian Gaming Commission, or the NIGC, and the Secretary of the US Department of the Interior. IGRA requires that the tribe and the state enter into a written agreement, a tribal-state compact, which governs the terms of the gaming activities. Tribal-state compacts vary from state-to-state and in many cases require equipment manufacturers and/or distributors to meet ongoing registration and licensing requirements. In addition, tribal gaming commissions have been established by many Native American tribes to regulate gaming related activity on Indian lands. We manufacture and supply gaming equipment to Native American tribes who have negotiated compacts with their state and have received federal approval. As of June 30, 2006, we have received approvals to supply gaming equipment and component to 16 states of Native American.

 

International Regulation

 

Certain foreign countries permit the importation, sale and operation of gaming equipment in casino and non-casino environments. Some countries prohibit or restrict the payout feature of the traditional slot machine or limit the operation and the number of slot machines to a controlled number of casinos or casino-like locations. Each gaming machine must comply with the individual country’s regulations. Certain jurisdictions require the licensing of gaming machine operators and manufacturers.

 

We manufacture and supply gaming equipment to various international markets including Australia, Canada, Malaysia, New Zealand, the Philippines, Russia and South Africa. We have obtained the required licenses to manufacture and distribute our products in the various foreign jurisdictions where we do business.

 

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Video Game Software

 

Japan.    No governmental entity in Japan is authorized to censor the content of computer entertainment software. The Computer Entertainment Supplier’s Association, or CESA, is a Japanese industry association that conducts market surveys, research and other activities to promote the computer entertainment software industry in Japan. CESA’s members are corporations and individuals engaged in projects relating to the development, manufacture and sale of computer entertainment software and organizations comprised of such individuals or organizations. We are a member of CESA and our Chief Executive Officer, Kagemasa Kozuki, had been the Chairman of CESA since its establishment in 1996 for three terms over six years.

 

The Computer Entertainment Rating Organization, or CERO, was established in 2002 and CERO started regulating home game software distributed in Japan through a rating system based upon the user’s age. CERO reviews expressions and contents of software based on its ethical guidelines upon request of software manufacturers. Expressions containing violence, anti-social behavior, sexual behavior and hazardous language or thought are subject to CERO’s rating. Each game software is categorized and labeled either as game software or educational/database software and those categorized as game software must label age classification mark based on the rating. CERO has adopted a four tiered game software age classification, including category “All Age” for persons all age, category “12” for persons 12 and older, category “15” for persons 15 and older and category “18” for persons 18 and older, thereby indicating that contents of each categorized software are subject to persons in categorized age group.

 

International.    The content of video game software is not subject to federal regulation in the United States. However, many video game software publishers comply with the standardized rating system established by the Entertainment Software Rating Board, or ESRB. The ESRB is an independent entity established in 1994. It rates video games, websites and online games and reviews advertising created by the video game industry. Video game software publishers such as us include ESRB ratings on their game software packages and Nintendo and Sony include the meanings of these ratings on their game console packages.

 

Pachinko Machines

 

Standards for pachinko machines are regulated under the Law Regulating Adult Entertainment in Japan. The Security Electronics Communication Technology Association is the only entity authorized to test new models of pachinko machines and determine whether such models meet certain specified technical criteria. Those who expect to produce new models are first required to pass such model test and then to obtain verification that such model complies with applicable standards from the prefectural Public Safety Commission in the prefecture in which such models would be distributed and operated.

 

Property

 

The following table sets forth information, as of March 31, 2006, with respect to our principal establishments:

 

Establishment


 

Location


 

Segment


 

Uses


  Book Value of
Machinery and
Equipment


    Land
Space


  Floor
Space


 

Tenure


                (millions of yen)     (square meters)    

Holding Company

  Chiyoda-ku, Tokyo   Holding Companu   Administrative   ¥ 40     —     4,234   Leased

Konami Digital Entertainment

 

Minato-ku, Tokyo

 

Digital Entertainment

 

Production, Sales, Administrative

  ¥ 2,692     129   20,777  

Leased

Konami Digital Entertainment Kobe Office

 

Nishi-ku, Kobe

 

Digital Entertainment

 

Production, Manufacturing, Administrative

  ¥ —   *   —     9,035  

Owned

 

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Establishment


 

Location


 

Segment


 

Uses


  Book Value of
Machinery and
Equipment


    Land
Space


  Floor
Space


 

Tenure


                (millions of yen)     (square meters)    

Konami Digital Entertainment Zama Office

 

Zama, Kanagawa

 

Digital Entertainment

 

Production, Manufacturing, Administrative

  ¥ *     —     7,854  

Owned

Konami Gaming, Inc., Japan Branch

 

Zama, Kanagawa

 

Gaming & System

 

Production, Manufacturing, Administrative

  ¥ —   *   —     1,489  

Owned

Game Software Company, Harumi Office

 

Chuo-ku, Tokyo

 

Digital Entertainment

 

Production, Administrative

  ¥ *     —     4,035  

Leased

Konami Sports & Life Co., Ltd.

 

Shinagawa-ku, Tokyo, and 209 locations

 

Health & Fitness

 

Fitness club

  ¥ 506     8,732   696,352  

Some owned and some leased

Konami Real Estate, Inc.

 

Shinjuku-ku, Tokyo and other

 

Other

 

Home Leasing

  ¥ *     700   1,409  

Owned

Konami Real Estate, Inc.

 

Nasu-gun, Tochigi

 

Other

 

Leader Training Facility

  ¥ 219     479,461   14,612  

Owned

Konami Real Estate, Inc.

 

Shinagawa-ku, Tokyo

 

Other

 

Office Leasing

  ¥ 9     41,932   92,830  

Owned

Konami Digital Entertainment, Inc.

 

Los Angeles, California, U.S.A.

 

Digital Entertainment

 

Sales, Administrative

  ¥ 623     —     7,433  

leased

Konami Digital Entertainment GmbH

 

Frankfurt, Germany (primary location)

 

Digital Entertainment

 

Sales, Administrative

  ¥ 67     —     4,582  

Leased

Konami Digital Entertainment B.V.

      
London, U.K.
      
Digital Entertainment
      
Sales, Administrative
  ¥ 9     3,440   1,670  

Owned

Konami Gaming, Inc.

  Las Vegas, Nevada, U.S.A.   Gaming & System   Production and sales of gaming machines   ¥ 24     —     10,605   Leased

Konami Australia Pty Ltd.

 

New South Wales, Australia

 

Gaming & System

 

Production and sales of gaming machines

  ¥ —       —     7,753  

Leased


*   Konami Digital Entertainment Japan manages and controls Machinery and Equipment.

 

In addition to the above facilities, we lease floor space in office buildings in various locations around the world including Japan, China, the United States and Europe.

 

Legal Proceedings

 

We are involved in a number of actions and proceedings in Japan and overseas in the ordinary course of our business. However, we are not involved in any legal or arbitration proceedings, nor, so far as our Directors are aware, are there any legal or arbitration proceedings pending or threatened involving us that, if determined adversely to us, would individually or in the aggregate have a material adverse effect on us or our financial condition and results of operations.

 

Breakdown of Total Revenues by Category of Activity and Geographic Market

 

See Item 5.A of this annual report.

 

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C.    Organizational Structure.

 

The table below shows our principal subsidiaries (companies in which we hold, directly or indirectly, more than 50% of the issued share capital and where we exercise control) and affiliates (companies in which we hold, directly or indirectly, 20-50% of the issued share capital and where we have significant influence) as of March 31, 2006. Except where stated otherwise, each of these companies is accounted for as a consolidated subsidiary. The issued share capital of each of these companies is fully-paid.

 

Name


 

Registered office


 

Issued share

capital

(in millions)


  Shares held
by us,
directly or
indirectly
(%)


 

Principal

business


 

Establishment
date


In Japan

                     

Konami Digital Entertainment Co., Ltd.

 

Chiyoda-ku, Tokyo

  ¥ 26,000   100  

Plan, produce, manufacture and sell video game software, toys, card games, video games for amusement facilities, online games, content, for mobile phones, music and video package products, books and magazines.

 

March 2006

KPE, Inc.

  Minato-ku, Tokyo   ¥ 100   100   Sales of pachinko LCDs   June 1997

Konami Sports & Life Co., Ltd.

 

Shinagawa-ku, Tokyo

  ¥ 5,040   100  

Operation of fitness clubs and sales of fitness equipment

 

March 1973

Konami Real Estate, Inc.

  Chuo-ku, Tokyo   ¥ 10,000   100   Real estate management   December 1987

Konami School, Inc.

  Chuo-ku, Tokyo   ¥ 80   100   Development and education of creators   August 2003

Konami Career Management, Inc.

 

Chuo-ku, Tokyo

  ¥ 60   100  

Recruitment of human resources

 

October 1995

The Club At Yebisu Garden Co., Ltd.

 

Meguro-ku, Tokyo

  ¥ 200   70  

Operation of fitness clubs

 

January 1994

HUDSON SOFT CO., LTD.

  Chuo-ku, Tokyo   ¥ 5,064   54   Development of video game, mobile and online game software   May 1973

Internet Revolution, Inc.

  Minato-ku, Tokyo   ¥ 1,250   70   Operation of portal site   February 2006

Resort Solution, Inc. (1)

  Shinjuku-ku, Tokyo   ¥ 3,948   20   Operation of golf courses, hotels and resorts   February 1931

One other company

                     

Overseas

                     

Konami Digital Entertainment, Inc.

 

Los Angeles,
California, U.S.A.

  U.S.$ 21.5   100  

Sales of video game software, toys and hobby products and production and sale of amusement games

 

November 1982

Konami Gaming, Inc.

  Las Vegas, Nevada, U.S.A.   U.S.$ 25.0   100  

Production and sales

of gaming machines

  February 1997

Konami Corporation of America

 

Redwood City, California, U.S.A.

  U.S.$ 35.5   100  

Holding company

 

October 1996

Hudson Entertainment, Inc.

  San Mateo, California, U.S.A.   U.S.$ 1.0   54   Production of network contents   October 2003

 

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Name


 

Registered office


 

Issued
share

capital

(in millions)


  Shares held
by us,
directly or
indirectly
(%)


 

Principal

business


 

Establishment
date


Konami Digital Entertainment of Europe B.V.

 

Amsterdam, Netherlands

  9.0   100  

Holding company, production and sale of toys and hobby products

 

November 1997

Konami Digital Entertainment GmbH

 

Frankfurt am Main, Germany

  5.1   100  

Sales of video game software

 

December 1984

Konami Digital Entertainment Limited

 

Queen’s Road Central, Hong Kong, China

  HK$ 19.5   100  

Sales of video game software and

amusement arcade games and sales of toys and hobby products

 

September 1994

Konami Software Shanghai, Inc.

 

Xi Zang Zhong Road, Shanghai, China

  U.S.$ 2.0   100  

Development of

video game software

 

June 2000

Konami Australia Pty Ltd.

  New South Wales, Australia   A$ 3.0   100   Production and sales of gaming machines   November 1996

One other company

                     

(1)   It is accounted for by the equity method.

 

D.    Property, Plants and Equipment.

 

The information required by this item is set forth in Item 4.B of this annual report.

 

Item 4A.   Unresolved Staff Comments

 

We are a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934. There are no written comments which have been provided by the staff of the Securities and Exchange Commission regarding our periodic reports under that Act not less than 180 days before the end of the fiscal year ended March 31, 2006 and which remain unresolved as of the date of the filing of this Annual Report with the Commission.

 

Item 5.   Operating and Financial Review and Prospects.

 

A.    Operating Results.

 

You should read the following discussion of our financial condition and results of operations together with our consolidated financial statements and other information included in this annual report. Fiscal 2006 herein refers to the fiscal year ended March 31, 2006, and other fiscal years are referred to in a corresponding manner.

 

This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under Item 3.D and elsewhere in this annual report.

 

Overview

 

We are a global entertainment products, health products and services provider. We publish and distribute video game software for use by customers with home and handheld video game systems, principally those manufactured by Sony and Nintendo and also produce and distribute Internet-based entertainment contents. We

 

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also offer a variety of other digital entertainment products by producing toys, including card games, and producing, manufacturing and distributing amusement games and token-operated games for amusement arcades. Some of these products use characters from or inspired by characters in our home video game software and other products. Since February 2001, we have also run the largest chain of fitness clubs in Japan. Furthermore, we produce and market a variety of entertainment and exercise machines and components, including fitness machines, gaming machines and LCDs for pachinko machines . We earn revenues and income and generate cash from sales of these products and services.

 

Through fiscal 2006, we divided our worldwide operations principally into three business segments for financial reporting purposes: Digital Entertainment, Health & Fitness and Gaming & System. The net revenue of these segments, before elimination of intersegment revenues, accounted for 63.0%, 31.0% and 4.1%, respectively, of our total net revenues, in fiscal 2006. Our consolidated net revenue for fiscal 2006 was ¥262,137 million.

 

With the increasing use of the Internet and the enhancement of digital technology, differences among businesses in the digital entertainment industry have been disappearing. The recent emergence of the online game market is further intensifying this trend. In this environment, in order to respond to diversifying customer needs, in April 2005, we merged , in addition to our three home-use video game software production consolidated subsidiaries, Konami Computer Entertainment Studios, Inc., Konami Computer Entertainment Tokyo, Inc. and Konami Computer Entertainment Japan, Inc., and also Konami Online, Inc., which engaged in the planning, production and distribution of mobile and online games and Konami Media Entertainment, Inc., which engaged in the music and publication business with and into Konami. Furthermore, in April 2005, we re-positioned five of our businesses, Computer & Video Games, Toy & Hobby, Amusement, Online and Multimedia, as Digital Entertainment Businesses, and set up a framework to maximize the synergies among these businesses. With this new focus, we reorganized our business into three segments: the Digital Entertainment segment, Health & Fitness segment and Gaming & System segment.

 

Due to the nature of the entertainment industry, our results of operations have largely been, and will to a considerable extent remain, affected by individual products or a series of products that are hits with consumers such as video game software and card game. See “ Factors Affecting Our Results of Operations—Hit Products.” We have been working to reduce volatility in our results by building a solid and well-balanced business portfolio with multiple segments, featuring a growing number and variety of products and services. We are also diversifying our revenue sources by expanding our businesses overseas. Our Digital Entertainment segments have been active in the North American and European markets and our Gaming & System segment has actively developed its operations in the North American market, the biggest gaming market in the world.

 

The entertainment industry in Japan has been expanding, reflecting an increasing social recognition of the importance of developing intellectual property and the rapid advance of technology.

 

Within the Japanese entertainment industry, the video game software industry has become increasingly competitive and more hit products-oriented, with the size of the market fluctuating depending on the number of hit products produced and distributed in a given year. The toy industry in Japan faces problems, including a declining birthrate, children growing out of toys at younger ages due to earlier maturity, a decrease in disposable incomes due to the sluggish economy and an increase in spending on other entertainment. The toy industry is holding firm, however, without any sharp decline in sales, due to an increase in expenditures per child and an increase in demand for toys targeting adults in line with the aging of society. The amusement arcade industry has been sluggish, reflecting intensifying competition with other entertainment options, but it has recovered recently due primarily to the development of large-size amusement arcades that attract new consumers. Also, with the increasing use of the Internet and the advancement of digital technology, the mobile phone and online game market has been expanding as a new entertainment business.

 

The Japanese health industry in which our Health & Fitness segment operates has been developing gradually with an increasing demand for health-related services among middle-aged and senior consumers.

 

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As a result of sluggish domestic markets in some of our business segments, we have been aggressively expanding overseas, taking advantage of opportunities for growth in foreign markets, such as North America and Europe, and we are increasingly dependent on our overseas business. For example, in the sports video game category, soccer titles such as the Winning Eleven series, including WORLD SOCCER Winning Eleven 9 and Pro Evolution Soccer 5, gained popularity in Japan and Europe and recorded sales of 5.8 million units worldwide in fiscal 2005 and over 7 million units in fiscal 2006. We seek to continue expanding our business by introducing products that were hits in the Japanese market into overseas markets, as well as developing and introducing products that reflect the unique customer preferences and the competitive environment in each market.

 

Our main business strategies for each segment are as follows:

 

    Digital Entertainment Segment

 

In our Computer & Video Games business, we are striving to strengthen our content lineup and make it attractive to customers not only in Japan, but also worldwide in North America, Europe and Asia, by developing products that respond to the characteristics of each market.

 

In our Toy & Hobby business, we aim to develop globally and be on the cutting edge with unique innovative products in new markets, utilizing our strength in software, IT and content.

 

In our Amusement business, we plan to further enhance our e-AMUSEMENT” service, which links amusement arcades throughout Japan, by strengthening existing content.

 

In our Online business, we plan to continually provide “intangible” service, the new value made possible by the Internet, by planning, producing, operating and distributing Internet-based entertainment contents, including mobile games and PC online games.

 

In our Multimedia business, we mainly publish game-related guides and plan, produce, manufacture and distribute game-related music CD’s and DVD’s. We aim to provide products that are unique to Konami and can be appreciated by a wide range of customers in the publication, music and video industries.

 

    Health & Fitness segment

 

In the Health & Fitness segment, we are focusing on improving the quality of our services, rather than giving discounts, by offering a wide range of health-related value-added services in order to develop our operations effectively.

 

    Gaming & System segment

 

In the Gaming & System segment, we aim to increase our revenue through development of competitive slot machines, better services for clients and improvement of client training for our casino management systems.

 

Factors Affecting Our Results of Operations

 

Factors Affecting Combined Results of Operations

 

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

 

Hit Products

 

Most of our non-fitness related revenues come from sales of entertainment software and devices and are dependent on our ability to anticipate or influence the kinds of games and products that are popular with consumers. Revenues for our Digital Entertainment and Gaming & System segments are strongly affected by

 

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whether individual products or a series of products become “hits” with consumers. A single hit product can generate very substantial revenues, which can continue over an extended period through the release of sequel products and through expansion and extension of the concept or characters from a popular games.

 

Previously, our strategy was to develop a large number of titles for various platforms, in order to limit fluctuations in sales. However, due to recent changes in the business environment, such as the spread of online games, and our expansion into overseas markets, we have decided to adopt a new strategy of increasing revenues for each title through streamlining and enhancing the versatility of our content. Accordingly, we are cutting the number of titles through a process of “Selection and Concentration,” which we expect will provide a more consistent stream of revenues from each hit title. We have also decreased the volatility of our net revenues by entering the fitness club business, which we believe will provide a more stable base of revenue.

 

Intellectual Property Licensing

 

One means we use to increase the likelihood that our products will succeed is licensing the right to utilize ideas and images from popular culture, such as comic book characters, sports and entertainment personalities and high visibility events. Thus, to some extent our revenues are dependent on successful identification and acquisition of rights to popular ideas and images. We have steadily increased the number of intellectual property licenses we hold to 332 licenses in fiscal 2006.

 

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

 

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

 

Seasonal Fluctuations

 

Many of our products are in the greatest demand from November to January. These months correspond to the periods of children’s school holidays, and it is customary in Japan to buy such products as Christmas and New Year presents in December and January. In addition, demand in the U.S is highest from November, starting with Thanksgiving and through the Christmas season. However, our earnings may not necessarily reflect the seasonal patterns of the industry as a whole as a result of increased sales due to the occurrence of various sports events or the release of “hit” titles.

 

Investments and Acquisitions

 

We have sought growth and diversification through investments and acquisitions in sectors that are expected to result in increased revenue stability and growth. These investments and acquisitions affected the composition of our assets and liabilities and our results of operations, sometimes materially. Among other things, we recognized an increase in the amount of goodwill and intangibles with indefinite life on our consolidated balance sheet in connection with such acquisitions, which we test for impairment at least on an annual basis—see “ Critical Accounting Policies—Valuation of Intangible Assets and Goodwill”.

 

Due to changes in our business environment, we have reviewed our capital relationships with affiliates.

 

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In particular, we have conducted the following transactions:

 

    Sale of 23.0% of the common stock of TAKARA Co., LTD.(“Takara”), which we had acquired in fiscal 2001 and 2002, in April 2005, for which we realized a gain on sale of ¥6,917 million in the first quarter of fiscal 2006.

 

    Consolidation of HUDSON SOFT CO., LTD. (“Hudson”), which was previously an affiliate accounted for by the equity method after our acquisition of 45.5% of its common stock in fiscal 2002, in April 2005, due to a capital investment of ¥1,434 million whereby we increased our interest to 54.0%.

 

    Acquisition of 77.8% of the common stock of Konami Träumer, Inc. in fiscal 2004 and thereafter its merger with Konami in June 2005.

 

    Acquisition of 34.8% of minority interest of Konami Computer Entertainment Studios, Inc., 36.9% of the minority interest of Konami Computer Entertainment Tokyo, Inc. and 37.6% of minority interest of Konami Computer Entertainment Japan, Inc. and the merger of these companies with Konami in April 2005. We recognized goodwill of ¥13,348 million from the acquisition of the minority interests in these companies as a result of these transactions in fiscal 2006.

 

    Merger between Konami Sports Corporation and Konami Sports Life Corporation in February 2006, and acquisition of the remaining minority interest by share exchange in March 2006. We recognized goodwill of ¥6,596 million from the acquisition of minority interests in Konami Sports Corporation as a result of the transaction.

 

    Acquisition of 20.0% of the common stock of Resort Solution Co., Ltd. in March, 2006, through which it became an affiliate accounted for by the equity method.

 

Foreign Currency Fluctuations

 

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

 

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

 

We use foreign exchange forward contracts to manage foreign exchange exposure associated with short-term movements in exchange rates applicable to our payable commitments and receivables that we expect to pay or receive in foreign currencies. Changes in the fair values of our foreign exchange forward contracts are recognized as gains or losses on derivative instruments in our income statement. For a more detailed discussion of these instruments, you should read Item 11 herein and Note 17 to our consolidated financial statements included in this annual report.

 

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Factors Affecting Results of Business Segments

 

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

 

Digital Entertainment Segment

 

Net Revenues.    In our Digital Entertainment segment, in addition to the production and distribution of video game software for home and handheld game platforms, personal computers, and we are engaged in the production and sales of card games and boys’ toy products, the development, manufacturing and maintenance of video arcade games and token-operated games for amusement arcades, the production and distribution of software for mobile phones and online network, the production and sale of books and music of our products, as well as the planning and production of original TV animation.

