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, 2004

 

OR

 

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

 

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, 2004, 120,483,252 shares of common stock were outstanding, including 246,400 shares represented by 246,400 American Depositary Shares.

 

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 which financial statement item the registrant has elected to follow:     Item 17  ¨    Item 18  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 5.

   Operating and Financial Review and Prospects.    62

Item 6.

   Directors, Senior Management and Employees.    89

Item 7.

   Major Shareholders and Related Party Transactions.    94

Item 8.

   Financial Information.    95

Item 9.

   The Offer and Listing.    96

Item 10.

   Additional Information.    97

Item 11.

   Quantitative and Qualitative Disclosures about Market Risk    112

Item 12.

   Description of Securities Other Than Equity Securities    115
PART II     

Item 13.

   Defaults, Dividend Arrearages and Delinquencies.    116

Item 14.

   Material Modifications to the Rights of Security Holders and Use of Proceeds.    116

Item 15.

   Controls and Procedures.    116

Item 16A.

   Audit Committee Financial Expert.    116

Item 16B.

   Code of Ethics.    116

Item 16C.

   Principal Accountant Fees and Services.    117

Item 16D.

   Exemption from the Listing Standards for Audit Committees.    117

Item 16E.

   Purchases of Equity Securities by the Issuer and Affiliates Purchasers.    117
PART III     

Item 17.

   Financial Statements.    118

Item 18.

   Financial Statements.    118

Item 19.

   Exhibits.    118

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

 

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

 

     Fiscal year ended/as of March 31,

 
     2001 (1)

   2002

   2003

    2004

    2004

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

Income Statement Data:

                                      

Net revenues

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

Cost of revenues

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

Impairment charge for goodwill and other intangible assets (2)

     —        —        47,599       —         —    

Selling, general and administrative expenses

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

  

  


 


 


Operating income (loss)

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

  

  


 


 


Other income (expenses), net

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

  

  


 


 


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

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

Income taxes

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

Minority interest in income (loss) of consolidated Subsidiaries

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

Equity in net income (loss) of affiliated companies

     356      755      (1,288 )     252       2,384  
    

  

  


 


 


Net income (loss)

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

  

  


 


 


Basic and diluted net income (loss) per share

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

Cash dividends per share

   ¥ 54.00    ¥ 54.00    ¥ 46.00     ¥ 62.00     $ 0.59  

Balance Sheet Data:

                                      

Total current assets

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

Total assets

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

Total current liabilities

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

Total long-term liabilities

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

Total shareholders’ equity

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

(1)  

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

 

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

(2)   Following the impairment review for fiscal 2003, we recognized impairment losses of ¥47,599 million with respect to our investment in Konami Sports Corporation. Approximately ¥36,717 million of this loss related to the write-off of goodwill and the remaining ¥10,882 million related to the impairment of identifiable intangible assets such as trademarks and franchise contracts. Under U.S. GAAP, impairment loss is treated as an operating expense.

 

Selected Financial Data Prepared in Accordance with Japanese GAAP

 

     Fiscal year ended/as of March 31,

     2000

   2001 (1)

   2002

   2002

    

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

except per share data)

Income Statement Data:

                           

Net revenues

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

Cost of revenues

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

Selling, general and administrative Expenses

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

  

  

  

Operating income

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

  

  

  

Other income (expenses), net

     3,471      946      2,322      17,426
    

  

  

  

Income before income taxes minority interest (2)

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

Income taxes

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

Minority interest in income of consolidated subsidiaries

     415      503      2,378      17,846
    

  

  

  

Net income

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

  

  

  

Net income per share—basic (3)

   ¥ 164.26    ¥ 190.91    ¥ 107.24    $ 0.80

Net income per share—diluted (3)

   ¥ 163.33    ¥ 190.91    ¥ 107.24    $ 0.80

Cash dividends per share

   ¥ 97.00    ¥ 54.00    ¥ 54.00    $ 0.41

Balance Sheet Data:

                           

Total current assets

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

Total assets

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

Total current liabilities

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

Total long-term liabilities

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

Total shareholders’ equity

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

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

 

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

 

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

 

Exchange Rate Data

 

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

 

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

 

Fiscal year ended March 31,


   High

   Low

   Average (1)

   Period-end

2000

   124.45    101.53    110.02    102.73

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

Calendar year 2004


                   

January

   107.17    105.52    106.27    105.84

February

   109.59    105.36    106.71    109.26

March

   112.12    104.18    108.52    104.18

April

   110.37    103.70    107.66    110.37

May

   114.30    108.50    112.20    110.18

June

   111.27    107.10    109.43    109.43

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

 

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

 

B.    Capitalization and Indebtedness.

 

Not applicable.

 

C.    Reasons for the Offer and Use of Proceeds.

 

Not applicable.

 

D.    Risk Factors.

 

Special Note Regarding Forward-looking Statements.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Risks Relating to Our Overall Business

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Our performance may be vulnerable to rapidly changing consumer preferences.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Risks Relating to Our Computer & Video Games Business

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Risks Relating to Our Gaming Business

 

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

 

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

 

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

 

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

 

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

 

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

 

    the pace of market expansion;

 

    changes in gaming regulation; and

 

    fluctuations in popularity of casino gaming.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Risks Relating to Our Health & Fitness Business

 

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

 

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

 

    obtain financing;

 

    locate suitable sites for clubs;

 

    successfully negotiate lease agreements and meet construction schedules and budgets;

 

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

 

    hire, train and retain qualified personnel;

 

    attract new members; and

 

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

 

If we are not able to achieve success with respect to the factors outlined above, the growth of our health & fitness business may be limited. We cannot assure you that we will be able to implement our growth strategy, open new clubs on a timely and cost-efficient basis or operate our new clubs profitably. Upon opening a new sports club, we often experience an initial period of club operating losses for the first twelve months, but this period can vary substantially depending on the individual club. Initial membership levels tend not to generate sufficient revenue for the club to generate positive earnings in its first full year of operation and substantially lower margins in its second full year of operations than a mature club. These losses and lower margins may negatively impact our future results of operations.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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Risks Relating to the Shares and the ADSs

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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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, Mr. 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, game software for personal computers in 1983, game software for home video game consoles in 1985 and software for LCD units 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 sports 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 Digital Entertainment, Inc., formerly known as Konami of America, 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.

 

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.

 

B.    Business Overview.

 

Overview

 

We develop, publish, market and distribute video game software products globally for use on Sony PlayStation and PlayStation 2, Nintendo GameCube, Microsoft Xbox console systems, and Nintendo Game Boy, Game Boy Color and Game Boy Advance handheld devices and, to a lesser extent, personal computers, mobile phones and online network systems. We have steadily increased the number of titles published for home and handheld video game platforms from 55 titles in the fiscal year ended March 31, 1999 to 120 titles in the fiscal year ended March 31, 2004.

 

We also make card games, character goods, toys, CDs 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 service software and hardware for amusement arcade games. In addition, we produce software for LCD units 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 sports clubs in Japan, in terms of revenues, members and the total number of facilities. As of March 31, 2004, our nationwide network of 208 directly operated health and sports club facilities and 32 franchised facilities cater to all age groups, from children through senior citizens. We also manufacture fitness equipment mainly for our sports clubs and manufacture and sell other goods and services related to sports and fitness.

 

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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 in the entertainment industry, 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 transporting concepts to and from our Computer & Video Games business. For example:

 

    We first sold Dance Dance Revolution, one of our most popular products, through our Amusement Division 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 “diet” 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! card game produced by our Toy &Hobby Division in February 1999.

 

    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 produced by our Toy & Hobby Division.

 

    We will publish comic book series based on METAL GEAR SOLID video game in the United States in September 2004.

 

    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, 2004, we had consolidated net revenues and net profit of ¥273,412 million and ¥20,104 million, respectively, compared with net revenues and net loss of ¥253,657 million and ¥28,519 million, respectively, for the fiscal year ended March 31, 2003.

 

Products and Services

 

We divide our business into five business segments, each of which is reflected in a separate division. The net revenue figures for each business segment described below include intersegment revenues:

 

    Computer & Video Games:    We develop, publish, distribute and market video game software primarily for use on home and handheld game console systems and are also entering into Internet and mobile phone platforms. During fiscal 2004, this segment had net revenues of ¥92,520 million, which accounted for 33.8% of consolidated net revenues.

 

    Toy & Hobby:    We are engaged in the production, sale and copyright of a range of products and brand-related goods, including card games, toys, portable electronic games, CDs and DVDs of music from our video game software, game tip books (containing clues and strategies for playing popular games), game prizes for amusement arcade games and other accessories. During fiscal 2004, this segment had net revenues and of ¥57,468 million, which accounted for 21.0% of consolidated net revenues.

 

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    Amusement:    This segment is involved in developing content and hardware for a variety of amusement-related products such as video game machines and token-operated game machines for amusement arcades mainly in Japan and software for LCD units used in pachinko machines. We also provide delivery and maintenance services with respect to these products. During fiscal 2004, this segment had net revenues of ¥35,427 million, which accounted for 13.0% of consolidated net revenues.

 

    Gaming:    This segment is involved in developing content and hardware for gaming machines for casinos in other countries. During fiscal 2004, this segment had net revenues of ¥10,947 million, which accounted for 4.0% of consolidated net revenues.

 

    Health & Fitness:    We are the leading health and sports club operator in Japan. We believe that we had approximately 25% 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 2004. During fiscal 2004, this segment had net revenues of ¥78,899 million, which accounted for 28.9% of consolidated net revenues.

 

The following table presents net revenues in each of our business segments, including intersegment revenues, for each of the three years ended March 31, 2004.

 

Segment Revenues

 

     Year ended March 31

 
     2002

   2003

    2004

 

Net Revenues:

                       

Computer & Video Games

   ¥ 90,129    ¥ 87,476     ¥ 92,520  

Toy & Hobby

     25,601      45,948       57,468  

Amusement

     37,918      34,305       35,427  

Gaming

     3,063      8,215       10,947  

Health & Fitness

     65,650      78,525       78,899  

Other, Corporate and Eliminations

     219      (812 )     (1,849 )
    

  


 


Consolidated net revenues

   ¥ 225,580    ¥ 253,657     ¥ 273,412  
    

  


 



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.

 

Computer & Video Games

 

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 game software applications.

 

A new generation of more technologically advanced game consoles has been introduced every several years. The first modern platform was introduced by Nintendo in 1983 using 8-bit technology. 8-bit means that the central processing unit, or chip, on which the software operates is capable of processing data in 8-bit units. Subsequent advances in technology have resulted in continuous increases in the processing power of the chips

 

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that power both the consoles and PCs. The new generation of systems is based primarily on 128-bit technology although the latest handheld platform, Game Boy Advance, uses 32-bit technology. As the technology of the hardware has advanced, the software has similarly advanced, with faster and more complex images, more lifelike animation and sound effects and more intricate scenarios.

 

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 home game console and handheld devices since 1989.

 

Manufacturer


 

Product Name


 

Year of
Introduction


 

Media Format


  Technology

   

Japan


 

U.S.


   

Home Game Consoles:

                   

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   128-bit

Nintendo

  GameCube   2001   2001   Proprietary Disc   128-bit

Microsoft

  Xbox   2002   2001   DVD-ROM Disc   128-bit

Handheld Devices:

                   

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

(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 industry has completed a transition from 32- and 64-bit home game consoles to the next generation 128-bit consoles, with the release of Sony’s PlayStation 2 in March 2000 (October 2000 in the United States) and the release of the Nintendo GameCube in September 2001 (November 2001 in the United States) and the release of Microsoft Xbox in February 2002 (November 2001 in the United States). Also, Sony released PlayStation X, a PlayStation 2 with a DVD recorder function, in Japan in December 2003. Similarly, the 8-bit Game Boy Color handheld platform, introduced in 1998, is now being replaced by the 32-bit Game Boy Advance, introduced in March 2001 and Game Boy Advance SP, introduced in February, 2003. By incorporating 128-bit processing speeds, more memory and better resolution, these platforms allow the design of games with more realistic graphics and better game performance than games designed for the prior-generation systems.

 

The 128-bit hardware platforms, such as Sony’s PlayStation 2 and Microsoft’s Xbox, utilize a DVD software format and serve as a player for DVD movies and compact discs. Sony’s PlayStation X released in

 

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December 2003 carries a DVD recorder function and can serve as a home entertainment center. The ability of the next generation game consoles to serve as multi-purpose entertainment devices with DVD and Internet capabilities should have crossover appeal to a segment of the market that might not otherwise be inclined to purchase game consoles.

 

World Video Game Software Markets

 

According to data by the Computer Entertainment Software Association, or CESA, the number of shipment of video game software was 66,373 thousand copies in Japan, 168,911 thousand copies in North America and 79,152 thousand copies in Europe in 2002. 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 shrinking.

 

Broadband, Mobile Phone and the Growth of Online Games

 

High-speed broadband Internet technologies provided users with a richer, more interactive online experience. The increased penetration of broadband services, together with increasing competition, stimulates growth in online games. With the rapid penetration of broadband infrastructure, many console manufactures and software publishers have launched online game businesses. For example, Sony Computer Entertainment Inc. launched a broadband online service for its PlayStation 2 console in Japan during the Spring of 2002 whereby PlayStation 2 users are able to play online games and download software, and also enjoy broadband content such as movie clips and music on their TV sets. Sony Computer Entertainment America Inc. started marketing an online adapter and software for PlayStation 2 in the U.S. in August 2002. Nintendo Co. launched online services with its GameCube in Japan and the U.S. in fall 2002. Microsoft Corp. launched online services with its Xbox in the U.S. in November 2002 and in Japan in January 2003. Some of our competitors have begun to operate web sites that allow players to enjoy games downloaded from the Internet and play games on the Internet. As broadband lines proliferate and speed up, we expect that investment and interest in online games will grow significantly.

 

We also believe that mobile phones will provide another platform for our video game software. In Japan, mobile phones are not just mobile phones—they are wireless net terminals equipped with cameras and a multimedia processor. As of March 31, 2004, there were over 69 million mobile Internet subscribers in Japan who download stock quotes, read news, send photographs and play games on their mobile phones. While the United States leads Japan in percentage of PCs and Internet use, Japan has more mobile Internet users and mobile phone is one of the popular ways to log on to the Internet.

 

Companies like NTT DoCoMo have developed cutting-edge technologies that provide Japanese subscribers with inexpensive, round-the-clock Internet access via mobile phone. One of the most popular services, i-mode, was created by DoCoMo and allows its users to view specially formatted web sites and receive email via their mobile phones. In addition to Internet and email access, i-mode offers access to financial information (including stocks and online banking), travel, news, and entertainment. Additional content such as games is offered on a monthly subscription basis generally ranging from ¥100 to ¥300 per month. Similar features are offered by other online mobile phone services such as vodafone live! and au’s Ezweb. In 2001, third-generation mobile phone technologies allowed high-speed wireless packet data services over the Internet. These third-generation services provide the speed and capacity necessary to support innovative mobile multimedia applications including not only broader and more efficient access to email systems, high speed web browsing and e-commerce applications but also more sophisticated online games, music downloads and video images.

 

Our Computer & Video Games Software Business

 

Our Computer & Video Games business develops, publishes, distributes and markets software for home and handheld video game consoles and, to a lesser extent, personal computers, mobile phones and online networks.

 

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Consolidated net revenues generated by our Computer & Video Games business, including intersegment revenues, increased 5.8% from ¥87,476 million during fiscal 2003 to ¥92,520 million during fiscal 2004. Most of our software consists of video games designed for use with video game platforms, including Sony PlayStation and PlayStation 2, Nintendo GameCube, Game Boy and Game Boy Advance and Microsoft Xbox. During the past five years we have released over 539 titles which includes 130 Sony PlayStation titles, 173 Sony PlayStation 2 titles, 106 Game Boy Advance titles, 30 Nintendo GameCube titles, 16 Microsoft Xbox titles and 15 PC titles.

 

By developing 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, Game Boy Advance and GameCube are elementary school students. Sony PlayStation and PlayStation 2, and Microsoft Xbox 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.

 

The table below shows, for the periods indicated, Konami’s non-consolidated net sales of video game software, categorized by major platform manufacturers. Although this table does not include sales made by our consolidated subsidiaries, it illustrates a trend of increasing overseas sales as well as the relative significance of the manufacturers of hardware platforms for which we design our home video games.