 

Our video game software is sold mainly in the format of DVD-ROMs or proprietary discs for home video game platforms such as Sony PlayStation 2, Nintendo GameCube and Microsoft Xbox 360 and ROM-cartridges and other media for handheld video game platforms such as the Game Boy Advance, Nintendo DS and PlayStation Portable.

 

Our sales of video game software are strongly influenced by our ability to develop or acquire popular game content. See “—Factors Affecting Combined Results of Operations—Hit Products, Intellectual Property Licensing.” For instance, sales of video game software are significantly affected by sales volumes of video game systems. The potential market for a software product designed for a particular video game system is determined by the total number of such video game systems purchased by consumers, a number which is sometimes referred to as the “installed base” of such video game systems. When new hardware systems are introduced, we may experience a temporary decline in net sales attributable to video game software until we are able to produce one or more hit products that utilize the increased capabilities of the new hardware.

 

The home video game industry is characterized by rapid technological changes, which have resulted in successive introductions of increasingly advanced game consoles. As a result of the rapid technological shifts, no single game console has achieved long-term dominance in the home video game and computer game market. To respond to these rapid shifts in video game hardware technology, it is necessary for us to continually anticipate game console cycles, time our product pipeline so that we do not publish games for hardware that is no longer popular, and develop software programming tools necessary for emerging hardware systems.

 

Our net revenue sales from card games and toys are principally affected by our identification and acquisition of rights to characters of popular comic books and TV programs, our ability to produce unique games, the number of children in the population, the timing of market entry, market competition, lifecycle of products and general economic trends. The toy industry in Japan is now faced with such issues as a decline of birthrates, young children’s shift away from toys due to their maturing at a younger age, and an increase in household expenses for children or other amusement purposes. However, the toy industry has not experienced a rapid decline in sales, but has continued a steady growth because of an increase in expense spent per child and a growing demand for toy products for adults along with an ageing society. In response, in order to maintain the balance of our business portfolio and to make our lineup of products more attractive, we strive to diversify products targeted to the Japanese market, especially boys’ toy products. For instance, we enhanced our reputation through sales of various action figures and others such as toys of SAZER X, a popular SF action hero TV program.

 

Net revenues from amusement arcade games are affected by market acceptance, the number and size of video arcades in Japan, introduction of hit titles and general economic trends. In addition, our e-Amusement service, which links amusement arcade machines throughout Japan online, is influenced by market acceptance of network-based interactive games, network stability, which is the backbone of our services, and general economic trends. In addition to creating new games, we believe that we may be able to increase margins and in this business by extending the life cycle of our existing arcade games by continuing to provide stable services after

 

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purchases of our machines. We also continue to benefit from sales of token-operated machines in Japan, mainly due to strong sales of G I-HORSEPARK, a series of G I-TURF WILD, FantasticFever 2. We are proud of being one of the leading companies in the token-operated machine industry in Japan. Because the arcade game industry in Japan continues to be streamlined, the average scale of each amusement arcade is expanding along with a decrease in the number of amusement arcades. Accordingly, large-scale token-operated machines that attract a large number of customers have a tendency to gain popularity within large amusement arcades.

 

Our online services are affected by market acceptance of network-based interactive games, the number of mobile phone and Internet users, network system stability, which is the backbone of our services, and general economic trends. We make every effort to strengthen stability of our network-based services through such measures as server maintenance and improved stress tests.

 

We are engaged in publishing books and in the production and sales of music and video software. Such sales are influenced by market acceptance of each media, our ability to select, find and develop attractive contents and general economic trends. The sale of books and magazines in Japan has remained flat, and the value of audio record shipments has continued to decline. On the other hand, the market for video software continues to expand. In particular, the widespread use of DVD players has driven strong growth in the sale and rental of DVD software. Thus, the markets for books, music and video are largely shaped by developments such as an increase in digitalization and in content distribution via the Internet and mobile phones. We are focused on maintaining stable sales of books on strategy for our game software, and are working on improvement of contents through identifying and developing new artists in the music business and planning and producing original animation.

 

Expenses.    Costs and expenses that we incur in the development of new video game software are expensed as research and development costs until such games reach technological feasibility, at which point we begin to capitalize the expenses. We expense capitalized costs to cost of revenues upon commercial release, as the commercial life of our software for home video game platforms is of short duration.

 

The rapid technological advances in home game consoles have significantly changed the software development process. The process of developing software for the new 128-bit consoles is extremely complex and we expect the process to become even more complex and expensive with the advent of more powerful next-generation game consoles. Our cost of revenues from software also includes the costs of licenses from content licensors. While some of our content licenses include prepaid or guaranteed royalties, most of the royalties we pay are on a revenue basis. We amortize the cost of prepaid royalties based on the number the associated products sold. We evaluate the future recoverability of any prepaid royalties and capitalized software development costs on a regular basis based on actual title performance. We expense as part of product development costs those capitalized costs that we deem unrecoverable.

 

Card games have historically shown a higher margin than other toy products due to their relatively low manufacturing costs. Costs include raw material costs, manufacturing outsourcing, licensing, research and development and administrative costs. Furthermore, because our card games and toys business is typically based on previously developed intellectual property, research and development costs are comparatively low.

 

As for amusement arcade games and token-operated games, we incur more limited cost of parts and raw materials and therefore have higher margins when we provide new game software contents for existing machines rather than selling new machines, because of lower cost of parts and raw materials. We are currently working on further improving margins in our Amusement business through the introduction of less expensive Network-linked amusement arcade games such as “e-AMUSEMENT” and other measures to decrease production costs.

 

Our cost of services rendered for mobile phones and personal computers game content consists of expenses incurred in the development of content, maintenance expenses for servers in our online services and service charge collection fees. We capitalize development and production costs in the same manner as for video game software for home video game platforms and then amortize such costs as cost of services rendered for a period of two to three years or based on the expected length of services.

 

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Costs and expenses related to publishing books, producing music and broadcasting original animation on television are comprised mainly of costs to produce contents, costs paid for royalties on copyrights and royalties paid. Products in this business mainly use intellectual property rights that were developed in the past. As a result, thus research and development costs of our multimedia business are comparatively low.

 

Health & Fitness Segment

 

Net Revenues.    We are the largest fitness club operator in Japan according to the Leisure Paper issued by the Japan Productivity Center for Socio-Economic Development. We also design, manufacture and sell fitness-related games and exercise machines. As of March 31, 2006, we operated 209 fitness clubs that collectively served approximately 960,000 members. Our Health & Fitness segment had ¥81,209 million in net revenues or 31% of our total net revenue, before elimination of intersegment revenues, in fiscal 2006.

 

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

 

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

 

Although we have not achieved expected growth, we expect to continue to increase revenues through club and membership growth. We currently serve many, but not all, of the major cities in Japan. We plan to extend our reach into new geographic markets until we cover all of Japan.

 

We have taken actions to create a more powerful brand. To cement our position as the No. 1 brand in the fitness club industry in Japan, we unified our collection of brands, including Egzas and PEOPLE, into a single brand: Konami Sports club, thereby strengthening our brand recognition and providing more sophisticated facility services, as part of our continuous efforts to improve the retention rate of current customers. Improving the retention rate of customers of existing clubs is one of our major objectives as revenue growth of existing clubs is lower than newly opened clubs. In a move to improve customer convenience, we introduced new services and products such as a personal trainer system where an instructor with specialized knowledge provides individualized lessons for each customer. Furthermore, we launched the first official i-mode (internet enabled cellular phone) site in the fitness industry, which provides various club facility information and health related information. Going forward, we plan to offer an IT health management system that will enable comprehensive management of a person’s health, connecting the three aspects of daily health and lifestyle—the fitness club, the home and outside the home.

 

Also, we focus more on improving the quality of our services than on reducing our prices in order to compete efficiently. For example, we offer value-added services such as spa and massage in our fitness clubs for extra charges. Also, we offer events and tours such as Honolulu Marathon tours and ski tours in which our members can participate. As a result of such efforts, the average amount spent per customer increased in fiscal 2006.

 

Our Health & Fitness segment develops fitness-oriented games and fitness machines for home use by our customers and fitness machines with entertainment quality, principally for our Konami Sports fitness clubs. In fiscal 2005, we completed a full lineup of our fitness machines, such as the “EZ series”, and these machines are now in our Konami Sports fitness clubs. We also have several new machines in various stages of development.

 

In fiscal 2004, our fitness-related game and fitness equipment business launched, a fitness game software that enables working out while enjoying exercising at home.

 

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In fiscal 2005, we launched Refreshment bike, a fitness machine for home use with functions designed to generate high concentrations of oxygen and minus ions, Kenshin Keikaku, software that displays and manages exercise data saved on e-walkeylife, a multi-function pedometer, and FLAVANGENOL UP50 and FLAVANGENOL MSMPLUS, an original supplement.

 

In fiscal 2006, we have launched FORCEDREP UPPER BODY, a facility-use fitness machine, featuring a high level of safety which automatically controls the load on a user’s body through six modes to fit any individuals’ training, and BODYSCAN network-connectable composition scale with high accuracy. Also, we began to distribute our original supplements, EXERDIET and Konami Sports Club BLACKCURRANT.

 

Expenses.    Operating expenses for our Health & Fitness segment include, for our health and fitness club business, leases for facilities, salaries for trainers and other club employees, costs of fitness machines and other equipment, utilities charges, marketing expenses, costs for maintaining the facilities and depreciation. Upon opening a new fitness club, we often experience an initial period of operating losses with respect to that club for the first year. However, this period can vary depending on the individual club , and may be substantially longer than a year. However, since most of our expenses are fixed, operating margins tend to improve significantly with respect to each club as membership increases. Expenses for our fitness-related game and fitness equipment business are largely related to cost of parts and raw materials, manufacturing costs and research and development expenses.

 

In fiscal 2006, we recognized impairment losses of ¥19,713 million related to our Health & Fitness segment, consisted of long-lived assets of ¥10,533 million and identifiable intangible assets of ¥9,180 million as a result of our annual impairment assessment. For long-lived assets, 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 Konami. These impairment losses for long-lived assets were attributed to the deterioration of the operating performance of certain club locations. For identifiable intangible assets, 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 for intangible assets were attributed to the segment’s failure to meet previous growth expectations and the cancellation of certain franchise contracts due to our review of such contracts during 2006.

 

Gaming & System Segment

 

Net Revenues.    In fiscal 2006, net revenues from the Gaming & System segment, before elimination of intersegment revenues, were ¥10,623 million, accounting for 4.1% of consolidated net revenues. The main revenue source for the Gaming & System segment is the sale of video slot machines and software contents in Australia and sales of videos, mechanical slot machines, casino management systems and software contents in North America. Revenues for the Gaming & System segment are affected by the timing of the introduction of products, timing of regulatory approvals in various markets, the ability to penetrate into foreign gaming markets, the number of gaming players, gaming regulations in relevant markets, our competitiveness in these markets, the average product life cycles and general economic trends.

 

Our sales of gaming machines are conducted overseas, primarily in North America and in Australia. Casinos are authorized to operate in more than 130 countries, and the number of countries authorizing casinos has been increasing each year according to the Tokyo Metropolitan Government, Bureau of Industrial and Labor Affairs. We believe that the market will continue to grow in 2007.

 

Konami Australia Pty Ltd, which has licenses for sales and manufacturing of gaming machines in all Australian states, markets gaming machines, focusing on our main product ES series. Additionally, we are actively promoting the K2V series, a new platform which was released in fiscal 2006. Although the dominance of the largest player in the Australian gaming markets has made it difficult for us to become a market leader quickly, we have gained a stable position in the Australian market as one of the other main gaming machine

 

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sellers and manufacturers. We believe the Australian gaming market is mature and has been leveling off, due in part to regulations limiting the maximum number of gaming machines allowed in each state, and we do not expect our sales of gaming machines in Australia to expand substantially in the future unless there is a major change in the nature or regulation of the market. As one source of potential overseas expansion, we are planning to gain a license for gaming in South Africa.

 

In North America, the largest gaming machine market in the world, we currently hold licenses to manufacture and sell gaming machines in major states and sell gaming machines to major Native American casinos. We participated in the Global Gaming Expo in September 2005, and advertised the expansion of our product line by exhibiting our products, including the new K2V series and our casino management systems.

 

In contrast to Australia, we believe demand for gaming machines in North America has been increasing. Also, following acquisition of a license in New Jersey, one of the largest gaming markets in North America, in August 2004, we are currently working to acquire additional licenses, mainly in Oklahoma, New Mexico and Alberta in Canada. Considering that there are ongoing plans to legalize casinos in Pennsylvania, if we are able to also receive product approvals, we expect to further expand our sales in the North American market. In order to meet increasing demand, we have built a new gaming machine facility in Las Vegas which commenced operations in June 2005, and which has significantly increased our production capacity compared to our previous facility.

 

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

 

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Results of Operations

 

The table below shows our consolidated statements of income for the periods indicated:

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

NET REVENUES:

                                

Product sales revenue

   ¥ 196,136     ¥ 183,030     ¥ 186,875     $ 1,590,832  

Service revenue

     77,276       77,661       75,262       640,691  
    


 


 


 


Total net revenues

     273,412       260,691       262,137       2,231,523  
    


 


 


 


COSTS AND EXPENSES:

                                

Costs of products sold

     115,229       114,547       112,613       958,653  

Costs of services rendered

     63,953       65,816       72,131       614,038  

Impairment of long-lived assets and other intangible assets

     —         —         19,713       167,813  

Selling, general and administrative

     53,517       52,192       55,199       469,899  
    


 


 


 


Total costs and expenses

     232,699       232,555       259,656       2,210,403  
    


 


 


 


Operating income

     40,713       28,136       2,481       21,120  
    


 


 


 


OTHER INCOME (EXPENSES):

                                

Interest income

     488       518       716       6,095  

Interest expense

     (865 )     (971 )     (1,137 )     (9,679 )

Gain on sale of shares of an affiliated company

     —         563       6,917       58,883  

Other, net

     (229 )     (804 )     (539 )     (4,588 )
    


 


 


 


Other income (expenses), net

     (606 )     (694 )     5,957       50,711  
    


 


 


 


INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND EQUITY IN NET INCOME (LOSS) OF AFFILIATED COMPANIES

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

INCOME TAXES:

                                

Current

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

Deferred

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


 


 


 


Total

     18,035       7,902       (10,270 )     (87,426 )

INCOME BEFORE MINORITY INTEREST AND EQUITY IN NET INCOME OF AFFILIATED COMPANIES

     22,072       19,540       18,708       159,258  

MINORITY INTEREST IN INCOME (LOSS) OF CONSOLIDATED SUBSIDIARIES

     2,220       2,761       (4,267 )     (36,324 )

EQUITY IN NET INCOME (LOSS) OF AFFILIATED COMPANIES

     252       (6,293 )     33       281  
    


 


 


 


NET INCOME

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


 


 


 


 

Comparison of Fiscal 2006 with Fiscal 2005

 

Net Revenues

 

Net revenues increased by ¥1,446 million, or 0.6%, to ¥262,137 million for fiscal 2006 from ¥260,691 million for fiscal 2005, due primarily to a increase in sales of the Digital Entertainment segment resulting from ¥1,605 million or 1.0% of increase in sales to ¥165,276 million, before elimination of intersegment revenues, or 63.0% of the total net revenues. In our Computer & Video Games business, the WORLD SOCCER Winning Eleven series recorded solid sales, with sales of more than 7 million units including all the series released during

 

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the period. In our Toy & Hobby business, we continued to achieve strong sales of card games with sales of the Yu-Gi-Oh! Trading Card Game series remaining at the same level, reflecting increased sales in Japan that offset decreased sales in the U.S. and Europe. In the Amusement business, MAH-JONG FIGHT CLUB, a series of titles incorporating the “e-AMUSEMENT” service and QUIZ MAGIC ACADEMY III received favorable reviews. Sales of the Health & Fitness increased by ¥2,103 million, or 2.7%, to ¥81,209 million for fiscal 2006 from fiscal 2005, whereas, sales of the Gaming & System segment decreased by ¥1,020 million, or 8.8%, to ¥10,623 million. We consolidated the results of operations of Hudson in the Digital Entertainment segment for the first time in fiscal 2006. Excluding the effect of Hudson, net revenues decreased by ¥8,808 million or 3.4%, to ¥251,883 million for fiscal 2006 from ¥260,691 million for fiscal 2005 due primarily in the Computer & Video Games business to fewer releases of major software titles in fiscal 2006 due to the transition period to develop toward new game consoles, which were partially offset by the positive effect to the yen based net revenues due to fluctuation in foreign currency exchange rates, especially the yen-U.S. dollar rate. For additional information regarding the increases and decreases in sales for each segment, see “—Segment Information.”

 

Cost of Revenues

 

Cost of revenues, which is the sum of costs of products sold and costs of services rendered, increased by ¥4,381 million, or 2.4%, to ¥184,744 million for fiscal 2006 from ¥180,363 million for fiscal 2005. Excluding the effect of Hudson, cost of revenues decreased by ¥1,368 million, or 0.8% to ¥178,995 million for fiscal 2006 from ¥180,363 million for fiscal 2005 due primarily to a decrease of sales. We were also able to reduce our cost of revenues, as a result of our “Selection and Concentration policy” whereby we are streamlining our titles to concentrate on those which provide the most versatility in terms of content and relatively high and consistent revenues, especially in our Digital Entertainment segment.

 

Impairment of long-lived assets and goodwill

 

We recorded pre-tax impairment charges of ¥10,533 million reducing goodwill balances related to our Health & Fitness operations for the year ended March 31, 2006. The impairment charged related to club locations with operating performance that deteriorated in the current year. In addition, we also recorded impairment charges reducing the intangible asset balances related to our Health & Fitness operations in the amount of ¥9,180 million. See”—Critical Accounting Policies—Valuation of Intangible Assets and Goodwill”.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased by ¥3,007 million, or 5.8%, to ¥55,199 million for fiscal 2006 from ¥52,192 million for fiscal 2005, due primarily to an addition of Hudson as a consolidated subsidiary from fiscal 2006.

 

Operating Income

 

As a result of the foregoing, our operating income decreased by ¥25,655 million, or 91.2% to ¥2,481 million for fiscal 2006 from ¥28,136 million for fiscal 2005. As a percentage of net revenues, operating income decreased 9.9% to 0.9% in fiscal 2006 from 10.8% in fiscal 2005.

 

Other Income (Expenses), net

 

Other income (expenses), net, increased by ¥6,651 million to income of ¥5,957 million for fiscal 2006 from expense of ¥694 million for fiscal 2005, due to a gain on sale of entire shares of Takara, previously an equity-method affiliate in fiscal 2006, in the amount of ¥6,917 million

 

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

 

As a result of the foregoing, our income before income taxes, minority interest and equity in net income (loss) of affiliated companies decreased by ¥19,004 million, or 69.3%, to ¥8,438 million for fiscal 2006 from ¥27,442 million for fiscal 2005.

 

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Income Taxes

 

Income taxes decreased by ¥18,172 million to a tax benefit of ¥10,270 million for fiscal 2006 from tax expense of ¥7,902 million for fiscal 2005, due primarily to a reversal of accrued income taxes to reflect the benefit derived from the tax deduction recognized upon the completion of the reorganization into a holding company structure, in the amount of ¥17,051 million, and to a decrease in income before income taxes of ¥19,004 million. As a result, the effective tax rate decreased by 150.5% to (121.7%) in fiscal 2006 from 28.8% in fiscal 2005.

 

Minority Interest in Income (Loss) of Consolidated Subsidiaries

 

Minority interest in income (loss) of consolidated subsidiaries decreased by ¥7,028 million to a loss of ¥4,267 million for fiscal 2006 from income of ¥2,761 million for fiscal 2005, due primarily to impairment losses on long-lived assets and identifiable intangible assets in the Health & Fitness segment, and the effect of the additional acquisition of equity interests in and merger on April 1, 2005 with Konami Computer Entertainment Studios, Inc., Konami Computer Entertainment Tokyo, Inc., and Konami Computer Entertainment Japan, Inc.

 

Equity in Net Income (Loss) of Affiliated Companies

 

Equity in net income (loss) of affiliated companies increased by ¥6,326 million to a profit of ¥33 million for the fiscal 2006 from a loss of ¥6,293 million for fiscal 2005, due primarily to sales of our entire shares of and termination of equity relationship with Genki Co., Ltd. (“Genki”), an equity-method affiliate for fiscal 2005 and Takara, previously an equity-method affiliate. Hudson, previously an equity-method affiliate, became a consolidated subsidiary in fiscal 2006. Takara and Hudson had incurred equity loss for fiscal 2005.

 

Net Income

 

As a result of the foregoing, our net income increased by ¥12,522 million, or 119.4%, to ¥23,008 million for fiscal 2006 from ¥10,486 million for fiscal 2005.

 

Comparison of Fiscal 2005 with Fiscal 2004

 

Net Revenues

 

Net revenues decreased by ¥12,721 million, or 4.7%, to ¥260,691 million for fiscal 2005 from ¥273,412 million for fiscal 2004, due primarily to a decrease in sales of the Toy & Hobby business resulting from decreased sales of the Yu-Gi-Oh! Trading Card Game from ¥49,500 million to ¥32,600 million, which more than offset a total increase in sales of the Computer & Video Games business, Amusement business and Gaming & System segments. For additional information regarding the increases and decreases in sales for each segment, see “—Segment Information.”

 

Cost of Revenues

 

Cost of revenues, which is the sum of costs of products sold and costs of services rendered, increased by ¥1,181 million, or 0.7%, to ¥180,363 million for fiscal 2005 from ¥179,182 million for fiscal 2004, due primarily to a decrease in sales of the low-cost Yu-Gi-Oh! Trading Card Game, as the increase in revenues from higher-cost products and services and an increase in personnel costs in the Health & Fitness segment more than offset a decrease in cost of the Yu-Gi-Oh! Trading Card Game.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased by ¥1,325 million, or 2.5%, to ¥52,192 million for fiscal 2005 from ¥53,517 million for fiscal 2004, due primarily to a decrease of ¥710 million in advertising expenses.

 

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Operating Income

 

As a result of the foregoing, our operating income decreased by ¥12,577 million to ¥28,136 million for fiscal 2005 from ¥40,713 million for fiscal 2004. As a percentage of net revenues, operating income decreased 4.1% to 10.8% in fiscal 2005 from 14.9% in fiscal 2004.