 

          Fiscal year ended March 31,

          2002

   2003

   2004

   2004

          (yen in millions, dollar in thousands)

Sony

   Domestic    ¥ 22,218    ¥ 20,520    ¥ 19,237    $ 182,013
     Overseas      20,000      14,021      15,022      142,133

Nintendo

   Domestic      8,698      7,861      7,240      68,502
     Overseas      6,649      8,247      11,356      107,446

Microsoft

   Domestic      381      103      1      9
     Overseas      997      2,021      1,085      10,266

(1)   This data is presented in accordance with Japanese GAAP because we do not maintain U.S. GAAP data on net sales broken down by hardware manufacturer. However, we do not believe that there are material differences between Japanese GAAP and U.S. GAAP net sales of video game software.
(2)   This table does not indicate total revenues of the Computer & Video Games segment because it does not include sales of game software made by our consolidated subsidiaries or sales of other goods and services.

 

In light of the recent growth in the online and mobile phone game markets, we have been moving aggressively into the mobile phone and online game software business, where we believe there are opportunities for realizing additional revenues from the sale of our software titles.

 

We established Konami Mobile & Online, Inc. in October 2001 as our primary mobile phone games development subsidiary. In September 2003, Konami Mobile & Online, Inc. added an online game business that manages online game infrastructures to its existing business and changed its name to Konami Online, Inc. Through Konami Online, we develop and distribute various types of contents for all three domestic mobile phone Internet services including i-mode, vodafone live! and EZweb. In 2003, we started distributing various types of game contents in North America, Europe and Asia. In Japan, we offer download services for our original mobile phone ringer melody and screen image data. Many of our mobile games are mobile phone versions of our popular

 

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home video games. In return for these services, we charge the mobile phone users a monthly fee of ¥70 to ¥300, depending upon the service provided. As of March 31, 2004 our games were posted on approximately 51 gaming sites for Internet mobile phone services.

 

We also publish a relatively small volume of game software for personal computers. The game software market for personal computers is not yet well established in Japan. Outside Japan, there is a substantial market for games for personal computers. We believe that our presence in the personal computers game market abroad assists us in the expansion of our sales of video game software worldwide.

 

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 home and handheld video game consoles. We publish software titles in a variety of categories, including sports, action, role playing and music simulation.

 

The following table illustrates the number of software titles that we have released as well as 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,

     2000

   2001

   2002

   2003

   2004

Platforms


   Titles

   Units

   Titles

   Units

   Titles

   Units

   Titles

   Units

   Titles

   Units

     (sales units in thousands)

PlayStation

   47    12,800    43    6,100    17    2,920    16    4,100    7    1,350

PlayStation 2

   1    100    30    4,000    43    11,490    42    8,900    57    10,750

Sega Saturn

   —      —      —      —      —      —      —      —      —      —  

Dreamcast

   6    —      2    —      —      —      —      —      —      —  

Nintendo 64

   9    1,300    3    700    —      —      —      —      —      —  

Game Boy

   25    2,600    19    4,850    4    290    —      1,400    —      250

Game Boy Advance

   —      —      8    450    32    4,750    33    4,800    33    6,700

GameCube

   —      —      —      —      3    150    15    800    12    1,450

Xbox

   —      —      —      —      3    630    8    800    5    550

PC

   —      —      —      —      3    10    6    200    6    550

Other

   1    700    —      400    —      60    —      —      —      —  
    
  
  
  
  
  
  
  
  
  

Total

   89    17,500    105    16,500    105    20,300    120    21,000    120    21,600
    
  
  
  
  
  
  
  
  
  

 

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The following two tables indicate the major software titles that we have either published, or anticipate publishing, during fiscal years 2004 and 2005 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 2005 will be released when scheduled, if ever. Sales of video game software in Japan accounted for approximately 57% and 49% of our total video software sales in the years ended March 31, 2003 and 2004, respectively. We are working to improve our title lineups covering overseas markets in order to increase our shares in overseas markets, especially in the U.S. and European markets which have continuous growth potential.

 

Titles Released In Fiscal 2004

 

Title


 

Category


 

Platform


 

Release Date


 

Market


Yu-Gi-Oh! WorldWide Edition

  Card Battle   Game Boy Advance   April 2003   Japan

Silent Hill 3

  Horror Adventure   PlayStation 2   July 2003   Japan

Powerful Professional
Baseball 10

  Sports (Baseball)   PlayStation 2/Nintendo GameCube   July 2003   Japan

WORLD SOCCER WINNING ELEVEN 7

  Sports (Soccer)   PlayStation 2   August 2003   Japan

Castlevania

  Adventure   PlayStation 2   November 2003   Japan

Pawapurokun Pocket 6

  Sports (Baseball)   Game Boy Advance   December 2003   Japan

Powerful Professional
Baseball 10

  Sports (Baseball)   PlayStation 2/Nintendo GameCube   December 2003   Japan

WORLD SOCCER WINNING ELEVEN 7 World Edition

  Sports (Soccer)   PlayStation 2   February 2004   Japan

METAL GEAR SOLID THE TWIN SNAKES

  Action   Nintendo GameCube   March 2004   Japan

Professional Baseball Spirits 2004

  Sports (Baseball)   PlayStation 2   March 2004   Japan

Yu-Gi-Oh! WorldWide Edition

  Card Battle   Game Boy Advance   April 2003   North America

Castlevania: Aria of Sorrow

  Action   Game Boy Advance   May 2003   North America

Silent Hill 3

  Horror Adventure   PlayStation 2   August 2003   North America

Teenage Mutant Ninja Turtles

  Action   Multi Platform   October 2003   North America

DDR Max 2 Dance Dance Revolution

  Music Game   PlayStation 2   October 2003   North America

Yu-Gi-Oh! Sacred Card

  Card Battle   Game Boy Advance   November 2003   North America

Castlevania Lament of Innocence

  Adventure   PlayStation 2   November 2003   North America

Yu-Gi-Oh! The Falsebound Kingdom

  Card Battle   Nintendo GameCube   November 2003   North America

METAL GEAR SOLID THE TWIN SNAKES

  Action   Nintendo GameCube   November 2003   North America

Yu-Gi-Oh! World Championship 2004

  Card Battle   Game Boy Advance   March 2004   North America

Yu-Gi-Oh! WorldWide Edition

  Card Battle   Game Boy Advance   April 2003   Europe

Dancing Stage Megamix

  Music Game   PlayStaion 2   May 2003   Europe

Silent Hill 3

  Horror Adventure   PlayStation 2   May 2003   Europe

Pro Evolution Soccer 3

  Sports   PlayStation 2   October 2003   Europe

Yu-Gi-Oh! Sacred Card

  Card Battle   Game Boy Advance   December 2003   Europe

Castlevania

  Adventure   PlayStation 2   January 2004   Europe

Yu-Gi-Oh! World Championship 2004

  Card Battle   Game Boy Advance   March 2004   Europe

METAL GEAR SOLID THE TWIN SNAKES

  Action   Nintendo GameCube   March 2004   Europe

 

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Titles Released and Anticipated To Be Released In Fiscal 2005 (1)

 

Title


  

Category


  

Platform


  

Release Date


  

Market


WORLD SOCCER WINNING ELEVEN 8

   Sports (Soccer)    PlayStation 2    August 2004    Japan

METAL GEAR SOLID 3 SNAKE EATER

   Action    PlayStation 2    2nd half of Fiscal 2005    Japan

Powerful Professional Baseball 11

   Sports (Baseball)    PlayStation 2    July 2004    Japan

Suikoden IV

   RPG    PlayStation 2    July 2004    Japan

WORLD SOCCER WINNING ELEVEN 8 INTERNATIONAL

   Sports (Soccer)    PlayStation 2    2nd half of Fiscal 2005    Japan

Enthusia

   Racing    PlayStation 2    2nd half of Fiscal 2005    Japan

Pawapurokun Pocket 7

   Sports (Baseball)    Game Boy Advance    2nd half of Fiscal 2005    Japan

Bokutai

   Action Adventure    Game Boy Advance    August 2004    Japan

METAL GEAR SOLID 3 SNAKE EATER

   Action    PlayStation 2    2nd half of Fiscal 2005    North America

Yu-Gi-Oh! Reshef of Destruction

   Card Battle    Game Boy Advance    June 2004    North America

Enthusia

   Racing    PlayStation 2    2nd half of Fiscal 2005    North America

DDR Extreme

   Music Game    PlayStation 2    September 2004    North America

Silent Hill 4 The Room

   Horror Adventure    PlayStation 2    September 2004    North America

Neo Contra

   Action    PlayStation 2    2nd half of Fiscal 2005    North America

Teenage Mutant Ninja Turtles 2

   Action    PlayStation 2    2nd half of Fiscal 2005    North America

Pro Evolution Soccer 4

   Sports (Soccer)    PlayStation 2    2nd half of Fiscal 2005    Europe

METAL GEAR SOLID 3 SNAKE EATER

   Action    PlayStation 2    2nd half of Fiscal 2005    Europe

Yu-Gi-Oh! Reshef of Destruction

   Card Battle    Game Boy Advance    September 2004    Europe

Silent Hill 4 The Room

   Horror Adventure    PlayStation 2    September 2004    Europe

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

 

The primary video game software products on which we have relied to produce revenues have been our hit titles, which include the following:

 

    METAL GEAR SOLID.    We have sold a total of over 14 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 six million units of the sequel, METAL GEAR SOLID 2 SONS OF LIBERTY.