 

Other Income (Expenses), net

 

Other income (expenses), net, increased by ¥88 million to ¥694 million for fiscal 2005 from ¥606 million for fiscal 2004, due to an increase in interest expense and increased losses associated with unfavorable currency exchange rates, which more than offset an increase in gain on sale of shares of affiliated companies.

 

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

 

As a result of the foregoing, our income before income taxes, minority interest and equity in net income (loss) of affiliated companies decreased by ¥12,665 million to ¥27,442 million for fiscal 2005 from ¥40,107 million for fiscal 2004.

 

Income Taxes

 

Income taxes decreased by ¥10,133 million to ¥7,902 million for fiscal 2005 from ¥18,035 million for fiscal 2004, due to a decrease in income before income taxes and to a reversal of deferred tax liabilities associated with the tax-free merger of our production subsidiaries back to us, which eliminated the temporary differences created by gains on sale of those subsidiary shares we previously recognized. As a result, the effective tax rate decreased by 16.2% to 28.8% in fiscal 2005 from 45.0% in fiscal 2004.

 

Minority Interest in Income (Loss) of Consolidated Subsidiaries

 

Minority interest in income (loss) of consolidated subsidiaries increased by ¥541 million to ¥2,761 million for fiscal 2005 from ¥2,220 million for fiscal 2004, due primarily to an increase in the net profits of Konami Computer Entertainment Tokyo, Inc., and Konami Computer Entertainment Japan, Inc., resulting from favorable sales of game software.

 

Equity in Net Income (Loss) of Affiliated Companies

 

Equity in net income (loss) of affiliated companies decreased by ¥6,545 million to a loss of ¥6,293 million for the fiscal year ended March 2005 from a profit of ¥252 million for fiscal 2004, due primarily to losses resulting from our interest in Takara and Hudson.

 

Net Income

 

As a result of the foregoing, our net income decreased by ¥9,618 million to ¥10,486 million for fiscal 2005 from ¥20,104 million for fiscal 2004.

 

Segment Information

 

Based on the applicable criteria set forth in Statement of Financial Accounting Standards No. 131, “Disclosures About Segments of an Enterprise and Related Information”, or SFAS No. 131, we have three reportable operating segments for which separate financial information is available and reported in our consolidated financial statements. Our chief operating decision maker regularly evaluates this data in deciding how to allocate resources and in assessing performance. The operating segments are managed separately as each segment represents a strategic business unit that offers different products and serves different markets. As

 

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required by SFAS No. 131, we present our business segment information in the accompanying consolidated financial statements as it is presented in reports to our management, derived from our U.S. GAAP financial statements.

 

Effective the first quarter ended June 30, 2005, we reorganized our five business segments into three: Digital Entertainment, Health & Fitness and Gaming & System. In accordance with this change, results for the year ended March 31, 2004 and for the year ended March 31, 2005 have been reclassified to conform to the presentation for the year ended March 31, 2006.

 

The following tables present net revenues, both including and excluding intersegment revenues, operating expenses and operating income (loss) for fiscal 2004, 2005 and 2006, by segment, which are the primary measures used by our chief operating decision makers to measure our operating results and to measure segment profitability and performance. The year-to-year comparisons following the tables discuss comparisons of net revenues, before elimination of intersegment revenues, operating expenses and operating income (loss) for each year.

 

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      7,121       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       11,643      6,271       260,691

Operating expenses

     131,018      77,059       10,201      14,227       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
    

  


 

  


 

 

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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
    

  


 

  


 

 

Comparison of Fiscal 2006 with Fiscal 2005

 

Digital Entertainment segment

 

Net revenues of our Digital Entertainment segment, before elimination of intersegment revenues, increased by ¥1,605 million, or 1.0%, to ¥165,276 million in fiscal 2006 from ¥163,671 million in fiscal 2005 due primarily to strong sales of business-use game machines for amusement arcades and increased net revenues from online services. Excluding the effect of Hudson, which was included in our Digital Entertainment segment for the first time in fiscal 2006, net revenues of our Digital Entertainment segment decreased by ¥8,649 million or 5.3%, to ¥155,022 million for fiscal 2006, from ¥163,671 million for fiscal 2005. This was primarily due to fewer releases of the major software titles in our Computer & Video Games business compared to fiscal 2005, as we have focused our efforts on developing new game consoles for release in the next transition period.

 

In addition, we recorded strong sales of the Winning Eleven series for PlayStation 2, Xbox, PlayStation Portable and PC, with total sales of over 7 million units worldwide. We also recorded solid sales of game music in North America, with more than 800 thousand units of the Dance Dance Revolution series, including Dance Dance Revolution EXTREME2. However, sales of our titles taken as a whole decreased to 22.21 million units in fiscal 2006 from 24.4 million in fiscal 2005, and sale of titles from third parties also decreased to 1.85 million units in fiscal 2006 from 2.3 million in fiscal 2005. On the other hand, revenues from all card games including the Yu-Gi-Oh! Series, with expanding sales in Japan offsetting decreased sales in the U.S. and Europe, remained almost the same level as the fiscal 2005 and amounted to approximately ¥33,000 million in fiscal 2006. With respect to games for amusement arcades, we recorded higher sales of the MAH-JONG FIGHT CLUB series, one of the e-AMUSEMENT products.

 

Operating expenses increased by ¥408 million, or 0.3%, to ¥131,426 million in fiscal 2006 from ¥131,018 million in fiscal 2005. This increase includes an increase in cost of revenues and an increase in selling, general and administrative costs resulting from consolidation of Hudson, which was previously an equity method affiliate. Excluding the effect of Hudson, operating expenses decreased by ¥8,940 million, or 6.8% to ¥122,078 million in fiscal 2006 from ¥131,018 million in fiscal 2005 due primarily to our strategy, “Selection and Concentration policy” whereby we are streamlining our titles to concentrate on those which provide the most versatility in terms of content and relatively high and consistent revenues.

 

As a result, operating income increased by ¥1,197 million, or 3.7%, to ¥33,850 million in fiscal 2006 from ¥32,653 million in fiscal 2005.

 

Health & Fitness segment

 

Net revenues of our Health & Fitness segment, before elimination of intersegment revenues, increased by ¥2,103 million, or 2.7%, to ¥81,209 million in fiscal 2006 from ¥79,106 million in fiscal 2005. This increase was due primarily to an increase in revenue per member due to further improvements in the quality of our services and our offering of a wider range of value-added health-related services to our members, and to an increase in net revenues from operation of sports facilities outsourced to us by others.

 

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Operating expenses increased by ¥21,209 million, or 27.5%, to ¥98,268 million in fiscal 2006 from ¥77,059 million in fiscal 2005, due primarily to impairment losses on long-lived assets and identifiable intangible assets of ¥19,513 million and an increase in expenses associated with improvements in the quality and safety of our services. For the fiscal year 2006, 6 facilities had been improved and 4 facilities are to be improved during fiscal 2007. Improvement expense is expected to be recognized every year, and for the fiscal year 2007, total of ¥509 million is estimated as improvement expense. As a result, operating loss of ¥17,059 million was recognized in fiscal 2006 compared to operating income of ¥2,047 million in fiscal 2005.

 

Gaming & System segment

 

Net revenues of our Gaming & system segment decreased by ¥1,020 million, or 8.8%, to ¥10,623 million in fiscal 2006 from ¥11,643 million in fiscal 2005. This decrease was due primarily to a decrease in revenues from sales of gaming machines and casino management systems at our U.S. subsidiary, Konami Gaming, Inc. Although sales of gaming machines by our Australian subsidiary, Konami Australia Pty Ltd, decreased slightly in Australia in fiscal 2006, we managed to maintain net revenues by expanding sales activities into other overseas markets.

 

Operating expenses increased by ¥362 million, or 3.5%, to ¥10,563 million in fiscal 2006 from ¥10,201 million in fiscal 2005. This increase was primarily due to an increase in the cost of reinforced development, and to an increase in the costs of development of software for gaming machines and of management systems. These costs were driven from recurring factor and are to be recognized continually. Operating income decreased by ¥1,382 million or, 95.8% to ¥60 million in fiscal 2006 from ¥1,442 million in fiscal 2005, reflecting the fact that revenues decreased and expenses increased.

 

Comparison of Fiscal 2005 with Fiscal 2004

 

Digital Entertainment Segment

 

Net revenues of our Digital Entertainment segment, before elimination of intersegment revenues, decreased by ¥12,773 million, or 7.2%, to ¥163,671 million in fiscal 2005 from ¥176,444 million in fiscal 2004.

 

Soccer titles for Video game software, including WORLD SOCCER Winning Eleven 8 and WORLD SOCCER Winning Eleven 8 LIVEWARE EVOLUTION for PlayStation 2 in Japan and Pro Evolution Soccer 4 for PlayStation 2, Xbox and PC in Europe, recorded sales of 5.8 million units worldwide, including Asia and North America. We also sold approximately 1.4 million units of the Dance Dance Revolution series, including Dance Dance Revolution EXTREME in North America. We continued to record strong sales of the Yu-Gi-Oh! series, including Yu-Gi-Oh! Capsule Monster Coliseum for PlayStation 2 and Yu-Gi-Oh! Destiny Board Traveler for Game Boy Advance, in North America and Europe, with total sales volume of more than 1.5 million units in North America and 1.2 million units in Europe respectively. On the other hand, sales of titles from third parties decreased to 2.3 million in fiscal 2005 from 3.1 million in the previous year. The revenue from the total card games including Yu-Gi-Oh! Trading Card Game amounted to ¥33,200 million in fiscal 2005 due primary to a decrease in sales of card games including the Yu-Gi-Oh! Trading Card Game in North America and Europe . This decrease more than offset a slight increase in sales from card games including the Yu-Gi-Oh! Trading Card Game in Asia. Net revenues of Video Game Machines for amusement arcades increased due primarily to the success of “e-AMUSEMENT” products for amusement arcades such as MAH-JONG FIGHT CLUB and QUIZ MAGIC ACADEMY and to a solid increase in net revenues of music simulation games such as pop’n music, GuitarFreaks & DrumMania.

 

Operating expenses increased by ¥2,192 million, or 1.7%, to ¥131,018 million in fiscal 2005 from ¥128,826 million in fiscal 2004. Operating income decreased by ¥14,965 million, or 31.4%, to ¥32,653 million in fiscal 2005 from ¥47,618 million in fiscal 2004.

 

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Health & Fitness Segment

 

Net revenues of our Health & Fitness segment, before elimination of intersegment revenues, increased by ¥207 million, or 0.3%, to ¥79,106 million in fiscal 2005 from ¥78,899 million in fiscal 2004. This increase was due primarily to an increase in revenue per member due to further improvements in the quality of our services and our offering of a wider range of value-added health-related services to our members, and to an increase in net revenues from the sports facilities outsourced to us.

 

Operating expenses increased by ¥931 million, or 1.2%, to ¥77,059 million in fiscal 2005 from ¥76,128 million in fiscal 2004, due primarily to an increase in expenses associated with improvements in the quality and safety of our services.

 

Operating income decreased by ¥724 million to ¥2,047 million in fiscal 2005 from ¥2,771 million in fiscal 2004, reflecting the fact that expenses increased more than revenues.

 

Gaming & System Segment

 

Net revenues of our Gaming & System segment increased by ¥696 million, or 6.4%, to ¥11,643 million in fiscal 2005 from ¥10,947 million in fiscal 2004. This increase was due primarily to an increase in revenues from sales of casino management systems, as our U.S. subsidiary, Konami Gaming Inc. has substantially completed and commenced the marketing of the management systems. Although sales of gaming machines by our Australian subsidiary, Konami Australia Pty Ltd, decreased slightly in Australia in fiscal 2005, we managed to maintain net revenues by expanding sales activities into other overseas markets.

 

Operating expenses decreased by ¥54 million, or 0.5%, to ¥10,201 million in fiscal 2005 from ¥10,255 million in fiscal 2004. Operating expenses decreased slightly despite the increase in net revenues, due to an increase in sales of casino management systems. This was primarily due to a decrease in the cost of research and development related to casino management systems.

 

Operating income increased by ¥750 million, or 108.4%, to ¥1,442 million in fiscal 2005 from ¥692 million in fiscal 2004, reflecting the fact that revenues increased and expenses decreased.

 

Critical Accounting Policies

 

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

 

Purchase Accounting

 

We account for acquired businesses using the purchase method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. The judgments made in determining the estimated fair value assigned to each class of assets acquired, as well as asset lives, can materially impact net income of the periods subsequent to the acquisition through depreciation and amortization, and in certain instances by impairment charges, if the asset becomes impaired in the future.

 

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In determining the estimated fair value for intangible assets, we typically utilize the income approach, which employs discounting of the projected future net cash flow using an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant estimates and assumptions inherent in the income approach or other methods include the projected future cash flows (including timing) and the discount rate reflecting the risks inherent in the future cash flows.

 

Determining the useful life of an intangible asset also requires judgment as different types of intangible assets will have different useful lives and certain assets may even be considered to have indefinite useful lives. 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 us, 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 made after termination of certain franchise contracts, 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 based on the current expectation as to future renewals of the existing contracts. 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.

 

Valuation of Intangible Assets and Goodwill

 

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

 

    significant underperformance relative to historical or projected future operating results;

 

    significant changes in the manner of our use of the acquired assets or the strategy for our overall business;

 

    significant negative industry or economic trends;

 

    significant decline in the stock price of the acquired entity for a sustained period; and

 

    significant decline in the market capitalization of the acquired entity relative to its net book value.

 

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

 

We engage an independent appraiser to assist us in our determination of the fair values of our reporting units. In its determination of the fair values, the appraiser primarily 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 include: (i) expected future revenue growth rates, profit margins and working capital levels of the reporting units; (ii) a discount rate; and (iii) a terminal value multiple. The revenue growth rates, profit margins and working capital levels of the reporting units are based on our expectation of future results. In evaluating the recoverability of other intangible assets which are allocated to the reporting units, we primarily utilize a discounted cash flow analysis as well as other applicable valuation approaches, and if applicable, independent valuations.

 

At March 31, 2005, we 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.

 

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However, in the fourth quarter of the fiscal year ended March 31, 2006, we 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 our 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 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 by our review during 2006.

 

Valuation of Long-Lived Assets

 

Our long-lived assets are reviewed for impairment in accordance with SFAS No. 144, “ Accounting for the Impairment or Disposal of Long-Lived Assets, “ whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Factors we consider 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.

 

The factors most significantly affecting the impairment calculation are our estimates of future cash flows. Our cash flow projections carry several years into the future and include assumptions on variables such as growth in revenues, and our cost of capital inflation, the economy and market competition. Any changes in these variables could have an effect upon our valuation.

 

In prior years, we performed impairment reviews for our fitness club assets based on certain grouping of clubs in the same geographic area where club operations were characterized by interdependencies such as the sharing of costs and expenses. However, in fiscal 2006, in connection with changes in management of our Health & Fitness operation and in our operating structure of clubs, which eliminated these interdependencies among clubs, we reassessed our asset grouping for fitness clubs and changed our focus to an individual club operation level, which we consider to be the lowest level at which identifiable cash flows are largely independent of the cash flows of other assets. 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.

 

Based on our review, we recorded a pre-tax impairment charge of ¥10,533 million ($89,665 thousand) for our Health & Fitness operation 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 additionally 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 us.

 

Software Development Costs

 

We utilize our internal development teams to develop our software. We account for software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or

 

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Otherwise Marketed”. We capitalize software development costs once technological feasibility is established and such costs are determined to be recoverable against future revenues. We expense software development costs incurred prior to technological feasibility to research and development. We evaluate the technological feasibility of our software in development on a product-by-product basis, based on our historical experience, whether the software is closely related to previously marketed software or uses existing technology, and other factors. For products where proven game engine technology exists, technological feasibility may occur early in the development cycle. We believe that our accounting policies for software development are critical for our financial statements as our decisions as to technological feasibility affect the timing of our recognition of the costs associated with development of our software products.

 

Revenue Recognition

 

We derive 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.

 

Our revenue recognition criteria are as follows:

 

Persuasive Evidence of an Arrangement.

 

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

 

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

 

For mobile game contents, we enter into distribution agreements with mobile phone carriers for the sale or subscription of mobile game contents by the carriers to their subscribers. We recognize as revenues the amount the mobile phone carrier pays to us upon the sale of our game contents, net of any service or other fees earned and deducted by the carrier.

 

Delivery Has Occurred.

 

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

 

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

 

Revenues from mobile game contents are derived from monthly subscription fees. Under the distribution agreements, the mobile phone carriers are responsible for billing, collection and remittance of those subscription

 

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fees to us. We have a collection risk for our accounts receivable except for certain mobile phone carriers. The carriers generally report the final sales data to us within 60 days following the end of each month. When final sales data is not available in a timely manner for reporting purposes, we estimate our 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 our customers pay for our products is negotiated at the outset of an arrangement, and is generally determined by the specific volume of product to be delivered. Therefore, the prices are considered to be fixed or determinable at the start of the arrangement. Our membership fee for fitness clubs is fixed at the time of admission of the member. 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. We typically sell to customers with whom we have a history of successful collection. New customers are subjected to a credit review process that evaluates the customers’ financial position and ultimately their ability to pay. For our fitness clubs, the collectibility of membership fees is always assured as we charge members’ accounts one-month in advance. In addition, for our mobile game contents, we have a collection risk for our accounts receivable except for certain mobile phone carriers.

 

Income Taxes

 

In the ordinary course of our business, there are many transactions where the ultimate tax determination is uncertain. Also, tax exposures can involve complex issues and may require an extended period to resolve. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which it operates. This process involves estimating tax exposures in each jurisdiction including the impact, if any, of additional taxes resulting from the resolution of tax uncertainties and making judgments regarding the recoverability of deferred tax assets. Tax uncertainties are recognized to the extent we believe we should prevail in the event tax authorities conduct an examination. Judgments related to tax uncertainties are based on available interpretations of tax law which are subject to change.

 

The recoverability of deferred tax assets ultimately depends on the existence of sufficient taxable income of an appropriate character and we record a valuation allowance to reduce the deferred tax assets to an amount that is more likely than not to be recoverable. A change in our ability to continue to generate future taxable income could affect our ability to recover the deferred tax assets and requires re-assessment of the valuation allowance. Such changes, if significant, could have a material impact on our effective tax rate, results of operations and cash flows.

 

Accounting Developments

 

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 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. We are required to adopt SFAS No.151 for fiscal years beginning after June 15, 2005. We do not expect the adoption of this statement will have a material effect on our consolidated financial statements.

 

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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. We will be required to adopt SFAS No.123R at the beginning of the first annual period beginning after June 15, 2005. We do not expect the adoption of this statement will have a material effect on our 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. We will be required to adopt SFAS No.153 for fiscal year beginning after June 15, 2005. We do not expect the adoption of this statement will have a material effect on our 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. We will be required to adopt SFAS No.154 for fiscal year beginning after December 15, 2005. We do not expect the adoption of this statement will have a material effect on our 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. We 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. We do not expect the adoption of this statement will have a material effect on our 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. We do not expect the adoption of this consensus will have a material effect on our consolidated financial statements.

 

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. We will be required to adopt SFAS No.115-1 for fiscal year beginning after December 16, 2005. We do not expect the adoption of this statement will have a material effect on our consolidated financial statements.

 

Capital Expenditures

 

Our capital expenditures amounted to ¥11,562 million, ¥18,654 million and ¥48,004 million on an accrual basis during fiscal 2004, 2005 and 2006, respectively. During fiscal 2004, our capital expenditures consisted

 

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mainly of funds for the opening and repair of fitness clubs in the amount of ¥2,073 million and the development of in-house software in the amount of ¥1,239 million. During fiscal 2005, our capital expenditures consisted mainly of acquisition of computer software in the amount of ¥8,365 million. During fiscal 2006, our capital expenditures consisted mainly of acquisition of goodwill in relation to the mergers in Digital Entertainment segment and Health & Fitness segment in the amount of ¥21,253 million, opening new fitness clubs in the amount of ¥10,759 million and acquisition of intangible assets including mainly computer software in the amount of ¥4,365 million. We expect our capital expenditures for fiscal 2007 to be approximately ¥13,000 million on an accrual basis, which will relate to mainly Konami Super Campus, tools for products development and computer software.

 

The following table shows reconciliation between capital expenditure disclosed in the cash flow statements to the amounts discussed here on an accrual basis.

 

     Fiscal year ended March 31,

     2004

   2005

   2006

   2006

     (millions of yen and thousands of dollars)

Capital expenditure in the consolidated statement of cash flows

   ¥ 8,788    ¥ 15,818    ¥ 14,513    $ 123,546

Property acquired under capital leases

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

Additions to long-lived assets including goodwill and Identifiable assets by acquisition

     338      386      23,683      201,609

Effects of timing difference of payments and other

     142      606      729      6,206
    

  

  

  

Capital expenditure (accrual basis)

   ¥ 11,562    ¥ 18,654    ¥ 48,004    $ 408,649
    

  

  

  

 

B.    Liquidity and Capital Resources

 

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

 

Our principal needs for cash for fiscal 2006 include cash used for ordinary operations of our business. In addition, we consider potential opportunities to expand our current business or enter new areas of business from time to time. Generally, our sources of funds include available cash reserves, cash provided by our current and future operating activities, borrowings from banks and other financial institutions and issuance of debt securities. We believe that available cash reserves and expected cash from operations and future borrowings or issuance of debt capital will provide sufficient financial resources to meet our currently anticipated capital and other expenditure requirements. There are no material contractual or legal restrictions on the ability of our subsidiaries to transfer funds to us in the form of dividends (assuming that they have sufficient distributable net assets or retained earnings as provided under the local law of the relevant jurisdiction), loans or advances. There are no material economic restrictions on payments of dividends, loans or advances to us by our subsidiaries other than general withholding or other taxes calculated at rates determined by the local tax law of the relevant jurisdiction (ordinarily 20% in the case of dividend payments by our Japanese subsidiaries and 10% (or, in certain circumstances, 15%) in the case of dividend payments and 10% in the case of interest payments by our U.S. subsidiaries).

 

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Cash Flows

 

The following table sets forth certain information about our cash flows during fiscal 2004, 2005 and 2006:

 

     Fiscal year ended March 31,

 
     2004

    2005

    2006

    2006

 
     (millions of yen and thousands of dollars)  

Net cash provided by operating activities

   ¥ 34,326     ¥ 27,760     ¥ 23,879     $ 203,277  

Net cash used in investing activities

     (9,457 )     (17,936 )     (7,266 )     (61,854 )

Net cash used in financing activities

     (11,685 )     (8,077 )     (38,330 )     (326,296 )
    


 


 


 


       13,184       1,747       (21,717 )     (184,873 )

Effect of exchange rate changes on cash and cash equivalents

     (979 )     951       828       7,049  
    


 


 


 


Net increase (decrease) in cash and cash equivalents

     12,205       2,698       (20,889 )     (177,824 )

Cash and cash equivalents at beginning of year

     74,680       86,885       89,583       762,603  
    


 


 


 


Cash and cash equivalents at end of year

   ¥ 86,885     ¥ 89,583     ¥ 68,694     $ 584,779  
    


 


 


 


 

For the year ended March 31, 2006, we 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, we 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.

 

Comparison of Fiscal 2006 with Fiscal 2005

 

Net cash provided by operating activities decreased by ¥3,881 million, or 14.0%, to ¥ 23,879 million in fiscal 2006 from ¥27,760 million in fiscal 2005. This decrease was due primary to an increase in the expenditure of tax payment along with elimination of net operating loss carryforward that we could utilize to decrease the expenditure of tax payment in the fiscal 2005.

 

Net cash used in investing activities decreased by ¥10,670 million, or 59.5% to ¥7,266 million in fiscal 2006 from ¥17,936 million in fiscal 2005. This decrease was due primary to investment in a new affiliate of ¥5,993 million offset by the proceeds from sales of shares of affiliates of ¥11,016 million along with the termination of equity relationship with these companies.

 

Net cash used in financing activities increased by ¥30,253 million yen, or 374.6% to ¥38,330 million for the fiscal 2006 from ¥8,077 million in the fiscal 2005. This was primarily due to the redemption of bonds of ¥ 15,000 million and payment of short-term borrowing of ¥12,551 million for some subsidiaries.

 

Comparison of Fiscal 2005 with Fiscal 2004

 

Net cash provided by operating activities decreased by ¥6,566 million, or 19.1%, to ¥27,760 million in fiscal 2005 from ¥34,326 million in fiscal 2004. This decrease was due primarily to a decrease in net income to ¥10,486 million in fiscal 2005 from ¥20,104 million in fiscal 2004. While we recorded strong results overall with favorable sales of soccer titles and the release of a new title in the METAL GEAR SOLID series in the Computer & Video Games business, we had even stronger sales, especially of the Yu-Gi-Oh! Trading Card Game in North America and Europe, in fiscal 2004.

 

Net cash used in investing activities increased by ¥8,479 million, or 89.7%, to ¥17,936 million in fiscal 2005 from ¥9,457 million in fiscal 2004. This was due primarily to an increase in capital expenditures of ¥7,030 million to ¥15,818 million in fiscal 2005 from ¥8,788 million in fiscal 2004, mostly reflecting an increase in the acquisition of intangible fixed assets including mainly computer software from ¥1,826 million in fiscal 2004 to ¥8,365 million in fiscal 2005. In addition, purchase of treasury stock by subsidiaries increased by ¥1,137 million to ¥3,593 million in fiscal 2005 from ¥2,456 million in fiscal 2004.

 

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Net cash used in financing activities decreased by ¥3,608 million, or 30.9%, to ¥8,077 million in fiscal 2005 from ¥11,685 million in fiscal 2004. This was due primarily to a ¥1,007 million decrease in dividend payments, to ¥7,963 million in fiscal 2005 from ¥8,970 million in fiscal 2004, and a net increase in short-term and long-term borrowings from banks from ¥611 million in fiscal 2004 to ¥6,001 million in fiscal 2005. Net proceeds from bank borrowings during fiscal 2005 were used mainly for acquisition of treasury stock by Konami in the amount of ¥2,605 million, as compared to ¥3 million in fiscal 2004.

 

Long and Short-term Debt

 

Our debt includes both long-term debt and short-term borrowings. Our borrowing requirements have not been seasonal. Short-term borrowings consisted entirely of unsecured bank loans totaling ¥8,582 million as of March 31, 2005 and ¥958 million as of March 31, 2006. As of March 31, 2006, the long-term debt consisted mainly of ¥45,000 million of unsecured bonds described in the following paragraphs, of which ¥20,000 million is the current portion. It also included ¥3,975 million of unsecured loans from banks, of which ¥1,993 million is the current portion. For information regarding the aggregate annual maturities of our long-term debt outstanding at March 31, 2006, please see the Contractual Obligations table below under Item 5.F. We are able to borrow from financial institutions at local market-based interest rates, which in our case is market-based rates in Japan. Approximately 37% of our short-term borrowings as of March 31, 2006 were borrowed on a U.S. dollar basis, and interest rates on these borrowings corresponded to prevailing market rates in the U.S. The interest rates of our long-term debt and short-term borrowings ranged from 0.59% to 5.59% during fiscal 2006. We plan to refinance repayment of our debt and borrowings due in one to three years by a combination of all or some of the following funding sources: available cash reserves; cash provided by our operations; borrowings from banks or other financial institutions; and issuance of debt securities. We have earmarked a part of our substantial cash on hand, which was ¥68,694 million as of March 31, 2006, for the repayment of ¥15,000 million of unsecured bonds due in September 2006 and of ¥5,000 million of unsecured bonds due in December 2006.

 

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

 

In connection with our purchases of certain products for distribution in North America and Europe, including Game Boy cartridges and GameCube discs, some of our suppliers require us to provide irrevocable letter of credit prior to accepting our purchase orders. As of March 31, 2006, we had no outstanding letters of credit.

 

Derivative Transactions

 

We enter into foreign exchange forward contracts to manage foreign exchange exposure associated with short-term movements in exchange rates applicable to our payables commitments and receivables that we expect to pay or receive in foreign currencies. For a more detailed discussion of these instruments, you should read Item 11 herein and Note 17 to our consolidated financial statements included in this annual report. We do not hold or issue derivatives for speculation purposes. Because the counterparties to those contracts are limited to major international financial institutions, we do not anticipate any material losses arising from credit risk. Our Finance Department executes and controls those contracts. Each contract and its results are to be periodically reported to an officer in charge of the department and the CFO.

 

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

 

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

 

Our research and development activities consist primarily of developing video game software, toy & hobby products, amusement arcade games and gaming machines. Research and development expenses are charged to income as incurred. On a consolidated basis, we spent ¥1,382 million, ¥1,813 million and ¥2,446 million on research and development for fiscal 2004, 2005 and 2006, respectively.

 

D.    Trend Information.

 

While our results of operations for fiscal 2007 remain subject to a number of uncertainties, we currently expect that our net revenues for fiscal 2007 will increase slightly from the previous year. We also expect a slight increase in operating income in fiscal 2007 due to stable revenues generated by regular titles in each segment, although we expect lower net income due to the fact that we do not expect a reversal of tax liabilities as in fiscal 2006. We base our expectations on the following assumptions:

 

Our fiscal 2007 business plans are formulated on the basis of the following assumptions:

 

    Digital Entertainment segment: In the Computer & Video Games business, the popularity of the Winning Eleven series is expected to continue to increase its sales from fiscal 2006 due to the popularity of the 2006 World Cup in Germany. However, we expect sales volume and net revenues as a whole to remain almost at the same level as fiscal 2006as a result of our “Selection and Concentration Policy” whereby we are streamlining our titles to concentrate on those which provide the most versatility in terms of content and relatively high and consistent revenues. We expect our net revenues of our Toy & Hobby business to remain almost at the same level as fiscal 2006, reflecting solid sales of the Yu-Gi-Oh! Trading Card Game in fiscal 2006. We expect net revenues of our Amusement business to increase, as a result of additional sales from our standard series products and improvement and expansion of “e-AMUSEMENT” products. We expect an increase in net revenues in our Online business, reflecting a growth of home online gaming and revenues from mobile game contents. We expect an increase in net revenues in our Multimedia business as a result of evolvingoriginal animations collaborating with other segments.

 

    Health & Fitness segment: We expect an increase in sales by our Health & Fitness segment in fiscal 2007, thanks to continuing factors, such as improved average spending per member, a higher retention rate of existing members and the establishment of new fitness clubs, as well as to the release of new health-related products such as home fitness equipment and care prevention.

 

    Gaming & System segment: We expect an increase in net revenues by our Gaming & System segment reflecting anticipated gains in sales of gaming machines and casino management systems in North America. In addition, our operating margin is expected to improve as a result of the expansion of profitable casino management systems in the North American market.

 

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

 

E.    Off-Balance Sheet Arrangements.

 

Not applicable.

 

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F. Tabular Disclosure of Contractual Obligations.

 

Contractual Obligations

 

The following table summarizes the contractual obligations and other commercial commitments that will affect our liquidity position for the next several years, as of March 31, 2006:

 

          Payments Due by Period

Contractual Obligations


   Total

   Less than
1 year


   1-3 years

   4-5 years

  

After

5 years


     (millions of yen)

Short-Term Debt

   ¥ 958    ¥ 958      —        —        —  

Long-Term Debt

     49,686      22,425    ¥ 26,460    ¥ 801      —  

Capital Lease Obligations

     13,065      2,751      3,597      1,845    ¥ 4,872

Operating Leases

     45,527      2,982      5,958      5,925      30,662

Purchase Obligations

     8,494      8,494      —        —       

Pension Contribution

     1,239      1,239      —        —        —  

Asset Retirement Obligation

     3,674      —        700      —        2,974
    

  

  

  

  

Total

   ¥ 122,643    ¥ 38,849    ¥ 36,715    ¥ 8,571    ¥ 38,508
    

  

  

  

  

 

Licenses.    We have several on-going contractual commitments involving minimum future royalties payments. Under these agreements, we commit to provide specified payments to the intellectual property holders, such as professional sports organizations, based upon contractual arrangements. Assuming all contractual provisions are met, the total future minimum contract commitment for contracts in place as of March 31, 2006 is ¥454 million, substantially all of which has been prepaid and recorded as prepaid royalties and license fees.

 

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Item 6.   Directors, Senior Management and Employees.

 

A.    Directors and Senior Management.

 

Directors, Corporate Auditors and Executive Officers

 

The following table sets forth our Directors including the executive officers and Corporate Auditors and certain other information:

 

Name


 

Position


  Date of Birth

  Current
Term
Expires


  Director,
Corporate
Auditor or
Corporate
Officer Since


  Number of
Konami
shares owned
as of
March 31,
2006
(1)


   

Percentage of
holding of
Konami shares
outstanding

as of
March 31,
2006


 

Directors:

                           

Kagemasa Kozuki

  Representative Director, Chairman of the Board and CEO   November 12, 1940   June 2007   March 1974   35,006,949
(200,000
(2)
)
  25.52 %

Kagehiko Kozuki

  Representative Director, Vice Chairman   March 7, 1944   June 2007   May 1984   117,148
(50,000
 
)
  *  

Noriaki Yamaguchi

  Representative Director and CFO   January 26, 1944   June 2007   June 1994   51,127
(50,000
 
)
  *  

Kimihiko Higashio

  Director and CHO   September 24, 1959   June 2007   June 2005   22,041
(20,000
 
)
  *  

Tsutomu Takeda

  Director   May 13, 1937   June 2007   June 2003   23,665
(11,850
 
)
  *  

Tomokazu Godai

  Outside Director   October 6, 1939   June 2007   May 1992   7,923
(10,000
 
)
  *  

Hiroyuki Mizuno

  Outside Director   April 20, 1929   June 2007   June 2001   8,800
(10,000
 
)
  *  

Akira Gemma

  Outside Director   August 1, 1934   June 2007   June 2004   7,300
(0
 
)
  *  

Corporate Auditors:

                           

Noboru Onuma

  Standing Corporate Auditor   January 1, 1948   June 2009   June 1999   1,360
(0
 
)
  *  

Tetsuro Yamamoto

  Standing Corporate Auditor   December 23, 1948   June 2007   June 2000   885
(0
 
)
  *  

Minoru Nagaoka

  Corporate Auditor   May 16, 1924   June 2007   June 2000   2,447
(0
 
)
  *  

Masataka Imaizumi

  Corporate Auditor   March 3, 1926   June 2007   June 2000   2,447
(0
 
)
  *  

Corporate Officers:

                           

Kazumi Kitaue

  Corporate Officer   February 20, 1957     April 2005   150,030
(50,000
 
)
  *  

Fumiaki Tanaka

  Corporate Officer   March 10, 1961     June 2000   67,119
(64,220
 
)
  *  

Akihiko Nagata

  Corporate Officer   January 19, 1959     June 2000   83,416
(50,000
 
)
  *  

Shigeo Niwa

  Corporate Officer   September 20, 1948     January 2003   293
(7,500
 
)
  *  

Naoyuki Notsu

  Corporate Officer   November 18, 1955     May 2004   808
(3,000
 
)
  *  

Akira Tamai

  Corporate Officer   October 14, 1963     April 2005   1,008
(7,000
 
)
  *  

(1)   Includes shares beneficially owned through the Director Stock Purchase Association. Numbers in parenthesis indicate the numbers of shares issuable by the exercise of rights to purchase shares held by each person listed above—see Item 6.E. “Share Ownership”.

 

  Includes shares beneficially owned through Yoko Kozuki (11,600 shares), Kozuki Foundation For Sports, Athletes and Higher Education (14,330,000 shares), Kozuki Holding B.V. (13,530,000 shares), Kozuki Capital Corporation (7,036,996 shares) and the Director Stock Purchase Association (27,497 shares) in addition to those owned of record by Kozuki (70,856 shares).

 

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  All of our Directors are Japanese nationals and, except for Tomokazu Godai, Hiroyuki Mizuno, Tsutomu Takeda and Akira Gemma, are engaged in our business on a full-time basis. The business address of our Directors is 4-1, Marunouchi 2-chome, Chiyoda-ku, Tokyo 100-6330, Japan.

 

  The list of corporate officers does not include those persons who also serve as director.

 

  Asterisks indicates ownership of less than one percent.

 

Kagemasa Kozuki became our Representative Director and President in 1974 and Representative Director and Chairman in 1987. He has also served as CEO since 1994. He established Konami in 1973.

 

Kagehiko Kozuki has served as our Vice Chairman since 1997. He has also served as Director since 1984 and as Representative Director since 1998. He joined Konami in 1983.

 

Noriaki Yamaguchi has served as our Representative Director, Vice President and CFO since 2003. He joined Konami in 1994.

 

Kimihiko Higashio has served as our Director since 2005 and also CHO since 2006. He was also Corporate Officer since 2000 and General Manager of the Human Resources Division from 2003 to 2005. He joined Konami in 1997.

 

Tsutomu Takeda has served as our Director since 2003. He has also served as Representative Director and Chairman of Konami Sports Corporation (predecessor of Konami Sports & Life Co., Ltd.) since 2004. He was Representative Director and President of Asatsu D.K. Co., Ltd. until 2000.

 

Tomokazu Godai has served as our Director since 1992. He has also served as Representative Director and President of Maya Tec Co., Ltd. since 1975, as Representative Director of Santetsu Giken Co., Ltd. since 1999, and as Representative Director of Hiroshima River Industrial Corporation since 1992.

 

Hiroyuki Mizuno has served as our Director since 2001. He has also served as Director of Research Institute of Kochi University of Technology since 2003.

 

Akira Gemma has served as our Director since 2004. He has also served as Senior Corporate Adviser of Shiseido Co., Ltd. since 2003.

 

Noboru Onuma has served as our Standing Corporate Auditor since 1999.

 

Tetsuro Yamamoto has served as our Standing Corporate Auditor since 2000.

 

Minoru Nagaoka has served as our Corporate Auditor since 2000. He has also served as Director of the Capital Markets Research Institute since 1999.

 

Masataka Imaizumi has served as our Corporate Auditor since 2000. He has also served as Chairman of the Police Associations since 2004.

 

Kazumi Kitaue was in charge of the Computer & Video Games Business until 2005 and served as Executive Corporate Officer from 2000 to 2006. He currently serves as Corporate Officer. He also served as Director from 1996 to 2001. He joined Konami in 1981.

 

Fumiaki Tanaka was in charge of the Amusement Business until 2005 and served as Executive Corporate Officer since 2000 till 2006. He currently serves as Corporate Officer. He also served as Director from 1996 to 2001. He has served as Representative Director and President of Konami Digital Entertainment Corporation since 2006. He joined Konami in 1981

 

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Akihiko Nagata was in charge of the Toy & Hobby Business until 2005 and served as Executive Corporate Officer since 2000 till 2006. He currently serves as Corporate Officer. He also served as Director from 1996 to 2001. He joined Konami in 1981.

 

Shigeo Niwa has served as our Corporate Officer of the Intellectual Property Division since 2003. He joined Konami in 2000.

 

Naoyuki Notsu has served as our Corporate Officer of the Administration Division since 2004. He joined Konami in 2000.

 

Akira Tamai has served as as Corporate Officer of the Finance Division since 2005. He joined Konami in 1999.

 

Our board of directors has the ultimate responsibility for the administration of our affairs. Our Articles of Incorporation provide for a maximum of 12 Directors. Directors are elected at a general meeting of shareholders, and the normal term of office of Directors is one year, although they may serve any number of consecutive terms. Our board of directors elects from among its members one or more Representative Directors, who have the authority individually to represent us in all matters. From among its members, our board of directors also elects a Chief Executive Officer and other executive officers.

 

Our Articles of Incorporation provide for not more than five Corporate Auditors. Corporate Auditors, of whom at least half must be persons who have not been any of the Director, executive officer (shikko-yakuin), manager or employee of our company or any of our subsidiaries preceding the date on which such person assumes the office of Corporate Auditor, are elected at a general meeting of shareholders from among those candidates nominated by our board of directors and, if any, by shareholders. The normal term of office of a Corporate Auditor is four years, although they may serve any number of consecutive terms. Corporate Auditors are under a statutory duty to oversee the administration of our affairs by our Directors, to examine our financial statements and business reports to be submitted by our board of directors to the general meetings of our shareholders and to report to the shareholders regarding any actions by our board of directors that are seriously unreasonable or which are in violation of laws, ordinances or our Articles of Incorporation. They are required to attend meetings of our board of directors and to express their opinions, but they are not entitled to vote. Under the Corporate Law of Japan, the Corporate Auditors collectively constitute the board of corporate auditors. The board of corporate auditors has a statutory duty to prepare and submit an audit report to our board of directors each year. A Corporate Auditor may note his opinion in the audit report if his opinion is different from the opinion expressed in the audit report. The board of corporate auditors is empowered to establish audit principles, the methods of examination by Corporate Auditors of our affairs and financial position and other matters concerning the performance of the Corporate Auditors’ duties.

 

In addition to Corporate Auditors, we must appoint independent public accountants who have statutory duties of examining the financial statements to be submitted by our board of directors to the general meetings of shareholders and reporting thereon to the board of corporate auditors and the Directors. Examination by independent public accountants of our financial statements is also required for the purposes of the securities reports which companies listed on Japanese stock exchanges must file with the Director of the relevant Local Finance Bureau and which are open to public inspection. KPMG AZSA & Co. currently acts as our Independent Registered Public Accounting Firm.

 

B.    Compensation.

 

The aggregate compensation, including bonuses and other benefits in kind, we paid to our Directors (who include the executive officers) and Corporate Auditors during fiscal 2006 was ¥1,220 million and ¥59 million, respectively.

 

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C.    Board Practices.

 

The information required by this item in relation to the date of expiration of the current term of office for our Directors, Corporate Auditors and Executive Officers is set forth in Items 6.A and 6.B of this annual report.

 

We have paid, and may pay again in the future, severance benefits to our Directors with the approval of our shareholders, pursuant to our internal rules concerning Directors’ retirement. For example, in June 2005 we provided severance benefits to one of our Directors upon the termination of the Director’s employment with us, pursuant to a resolution of our shareholders.

 

D.    Employees.

 

We employed 5,127 persons on a full-time basis and 7,091 persons on a part-time basis as of March 31, 2006. One of our subsidiaries, Konami Sports & Life Co., Ltd., has a labor union to which 812 employees belonged as of March 31, 2006. We have no other labor union and have experienced no labor disputes. We believe that our labor relations are good.

 

The following two tables show the number of our employees by segment and geographic location as of the dates indicated:

 

Breakdown of Employees by Segment

 

     As of March 31,

Segment


   2004

   2005

   2006

Digital Entertainment

   2,204    2,181    2,664

Health & Fitness

   1,336    1,437    1,549

Gaming & System

   317    329    320

Others

   151    101    196

General Administrative (1)

   385    499    398
    
  
  

Total

   4,393    4,547    5,127
    
  
  

(1)   Employees in the General Administrative segment consist of those who cannot be classified into a specific segment.

 

Breakdown of Employees by Geographic Location

 

     As of March 31,

     2004

   2005

   2006

Japan

   3,766    3,865    4,417

North America

   281    323    344

Asia (other than Japan)

   130    146    156

Europe

   84    80    81

Australia

   132    133    129
    
  
  

Total

   4,393    4,547    5,127
    
  
  

 

The retirement age for our employees (excluding contract workers), other than Directors and Corporate Auditors, is 60. Employees are generally entitled to receive upon retirement or earlier termination of employment a lump sum payment and/or pension based upon their years of service, their basic pay at the time of termination of employment and certain other factors.

 

From August 1998, we began offering a fixed compensation system that eliminated separate retirement benefits to our management and this plan is currently offered to most of our employees.

 

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Many of our employees receive compensation on the basis of fixed annual salaries. In addition, we have in place a performance-linked incentive system for employees. Salaries of the employees are decided by our committee responsible for rewards upon evaluations by the person in charge of the employees’ respective businesses and divisions based on our results, the relevant division, the relevant section, as well as the individual’s own efforts and contribution. Also, employees and directors may receive additional compensation for the development of a patent that makes a significant contribution to our business. In addition, employees involved in production of our products receive rewards based on the contributions of their production teams to our financial results.

 

E.    Share Ownership.

 

(1) Share Ownership by Directors and Corporate Auditors

 

Except as described in Item 7.A below, none of our directors or members of our administrative, supervisory or management bodies beneficially owns more than one percent of our shares of common stock.