 

    Yu-Gi-Oh!    Since we introduced the first Yu-Gi-Oh! title in July 1998, we have sold a total of over 19 million units of our Yu-Gi-Oh! series for the Game Boy, Game Boy Advance, PlayStation and PlayStation 2 platforms.

 

    Soccer titles.    We sold a total of 15.6 million units of WORLD SOCCER WINNING ELEVEN series and Pro Evolution Soccer series in Japan, Europe and North America form the year ended March 31, 1996 to the year ended March 31, 2004.

 

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    Baseball titles.    We sold a total of 12 million units of baseball titles in Japan from the year ended March 31, 1994 to the year ended March 31, 2004.

 

    Silent Hill.    We have sold a total of over 4.3 million units of the Silent Hill series, a horror action game, since we introduced the first Silent Hill title in 1999.

 

Software Development

 

We seek to develop video games that are fun and exciting, and which provide sufficient challenge 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 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.

 

We believe that the best software products tend to be developed by small independent development groups, which encourages creativity and productivity. Accordingly, we operate our internal development groups as autonomous development studios, each in a separately incorporated but majority-owned subsidiary, three of which—Konami Computer Entertainment Studios, Inc., Konami Computer Entertainment Tokyo, Inc., and Konami Computer Entertainment Japan, Inc.—are publicly listed companies that trade on JASDAQ, Japan’s over-the-counter market.

 

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

 

Our software development is a collaborative process between our head office and our development subsidiaries. Our development subsidiaries are allowed wide creative freedom including the development of strategies, story lines and other characteristics. Also, compensation of the employees of each subsidiary is based in part upon the success of the titles published by that subsidiary. Each development subsidiary is generally supported by our central administrative and technology resources. Each subsidiary tends to specialized in the development of software for a particular game genre in which it excels. We monitor and coordinate these development activities in order to ensure that sufficient resources are allocated among the subsidiaries so that the development of games is appropriately balanced. In addition, earnings performance of each development subsidiary can more readily be identified. By taking a collaborative approach to development, we seek to assure that our software product line is of consistently high quality across the range of our game concepts. Prior to release, each product undergoes careful quality assurance testing which involves technical review of each component of the final product and testing on the applicable platforms.

 

Hiring and retaining talented creative staff is key to developing successful content. To do this, we have introduced equity-based incentives for creative staff at our publicly-traded development subsidiaries with respect to the subsidiaries’ shares and remuneration packages for 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 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

 

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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.

 

Development of a video game generally takes six to 24 months or longer and typically costs ¥100 million to ¥700 million. Because of the increasingly complex technology and software involved, both the time and cost to develop games have increased during the past few years. We believe that we can generate significant incremental revenue from our games by introducing them on additional platforms at a significantly lower cost than the development cost for introducing the game on the first platform. Converting an existing next-generation game from one platform to another is expected to take three to six months. These relatively long development cycles require that we assess whether there will be adequate demand for a game well in advance of its release, which is difficult to predict.

 

Manufacturing

 

The manufacturers of the home and handheld game platforms, such as Sony, Nintendo and Microsoft, generally manufacture our video games for us, either themselves or through their designees, 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 and opening a letter of credit in favor of the manufacturer. Hardware manufacturers or their authorized vendors typically deliver the first order to us within four to six weeks and additional orders for the same title within two 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 retain 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


  

Expiration Date


Nintendo

   Game Boy Color    Japan    March 7, 2005

Nintendo

   Game Boy Advance    Japan    January 8, 2005

Nintendo

   Game Boy Advance    United States and Canada    July 5, 2007

Nintendo

   GameCube    Japan    October 31, 2004

Nintendo

   GameCube    United States and Canada    January 9, 2005

Sony

   PlayStation    Japan    April 7, 2005

Sony

   PlayStation    Europe    December 31, 2005

Sony

   PlayStation 2    Japan    March 31, 2005

Sony

   PlayStation 2    Asia    March 31, 2005

Sony

   PlayStation 2    United States and Canada    March 31, 2005

Microsoft

   Xbox    Determined on a software title-by-title basis    November 14, 2004

 

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Nintendo charges us an amount for each Game Boy Advance, Game Boy Color and Game Boy Pocket cartridge. 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 generally include a manufacturing, printing and packaging fee as well as 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 prototype 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. Konami Marketing Japan, Inc., our wholly-owned subsidiary, conducts sales and market research for all of our products in Japan, other than our Pachinko LCD units and products sold at shops within fitness facilities directly managed by Konami Sports, and oversees our relationships with retailers.

 

Our video game software products are sold in Japan primarily through our sales distribution network, coordinated by Konami Marketing Japan, Inc., which has offices throughout Japan. Each of these sales offices focuses its efforts on a specified 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. 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, 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.

 

Toy & Hobby

 

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 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 1.19 million in 2000. Consequently, the population of this age group has decreased from 27 million in the beginning of the 1980s to 18.5 million in the population census of 2000. 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.), sports clubs (swimming schools, etc.) and cram schools (educational institutions to help enter kindergartens, primary schools and junior and senior high

 

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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.

 

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 consoles and software, have been stable with the 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 December and January, 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 the market research conducted by the Japan Toy Association, sales of girl’s toys, such as dress-up dolls, are decreasing, while sales of hobby items, such as plastic models, radio controlled toys and miniature trains, have steadily increased. As to card games, according to the Toy Industry White Papers, retail sales grew dramatically from ¥30 billion in fiscal 1996 to ¥120 billion in fiscal 2001. However, sales of card games during fiscal 2003 and fiscal 2004 declined to ¥60 billion. Because our products represent a significant portion of the Japanese card game market, we believe that much of this decline is due to the reduced popularity of our Yu-Gi-Oh! card games 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.

 

    character toys, which were created from the multiplier effects of mass-media and TV-animation films, movie animation films, comic books and so on have sold extremely well;

 

    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 has caused them difficulties. The system of fixed price sales, which is the traditional business practices in the toy market, has begun to collapse, and even department stores have sold at a discount prices.

 

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

 

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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 create, develop, design and sell a range of toys and brand-related goods, including card games, figures, toys with confectionery, CDs and DVDs of music from our video game software, game tip books (containing clues and strategies for playing popular games), capsule toys, game prizes for amusement arcade games and other accessories. These original toys and brand-related goods are based on well-known characters, brands and images, or content, that we either create on our own or license from third parties. 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. 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 create, develop and design the product around popular content and subcontract the manufacturing to a third party.

 

Our Toy & Hobby business is divided into four divisions: (i) card games; (ii) toys; (iii) music CDs and DVDs; and (iv) publications. Consolidated net revenues generated by our Toy & Hobby business increased ¥11,520 million, or 25.1%, to ¥57,468 million in fiscal 2004 from ¥45,948 million in fiscal 2003 due primarily to an increase of approximately ¥11,400 million in sales of the Yu-Gi-Oh! card games. More than 80% of our revenues from our Toy & Hobby business has been derived from worldwide sales of card games. 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! Official 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. Yu-Gi-Oh! 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. Our license agreement with the Japanese publisher automatically extends on a yearly basis unless terminated with notice.

 

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 recorded ¥26 billion sales of the Yu-Gi-Oh! Trading Card Game in the U.S in fiscal 2004. We have sold several new versions of Yu-Gi-Oh! Trading Card Game and plan to release additional new versions to the extent that it produces sufficient profit. We believe our card games are popular both for play and for card collecting.