 

(2) Stock option plan for directors and employees

 

Our shareholders authorized the issuance of 17,879 rights to purchase 1,787,900 shares of our common stock by resolution at our annual general meeting of shareholders held on June 20, 2002. We issued these rights to subscribe for or purchase shares of our common stock, which function in the manner of stock options, to our directors and employees as well as to the directors and employees of our subsidiaries. These rights were issued to increase director and employee motivation to improve our financial performance and to attract highly qualified personnel. These rights are exercisable from July 1, 2004 to June 30, 2007. The exercise price is ¥3,640.

 

On June 23, 2005, the shareholders approved the Company’s Board of Directors resolution on May 10, 2005 for approval of the eight plans of stock subscription rights to directors and employees of the Company and its subsidiaries. Those stock subscription rights plans are intended to enable the grant of stock options and the total maximum number of shares issuable under the plans is 412,900 shares of common stock of the Company. The exercise periods range from August 1, 2005 through June 30, 2008, and exercise prices range from ¥1,670 to ¥2,857.

 

On June 23, 2005, the shareholders also approved the Company’s Board of Directors resolution on May 19, 2005 for approval of another plan of stock subscription rights to directors and employees of the Company and its subsidiaries. The stock subscription rights are intended to enable the grant of stock options, and the maximum number of shares issuable under the plan is 1,150,000 shares of common stock of the Company. The exercise period is from July 1, 2007 to June 30, 2009. The exercise price will be equal to 1.20 times the daily average closing price on the Tokyo Stock Exchange for the month prior to the grant date. However, these stock subscription rights were not issued although they were approved as mentioned above.

 

Following a resolution by the extraordinary general meeting of shareholders held on January 26, 2006, and a share exchange executed on March 1, 2006, we succeeded to obligations related to 12,020 stock subscription rights issued as series 1 by Konami Sports & Life Co., Ltd, which former Konami Sports Corporation approved in the Annual Meeting of Shareholders held on March 1, 2006. We believe that these stock subscription rights are important for enhancing the motivation and morale of directors and employees of Konami Sports & Life Co., Ltd. subsequent to the share exchange, and to maximize the corporate value of the Konami Group. The exercise period is from July 1, 2006 to June 30, 2009, and the exercise price is ¥3,133.

 

(3) Employee Stock Purchase Plan

 

Our directors and employees (excluding part-time employees) are eligible to participate in stock purchase plans, pursuant to which a plan administrator makes open market purchases of our shares of common stock for the accounts of participating directors and employees on a monthly basis. Such purchases are made out of

 

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amounts deducted from each director’s or employee’s salary. We provide a 5% subsidy on top of any funds contributed to the plan by employees, other than officers. In addition, we provide a further 5% subsidy on top of any funds contributed to the plan by employees who participated before March 31, 2001 and a further 10% subsidy on top of any funds contributed by employees who we recognize as making high contribution to the Company. As of March 31, 2006, the Employee Stock Purchase Association held a total of 1,482,408 shares of our common stock and the Director Stock Purchase Association held a total of 59,927 shares of our common stock.

 

Item 7.   Major Shareholders and Related Party Transactions.

 

A.    Major Shareholders.

 

As of March 31, 2006, 137,152,347 shares of our common stock were outstanding.

 

Any person who becomes, beneficially and solely or jointly, a holder of more than 5% of the total issued shares of a company listed on any Japanese stock exchange or whose shares are traded on the Japanese over-the-counter market, as calculated pursuant to the Securities and Exchange Law of Japan, must file with the Regional Finance Bureau having jurisdiction within five business days a report concerning such shareholding. See Item 10.B “Memorandum and Articles of Association below.

 

To our knowledge, as of March 31, 2006 or a later date as indicated, the following persons beneficially owned more than 5% of our outstanding common stock. The information in this table is based upon our register of shareholders and reports filed with the Regional Financial Bureau:

 

Shareholders


  

Number of shares of

common stock owned


  

Percentage of

common stock

outstanding as of
March 31, 2006


 

Kagemasa Kozuki (1)

   35,006,949    25.52 %

Kozuki Foundation For Sports, Athletes and Higher Education (2)

   14,330,000    10.45  

Kozuki Holding B.V. (2)

   13,530,000    9.86  

Kozuki Capital Corporation (2)

   7,036,996    5.13  

(1)   Kagemasa Kozuki’s share ownership includes shares beneficially owned through Yoko Kozuki (11,600 shares), Kozuki Foundation For Sports, Athletes and Higher Education (14,330,000 shares), Kozuki Holding B.V. (13,530,000 shares), Kozuki Capital Corporation (7,036,996 shares), and the Director Stock Purchase Association (27,497 shares) in addition to those owned of record by Kozuki (70,856 shares).
(2)   As explained in note (1) above, Kagemasa Kozuki is also a beneficial owner of these shares.

 

None of our shares of common stock entitles the holder to any preferential voting rights.

 

The ownership and distribution of the shares (in 100-share units) by category of shareholders according to our register of shareholders and register of beneficial shareholders as at March 31, 2006 were as follows:

 

Category


   Number of
Shareholders


   Number of
Shares Held


    Percentage of Total
Outstanding Shares


 

Japanese financial institutions

   88    39,099,564     28.51 %

Japanese securities companies

   42    4,133,150     3.01  

Other Japanese corporations

   510    22,450,607 (1)   16.37  

Foreign corporations and individuals

   333    43,116,170     31.44  

Japanese individuals and others

   61,320    28,352,856     20.67  
    
  

 

Total

   62,293    137,152,347     100.00 %

(1)   Other Japanese Corporations hold 25,499,088, but the number in the table excludes 3,048,481 shares owned by KSL.

 

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According to our register of shareholders and register of beneficial owners, as of March 31, 2006, there were 137,152,347 shares of our common stock outstanding. According to JPMorgan Chase Bank, depositary for our ADSs, as of March 31, 2006, 920,500 shares of our common stock were held in the form of ADRs and there were 11 ADR holders of record in the United States. According to our register of shareholders and register of beneficial owners, as of March 31, 2006, there were 62,294 holders of common stock of record worldwide, including 83 shareholders of record with addresses in the United States who held 8,042,627 shares, representing approximately 5.86% of our outstanding common stock as of that date. Because some of these shares were held by brokers or other nominees, the number of record holders with addresses in the United States may be fewer than the number of beneficial owners in the United States.

 

None of our shares of common stock entitles the holder to any preferential voting rights.

 

To our knowledge, we are not, directly or indirectly, owned or controlled by any other corporation or by any government or by any other natural or legal persons severally or jointly. We know of no arrangements the operation of which may at a later time result in a change of control of Konami.

 

B.    Related Party Transactions.

 

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 March 31, 2005, and were included in Trade notes and accounts payable in the accompanying consolidated balance sheets. We sold our entire shares of Takara, an equity-method affiliate, and dissolved our 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 our additional acquisition of newly issued shares of Hudson on April 27, 2005, Hudson, an equity-method affiliate, became a 54.0% owned consolidated subsidiary.

 

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 ¥246 million at March 31, 2005, and were included in Trade notes and accounts payable in the accompanying consolidated balance sheets. We sold our entire shares of Genki, an equity-method affiliate, and dissolved our equity relationship on March 31, 2005.

 

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 our senior management team and our major shareholders. 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 our senior management shareholders 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.

 

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C.    Interests of Experts and Counsel.

 

Not applicable.

 

Item 8.   Financial Information.

 

A.    Consolidated Statements and Other Financial Information.

 

Financial Statements

 

The information required by this item is set forth beginning on page F-2 of this annual report.

 

Legal or Arbitration Proceedings

 

The information on legal or arbitration proceedings required by this item is set forth in Item 4.B of this annual report.

 

Dividend Policy

 

Konami believes that it is the important return of Konami’s profits to the stockholders to secure constant high dividends and improve the corporate value. however, be subject to our future earnings and financial condition, approval at the shareholders’ meeting (in the case of year-end dividends) and other factors, including statutory and other restrictions with respect to the payment of dividends.

 

B.    Significant Changes.

 

We are not aware of any significant change in our financial position since March 31, 2006, the date of our last audited financial statements.

 

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Item 9.   The Offer and Listing.

 

A.    Offer and Listing Details.

 

See Item 9.C of this annual report for information on the stock exchanges on which our common stock is listed.

 

The following table indicates the reported closing high and low sale prices (adjusted to reflect the prior stock splits of shares referred to in the table included in Item 10.A “Share Capital—Changes in Issued Share Capital” of our registration statement on Form 20-F filed with the Securities and Exchange Commission on September 20, 2002) and the average trading volume of our common stock on the Tokyo Stock Exchange, the closing highs and lows of the Nikkei Stock Average and the closing highs and lows of the TOPIX for the periods indicated:

 

     Price per Share of
Konami Common Stock
on
Tokyo Stock Exchange


   Average
Daily Trading
Volume of
Konami
Common Stock


   Closing TOPIX

   Closing Nikkei Stock
Average


          High     

        Low     

      High

   Low

   High

   Low

Fiscal Period

                                  

2001

   9,970    4,470    465,911    1,732.45    1,161.97    20,833.21    11,819.70

2002

   6,730    2,360    514,736    1,440.97    922.51    14,529.41    9,420.85

2003

   3,480    1,735    512,093    1,139.43    770.62    11,979.85    7,862.43

2004

   4,250    1,500    710,094    1,179.23    773.1    11,770.65    7,607.88

2005

   3,140    2,165    605,399    1,217.87    1,053.77    12,163.89    10,505.05

2005:

                                  

First quarter

   3,140    2,310    712,115    1,217.87    1,053.77    12,163.89    10,505.05

Second quarter

   2,820    2,315    549,037    1,188.42    1,084.64    11,896.01    10,687.81

Third quarter

   2,600    2,165    600,677    1,149.63    1,073.20    11,488.76    10,659.15

Fourth quarter

   2,475    2,245    560,848    1,203.26    1,132.18    11,966.69    11,238.37

2006:

                                  

First quarter

   2,415    2,115    619,736    1,201.30    1,109.19    11,874.75    10,825.39

Second quarter

   2,650    2,340    553,537    1,428.13    1,177.61    13,617.24    11,565.99

Third quarter

   2,710    2,210    881,385    1,663.75    1,371.37    16,344.20    13,106.18

Fourth quarter

   3,110    2,430    957,375    1,728.16    1,572.11    17,059.66    15,341.18

Calendar Period

                                  

2006:

                                  

January

   2,770    2,430    804,321    1,710.77    1,574.67    16,649.82    15,341.18

February

   2,935    2,530    1,150,065    1,713.47    1,572.11    16,747.76    15,437.93

March

   3,110    2,850    914,386    1,728.16    1,605.58    17,059.66    15,627.49

April

   3,020    2,760    877,025    1,783.72    1,710.76    17,563.37    16,906.23

May

   2,960    2,500    1,092,345    1,755.03    1,579.26    17,291.67    15,467.33

June

   2,665    2,330    1,359,541    1,606.11    1,458.30    15,789.31    14,218.60

 

On July 19, 2006, the reported closing price of our shares on the Tokyo Stock Exchange was ¥2,435 per share, the closing Nikkei Stock Average was ¥14,500.26 and the closing TOPIX was 1,475.42.

 

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Our ADSs have been listed on the New York Stock Exchange since September 30, 2002. On July 19, 2006, the closing sale price of our American Depositary Shares on the New York Stock Exchange was $21.85 per share. The following table sets forth, for the periods indicated, the closing high and low sales price in U.S. dollars and the average trading volume of our American Depositary Shares on the New York Stock Exchange:

 

     New York Stock Exchange
Price per ADS


   Average daily trading
volume of ADSs


         High ($)    

       Low ($)    

  

Fiscal Period

                  

2006:

                  

Third quarter

   $ 22.90    $ 19.00    310

Fourth quarter

     26.83      21.50    2,210

2007:

                  

First quarter

     26.67      20.42    3,190

Calendar Period:

                  

2006:

                  

January

   $ 24.20    $ 22.13    650

February

     25.05      21.50    1,300

March

     26.83      24.25    4,330

April

     26.45      23.89    2,300

May

     26.67      23.01    3,950

June

     24.10      20.42    3,200

 

B.    Plan of Distribution.

 

Not applicable.

 

C.    Markets.

 

See Item 9.A of this annual report for information on the markets on which our common stock is listed or quoted.

 

D.    Selling Shareholders.

 

Not applicable.

 

E.    Dilution.

 

For the year ended March 31, 2006, we had 42,014 shares of dilutive securities . Also, for the years ended March 31, 2004, 2005 and 2006, 1,657,600, we had 1,618,700 and 2,572,280 shares attributable to outstanding stock options were excluded as the exercise prices of the stock subscription rights were greater than or equal to the average price of the common shares, and therefore their inclusion would have been anti-dilutive.

 

F.    Expenses of the Issue.

 

Not applicable.

 

Item 10.   Additional Information.

 

A.    Share Capital.

 

Not applicable.

 

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B.    Memorandum and Articles of Association.

 

Objects and Purposes in Our Articles of Incorporation

 

Our corporate purposes, as specified in Article 2 of our Articles of Incorporation, which are attached as an exhibit to this annual report, are to own shares of companies which engage in the following businesses and to be engaged in the control and administration of such companies’ business activities as well as implementation of operations incidental to such activities:

 

  (1)   Research, development, manufacture and distribution of software and hardware relating to electric appliances and electronic components;

 

  (2)   Planning, production, manufacture, rental and distribution of music, audio and visual software (including disks, tape and film, etc.); production and acquisition of master copies, and transferal or usage permission thereof;

 

  (3)   Acquisition, management, promotion of usage and development of music copyright and related performance rights, and transferal or usage permission thereof;

 

  (4)   Planning, production and distribution of books, magazines, sheet music and other publications;

 

  (5)   Development, manufacture and distribution of toys;

 

  (6)   Design of character products (with images of people, animals, etc. which have unique names or characters);

 

  (7)   Planning, production, distribution on the Internet and Internet related services;

 

  (8)   Gathering, online distribution, processing and online sales of information, pictures and music using electrical communication and electrical communication related services;

 

  (9)   Information processing services and information reporting services;

 

  (10)   Management and control of sports facilities, amusement arcades, restaurants, accommodations, hot spring bathing facilities, saunas and parking lots;

 

  (11)   Management of schools for training and educating sport instructors, producers of digital content (application software for digital technologies) and producers of computer software;

 

  (12)   Medical treatment services and beauty services;

 

  (13)   Distribution of soft drinks, foods, alcoholic beverages, sports gear, clothing and computer game machines;

 

  (14)   Advertising agency, insurance agency, broadcasting business, travel agency and leisure business including tours, sports, etc.;

 

  (15)   Purchase and sale of antiques;

 

  (16)   Sale, purchase, lease, blockage and management of real estate;

 

  (17)   Job placement;

 

  (18)   General lease business and finance business;

 

  (19)   Holding of and investment in securities;

 

  (20)   Acquisition and management of copyrights, trademark rights, design rights, performance rights and rights to produce records and videos related to each of the preceding items;

 

  (21)   Import, export and agency business related to each of the preceding items;

 

  (22)   Investment in the party in charge of the business specified in the preceding items; and

 

  (23)   Any and all businesses incidental to any of the preceding items.

 

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Provisions Regarding Our Directors

 

Our Articles of Incorporation do not contain any provision concerning the power of any Director to vote at a meeting of our board of directors on proposals in which he is materially interested. However, in accordance with Article 369 Clause2 of the Corporate Law, a Director is not empowered to participate in discussion or exercise his vote at a meeting of our board of directors on proposals in which he has a personal interest.

 

Our Articles of Incorporation do not contain any provision concerning the power of any Director to vote to himself, or to any one or more of the elected members of our board of directors, any remuneration (including retirement allowances or other benefit). However, in accordance with Article 361 of the Corporate Law, Directors are not empowered to determine their remuneration (including retirement allowances or other benefits), such determination being made by resolutions of a general meeting of our shareholders.

 

Our Articles of Incorporation do not contain any provision concerning the powers of the Directors to borrow on our behalf. In accordance with Article 362 of the Corporate Law, our board of directors is not restricted in any way in the exercise of its power to borrow on our behalf.

 

There is no provision under our Articles of Incorporation or under the Commercial Code which requires a Director to retire from our board of directors at a particular age. However, in accordance with Article 22 of our Articles of Incorporation, the term of office of each Director who has been duly elected at a general meeting of shareholders in accordance with Article 21 of our Articles of Incorporation shall expire upon conclusion of the ordinary general meeting of shareholders for the last fiscal period ending within one year after his assumption of office. Directors can be re-elected. All of our existing Directors have been elected by the resolution of the shareholders’ meeting held on June 29, 2006 and each has entered into contract with us on the same date.

 

Article 361 of the Corporate Law provides, unless otherwise specified in the Articles of Incorporation, that remuneration for directors, in respect of its amount (if the amount is fixed), calculation manner (if the amount is not fixed) or its substance (if the remuneration is not cash), is determined at a general meeting of shareholders of a company. Within the upper limit approved by the shareholders’ meeting, our board of directors will determine the amount of compensation for each director. The board of Directors may, by its resolution, leave such decision to the discretion of the company’s representative director.

 

Article 361 Clause 4 Sub-clause 2 of the Corporate Law provides that the incurrence by a company of a significant loan from a third party should be approved by the company’s board of directors. Our Regulations of our board of directors have adopted this policy.

 

There is no mandatory retirement age for our Directors under the Corporate Law or our Articles of Incorporation.

 

There is no requirement concerning the number of shares one individual must hold in order to qualify him or her as a Director of Konami under the Corporate Law or our Articles of Incorporation.

 

Article 28 of our Articles of Incorporation and Article 427 Clause 1 of the Corporate Law provide that we may enter into agreements with external directors which limit the liability of such directors provided for by Article 423 Clause 1 of the Corporate Law.

 

Holding of Our Shares by Foreign Investors

 

There are no limitations on the rights of non-residents or foreign shareholders to hold or exercise voting rights on our shares imposed by the laws of Japan or our Articles of Incorporation or our other constituent documents.

 

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Rights of Our Shareholders

 

The following section contains certain information relating to the shares, including summaries of certain provisions of our Articles of Incorporation and Share Handling Regulations and of the Corporate Law relating to joint stock corporations.

 

General

 

Our authorized share capital consists of 450,000,000 shares in registered form with no par value. All issued shares are fully-paid and non-assessable. As of March 31, 2006, 137,152,347 of our shares were issued and outstanding and our stated capital was ¥47,399 million. Under the Corporate Law, the transfer of shares is effected by delivery of share certificates, but in order to assert rights as a shareholder against us, the transferee must have its name and address registered on our register of shareholders in accordance with our Share Handling Regulations. The registered beneficial holder of deposited shares underlying the ADSs is the depositary for the ADSs. Accordingly, holders of ADSs will not be able to directly assert shareholders’ rights such as the right to bring a derivative action, examine our accounting books and records or exercise appraisal rights. No temporary documents of title in respect of the shares will be issued. For this purpose, shareholders are required to file their names, addresses and seals with the transfer agent for the shares. Non-Japanese shareholders may file specimen signatures in lieu of seals. Non-resident shareholders are required to appoint a standing proxy in Japan or designate a mailing address in Japan. Japanese securities firms and commercial banks will customarily act as standing proxy and provide related services for standard fees. The transfer agent for our shares is The Sumitomo Trust & Banking Co., Ltd.

 

Our shares are freely transferable and there are no restrictions on transfer of the shares under the terms of the Corporate Law or our Articles of Incorporation.

 

Our shares are generally held in a certificated form, except that, if a shareholder deposits his share certificate with us we may cancel such share certificate. In the event a shareholder whose share certificate has been cancelled by us wishes to transfer his shares, reissuance of his share certificate by us to such shareholder and delivery to a transferee shall be required. The central clearing system of share certificates under the Law Concerning Central Clearing of Share Certificates and Other Securities in Japan applies to the shares. Holders of shares may deposit certificates for shares with the Japan Securities Depositary Center, or JASDEC, the sole depositary under the system, through the participants in the system (which normally will be securities companies). The shares deposited with JASDEC will be registered in the name of JASDEC in our register of shareholders. The beneficial owners of the deposited shares will be recorded in the register of beneficial shareholders which we prepare based on information furnished by the participants and JASDEC. Such register of beneficial shareholders will be updated as of record dates at which shareholders entitled to rights pertaining to the shares are determined. For the purpose of transferring the deposited shares, delivery of share certificates is not required. In general, beneficial shareholders of deposited shares registered in the register of beneficial shareholders will be entitled with respect to such shares to the same rights and benefits as the holders of shares registered in the register of shareholders. The registered beneficial shareholders may exercise the rights attached to the shares such as voting rights and will receive dividends (if any) and notices to shareholders directly from us. The shares held by a person as a registered shareholder and those held by the same person as a registered beneficial shareholder are aggregated for such purposes. New shares issued with respect to deposited shares, including those issued upon a stock split, automatically become deposited shares. The beneficial shareholders will be required to file with our transfer agent the same information as would be required from the registered shareholders principally through the relevant participants. Beneficial shareholders may at any time withdraw their shares from deposit and receive share certificates.

 

Settlement transactions concerning shares listed on any of the stock exchanges in Japan normally are effected on the fourth dealing day after the transaction. Settlement in Japan is made by physical delivery of share certificates or through JASDEC as stated above.

 

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As described above, non-resident shareholders are required to appoint a standing proxy in Japan or to provide a mailing address in Japan to receive notices from us. A local standing proxy can handle the transfer of share certificates and registration of transfer and the application for reduced withholding tax. See Item 10.E “Taxation—Japanese Taxation”. Persons holding shares through Euroclear or Clearstream Banking, société anonyme (“Clearstream, Luxembourg”) appoint the depositary of Euroclear or Clearstream, Luxembourg as proxy on a standing basis. Persons holding shares through shares through Euroclear or Clearstream, Luxembourg may receive notice from us, such as notices of shareholders’ meeting and dividend distributions, and are eligible for reduced withholding tax in accordance with the operating procedures of Euroclear and Clearstream, Luxembourg.

 

The Duties and Liabilities of Directors

 

Article 355 of the Corporate Law requires directors to “perform their duties faithfully on behalf of the company,” thus subjecting directors to a duty of loyalty (chujitsu gimu). This duty is supplemented by other duties such as to avoid self-interested transactions and competition with the corporation as well as to abide by all laws and regulations, the articles of incorporation and resolutions of general meetings of shareholders.