 

The Yu-Gi-Oh! card game was launched in the United Kingdom in December 2002, in France in March 2003 and in other European countries in April 2003. The Yu-Gi-Oh! card game gained popularity in these European markets and recorded sales of ¥14 billion in fiscal 2004.

 

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 The Gransazers, a science fiction action hero in a TV show produced by Toho and broadcast by 26 TV stations around the country, including six stations affiliated with TV Tokyo. 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 intend to introduce a lineup of toy products using the characters from this television program.

 

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Toy & Hobby Business—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.

 

Toy & Hobby Business—Marketing, Sales and Distribution

 

Marketing and sales in Japan are conducted through our sales network in the company 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 retail partners, including The Upper Deck Company, LLC until March 2004, however, we currently distribute our products through The Upper Deck Company, LLC’s European entity employing the scheme used in the U.S.

 

Amusement

 

Our Amusement segment produces and sells products in the two industries:

 

    video game machines and token-operated game machines for amusement arcades; and

 

    software for LCD units used in pachinko machines.

 

The discussion below presents a separate overview of these two industries—amusement arcade games and software for LCD units used in pachinko machines—each of which is followed by a description of our Amusement segment operations corresponding to that industry.

 

Amusement Arcade Games—Industry Overview

 

According to the most recent industry statistics, the domestic amusement arcade industry had total revenues of ¥760.0 billion during 2003. The breakdown by category is shown in the following table.

 

Amusement Arcades—Japanese Industry Revenues

 

Industry Segment


   2000

   2001

   2002

   2003

     (in billions of yen)

Amusement arcade operations

   ¥ 619.5    ¥ 596.4    ¥ 590.3    ¥ 605.5

Amusement arcade games (domestic)

                           

Video Game Machines

     43.1      28.3      24.5      22.7

Token-operated game machines

     13.1      24.3      22.3      27.1

Prize Machines

     14.1      11.2      10.7      12.3

Vending Machines

     10.4      13.1      18.0      18.8

Music Simulation Game Machines

     16.2      6.6      4.9      3.4

Other

     48.4      36.6      39.7      50.2
    

  

  

  

Sub-total

     145.2      120.2      120.2      134.5

Amusement arcade games (exports)

     41.9      22.4      20.6      20.0
    

  

  

  

Total

   ¥ 806.6    ¥ 739.0      731.1      760.0
    

  

  

  


Source:   “Amusement Industry Survey, Fiscal 2003” (September 11, 2003), Japan Amusement Machinery Manufacturers Association, All Nippon Amusement Machine Operators’ Union and Nippon SC Amusement Park Association.

 

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The number of amusement arcades in Japan has been declining over the past several years. According to industry statistics, revenues from the operation of amusement arcades in Japan decreased for five years in a row from 1997. It is believed that the weak market condition for amusement arcades is primarily due to reduced player interest because of the increase in entertainment alternatives available to potential amusement arcade game players. 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 in 2003 to ¥605.5 billion due primarily to 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 marketing efforts targeting families and women.

 

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. Consolidated net revenues generated from the sale of amusement arcade games, including intersegment revenues, amounted to approximately ¥17,900 million in fiscal 2003 and approximately ¥18,100 million in fiscal 2004, an increase of approximately ¥200 million, or 1.1%.

 

Last year, we introduced approximately 14 new titles for video game machines for amusement arcades, half of which tend to be 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.

 

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 can not be replicated easily by home video game consoles. 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’nmusic, drummania and GUITARFREAKS. 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 increasing in popularity in part due to events such as national conventions where players can try their skills in a tournament.

 

    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; and

 

    drummania, a drum simulation game that corresponds to e-AMUSEMENT.

 

Amusement Business—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.

 

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Amusement Business—Video Game Machines—Marketing, Sales and Distribution

 

Our video game machines for amusement arcades are marketed, sold and distributed in Japan through our sales distribution network, coordinated by Konami Marketing Japan, Inc. 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, total industry revenues from the sale of token-operated game machines had been generally decreasing through fiscal 1999. However, sales rebounded to a record ¥24.3 billion in fiscal 2001, which was an increase of 186.0% as compared to the previous fiscal year. This growth was due primarily to the popularity of large-sized mass medal game machines, particularly horse racing games. As of fiscal 2003, sales of token-operated game machines amounted to ¥27.1 billion, comprising approximately 20.1% of the ¥134.5 billion Japanese amusement arcade game market. As indicated in the following table, revenues from amusement arcade operations have been declining, whereas revenues from the operation of token-operated game machines increased largely in fiscal 1999, 2001, 2002, 2003 and 2004. 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 consoles, is largely responsible for this trend.

 

Token-Operated Game Machines—Japanese Industry Revenues

 

     Year ended March 31,

 
     1997

    1998

    1999

    2000

    2001

    2002

    2003

 
     (billions of yen except for percentages)  

Revenues from the sale of token-operated game machines

   ¥ 11.1     ¥ 11.3     ¥ 9.8     ¥ 13.1     ¥ 24.3     ¥ 22.3     ¥ 27.1  

Revenues from amusement arcade operations

     642.3       643.4       628.9       619.5       596.4       590.3       605.5  

Revenues from token-operated game machines

     114.6       114.8       123.5       117.6       129.5       137.4       152.6  

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

     17.8 %     17.8 %     19.6 %     19.0 %     21.7 %     23.3 %     25.2 %

Source:   “Amusement Industry Survey, Fiscal 2003” (September 11, 2003), Japan Amusement Machinery Manufacturers Association, All Nippon Amusement Machine Operators’ Union and Nippon SC Amusement Park Association.

 

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

 

We develop, produce and sell token-operated game machines that we sell primarily to amusement arcade operators in Japan. Consolidated net revenues generated by our token-operated game machines amounted to approximately ¥7,400 million in fiscal 2003 and approximately ¥11,000 million in fiscal 2004, an increase of approximately ¥3,600 million, or 48.6%. We believe that we have over 40.2% of the domestic market for token-operated game machines based on Amusement Industry Survey.

 

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 two most popular token-operated game machines, FORTUNE ORB and GI-WINNING SIRE, accounted for a substantial majority of our net revenues of token-operated game machines in fiscal 2004. Fantasic Fever is a golden spiral

 

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decorated with numerous lamps, above which tokens shiningly flow and fall in front of the player. FORTUNE ORB is a classic token-operated game with additional attractive slot characters such as direct chance and fortune bonus, and significantly increased reach patterns as compared to the previous version in order to retain players’ attention and increase the excitement of the game.

 

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 Fantasic Fever and FORTUNE ORB, our principal machines include GI-TURFWILD, a “penny falls” type of horse racing game. Such large-sized token operated game machines have a typical commercial life span of four to five years and we typically introduce two new types of large-sized token-operated game machines each year. We also sell small-sized token-operated game machines.

 

Amusement Business—Token Operated Game Machines—Production

 

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

 

Amusement Business—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, coordinated by Konami Marketing Japan, Inc., in the same manner as video game machines for amusement arcades.

 

Pachinko—Overview

 

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 players and is the most important component. Our LCD unit is installed in the board face.

 

Our Pachinko LCD Unit Operations

 

We develop software that is incorporated into and sold together with LCD units for pachinko machines. The life cycle of such software for LCD units is approximately several months to one year. Consolidated net revenues generated by our pachinko LCD unit operations decreased in fiscal 2004 due to our inability to introduce new products meeting rapidly changing market needs in a timely manner.

 

We typically introduce between five and ten new pachinko software installed in LCD units 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 LCD units because we maybe 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.

 

LCD Units for Pachinko Machines—Development, Production and Components Supply

 

We develop the software for LCD units used in pachinko machines and, in a few limited cases, we have begun to sub-contract a portion of the software production to various third parties who produce our software to

 

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our circuit design specifications. We also work with third-party subcontractors who integrate the software with LCDs, semi-conductors and printed circuit boards that we order from major electrical manufacturers in Japan. Because of the increasing demand for LCDs, we have encountered difficulties in the past in procuring LCDs in sufficient quantities, although currently there are no such difficulties because of the increasing production capabilities of LCD makers. There is also increasing demand for semiconductors and, in order to avoid future procurement problems, we regularly place orders in advance of our requirements. We have not encountered, and do not expect to encounter, any difficulty in procuring printed circuit boards for our use. After our subcontractors have integrated the software and hardware, we then supply the bundled unit to the pachinko hardware manufacturer for the relevant pachinko machines.

 

LCD Units for Pachinko Machines—Marketing and Sales

 

We sell our LCD units directly to pachinko machine manufacturers. Certain 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 but are seeking to sell to other pachinko machine manufacturers.

 

Gaming

 

Our Gaming segment develops, produces and sells gaming machines such as video/mechanical slot machines to casino operators in the United States, Australia and other overseas jurisdictions.

 

Gaming Industry Overview

 

Global Gaming Industry

 

We believe that the North American market constitutes approximately 60% of the global gaming market, followed by the Oceania market with approximately 20%, the South American market with approximately 7% and the African and Asian market with approximately 1% each. The North American gaming market has been growing at an annual rate of approximately 10% and major players in this market have been growing significantly.

 

Gaming in the United States

 

The casino industry in the United States, and the gaming industry in general, have experienced substantial growth in the last decade. Prior to 1979, casino gaming was limited to Nevada. In 1979, casino gaming was legalized in New Jersey. Between 1979 and 1988, gaming activities by various Native American tribes developed, leading to the federal enactment of the Indian Gaming Regulatory Act. The growth of Native American gaming served as a catalyst for certain jurisdictions to consider non-Native American casino gaming because of its potential as a source of government revenue. Since 1989, various forms of casino 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 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 casino gaming.

 

Gaming in Australia

 

In Australia, the gaming industry is characterized by limited market growth and intense competition between manufacturers due partly to upper limits for numbers of gaming machines installed in major states. Australia is the largest and most established market for gaming products outside of North America and is primarily a video slot machine market.

 

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Our Gaming Business

 

Net revenues generated by our Gaming business, including intersegment revenues, amounted to approximately ¥8,215 million in fiscal 2003 and approximately ¥10,947 million in fiscal 2004, an increase of approximately ¥2,732 million, or 33.3%. We develop, produce and sell gaming machines for international markets, primarily in North America and Australia. We sold 4,500 gaming machines and 5,600 gaming machines in North America and Australia, respectively, in fiscal 2004.

 

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. We obtained two new customers in fiscal 2003 due to this acquisition and expect that this acquisition will further increase our market opportunities for gaming machines in North America. We are actively seeking additional licenses and sales opportunities in North America as we have received licenses to manufacture and/or sell gaming machines in Arizona, California, Illinois, Indiana, Iowa, Kansas, Louisiana, Michigan, Minnesota, Mississippi, Nevada, New Mexico, New York, Oregon, West Virginia, Wisconsin North Dakota, Idaho and Puerto Rico, and the Canadian provinces of British Columbia, Ontario, Quebec and Saskatchewan. In addition, our application for license in New Jersey has been in process. In September 2003 we introduced 22 new video slot games during the Global Gaming Expo held in Las Vegas. Our product lineup has been improving in its quality and number.

 

We believe that the annual demand of casino gaming machines in North America is approximately 100,000 units, out of which approximately 50% are mechanical slot machines. We launched mechanical slot machines in North America in December 2003 and hope to grow our share. Also, we sell video slot machines, the market for which is expected to grow in the United States as we believe that video slot machines provide more powerful performance gains and better cost advantages over mechanical slot machines, and our sales of video slot machines have been growing steadily.

 

Gaming Business—Production

 

Our gaming machines sold in North America are assembled at our production facility in Las Vegas, Nevada, and 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. We supply certain software and electronic components to our overseas production facilities. We have identified alternate sources of supply for significant parts and components in the event any of our current vendors fail to meet order requirements.

 

We are currently building a new gaming machine factory in Las Vegas. The new factory will have a production capacity of approximately 1,000 gaming machines per month, which is almost double of the production capacity of the current factory, and is scheduled to commence its operation in November 2004.

 

Gaming Business—Marketing, Sales and Distribution

 

Our gaming machines are marketed, sold and distributed overseas through our local subsidiaries directly to casino operators.

 

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Health & Fitness

 

Our Health & Fitness business is comprised of the operation of sports clubs and the design, manufacture and sales of fitness machines and fitness-related products.

 

Sports Club Operations

 

Industry Overview

 

According to Fitness Online, a website operated by the publisher of a professional fitness industry magazine called “Club Management”, as of December 2002 only 2.6% of the Japanese population had a private sports club membership. This compares to 6.3% in the United States and 5.3% in England. Judging from Japan’s low membership figures relative to the United States and England, the industry believes that there is room for future growth over the long-term, although weak economic conditions in Japan may dampen growth in the short-term.

 

According to “Club Business Trends in Japan, 2002” available at Fitness Online, private sports club revenues in Japan have leveled off at a compound annual rate of increase of approximately 0.2% over a five year period, from ¥294.5 billion in 1998 to ¥297.3 billion in 2002. On the other hand, over the same period, the number of private sports clubs has grown at a compound annual rate of approximately 1.8% from 1,708 in 1998 to 1,873 in 2002. However, sports club membership has increased over the same period only at a compound annual rate of 0.7%, from 2.9 million in 1998 to 3.0 million in 2002, which implies that the number of sports clubs increased at a higher level than the number of sports club membership and average revenue per member has declined at a compound annual rate of 0.45% since 1998. We believe that sports clubs, on average, are experiencing excess capacity together with discounted membership fees. Surviving in the current sports 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 growth in sports club memberships is attributable to several factors. Japanese are becoming increasingly focused on achieving healthier, more active and less stressful lives. Of the factors that members consider very important in their decision to join a sports 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 sports clubs include the distance from home, quality of facilities and price. We believe that interest in sports 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 sports 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 sports clubs in an effort to build national platforms.

 

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We believe that we had approximately 27% of the Japanese sports club market, as measured by revenues, for the year ended March 31, 2004 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 Sports 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 sports clubs in Japan in terms of revenues, members and total number of facilities. Consolidated net revenues generated by our Health & Fitness business, including intersegment revenues, amounted to ¥78,525 million in fiscal 2003 and ¥78,899 million in fiscal 2004, an increase of ¥374 million. Since our acquisition of PEOPLE CO., LTD., we have grown our sports club business through acquisitions of other sports 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 sports 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. Sports club revenues tend to be more stable than video game software revenues, which can fluctuate widely depending on the release of hit products. Sports clubs also tend to have a more diverse consumer base across both gender and age. Finally, we expect that our sports clubs will provide demand for our fitness machine business.

 

As of March 31, 2004, we owned and operated a nationwide network of 208 sports clubs and an additional 32 franchised facilities. These 240 clubs collectively served approximately 844,000 members as of March 31, 2004. 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-based operations include franchising of sports 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 business, including travel agency operations, issuing proprietary IC cards (which record training and other information) 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 expand our business. While Japan’s population is growing very slowly, and is projected to begin contracting in the future, the percentage of the population that are members of sports clubs is significantly lower in Japan than it is in the United States. First, we plan to continue opening new sports club facilities to increase our revenues. 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 expand our business into value-added services that can meet the evolving needs of consumers by establishing fitness and sports equipment shops, cafes, 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 addition, we have widened our business focus from a membership-focused strategy to include facilities that allowing non-members access on a pay-per-use basis in order to expand our customer base.

 

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Sports Club Business—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.

 

We operate the following three types of sports clubs, each under its own brand name at various locations in Japan.

 

    Eg-zas clubs.    Our Eg-zas clubs target adult consumers and offer fitness programs based on combinations of aerobics, machine training, stretch exercises and pool exercises. In a move to strengthen brand recognition of our Eg-zas clubs, we decided to integrate and operate our Sele clubs, which are sports clubs with basic health club facilities including studios and fitness machines, and Freizeit clubs, which are large-scale health complexes open to members and non-members that include spa and health club facilities, massage services, sportswear sales outlets and dining facilities, under the Eg-zas brand from April 1, 2002. Our Eg-zas clubs also include our tennis clubs. Our Eg-zas clubs (together with GRANCISE clubs) accounted for 68.0% of our Health & Fitness segment revenues for the fiscal year ended March 31, 2004.

 

    Undo-Jyuku.    Our Undo-Jyuku operates swimming and gymnastics schools with a focus on kindergarten and elementary school students. The swimming schools include programs for children—infants through elementary school—as well as adults, and include therapeutic programs such as aqua-walking, swimming for people with back problems and maternity swimming courses, and seek to accommodate various levels of ability and stamina and different fitness objectives. The gymnastics schools provide instruction in various gymnastics disciplines for children from pre-schoolers through junior high school students. Our Undo-Jyuku accounted for 18.1% of our Health & Fitness segment revenues for the fiscal year ended March 31, 2004.