 

Directors shall be held liable for damages caused by any of the following actions:

 

    declaring an unlawful dividend or distribution of money;

 

    offering undue benefit in relation to the exercise of shareholder’s rights;

 

    engaging in a transaction that conflicts with interests of the company; or

 

    performing any other actions that violate laws and regulations, including the general duties of directors described in the preceding paragraph or the articles of incorporation.

 

Shareholders’ Rights to Bring Actions Against Directors

 

The provisions of Articles 847 of the Corporate Law constitute the Japanese shareholder derivative action mechanism. The provisions allow any shareholder who has continuously held a share for the previous six months to demand of the corporation that it file a suit to protect the company and enforce the liability of directors. Specifically, it provides that derivative actions may be brought to “enforce the liability of directors” in situations including, but not limited to, that where directors engage in self-interested transactions, or violate any laws and regulations or the articles of incorporation. If a corporate auditor has not instituted an action for the company within sixty days, the plaintiff-shareholder may initiate a lawsuit as a derivative action. Article 847 Clause 5 of the Corporate Law provides an exception to the sixty day waiting period, however, for cases in which waiting sixty days might cause the company “irreparable damage.” In such cases, the shareholder may institute the action immediately. After having brought the action, the shareholder who has done so must make notification of litigation (notice under litigation proceedings) to the company “without delay.” If a company might suffer irreparable damage from an act of a director, a shareholder who has owned a share continuously for the previous six months may seek an injunction suspending the performance of the act by the director.

 

Dividends

 

Following directors’ approval at our board of director’s meeting of shareholders, annual dividends are distributed to shareholders, beneficial shareholders or pledgees of record as at March 31 in each year in proportion to the number of shares held by each shareholder, beneficial shareholder or pledgee. Our Articles of Incorporation permit the payment of interim cash dividends (i.e. cash distributions made pursuant to Article 454 Clause 5 of the Corporate Law) to shareholders, beneficial shareholders or pledgees of record as at September 30 in each year by resolution of our board of directors. Under our Articles of Incorporation, we are not obliged to pay any annual or interim dividends unclaimed for a period of three years after the date on which they are first

 

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made available by us. In addition, pursuant to Article 459 of the Corporate Law, our Articles of Incorporation permit our board of directors to determine the distribution of our reserves based on the Board’s resolution, as well as to establish an alternative record date.

 

Article 445 Clause 4 of the Corporate Law and Article 45 of the Corporate Computation Rule under the Corporate Law provide in effect that until the sum of our additional paid-in capital and our legal reserve is at least one-quarter of our capital, we may not make any distribution of retained earnings by way of annual and interim dividends in cash unless we have retained in our legal reserve and set aside as our legal reserve, an amount equal to at least one-tenth of any amount paid out by us as an appropriation of retained earnings or equal to one-tenth of any amount paid out by us as an interim dividends. We may distribute profits by way of annual dividends or interim dividends out of the amount remaining (the “Distributable Amount” (Article 461 Clause 2 of the Corporate Law)) from the aggregate of retained capital and retained earnings at the end of the most recent fiscal year, adjusted for the amount of dividends distributed thereafter, “Retained Earnings” (Article 446 of the Corporate Law) and after adjustment, such as deduction of the book value of treasury stock, in accordance with laws and regulations. In our Company, the ex-dividend date and the record date for dividends precede the date of determination of the amount of the dividends to be paid.

 

For information as to Japanese taxes on dividends, see Item 10.E “Taxation—Japanese Taxation” below.

 

Capital and Reserves

 

The entire amount of the issue price of new shares is required to be accounted for as stated capital, although we may account for an amount not exceeding one-half of such issue price as additional paid-in capital. We may at any time transfer the whole or any part of our additional paid-in capital and legal reserve to stated capital by resolution of our board of directors. The whole or any part of retained earnings which are distributable as annual dividends may also be transferred to stated capital by resolution of an ordinary general meeting of shareholders.

 

Stock Splits

 

Pursuant to Article 183 and 184 of the Corporate Law, we may at any time split the shares in issue into a greater number of shares by resolution of our board of directors. Shareholders will not be required to exchange share certificates for new share certificates, but certificates representing the additional shares resulting from the stock split will be issued to shareholders. We must give public notice of the stock split, specifying a record date therefor, not less than two weeks prior to such record date and, in addition, promptly after the stock split takes effect, give notice to each shareholder specifying the number of shares to which such shareholder is entitled by virtue of the stock split. In conjunction with a stock split, we may increase the number of our authorized shares by the same ratio as the stock split ratio through a resolution of our board of directors.

 

Unit Share System

 

Under our Articles of Incorporation, the number of shares constituting one unit is 100 shares. Our board of directors may amend our Articles of Incorporation reducing the number of shares constituting one unit or eliminating the provision for the unit from our Articles of Incorporation although any amendment to our Articles of Incorporation increasing the number of shares constituting one unit requires a special resolution of a general meeting of shareholders. In any event, the number of shares constituting one unit shall not exceed 1,000 shares or one two-hundredth (1/200) of the total number of outstanding shares, whichever is smaller. Under the unit share system, each shareholder shall have one voting right for each unit of shares that he or she holds, and any number of shares less than one unit carries no voting rights. We may provide in our Articles of Incorporation that any share certificates which represent a number of shares less than one unit shall not be issued. Holders of less than one unit of shares may at any time require us to purchase such shares at their then current market price as determined pursuant to the Corporate Law and to sell them additional shares to create a whole unit of 100 shares.

 

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General Meeting of Shareholders

 

The ordinary general meeting of our shareholders is usually held in June of each year in Tokyo. In addition, we may hold an extraordinary general meeting of shareholders whenever necessary. Notice of a shareholders’ meeting stating the purpose thereof and a summary of the matters to be acted upon must be mailed to each shareholder having voting rights (or, in the case of a non-resident shareholder, to his mailing address or proxy in Japan) at least two weeks prior to the date set for the meeting. The record date for an ordinary general meeting of shareholders is March 31.

 

Any shareholder holding at least 300 voting rights or one percent of the total number of voting rights for six months or longer may propose a matter to be considered at a general meeting of shareholders by submitting a written request to a Representative Director at least eight weeks prior to the date of such meeting.

 

Voting Rights

 

A holder of shares constituting one or more whole units is entitled to one vote for each unit of shares, except that neither we, nor a corporate shareholder with more than one-quarter of the total voting rights of which are directly or indirectly owned by us, has voting rights in respect of the shares held by us or such a corporate shareholder. Except as otherwise provided by law or by our Articles of Incorporation, a resolution can be adopted at a general meeting of shareholders by a majority of the voting rights that are represented at the meeting. The quorum for election of Directors and Corporate Auditors is one-third of the total number of voting rights. Our shareholders are not entitled to cumulative voting in the election of Directors. Our shareholders may cast their votes in writing. Shareholders may also exercise their voting rights through proxies, provided that the proxies are also holders of shares with voting rights and are sole.

 

Our Articles of Incorporation provide that, in order to amend our Articles of Incorporation and in certain other instances, including any reduction of the stated capital, any removal of a Director or a Corporate Auditor, dissolution, merger or consolidation, exchange of shares for shares of an existing company, transfer of the whole or an important part of the business, taking over the whole of the business of any other company or any offering of new shares at a “specially favorable” price (or any offering of stock acquisition rights or bonds with stock acquisition rights with “specially favorable” conditions) to persons other than shareholders, the quorum is at least one-third of the total number of voting rights and the approval by at least two-thirds of the voting rights represented at the general meeting of shareholders is required.

 

The voting rights of holders of ADSs are exercised by the depositary based on instructions from those holders. With respect to voting by holders of ADRs, please see Item 12.D of our registration statement on Form 20-F filed with the Securities and Exchange Commission on September 20, 2002.

 

Liquidation Rights

 

In the event of our liquidation, the assets remaining after payment of all taxes, liquidation expenses and debts will be distributed among the shareholders in proportion to the respective number of shares which they hold.

 

Issue of Additional Shares and Pre-emptive Rights

 

Holders of shares have no pre-emptive rights. Authorized but unissued shares may be issued at such time and upon such terms as our board of directors determines, subject to the limitations as to the offering of new shares at a “specially favorable” price mentioned in “Rights of Our Shareholders—Voting Rights” above. Our board of directors may, however, determine that shareholders be given subscription rights to new shares, in which case they must be given on uniform terms to all shareholders as of a record date of which not less than two weeks’ prior public notice must be given. Each of the shareholders to whom such rights are given must also be given at least two weeks’ prior notice of the date on which such rights expire.

 

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Stock Subscription Rights

 

We may grant stock subscription rights to persons other than shareholders, as well as shareholders pursuant to a resolution of our board of directors. In the case of granting stock subscription rights to person other than our shareholders under “specially favorable” conditions, a special resolution of the general meeting of shareholders is required. Upon exercise of such stock subscription rights, we shall issue new shares or transfer shares which are held by us as treasury stock to the holder of the stock subscription rights.

 

Dilution

 

It is possible that, in the future, market conditions and other factors might make rights issues to shareholders desirable at a subscription price substantially below their then current market price, in which case shareholders who do not exercise and are unable otherwise to realize the full value of their subscription rights will suffer dilution of their equity interest in us.

 

Report to Shareholders

 

We furnish to our shareholders notices of shareholders’ meetings, annual business reports, including financial statements, and notices of resolutions adopted at the shareholders’ meetings, all of which are in Japanese.

 

In addition, we intend, upon request, to furnish to our shareholders with addresses outside Japan, through their resident proxies in Japan, copies of our annual report in English, containing annual audited consolidated financial statements.

 

Record Date

 

The record date for annual dividends is March 31 and the record date for interim dividends is September 30. In addition, by a resolution of our board of directors and after giving at least two weeks’ prior public notice, we may at any time set a record date in order to determine shareholders who are entitled to certain rights pertaining to the shares.

 

March 31 is the record date for the payment of annual dividends and September 30 is the record date for the payment of interim dividends. Shareholders appearing on our shareholders’ register at the close of business on March 31 of each year are entitled to vote at the ordinary general meeting of shareholders with respect to the financial year ending on such date. In addition, by resolution of our board of directors and after giving at least two weeks’ prior public notice, we may at any time set a record date to determine the shareholders who are entitled to interim dividends and certain other rights pertaining to the shares.

 

Repurchase of Our Shares

 

We may acquire our shares (i) by purchasing them on any Japanese stock exchange on which our shares are listed or by way of tender offer (pursuant to an ordinary resolution of any ordinary general meeting of shareholders or a resolution of our board of directors), (ii) from a specific shareholder other than our subsidiary (pursuant to a special resolution of an ordinary general meeting of shareholders) or (iii) from our subsidiary (pursuant to a resolution of our board of directors). In the case of (ii) above, any other shareholder may make a request directly to a Representative Director in writing, five days prior to the relevant shareholders’ meeting that we acquire our shares held by such other shareholder. If our shares are purchased by us pursuant to an authorization of our board of directors as mentioned in (i) above, then the reason for the purchase, as well as the kind, number and aggregate purchase price of such shares, must be reported to shareholders at the following ordinary general meeting of shareholders.

 

Any such acquisition of our shares must satisfy certain requirements, inter alia, that the purchase price may not exceed the amount of the retained earnings available for annual dividend payments plus the amount of any

 

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reduction of the stated capital, additional paid-in capital or legal reserve in accordance with the relevant provisions of the Corporate Law (if such reduction is authorized by a resolution of the relevant general meeting of shareholders) minus the sum of the amount to be paid by way of appropriation of retained earnings and the amount of retained earnings to be transferred to the stated capital in respect of the relevant fiscal year pursuant to a resolution of such general meeting of shareholders. However, if it is anticipated that the net assets, as stated on the balance sheet at the end of the immediately following fiscal year, will be less than the aggregate amount of items described in (i) through (vi) in “Dividends” above, we may not purchase such shares. We may hold our shares acquired in compliance with the provisions of the Corporate Law (the “treasury stock”) and generally may cancel or dispose of such shares by resolutions of our board of directors subject to the limitation as to the disposal of such treasury stock at a specially favorable price mentioned in “Voting Rights” above.

 

Disposal by Us of Shares Held by Unknown Shareholders

 

We are not required to send a notice to a shareholder if a notice to such shareholder fails to arrive at the registered address of the shareholder in the register of shareholders, or at the address otherwise notified to us, continuously for five years or more.

 

In addition, we may sell or otherwise dispose of shares for which the location of the shareholder is unknown. Generally, if (i) notices to a shareholder fail to arrive continuously for five years or more at the shareholder’s registered address in the register of shareholders or at the address otherwise notified to us and (ii) the shareholder fails to receive dividends on the shares continuously for five years or more at the address registered in the register of shareholders or at the address otherwise notified to us, we may sell or otherwise dispose of the shareholder’s shares (including repurchase by us) by a resolution of our board of directors after giving at least three months’ prior public and individual notice and shall hold or deposit the proceeds of such sale or disposal of shares for the shareholder, the location of which is unknown.

 

The Japan Securities Depositary Center

 

The central clearing system of share certificates under the Law Concerning Central Clearing of Share Certificates and Other Securities in Japan applies to the shares. Under this system, holders of shares may deposit certificates for shares with JASDEC, the sole depositary under the system, through the participants. See “Rights of Our Shareholders—General”.

 

Japanese Foreign Exchange And Certain Other Regulations

 

The Foreign Exchange and Foreign Trade Law of Japan, as amended, and the cabinet orders and ministerial ordinances thereunder (collectively, the “Foreign Exchange Regulations”) govern certain matters relating to the acquisition and holding of shares by “non-residents of Japan” and “foreign investors”. The Foreign Exchange Regulations currently in effect do not affect the purchase, sale or exchange of shares provided such transactions take place outside Japan between non-residents of Japan.

 

“Non-residents of Japan” is defined in the Foreign Exchange Regulations to mean individuals who are not residents of Japan and corporations whose principal offices are located outside Japan. Generally, branches and other offices located within Japan of non-resident corporations are regarded as residents of Japan, and branches and other offices of Japanese corporations located outside Japan are regarded as non-residents of Japan.

 

“Foreign investors” is defined in the Foreign Exchange Regulations to mean (i) individuals not resident in Japan, (ii) corporations organized under the laws of foreign countries or whose principal offices are located outside Japan, or (iii) corporations organized in Japan not less than 50% of the total voting rights of which are held, directly or indirectly, by individuals and/or corporations falling within (i) and/or (ii) above or a majority of the directors or other officers (or directors or other officers having the power of representation) of which are non-resident individuals.

 

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Acquisition of Shares

 

In general, the acquisition of shares of stock of a Japanese company listed on any Japanese stock exchange or traded in any over-the-counter market in Japan by a non-resident of Japan from a resident of Japan may be made without any restriction, except as mentioned below. However, a report by the relevant resident of Japan to the Minister of Finance must be filed following the transfer of shares to the non-resident of Japan, unless the consideration for such transfer is ¥100 million or less or such transfer is made through a bank, securities company or financial futures trader licensed under the relevant Japanese laws. In addition to the above, the Foreign Exchange Regulations give the Minister of Finance the power to require a prior approval for any such acquisition in certain exceptional circumstances.

 

If a foreign investor acquires shares of a Japanese company listed on a Japanese stock exchange or traded on an over-the-counter market in Japan and as a result of such acquisition (regardless of the person from or through whom it acquires the shares), aggregated with existing holdings (if any), the foreign investor directly or indirectly holds 10% or more of the issued shares of the relevant company, the foreign investor is, in general, required to report such acquisition to the Minister of Finance and any other competent Ministers within 15 days from and including the date of such acquisition. In certain exceptional cases, a prior notification is required in respect of such an acquisition.

 

Dividends and Proceeds of Sale

 

Under the Foreign Exchange Regulations, dividends paid on, and the proceeds of sales in Japan of, shares held by non-residents of Japan may in general be converted into any foreign currency and repatriated abroad. The acquisition of shares by non-resident shareholders by way of a stock split is not subject to any notification or reporting requirements. Under the terms of the deposit agreement pursuant to which our ADSs are issued, the depositary is required, to the extent that in its judgment it can convert yen on a reasonable basis into dollars and transfer the resulting dollars to the United States, to convert all cash dividends that it receives in respect of deposited shares into dollars and to distribute the amount received (after deduction of applicable withholding taxes) to the holder of ADSs. For additional information regarding our ADSs, please see Item 12.D of our registration statement on Form 20-F filed with the Securities and Exchange Commission on September 20, 2002.

 

Reporting of Substantial Shareholdings

 

The Securities and Exchange Law of Japan and regulations thereunder generally requires any person who has become a beneficial holder (including certain sole or joint holders) of more than 5% of the total issued voting shares of a company listed on any Japanese stock exchange or traded on the over-the-counter market in Japan to file with the Director-General of the relevant local Finance Bureau, within five business days, a report concerning such shareholdings. A similar report must also be made (with certain exceptions) if the percentage of such holding subsequently increases or decreases by 1% or more. Copies of any such report must also be furnished to the issuer of such shares and to all Japanese stock exchanges on which the shares are listed or the Japan Securities Dealers Association in the case of over-the-counter registered shares. For this purpose, shares issuable upon exercise of stock acquisition rights are taken into account in determining both the number of shares held by such holder and the issuer’s total issued share capital.

 

Daily Price Fluctuation Limits under Japanese Stock Exchange Rules

 

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

 

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On July 19, 2006, the closing price of our shares on the Tokyo Stock Exchange was ¥2,435 per share. The following table shows the daily price limit for a stock on the Tokyo Stock Exchange with a closing price of between ¥2,000 and ¥3,000 per share, as well as the daily price limit if our per share price were to rise to between ¥3,000 and ¥5,000, or fall to between ¥1,500 and ¥2,000. Other daily price limits would apply if our per share price moved to other ranges.

 

Selected Daily Price Limits

 

Previous Day’s Closing Price or Special Quote


   Maximum Daily Price Movement

Over

   ¥1,500      Less than    ¥2,000    ¥ 300

Over

   2,000      Less than    3,000      400

Over

   3,000      Less than    5,000      500

 

For a history of the trading price of our shares on the Tokyo Stock Exchange, see Item 9.A of this annual report.

 

C.    Material Contracts.

 

We have not entered into any material contract, other than in the ordinary course of business, within the two years immediately preceding the date of this document or any contract, other than in the ordinary course of business, which contains any provision under which we have any obligation or entitlement which is material to us as at the date of this document.

 

D.    Exchange Controls.

 

There are no laws, decrees, regulations or other legislation which affect our ability to import or export capital for our use or our ability to pay dividends to nonresident holders of our shares.

 

E.    Taxation.

 

United States Federal Income Taxation

 

This section describes the material United States federal income tax consequences of owning shares or ADSs. It applies to you only if you are a U.S. holder, as defined below, and you hold your shares or ADSs as capital assets for tax purposes. This section does not apply to you if you are a member of a special class of holders subject to special rules, including:

 

    a dealer in securities,

 

    a trader in securities that elects to use a mark-to-market method of accounting for your securities holdings,

 

    a tax-exempt organization,

 

    a life insurance company,

 

    a person liable for alternative minimum tax,

 

    a person that actually or constructively owns 10% or more of our voting stock,

 

    a person that holds shares or ADSs as part of a straddle or a hedging or conversion transaction, or

 

    U.S. holder (as defined below) whose functional currency is not the U.S. dollar.

 

This section is based on the Internal Revenue Code of 1986, as amended, its legislative history, existing and proposed regulations, published rulings and court decisions, all as currently in effect, as well as on the

 

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Convention Between the United States of America and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (the “Treaty”). These laws are subject to change, possibly on a retroactive basis. In addition, this section is based in part upon the representations of JPMorgan Chase Bank as Depositary and the assumption that each obligation in the Deposit Agreement and any related agreement will be performed in accordance with its terms.

 

You are a U.S. holder if you are a beneficial owner of shares or ADSs and you are:

 

    a citizen or resident of the United States,

 

    a domestic corporation,

 

    an estate whose income is subject to United States federal income tax regardless of its source, or

 

    a trust if a United States court can exercise primary supervision over the trust’s administration and one or more United States persons are authorized to control all substantial decisions of the trust.

 

You should consult your own tax adviser regarding the United States federal, state and local and the Japanese and other tax consequences of owning and disposing of shares and ADSs in your particular circumstances.

 

In general, and taking into account the earlier assumptions, for United States federal income tax purposes, if you hold ADRs evidencing ADSs, you will be treated as the owner of the shares represented by those ADRs. Exchanges of shares for ADRs, and ADRs for shares, generally will not be subject to United States federal income tax.

 

Taxation of Dividends

 

Under the United States federal income tax laws, and subject to the passive foreign investment company, or PFIC, rules discussed below, if you are a U.S. holder the gross amount of any dividend paid by us out of our current or accumulated earnings and profits (as determined for United States federal income tax purposes) will be subject to U.S. federal taxation. If you are a non-corporate U.S. holder, dividends paid to you in taxable years before January 1, 2011 that constitute qualified dividend income will be taxable to you at a maximum tax rate of 15% provided that you hold the shares or ADSs for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date and meet other holding period requirements. Dividends we pay with respect to the shares or ADSs generally will be qualified dividend income. You must include any Japanese tax withheld from the dividend payment in this gross amount even though you do not in fact receive it. The dividend is taxable to you when you, in the case of shares, or the Depositary, in the case of ADSs, receive the dividend, actually or constructively. The dividend will not be eligible for the dividends-received deduction generally allowed to United States corporations in respect of dividends received from other United States corporations. The amount of the dividend distribution that you must include in your income as a U.S. holder will be the U.S. dollar value of the Japanese yen payments made, determined at the spot Japanese yen/U.S. dollar rate on the date the dividend distribution is includible in your income, regardless of whether the payment is in fact converted into U.S. dollars. Generally, any gain or loss resulting from currency exchange fluctuations during the period from the date you include the dividend payment in income to the date you convert the payment into U.S. dollars will be treated as ordinary income or loss and will not be eligible for the special tax rate applicable to qualified dividend income. The gain or loss generally will be income or loss from sources within the United States for foreign tax credit limitation purposes. Distributions in excess of current and accumulated earnings and profits, as determined for United States federal income tax purposes, will be treated as a non-taxable return of capital to the extent of your basis in the shares or ADSs and thereafter as capital gain.