 

    GRANCISE clubs.    Our GRANCISE clubs target corporate executives and businesspeople who desire premium services and facilities. As of May 31, 2004, we operated three GRANCISE clubs. The first club is located in Otemachi, the heart of Tokyo’s financial district. This luxurious facility with stunning views of downtown Tokyo offers comprehensive services such as personal nutrition and fitness coaching, exercise machines and aerobics, men’s and women’s steam room, jacuzzi, sauna, pool, spacious locker and shower facilities, massage therapy, complete workout wear and towel service. In April 2003, we opened our second GRANCISE club in Aoyama, Tokyo and later we opened GRANCISE clubs in Umedachayamachi, Osaka.

 

Sports Club Business—Ancillary Revenue

 

Since 2002, we have expanded the level of ancillary services provided to our members. We charge additional fees for service programs such as personal trainers, fitness counseling, jazzercise, acupuncture and massage, muscle toning training, diet programs, scuba diving classes and golf training. We also collect additional revenue from sales of goods at our pro shops, from the use of our facilities by non-members and from organizing sports and leisure-related tours for adults and after-school activities for children. Ancillary revenue as a percentage of total revenues from our Health & Fitness segment was 6.7% during fiscal 2004 and contributed ¥5,217 million to our total Health & Fitness segment revenues.

 

Sports Club Business—Marketing

 

Our marketing campaigns are directed by our in-house Facilities Management Department. This team consigns marketing business to Brand Communication Department, or BC, within our headquarter and the group of marketing professionals in BC conveys each of our nationally branded sports clubs as the premier network of sports clubs in that region. Advertisements are designed to highlight the consistent quality and high value-to-price ratio

 

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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.

 

During the second half of fiscal 2004, we introduced a system which offers reduced initiation fees of individual customers 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.

 

Sports Club Business—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 facilities of all GRANCISE and Eg-zas branches for no charge; (ii) GRANICISE Branch Membership, which enables members to use facilities of one GRANCISE branch and all Eg-zas branches for no charge; (iii) Eg-zas Special Membership, which allows members to use facilities of all Eg-zas branches nationwide; (iv) Eg-zas Regular Membership, which entitles members to use facilities of one Eg-zas branch for no charge and all other Eg-zas branches nationwide on a per-use charge; and (v) Eg-zas Branch Membership, which enables members to use facilities of one Eg-zas Branch 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. We also offer corporate membership plans with various price ranges in order to respond to each company’s needs. In addition, we provide corporate fitness programs, which allow companies to use our sports clubs as part of their employee benefit plans, and offer fitness assessment services and health clinics. Further, we offer our Konami Sports Club members various fitness tours. These corporate activities accounted for 7.2% of our Health & Fitness segment revenues for fiscal 2004.

 

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 (often corporate group members) 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 or Pocket Card, two Japanese credit card companies. Discrepancies and insufficient funds incidents are researched and resolved by in-house staff.

 

The Fitness Equipment Industry—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;

 

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    an aging population that is maintaining a more active lifestyle;

 

    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 Equipment 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 sports club memberships, thereby benefiting our sports 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.

 

Fitness Equipment Business—Production, Marketing, Sales and Distribution

 

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 move characters in a video game by running or pedaling. 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. We have also introduced home fitness products that allow users to enjoy exercising at home, such as MARTIAL BEAT II, a martial art fitness game, Aerobics Revolution, an aerobics game, and Diet Channel, a virtual broadcasting which reproduces contents regarding diet within game, for Sony PlayStation.

 

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 commissions Konami Corporation to do some of the manufacturing on its behalf. Currently, the largest customer for our fitness equipment is Konami Sports Corporation, which operates our sports clubs.

 

Other Operations

 

In addition to the five business segments described above, we run Konami Computer Entertainment School, which aims to support our entertainment development capabilities and to foster and maintain creative talent. Many graduates of school are employed by us and there are approximately 580 students enrolled at Konami Computer Entertainment School as of June 1, 2004. Also, 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 sports 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.

 

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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 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 Disney Interactive, Inc., Vivendi Universal Games, Inc., 4KIDS Entertainment Inc., Mirage Licensing, Inc., Nihon Ad Systems Inc., Kodansha and Shogakukan Production Co., Ltd.

 

Overseas Activities

 

The following tables show net revenues, operating expenses and operating income (loss) by geographic area for the periods indicated:

 

Year Ended

March 31, 2002


   Japan

    Americas

    Europe

   Asia/
Oceania


   Total

   

Eliminations

and

Corporate (2)


    Consolidated

 
     (Millions of Yen)  

Net revenues:

                                                      

Customers

   ¥ 177,618     ¥ 26,002     ¥ 19,320    ¥ 2,640    ¥ 225,580       —       ¥ 225,580  

Intersegment (1)

     31,446       2,860       6      199      34,511     ¥ (34,511 )     —    
    


 


 

  

  


 


 


Total

     209,064       28,862       19,326      2,839      260,091       (34,511 )     225,580  

Operating expenses

     185,089       30,438       14,944      2,695      233,166       (25,673 )     207,493  
    


 


 

  

  


 


 


Operating income (loss)

   ¥ 23,975     ¥ (1,576 )   ¥ 4,382    ¥ 144    ¥ 26,925     ¥ (8,838 )   ¥ 18,087  
    


 


 

  

  


 


 


Year Ended

March 31, 2003


   Japan

    Americas

    Europe

   Asia/
Oceania


   Total

    Eliminations
and
Corporate (2)


    Consolidated

 
     (Millions of Yen)  

Net revenues:

                                                      

Customers

   ¥ 182,345     ¥ 47,729     ¥ 16,297    ¥ 7,286    ¥ 253,657       —       ¥ 253,657  

Intersegment (1)

     50,670       805       27      506      52,008     ¥ (52,008 )     —    
    


 


 

  

  


 


 


Total

     233,015       48,534       16,324      7,792      305,665       (52,008 )     253,657  

Operating expenses

     258,551       47,112       14,917      6,236      326,816       (51,289 )     275,527  
    


 


 

  

  


 


 


Operating income (loss)

   ¥ (25,536 )   ¥ 1,422     ¥ 1,407    ¥ 1,556    ¥ (21,151 )   ¥ (719 )   ¥ (21,870 )
    


 


 

  

  


 


 


Assets

   ¥ 277,637     ¥ 18,787     ¥ 13,715    ¥ 4,281    ¥ 314,420     ¥ (36,170 )   ¥ 278,250  

 

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Year Ended

March 31, 2004


   Japan

   Americas

   Europe

   Asia/
Oceania


   Total

   Eliminations
and
Corporate (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
    

  

  

  

  

  


 

Assets

   ¥ 294,486    ¥ 19,647    ¥ 13,442    ¥ 4,652    ¥ 332,227    ¥ (37,730 )   ¥ 294,497

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

 

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. During fiscal 2002, our net revenues increased by ¥17,503 million in the Americas and by ¥11,148 million in Europe due primarily to the success of video game software titles such as METAL GEAR SOLID 2 SONS OF LIBERTY and Silent Hill 2. During fiscal 2003, our net revenues increased by ¥21,727 million in the United States due primarily to the success of the Yu-Gi-Oh! game software and the Yu-Gi-Oh! Trading Card Game. 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! card games and soccer titles. We also engage in limited overseas manufacturing activities.

 

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 the states of Arizona, California, Illinois, Indiana, Iowa, Kansas, Louisiana, Michigan, Minnesota, Mississippi, Oregon, West Virginia, Wisconsin, North Dakota and Idaho, and Puerto Rico and the Canadian provinces of British Columbia, Ontario, Quebec and Saskatchewan. In addition, we have been licensed by 39 Native American tribes in California, 13 tribes in Arizona, 11 tribes in New Mexico, nine tribes each in Minnesota and Michigan, five tribes in Wisconsin, four tribes each in Oregon and Kansas, three tribes in North Dakota, two tribes each in Iowa, New York and Louisiana and one tribe each in Idaho and Mississippi. We intend to file applications 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.

 

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.

 

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

 

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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.

 

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.