 

Subject to certain limitations, the Japanese tax withheld in accordance with the Treaty and paid over to Japan will be creditable against your United States federal income tax liability. Special rules apply in

 

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determining the foreign tax credit limitation with respect to dividends that are subject to the maximum 15% tax rate. To the extent a refund of the tax withheld is available to you under Japanese law or under the Treaty, the amount of tax withheld that is refundable will not be eligible for credit against your United States federal income tax liability. Dividends will be income from sources outside the United States, but dividends paid in taxable years beginning before January 1, 2007 generally will be “passive” or “financial services” income, and dividends paid in taxable years beginning after December 31, 2006 will, depending on your circumstances, be “passive” or “general” income which, in either case, is treated separately from other types of income for purposes of computing the foreign tax credit allowable to you.

 

Taxation of Capital Gains

 

Subject to the PFIC rules discussed below, if you are a U.S. holder and you sell or otherwise dispose of your shares or ADSs, you will recognize capital gain or loss for United States federal income tax purposes equal to the difference between the U.S. dollar value of the amount that you realize and your tax basis, determined in U.S. dollars, in your shares or ADSs. Capital gain of a noncorporate U.S. holder that is recognized before January 1, 2011 is generally taxed at a maximum rate of 15% where the holder has a holding period greater than one year. The gain or loss will generally be income or loss from sources within the United States for foreign tax credit limitation purposes.

 

Passive Foreign Investment Company Rules

 

We believe that shares and ADSs should not be treated as stock of a PFIC for United States federal income tax purposes, but this conclusion is a factual determination that is made annually based on our asset values, including the value of our intangibles as evidenced by the fair market value of our shares or ADSs, and our gross income, each of which is subject to change. Therefore, it may be subject to change.

 

In general, we will be a PFIC with respect to you if for any taxable year in which you held our ADSs or shares:

 

    at least 75% of our gross income for the taxable year is passive income or

 

    at least 50% of the value, determined on the basis of a quarterly average, of our assets is attributable to assets that produce or are held for the production of passive income.

 

Passive income generally includes dividends, interest, royalties, rents (other than certain rents and royalties derived in the active conduct of a trade or business), annuities and gains from assets that produce passive income. If a foreign corporation owns at least 25% by value of the stock of another corporation, the foreign corporation is treated for purposes of the PFIC tests as owning its proportionate share of the assets of the other corporation, and as receiving directly its proportionate share of the other corporation’s income.

 

If we are treated as a PFIC, and you are a U.S. holder that did not make a mark-to-market election, as described below, you will be subject to special rules with respect to:

 

    any gain you realize on the sale or other disposition of your shares or ADSs and

 

    any excess distribution that we make to you (generally, any distributions to you during a single taxable year that are greater than 125% of the average annual distributions received by you in respect of the shares or ADSs during the three preceding taxable years or, if shorter, your holding period for the shares or ADSs).

 

Under these rules:

 

    the gain or excess distribution will be allocated ratably over your holding period for the shares or ADSs,

 

    the amount allocated to the taxable year in which you realized the gain or excess distribution will be taxed as ordinary income,

 

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    the amount allocated to each prior year, with certain exceptions, will be taxed at the highest tax rate in effect for that year, and

 

    the interest charge generally applicable to underpayments of tax will be imposed in respect of the tax attributable to each such year.

 

Special rules apply for calculating the amount of the foreign tax credit with respect to excess distributions by a PFIC.

 

If you own shares or ADSs in a PFIC that are treated as marketable stock, you may make a mark-to-market election. If you make this election, you will not be subject to the PFIC rules described above. Instead, in general, you will include as ordinary income each year the excess, if any, of the fair market value of your shares or ADSs at the end of the taxable year over your adjusted basis in your shares or ADSs. These amounts of ordinary income will not be eligible for the favorable tax rates applicable to qualified dividend income or long-term capital gains. You will also be allowed to take an ordinary loss in respect of the excess, if any, of the adjusted basis of your shares or ADSs over their fair market value at the end of the taxable year (but only to the extent of the net amount of previously included income as a result of the mark-to-market election). Your basis in the shares or ADSs will be adjusted to reflect any such income or loss amounts.

 

In addition, notwithstanding any election you make with regard to the shares or ADSs, dividends that you receive from us will not constitute qualified dividend income to you if we are a PFIC either in the taxable year of the distribution or the preceding taxable year. Dividends that you receive that do not constitute qualified dividend income are not eligible for taxation at the 15% maximum rate applicable to qualified dividend income. Instead, you must include the gross amount of any such dividend paid by us out of our accumulated earnings and profits (as determined for United States federal income tax purposes) in your gross income, and it will be subject to tax at rates applicable to ordinary income.

 

If you own shares or ADSs during any year that we are a PFIC, you must file Internal Revenue Service Form 8621.

 

Japanese Taxation

 

The following is a summary of the principal Japanese tax consequences to owners of our shares or ADSs who are non-resident individuals or non-Japanese corporations without a permanent establishment in Japan to which income from our shares is attributable. The tax treatment is subject to possible changes in the applicable Japanese laws or double taxation conventions occurring after that date. This summary is not exhaustive of all possible tax considerations that may apply to a particular investor. Potential investors should consult their own tax advisers as to:

 

    the overall tax consequences of the acquisition, ownership and disposition of shares or ADSs, including specifically the tax consequences under Japanese law;

 

    the laws of the jurisdiction of which they are resident; and

 

    any tax treaty between Japan and their country of residence.

 

Generally, a non-resident holder of shares or ADSs is subject to Japanese withholding tax on dividends paid by us. In the absence of any applicable tax treaty, convention or agreement reducing the maximum rate of withholding tax, the rate of Japanese withholding tax applicable to dividends paid by us to non-resident holders is 20%. Except for any individual shareholder who holds 5% or more of the total outstanding shares, the aforementioned 20% withholding tax rate is reduced pursuant to the Special Taxation Measures Law of Japan to (i) 7% for dividends due and payable on or before March 31, 2008, and (ii) 15% for dividends due and payable on or after April 1, 2008. Japan has income tax treaties, conventions or agreements whereby this withholding tax rate is reduced to, in most cases, 15% for portfolio investors, with, among other countries, Australia, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, New Zealand, Norway, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States.

 

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The Convention between the United States of America and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, which we refer to as the Tax Convention, established the maximum rate of Japanese withholding tax which may be imposed on dividends paid to a United States resident not having a permanent establishment in Japan. Under the Tax Convention, the maximum withholding rates for U.S. shareholders and U.S. holders of ADSs are limited to (a) 5% of the gross amount of the dividends if the recipient is a corporation which holds more than 10% of voting shares of the paying corporation, or (b) 10% of the gross amount of the dividends in otherwise.

 

    Notwithstanding the above, no withholding tax shall be imposed if the recipient is:

 

    a corporation which has continued to hold more than 50% of the voting shares of the paying corporation for a period of 12 months ending on the date on which entitlement to the dividends is determined, and that either (i) whose shares are listed or registered on a certified stock exchange and traded thereon; or (ii) the purpose or business of which is not focused on achieving the benefit of the Tax Convention, and which has continued to hold more than 50% of the voting shares of the paying corporation for a period of 12 months ended on the last day of the financial year of such paying corporation; or

 

    a certain pension fund.

 

Non-resident holders who are entitled to a reduced rate of Japanese withholding tax on payments of dividends on the shares by us are required to submit an Application Form for the Income Tax Convention regarding Relief from Japanese Income Tax on Dividends in advance through us to the relevant tax authority before the payment of dividends. A standing proxy for non-resident holders may provide such application service. With respect to ADSs, this reduced rate is applicable if the depositary or its agent submits two Application Forms for Income Tax Convention (one prior to payment of dividends, the other within eight months after our fiscal year-end). To claim this reduced rate, a non-resident holder of ADSs will be required to file proof of taxpayer status, residence and beneficial ownership (as applicable) and to provide other information or documents as may be required by the depositary. Non-resident holders who do not submit an application in advance will generally be entitled to claim a refund from the relevant Japanese tax authority of withholding taxes withheld in excess of the rate of an applicable tax treaty.

 

Gains derived from the sale of shares or ADSs outside Japan, or from the sale of shares within Japan by a non-resident holder, generally are not subject to Japanese income or corporation taxes.

 

Japanese inheritance and gift taxes at progressive rates may be payable by an individual who has acquired shares or ADSs as a legatee, heir or donee, even if the individual is not a Japanese resident.

 

F.    Dividends and Paying Agents.

 

Not applicable.

 

G.    Statement by Experts.

 

Not applicable.

 

H.    Documents on Display.

 

We file periodic reports and other information with the Securities and Exchange Commission. You may read and copy any document that we file with the SEC at the SEC’s public reference room at 100F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of its public reference room. The Securities and Exchange Commission also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding registrants that file electronically with the

 

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Securities and Exchange Commission. You may also inspect our SEC reports and other information at the New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005. Some of this information may also be found on our website at www.konami.com. Our website is not part of this annual report.

 

As a foreign private issuer, we are exempt from the rules under the Securities Exchange Act of 1934 prescribing the furnishing and content of proxy statements to shareholders.

 

I.    Subsidiary Information.

 

Not applicable.

 

Item 11.   Quantitative and Qualitative Disclosures about Market Risk

 

We are exposed to market risk primarily from changes in foreign currency exchange rates, interest rates and equity prices. Our earnings and cash flows may be negatively impacted by fluctuating interest and foreign exchange rates as well as equity prices associated with assets, liabilities or anticipated transactions which may affect our operating results and financial condition. We seek to minimize market risk through our regular operating and financing activities and, following the evaluation of the exposures, selectively enter into derivative hedging instruments. Foreign exchange forward contracts are used by us primarily to reduce foreign exchange currency risks. We do not hold derivative instruments for speculative purposes. Also, we do not hold or issue financial instruments for trading purposes.

 

Foreign currency exchange rate risk

 

Transaction risk

 

A portion of our business is conducted in currencies other than yen, most significantly the U.S. dollar and the Euro. For the fiscal year ended March 31, 2006, our U.S. dollar and Euro denominated sales comprised 12.9% and 10.4% of total revenues, respectively. While sales denominated in U.S. dollars and the Euro are, to a significant extent, offset by U.S. dollar and Euro denominated costs, we generally have had a significant net long U.S. dollar and Euro position. As of March 31, 2006 we had net U.S. dollar dominated monetary assets of approximately $167 million and Euro denominated monetary assets of approximately €63 million. To the extent that there are any open foreign currency positions, we are exposed to the risk of foreign currency fluctuations. Any gains and losses that result are recorded in our results of operations for the period. The foreign exchange gain (loss), net represents the differences between the value of monetary assets and liabilities when they are originated at exchange rates current when a purchase or sale occurs and their value at the prevailing exchange rate when they are settled or translated at year-end. Foreign currency-denominated monetary assets may include bank deposits, trade receivables and other receivables and monetary liabilities may include trade and notes payable, borrowings and debt.

 

Translation risk

 

Our reporting currency is the Japanese yen. We have assets and liabilities outside Japan, primarily in the United States and Europe, that are subject to fluctuations in foreign currency exchange rates. We prepare financial statements of our foreign operations in their functional currencies prior to consolidation in our financial statements. As a result, changes in the value of yen relative to the functional currencies of the underlying operations create translation gains and losses, which are recorded outside of our statement of operations in other comprehensive income until we dispose of or liquidate the relevant foreign operation.

 

Foreign currency derivatives

 

We enter into foreign exchange forward contracts to manage foreign exchange exposure associated with short-term movements in exchange rates applicable to our payables commitments and receivables that we expect

 

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to be paid that are denominated in foreign currencies. Because the counterparties to these contracts are limited to major international financial institutions, we do not anticipate any losses arising from credit risk. Our Finance Department executes and controls these contracts. Foreign exchange forward contracts are presented below by the notional balances with weighted average exchange rates. All of these forward contracts are expected to mature in three to six months.

 

Foreign exchange forward contracts at March 31, 2006

 

     Millions of Yen

     Contract
amount


   Fair value

   Gain (loss)

    Weighted
average
exchange
rates


Foreign exchange forward contracts

                            

Selling U.S. Dollar

   ¥ 3,307    ¥ 3,320    ¥ (13 )   ¥ 116.03

Selling EURO

     451      456      (5 )     140.81
    

  

  


 

Total

   ¥ 3,758    ¥ 3,776    ¥ (18 )      
    

  

  


     

 

Foreign exchange forward contracts at March 31, 2005

 

     Millions of Yen

     Contract
amount


   Fair value

   Gain (loss)

    Weighted
average
exchange
rates


Foreign exchange forward contracts

                            

Selling U.S. Dollar

   ¥ 4,356    ¥ 4,494    ¥ (138 )   ¥ 103.72

Selling EURO

     5,137      5,259      (122 )     135.18
    

  

  


 

Total

   ¥ 9,493    ¥ 9,753    ¥ (260 )      
    

  

  


     

 

Interest rate risk

 

The tables below present the principal cash flows and related weighted-average interest rates for our long-term debt obligations by expected maturity dates and the expected fair value as of March 31, 2006 and 2005 respectively. All of our long-term debt obligations have fixed interest rates.

 

Interest rate risk at March 31, 2006

 

    Expected maturity dates

Type of debt and average interest rates


  2007

  2008

  2009

  2010

  2011

  Thereafter

  Total
3/31/06


  Fair Value
3/31/06


    (in millions of yen)

Unsecured bank loans (1.005%)

  ¥ 1,993   ¥ 593   ¥ 593   ¥ 593   ¥ 204   —     ¥ 3,975   ¥ 3,864

Unsecured bonds (1.08%)

  ¥ 20,000   ¥ 20,000   ¥ 5,000     —       —     —     ¥ 45,000   ¥ 44,103
   

 

 

 

 

 
 

 

Total

  ¥ 21,993   ¥ 20,593   ¥ 5,593   ¥ 593   ¥ 204       —     ¥ 481,975   ¥ 47,967
   

 

 

 

 

 
 

 

 

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Interest rate risk at March 31, 2005

 

    Expected maturity dates

Type of debt and average interest rates


  2006

  2007

  2008

  2009

  2010

  Thereafter

  Total
3/31/05


  Fair Value
3/31/05


    (in millions of yen)

Unsecured bank loans (1.007%)

  ¥ 929   ¥ 1,998   ¥ 596   ¥ 593   ¥ 796   —     ¥ 4,912   ¥ 4,802

Unsecured bonds (0.99%)

  ¥ 15,000   ¥ 20,000   ¥ 20,000   ¥ 5,000     —     —     ¥ 60,000   ¥ 58,992
   

 

 

 

 

 
 

 

Total

  ¥ 15,929   ¥ 21,998   ¥ 20,596   ¥ 5,593   ¥ 796       —     ¥ 64,912   ¥ 63,794
   

 

 

 

 

 
 

 

 

Investment price risk

 

The fair value of certain of our investments, primarily in marketable securities, exposes us to equity price risks. In general, we have invested in highly-liquid and low-risk instruments, which are not held for trading purposes. These investments are subject to changes in the market prices of the securities. If the fair value of these securities were to change by 10%, the impact on the carrying amount of those securities as of March 31, 2006 would be ¥45.64 million. We had no open equity derivative positions during March 31, 2005 or 2006.

 

The following tables below provide information about our market sensitive marketable securities as of March 31, 2006 and 2005, respectively:

 

    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
   

 

 

 

 

 

 

 

    Millions of Yen

  Thousands of U.S. Dollars

    March 31, 2005

  March 31, 2005

    Cost

  Gross
unrealized
gains


  Gross
unrealized
losses


  Fair
value


  Cost

  Gross
unrealized
gains


  Gross
unrealized
losses


  Fair
value


Available-for-sale:

                                               

Marketable equity securities

  ¥ 76   ¥ 89   ¥ —     ¥ 165   $ 707   $ 829   $ —     $ 1,536
   

 

 

 

 

 

 

 

Total

  ¥ 76   ¥ 89   ¥ —     ¥ 165   $ 707   $ 829   $ —     $ 1,536
   

 

 

 

 

 

 

 

 

Credit Risk

 

As of March 31, 2006, we did not have any significant concentration of business transacted with an individual counterparty or group of counterparties that could , if suddenly eliminated, severely impact our operations. Moreover our derivative financial instruments are executed with credit worthy financial institutions, and our management believes there is little risk of default by these parties.

 

Commodity price risk

 

As of March 31, 2006, we had no open commodity derivative positions.

 

Item 12.   Description of Securities Other Than Equity Securities

 

Not applicable.

 

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PART II

 

Item 13.   Defaults, Dividend Arrearages and Delinquencies.

 

None.

 

Item 14.   Material Modifications to the Rights of Security Holders and Use of Proceeds.

 

None.

 

Item 15.   Controls and Procedures.

 

Our Disclosure Committee is charged with the maintenance and evaluation of our disclosure controls and procedures. As of March 31, 2006, an evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, and the Disclosure Committee, of the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based on that evaluation, these officers concluded that, as of March 31, 2006, the disclosure controls and procedures were effective. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934) occurred that has materially affected, or is reasonably likely to affect, our internal control over financial reporting during the year ended March 31, 2006 and through the date of this report.

 

Item 16A.   Audit Committee Financial Expert.

 

Our Board of Corporate Auditors has determined that we do not have an “audit committee financial expert” as defined in Item 16A of Form 20-F serving on our Board of Corporate Auditors. We believe that the combined knowledge, skills and experience of the members of our Board of Corporate Auditors enables them, as a group, to act effectively in the fulfillment of their tasks and responsibilities, including those under the Sarbanes-Oxley Act of 2002, and that our Board of Corporate Auditors has functioned and can continue to function effectively without appointing a member who would qualify as an audit committee financial expert under Item 16A. In addition, the Corporate Auditors have the power and authority to engage outside experts as they deem appropriate to provide them with advice on matters related to their responsibilities.

 

Item 16B.   Code of Ethics.

 

We have adopted a code of ethics, the “Konami Group Code of Business Conduct and Ethics” which applies to all of our personnel, including our chief executive officer, chief financial officer, corporate auditors, corporate officers, and employees, whether working for Konami or another company in the Konami Group. The text of the Konami Group Code of Business Conduct and Ethics is attached as exhibit 11.1 to this annual report.

 

Item 16C.   Principal Accountant Fees and Services.

 

Fees Paid to the Independent Auditor

 

The board of directors engaged KPMG AZSA &Co. to perform an annual audit of our financial statements in the years ended March 31, 2005 and 2006. The following table presents information concerning fees paid to KPMG AZSA &Co. and KPMG international member firms (“KPMG”) in those years.

 

     Year ended March 31,

     (in millions)

         2005    

       2006    

Audit fees (1)

   ¥ 239    ¥ 249

Audit-related fees (2)

     5      19

Tax fees (3)

     118      148

All other fees (4)

     31      —  
    

  

Total

   ¥ 393    ¥ 416
    

  

 

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(1)   These are fees for professional services for the audit of our annual financial statements and services that are normally provided in connection with statutory and regulatory filings.
(2)   These are fees for assurance and related services performed by auditors that are reasonably related to the performance of the audit or review of our financial statements but not described in item (1) above. These services include audit of pension funds and employee benefit plans, internal control reviews and consultation concerning financial accounting and reporting standards.
(3)   These are fees for professional tax services performed including tax compliance, tax advice and tax planning.
(4)   These are fees for all other services except those separately defined above.

 

Pre-Approval of Services Provided by KPMG

 

Our Corporate Auditors have adopted policies and procedures for pre-approving all non-audit work performed by KPMG. Specifically, the policies and procedures prohibit KPMG from performing any services for Konami or its subsidiaries without the prior approval of our Corporate Auditors.

 

All of the services provided by KPMG in the year ended March 31, 2006 were approved by our Corporate Auditors pursuant to the approval policies described above, and none of such services were approved pursuant to the procedures described in Rule 2-01(c)(7)(i)(C) of Regulation S-X, which waives the general requirement for pre-approval in certain circumstances.

 

Item 16D.   Exemption from the Listing Standards for Audit Committees.

 

With respect to the requirements of Rule 10A-3 under the Securities Exchange Act of 1934 relating to listed company audit committees, which apply to us through Section 303A.06 of the New York Stock Exchange’s Listed Company Manual, we rely on an exemption provided by paragraph (c)(3) of that Rule available to foreign private issuers with boards of corporate auditors meeting certain requirements. For a New York Stock Exchange-listed Japanese company with a board of corporate auditors, the requirements for relying on paragraph (c)(3) of Rule 10A-3 are as follows:

 

    The board of corporate auditors must be established, and its members must be selected, pursuant to Japanese law expressly requiring such a board for Japanese companies that elect to have a corporate governance system with corporate auditors.

 

    Japanese law must and does require the board of corporate auditors to be separate from the board of directors.

 

    None of the members of the board of corporate auditors may be elected by management, and none of the listed company’s executive officers may be a member of the board of corporate auditors.

 

    Japanese law must and does set forth standards for the independence of the members of the board of corporate auditors from the listed company or its management.

 

    The board of corporate auditors, in accordance with Japanese law or the registrant’s governing documents, must be responsible, to the extent permitted by Japanese law, for the appointment, retention and oversight of the work of any registered public accounting firm engaged (including, to the extent permitted by Japanese law, the resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for the listed company, including its principal accountant which audits its consolidated financial statements included in its annual reports on Form 20-F.

 

    To the extent permitted by Japanese law:

 

    the board of corporate auditors must establish procedures for (i) the receipt, retention and treatment of complaints received by us regarding accounting, internal accounting controls, or auditing matters, and (ii) the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters;

 

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    the board of corporate auditors must have the authority to engage independent counsel and other advisers, as it determines necessary to carry out its duties; and

 

    the listed company must provide for appropriate funding, as determined by its board of corporate auditors, for payment of (i) compensation to any registered public accounting firm engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for us, (ii) compensation to any advisers employed by the board of corporate auditors, and (iii) ordinary administrative expenses of the board of corporate auditors that are necessary or appropriate in carrying out its duties.

 

In our assessment, our Board of Corporate Auditors, which meets the requirements for reliance on the exemption in paragraph (c)(3) of Rule 10A-3 described above, is not materially less effective than an audit committee meeting all the requirements of paragraph (b) of Rule 10A-3 (without relying on any exemption provided by that Rule) at acting independently of management and performing the functions of an audit committee as contemplated therein.

 

Item 16E.   Purchases of Equity Securities by the Issuer and Affiliated Purchasers.

 

The following table sets forth, for each of the months indicated, the total number of shares purchased by us and any affiliated purchaser, the average price paid per share, the number of shares purchased as part of a publicly announced repurchase plan or program, and the maximum number of shares that may yet be purchased under the plans.

 

Period


  

(a)
Total Number

of Shares

Purchased

(shares)


  

(b)
Average
Price Paid
per Share

(yen)


   (c)
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans


   (d)
Maximum Number of
Shares that May Yet
Be Purchased
Under the Plans


April 1 to April 30, 2005

   2,125    2,292.06    —      1,500,000

May 1 to May 31, 2005

   1,330    2,190.91    —      1,500,000

June 1 to June 30, 2005

   3,622    2,212.60    —      —  

July 1 to July 31, 2005

   3,838    2,402.01    —      —  

August 1 to August 31, 2005

   2,978    2,457.99    —      —  

September 1 to September 30, 2005

   3,425    2,568.61    —      —  

October 1 to October 31, 2005

   3,211    2,461.46    —      —  

November 1 to November 30, 2005

   1,211    2,353.99    —      —  

December 1 to December 31, 2005

   1,453    2,438.01    —      —  

January 1, to January 31, 2006

   1,981    2,650.59    —      —  

February 1, to February 28, 2006

   1,731    2,737.70    —      —  

March 1 to March 31, 2006

   7,322    2,983.72    —      —  

Notes:  
1.   Total number of purchase shares shown include the purchase of fractional shares from fractional share owners, pursuant to the Japanese Commercial Code. For an explanation of the right of such shareholders, see “Right of our Shareholders—Unit shares System” under Item 10.B of this Annual Report.
2.   The number of shares for April 2005 to May 2005 in column (d) are based on the 1,500,000 shares authorized for repurchase at a Board of Director’s meeting held on October 21, 2004.
  a.   The date plan was publicly announced: October 21, 2004.
  b.   Total yen amount approved: 4.5 billion yen.
  c.   Duration of plan: From November 11, 2004 to May 10, 2005.

 

119


Table of Contents

PART III

 

Item 17.   Financial Statements.

 

In lieu of responding to this item, we have responded to Item 18 of this annual report.

 

Item 18.   Financial Statements.

 

The information required by this item is set forth beginning on page F-2 of this annual report.

 

Item 19.   Exhibits.

 

Exhibit
Number


  

Description


1.1   

— Articles of Incorporation of the registrant (English translation)

1.2   

— Share Handling Regulations of the registrant (English translation)

1.3   

— Regulations of the board of directors of the registrant (English translation)

1.4   

— Regulations of the board of corporate auditors of the registrant (English translation)

2.1   

— Specimen common stock certificates of the registrant (English translation)**

2.2   

— Form of Deposit Agreement among the registrant, JPMorgan Chase Bank as Depositary and all owners and holders from time to time of American Depositary Receipts, including the form of American Depositary Receipt***

8.1   

— List of subsidiaries of the registrant

11.1   

— The Konami Group Code of Business Conduct and Ethics*

12.1   

— Certification of the Chief Executive Officer required by Rule 13a-14(a)

12.2   

— Certification of the Chief Financial Officer required by Rule 13a-14(a)

13.1   

— Certification of the Chief Executive Officer required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code

13.2   

— Certification of the Chief Financial Officer required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code


*   Incorporated by reference to the Annual Report on Form 20-F filed on July 22, 2005
**   Incorporated by reference to the Annual Report on Form 20-F filed on July 31, 2003
***   Incorporated by reference to the Registration Statement on Form F-6 filed on September 20, 2002.

 

We have not included as exhibits certain instruments with respect to our long-term debt. The amount of debt authorized under each such debt instrument does not exceed 10% of our total assets. We agree to furnish a copy of any such instrument to the Commission upon request.

 

120


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

Index to Consolidated Financial Statements and Financial Statement Schedule

 

Report of Independent Registered Public Accounting Firm.

   F-2

Consolidated balance sheets as March 31, 2005 and 2006

   F-3

Consolidated statements of income for the years ended March 31, 2004, 2005 and 2006

   F-4

Consolidated statements of stockholders’ equity for the years ended March 31, 2004, 2005 and 2006

   F-5

Consolidated statements of cash flows for the year ended March 31, 2004, 2005 and 2006

   F-7

Notes to consolidated financial statements

   F-8

Schedule II—Valuation and qualifying accounts

   F-48

 

F-1


Table of Contents

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

KONAMI CORPORATION:

 

We have audited the consolidated financial statements of KONAMI CORPORATION (a Japanese corporation) and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of KONAMI CORPORATION and subsidiaries as of March 31, 2005 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2006, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

 

The accompanying consolidated financial statements as of and for the year ended March 31, 2006 have been translated into United States dollars solely for the convenience of the reader. We have audited the translation and, in our opinion, the consolidated financial statements expressed in Japanese yen have been translated into dollars on the basis set forth in note 1 of the notes to the consolidated financial statements.

 

/s/    KPMG AZSA & Co.

 

Tokyo, Japan

June 29, 2006

 

F-2


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

March 31, 2005 and 2006

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2005

    2006

    2006

 

ASSETS

                        

CURRENT ASSETS:

                        

Cash and cash equivalents

   ¥ 89,583     ¥ 68,694     $ 584,779  

Trade notes and accounts receivable, net of allowance for doubtful accounts of ¥604 million and ¥541 million ($4,605 thousands) at March 31, 2005 and 2006, respectively

     33,577       32,294       274,913  

Inventories

     15,488       20,109       171,184  

Deferred income taxes, net

     18,392       16,510       140,547  

Prepaid expenses and other current assets

     4,898       6,720       57,206  
    


 


 


Total current assets

     161,938       144,327       1,228,629  

PROPERTY AND EQUIPMENT, net

     46,595       42,452       361,386  

INVESTMENTS AND OTHER ASSETS:

                        

Investments in marketable securities

     165       572       4,869  

Investments in affiliates

     5,184       6,050       51,503  

Identifiable intangible assets

     45,991       38,575       328,382  

Goodwill

     849       22,102       188,150  

Lease deposits

     24,216       25,277       215,178  

Deferred income taxes, net

     —         3,179       27,062  

Other assets

     19,383       20,103       171,133  
    


 


 


Total investments and other assets

     95,788       115,858       986,277  
    


 


 


TOTAL ASSETS

   ¥ 304,321     ¥ 302,637     $ 2,576,292  
    


 


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                        

CURRENT LIABILITIES:

                        

Short-term borrowings

   ¥ 8,582     ¥ 958     $ 8,155  

Current portion of long-term debt and capital lease obligations

     16,727       24,492       208,496  

Trade notes and accounts payable

     16,134       19,357       164,782  

Accrued income taxes

     28,372       7,487       63,735  

Accrued expenses

     19,875       16,323       138,955  

Deferred revenue

     5,396       5,353       45,569  

Other current liabilities

     4,741       7,254       61,753  
    


 


 


Total current liabilities

     99,827       81,224       691,445  

LONG-TERM LIABILITIES:

                        

Long-term debt and capital lease obligations, less current portion

     52,780       35,631       303,320  

Accrued pension and severance costs

     2,344       2,658       22,627  

Deferred income taxes, net

     16,147       11,924       101,507  

Other long-term liabilities

     1,879       5,264       44,811  
    


 


 


Total long-term liabilities

     73,150       55,477       472,265  

MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES

     25,487       2,121       18,056  

COMMITMENTS AND CONTINGENCIES (Notes 11 and 20)

     —         —         —    

STOCKHOLDERS’ EQUITY:

                        

Common stock, no par value—Authorized 450,000,000 shares; issued 128,737,566 shares at March 31, 2005 and 143,555,786 shares at March 31, 2006 : outstanding 119,481,411 shares at March 31, 2005 and 137,152,347 shares at March 31, 2006

     47,399       47,399       403,499  

Additional paid-in capital

     46,736       77,110       656,423  

Legal reserve

     —         284       2,417  

Retained earnings

     37,776       53,756       457,615  

Accumulated other comprehensive income

     2,217       3,957       33,685  
    


 


 


Total

     134,128       182,506       1,553,639  

Treasury stock, at cost—9,256,155 shares and 6,403,439 shares at March 31, 2005 and 2006, respectively

     (28,271 )     (18,691 )     (159,113 )
    


 


 


Total stockholders’ equity

     105,857       163,815       1,394,526  
    


 


 


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   ¥ 304,321     ¥ 302,637     $ 2,576,292  
    


 


 


 

See accompanying notes to consolidated financial statements.

 

F-3


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

Years ended March 31, 2004, 2005 and 2006

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

NET REVENUES:

                                

Product sales revenue

   ¥ 196,136     ¥ 183,030     ¥ 186,875     $ 1,590,832  

Service revenue

     77,276       77,661       75,262       640,691  
    


 


 


 


Total net revenues

     273,412       260,691       262,137       2,231,523  
    


 


 


 


COSTS AND EXPENSES:

                                

Costs of products sold

     115,229       114,547       112,613       958,653  

Costs of services rendered

     63,953       65,816       72,131       614,038  

Impairment of long-lived assets

     —         —         10,533       89,665  

Impairment of identifiable intangible assets

     —         —         9,180       78,148  

Selling, general and administrative

     53,517       52,192       55,199       469,899  
    


 


 


 


Total costs and expenses

     232,699       232,555       259,656       2,210,403  
    


 


 


 


Operating income

     40,713       28,136       2,481       21,120  
    


 


 


 


OTHER INCOME (EXPENSES):

                                

Interest income

     488       518       716       6,095  

Interest expense

     (865 )     (971 )     (1,137 )     (9,679 )

Gain on sale of shares of affiliated companies

     —         563       6,917       58,883  

Other, net

     (229 )     (804 )     (539 )     (4,588 )
    


 


 


 


Other income (expenses), net

     (606 )     (694 )     5,957       50,711  
    


 


 


 


INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND EQUITY IN NET INCOME (LOSS) OF AFFILIATED COMPANIES

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

INCOME TAXES:

                                

Current

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

Deferred

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


 


 


 


Total

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

INCOME BEFORE MINORITY INTEREST AND EQUITY IN NET INCOME OF AFFILIATED COMPANIES

     22,072       19,540       18,708       159,258  

MINORITY INTEREST IN INCOME (LOSS) OF CONSOLIDATED SUBSIDIARIES

     2,220       2,761       (4,267 )     (36,324 )

EQUITY IN NET INCOME (LOSS) OF AFFILIATED COMPANIES

     252       (6,293 )     33       281  
    


 


 


 


NET INCOME

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


 


 


 


PER SHARE DATA:    Yen

    U.S. Dollars

 
     2004

    2005

    2006

    2006

 

Basic net income per share

   ¥ 166.86     ¥ 87.41     ¥ 175.86     $ 1.49  
    


 


 


 


Diluted net income per share

   ¥ 166.86     ¥ 87.41     ¥ 175.80     $ 1.49  
    


 


 


 


 

See accompanying notes to consolidated financial statements.

 

F-4


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Years ended March 31, 2004, 2005 and 2006

 

    Millions of Yen

 
    Common
Stock


  Additional
Paid-in
Capital


    Legal
Reserve


    Comprehensive
Income (Loss)


    Retained
Earnings


    Accumulated
Other
Comprehensive
Income (Loss)


    Treasury
Stock,
at Cost


    Total
Stockholders’
Equity


 

Balance at March 31, 2003

  ¥ 47,399   ¥ 46,736     ¥ 2,163             ¥ 18,981     ¥ 790     ¥ (25,663 )   ¥ 90,406  

Comprehensive income:

                                                             

Net income

                        ¥ 20,104       20,104                       20,104  
                         


                               

Foreign currency translation adjustments

                          (1,108 )                             (1,108 )

Net unrealized gains on available-for-sale securities

                          270                               270  

Minimum pension liability adjustment

                          (71 )                             (71 )
                         


                               

Other comprehensive income

                          (909 )             (909 )                
                         


                               

Comprehensive income

                        ¥ 19,195                                  
                         


                               

Transfer from legal reserve

                  (2,163 )             2,163                       —    

Cash dividends, ¥ 62.0 per share

                                  (7,469 )                     (7,469 )

Purchase of treasury stock

                                                  (3 )     (3 )
   

 


 


         


 


 


 


Balance at March 31, 2004

  ¥ 47,399   ¥ 46,736     ¥ —               ¥ 33,779     ¥ (119 )   ¥ (25,666 )   ¥ 102,129  

Comprehensive income:

                                                             

Net income

                        ¥ 10,486       10,486                       10,486  
                         


                               

Foreign currency translation adjustments

                          2,285                               2,285  

Net unrealized gains on available-for-sale securities

                          (20 )                             (20 )

Minimum pension liability adjustment

                          71                               71  
                         


                               

Other comprehensive income

                          2,336               2,336                  
                         


                               

Comprehensive income

                        ¥ 12,822                                  
                         


                               

Cash dividends, ¥ 54.0 per share

                                  (6,489 )                     (6,489 )

Purchase of treasury stock

                                                  (2,605 )     (2,605 )
   

 


 


         


 


 


 


Balance at March 31, 2005

  ¥ 47,399   ¥ 46,736     ¥ —               ¥ 37,776     ¥ 2,217     ¥ (28,271 )   ¥ 105,857  

Comprehensive income:

                                                             

Net income

                        ¥ 23,008       23,008                       23,008  
                         


                               

Foreign currency translation adjustments

                          1,888                               1,888  

Net unrealized losses on available-for-sale securities

                          (132 )                             (132 )

Minimum pension liability adjustment

                          (16 )                             (16 )
                         


                               

Other comprehensive income

                          1,740               1,740                  
                         


                               

Comprehensive income

                        ¥ 24,748                                  
                         


                               

Issuance of common stock for stock exchange

          33,095                                               33,095  

Reissuance of treasury stock for stock exchange

          (2,818 )                                     9,612       6,794  

Stock-based compensation

          97                                       39       136  

Transfer from Retained Earnings

                  284               (284 )                     —    

Cash dividends, ¥ 54.0 per share

                                  (6,744 )                     (6,744 )

Purchase of treasury stock

                                                  (71 )     (71 )
   

 


 


         


 


 


 


Balance at March 31, 2006

  ¥ 47,399   ¥ 77,110     ¥ 284             ¥ 53,756     ¥ 3,957     ¥ (18,691 )   ¥ 163,815  
   

 


 


         


 


 


 


 

F-5


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

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

 

    Thousands of U.S. Dollars

 
    Common
Stock


  Additional
Paid-in
Capital


    Legal
Reserve


  Comprehensive
Income (Loss)


    Retained
Earnings


    Accumulated
Other
Comprehensive
Income (Loss)


  Treasury
Stock,
at cost


    Total
Stockholders’
Equity


 

Balance at March 31, 2005

  $ 403,499   $ 397,855     $ —             $ 321,580     $ 18,873   $ (240,666 )   $ 901,141  

Comprehensive income:

                                                         

Net income

                      $ 195,863       195,863                     195,863  
                       


                             

Foreign currency translation adjustments

                        16,072                             16,072  

Net unrealized losses on available-for-sale securities

                        (1,124 )                           (1,124 )

Minimum pension liability adjustment

                        (136 )                           (136 )
                       


                             

Other comprehensive income

                        14,812               14,812                
                       


                             

Comprehensive income

                      $ 210,675                                
                       


                             

Issuance of common stock for stock exchange

          281,371                                           281,371  

Reissuance of treasury stock for stock exchange

          (23,989 )                                 81,825       57,836  

Stock-based compensation

          826                                   332       1,158  

Transfer from Retained Earnings

                  2,417             (2,417 )                   —    

Cash dividends, $0.46 per share

                                (57,411 )                   (57,411 )

Purchase of treasury stock

                                              (604 )     (604 )
   

 


 

         


 

 


 


Balance at March 31, 2006

  $ 403,499   $ 656,423     $ 2,417           $ 457,615     $ 33,685   $ (159,113 )   $ 1,394,526  
   

 


 

         


 

 


 


 

See accompanying notes to consolidated financial statements.

 

F-6


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended March 31, 2004, 2005 and 2006

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2004

    2005

    2006

    2006

 

Cash flows from operating activities:

                                

Net income

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

Adjustments to reconcile net income to net cash provided by operating activities -

                                

Depreciation and amortization

     8,528       9,360       13,782       117,323  

Impairment of long-lived assets

     —         —         10,533       89,665  

Impairment of identifiable intangible assets

     —         —         9,180       78,148  

Provision for doubtful receivables

     (170 )     (400 )     (10 )     (85 )

Loss on sale or disposal of property and equipment, net

     1,231       1,553       645       5,491  

Loss (gain) on sale of marketable securities

     (1,303 )     46       (173 )     (1,473 )

Gain on sale of shares of an affiliated company

     —         (563 )     (6,917 )     (58,883 )

Equity in net loss (income) of affiliated companies

     (252 )     6,293       (33 )     (281 )

Minority interest

     2,220       2,761       (4,267 )     (36,324 )

Deferred income taxes

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

Change in assets and liabilities, net of businesses acquired:

                                

Decrease (increase) in trade notes and accounts receivable

     1,848       (5,632 )     3,369       28,680  

Decrease (increase) in inventories

     (4,791 )     2,949       (635 )     (5,406 )

Increase (decrease) in trade notes and accounts payable

     (1,724 )     352       2,945       25,070  

Increase (decrease) in accrued income taxes

     9,456       4,954       (20,772 )     (176,828 )

Increase (decrease) in accrued expenses

     (293 )     617       (3,043 )     (25,904 )

Increase (decrease) in deferred revenue

     501       (640 )     (43 )     (366 )

Increase in advance received

     44       1,301       1,685       14,344  

Other, net

     (422 )     1,938       110       936  
    


 


 


 


Net cash provided by operating activities

     34,326       27,760       23,879       203,277  

Cash flows from investing activities:

                                

Proceeds from sales of shares of affiliates

     —         1,407       11,016       93,777  

Capital expenditures

     (8,788)       (15,818)       (14,513)       (123,546)  

Proceeds from sales of property and equipment

     281       696       2,455       20,899  

Proceeds from sales of investments in marketable securities

     1,596       22       245       2,086  

Acquisition of new subsidiaries, net of cash acquired

     (206 )     —         1,433       12,198  

Purchase of investments in subsidiaries

     —         —         (6,688 )     (56,934 )

Decrease in time deposits, net

     63       —         —         —    

Decrease (increase) in lease deposits, net

     121       (542 )     (697 )     (5,933 )

Purchases of treasury stock by subsidiaries

     (2,456 )     (3,593 )     —         —    

Other, net

     (68 )     (108 )     (517 )     (4,401 )
    


 


 


 


Net cash used in investing activities

     (9,457 )     (17,936 )     (7,266 )     (61,854 )

Cash flows from financing activities:

                                

Net increase (decrease) in short-term borrowings

     (5,789 )     6,001       (12,551 )     (106,844 )

Proceeds from long-term debt

     6,400       —         —         —    

Repayments of long-term debt

     (896 )     (1,177 )     (1,099 )     (9,356 )

Principal payments under capital lease obligations

     (2,355 )     (2,255 )     (2,526 )     (21,503 )

Dividends paid

     (8,970 )     (7,963 )     (7,025 )     (59,803 )

Purchases of treasury stock by parent company

     (3 )     (2,605 )     (71 )     (604 )

Redemption of bonds

     —         —         (15,000 )     (127,692 )

Other, net

     (72 )     (78 )     (58 )     (494 )
    


 


 


 


Net cash used in financing activities

     (11,685 )     (8,077 )     (38,330 )     (326,296 )

Effect of exchange rate changes on cash and cash equivalents

     (979 )     951       828       7,049  

Net increase (decrease) in cash and cash equivalents

     12,205       2,698       (20,889 )     (177,824 )

Cash and cash equivalents, beginning of year

     74,680       86,885       89,583       762,603  
    


 


 


 


Cash and cash equivalents, end of year

   ¥ 86,885     ¥ 89,583     ¥ 68,694     $ 584,779  
    


 


 


 


 

See accompanying notes to consolidated financial statements.

 

F-7


Table of Contents

KONAMI CORPORATION

AND SUBSIDIARIES

 

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.

 

F-8


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.

 

F-9


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.

 

F-10


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


Table of Contents

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.

 

F-14


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.

 

F-15


Table of Contents

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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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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Table of Contents

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.

 

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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)

 

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  
    


 


 


 

F-25


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  
    


 


 


 


 

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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)

 

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.

 

F-35


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

SIGNATURES

 

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

 

KONAMI CORPORATION

 

Date:  July 21, 2006

 

/s/    NORIAKI YAMAGUCHI        


Noriaki Yamaguchi

Representative Director and Chief Financial Officer


Table of Contents

INDEX TO EXHIBITS

 

Exhibit
Number


  

Description


1.1   

Articles of Incorporation of the registrant (English translation)

1.2   

— Share Handling Regulations of the registrant (English translation)

1.3   

— Regulations of the board of directors of the registrant (English translation)

1.4   

— Regulations of the board of corporate auditors of the registrant (English translation)

2.1   

— Specimen common stock certificates of the registrant (English translation)**

2.2   

— Form of Deposit Agreement among the registrant, JPMorgan Chase Bank as Depositary and all owners and holders from time to time of American Depositary Receipts, including the form of American Depositary Receipt***

8.1   

— List of subsidiaries of the registrant

11.1   

— The Konami Group Code of Business Conduct and Ethics*

12.1   

— Certification of the Chief Executive Officer required by Rule 13a-14(a)

12.2   

— Certification of the Chief Financial Officer required by Rule 13a-14(a)

13.1   

— Certification of the Chief Executive Officer required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code

13.2   

— Certification of the Chief Financial Officer required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code


*   Incorporated by reference to the Annual Report on Form 20-F filed on July 22, 2005
**   Incorporated by reference to the Annual Report on Form 20-F filed on July 31, 2003
***   Incorporated by reference to the Registration Statement on Form F-6 filed on September 20, 2002.

 

We have not included as exhibits certain instruments with respect to our long-term debt. The amount of debt authorized under each such debt instrument does not exceed 10% of our total assets. We agree to furnish a copy of any such instrument to the Commission upon request.


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