 

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. However, we may not be able to make any such acquisition or investment on terms acceptable to us.

 

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


Computer & Video Games

   Software such as WORLD SOCCER WINNING ELEVEN 7 and Powerful Professional Baseball Series.

Toy & Hobby

   Card games such as the Yu-Gi-Oh! card game series, toys for boys and infants such as The Gransazers and bath and toiletry products.

Amusement

   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 LCD units.

Gaming

   Gaming machines and software for North America and Australia.

Health & Fitness

   Fitness machines such as “EZ” Series

Year Ended March 31, 2003


Segment


  

Focus of R&D Activity


Computer & Video Games

   Software such as WORLD SOCCER WINNING ELEVEN 6 and Yu-Gi-Oh!.

Toy & Hobby

   Card games such as the Yu-Gi-Oh! card game series and toy confectionaries and toys such as MICROiR.

Amusement

   Video games such as MAH-JONG FIGHT CLUB, 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 OVALARENA, GI series and Monster Gate, as well as software for pachinko LCD units.

Gaming

   Gaming machines and software for North America and Australia.

Health & Fitness

   Fitness machines such as “EZSeries and fitness games such as MARTIAL BEAT II

 

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Year Ended March 31, 2002


Segment


  

Focus of R&D Activity


Computer & Video Games

   Software such as METAL GEAR SOLID 2 SONS OF LIBERTY and WORLD SOCCER WINNING ELEVEN 5 Final Evolution for the PlayStation 2 platform.

Toy & Hobby

   Card games such as the Yu-Gi-Oh! card game series and toys such as DigiQ infra-red remote control cars.

Amusement

   New software for music simulation games such as drummania, pop’n music and medium- and large-sized token-operated games such as FORTUNE ORB and Monster Gate as well as software for pachinko LCD units.

Gaming

   Gaming machines and software for North America and Australia.

 

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 December 2003, Sammy Corporation acquired shares of Sega Corporation and made Sega its equity method affiliate. In May 2004, Sammy and Sega agreed to establish a holding company that will hold both company’s entire stake in October 2004.

 

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 Ltd., and Sega Corporation., 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 console hardware/software companies, such as Sony 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.

 

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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 Bandai Co., Ltd. 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.

 

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 Corporation and Namco Ltd., and competition in these markets is intense. The principal method of competition in the market for video game machines and token-operated games machines for amusement arcades is new product development.

 

The market for software for LCD units 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 LCD units for pachinko machines.

 

Our principal competitors in overseas gaming machine markets include International Game Technology, Alliance Gaming Corporation, Aristocrat Leisure Limited and WMS Industries Inc. A library of strong performing games 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.

 

In the sports club market, we compete with other commercial health and sports 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 sports 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.

 

Intellectual Property

 

    As of March 31, 2004, we had approximately 4,024 trademarks, 568 patents and 362 registered designs (excluding applications pending) in Japan and we also had approximately 3,709 trademarks, 692 patents and 428 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, LCD units 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.

 

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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 (other than our trademarks) could have a material adverse effect on our business.

 

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 Sega 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 game 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

 

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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 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

 

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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 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.

 

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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 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

 

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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 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.

 

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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 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.

 

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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.

 

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

 

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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 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 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 are in the process of applying for a CSI license.

 

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

 

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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 (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 Company Act 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.

 

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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 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, 2004, we are authorized to sell gaming machines and components to Native American casinos in 14 states.

 

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 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 Software 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 or 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, 2004, 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)    

Head Office

  Chiyoda-ku, Tokyo   All   Administrative   ¥ 1,326   —     4,234   Leased

Computer & Video Games Office

 

Minato-ku, Tokyo

 

Computer & Video Games

 

Sales, Administrative

  ¥ 6   —     692  

Leased

Toy & Hobby Office

  Shibuya-ku, Tokyo   Toy & Hobby   Production, Sales, Administrative   ¥ 617   —     1,294   Leased

 

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Establishment


 

Location


 

Segment


 

Uses


 

Book Value of
Machinery

and

Equipment


 

Land

Space


  Floor
Space


 

Tenure


Amusement Office

  Minato-ku, Tokyo   Amusement  

Production,

Sales,

Administrative

  ¥ 36   —     2,327   Leased

Amusement Kobe Office

      
Nishi-ku, Kobe
      
Amusement
 

    
Production,

Manufacturing,

Administrative

  ¥ 83   —     9,288  

Leased

Amusement Zama Office

 

Zama, Kanagawa
 

Amusement
 

    
Production,

Manufacturing,

Administrative

  ¥ 72   —     7,854  

Leased

Gaming Machine Research & Development Center

 



Zama, Kanagawa
 



Gaming
 

    
    
Production,

Manufacturing,

Administrative

  ¥ 24   —     1,676  

Leased

Konami Computer Entertainment Studios, Inc.

 



Minato-ku, Tokyo
 


Computer &

Video Games

 

    
    
Production,

Sales,

Administrative

 

¥

 

299

 

—  

 

3,602

  Leased

Konami Computer Entertainment Tokyo, Inc.

 



Chuo-ku, Tokyo
 


Computer &

Video Games

 

    
    
Production,

Sales,

Administrative

  ¥ 207   —     4,035  

Leased

Konami Computer Entertainment Japan, Inc.

 



Minato-ku, Tokyo
 



Computer & Video Games
 

    
    
Production,

Sales,

Administrative

  ¥ 362   —     4,912  

Leased

Konami Sports Corporation

 

Shinagawa-ku, Tokyo, and 210 locations
      
Health & Fitness
      
Sports Club
  ¥ 5,119   8,925   696,352  

Some owned and some leased

Konami Real Estate, Inc.

      
Shinjuku-ku, Tokyo and other
      
Other
      
Home Leasing
  ¥ 2   834   1,409  

Owned

Konami Real Estate, Inc.

      
Nasu-gun, Tochigi
      
Other
 

    
Leader

Training Facility

  ¥ 17   460,640   14,612  

Owned

Konami Real Estate, Inc.

      
Shinagawa-ku, Tokyo
      
Other
      
Office Leasing
  ¥ 49   41,156   92,830  

Owned

Konami Digital Entertainment, Inc.

 

Redwood City, California, U.S.A. (primary location)
      
Computer & Video Games, Toy & Hobby and Amusement
      
Sales, Administrative
  ¥ 131   22,501   7,433  

Some owned and some leased

Konami of Europe GmbH

      
Frankfurt, Germany (primary location)
      
Computer & Video Games and Toy & Hobby
      
Sales, Administrative
  ¥ 78   —     4,582  

Leased

Konami Corporation of Europe B.V.

      
London, U.K.
      
Amusement
      
Sales, Administrative
  ¥ 15   3,440   1,670  

Owned

Konami Gaming, Inc.

  Las Vegas, Nevada, U.S.A.   Gaming   Production and sales of gaming machines   ¥ 120   —     6,347   Leased

Konami Australia Pty Ltd.

      
New South Wales, Australia
      
Gaming
      
Production and sales of gaming machines
  ¥ 209   —     7,753  

Leased

 

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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.

 

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, 2004. 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 Computer Entertainment
Tokyo, Inc.

  Chuo-ku, Tokyo    ¥2,323    65    Development of video game software   

April 1995

Konami Computer Entertainment
Japan, Inc.

   Minato-ku, Tokyo    ¥3,366    66    Development of video game software   

April 1996

Konami Computer Entertainment
Studios, Inc.

   Minato-ku, Tokyo    ¥1,213    67    Development of video game software   

April 1995

Konami Online, Inc.

   Minato-ku, Tokyo    ¥300    100    Production and operation of mobile and online games    October 2001

Konami Media Entertainment, Inc.

   Shibuya-ku, Tokyo    ¥180    100    Production of music and publications    December 1995

Konami Traumer, Inc.

   Katsushika-ku, Tokyo    ¥142    78    Production and sales of toys and hobby products    March 1982

KPE, Inc.

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

Konami Sports Life Corporation

   Minato-ku, Tokyo    ¥15,050    100    Sales of fitness equipment    June 22, 1989

Konami Sports Corporation

   Shinagawa-ku, Tokyo    ¥5,040    61    Operation of sports clubs    March 1973

Konami Marketing Japan, Inc.

   Minato-ku, Tokyo    ¥1,162    100    Marketing and sales    October 2000

Konami Real Estate, Inc.

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

 

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Name


  

Registered office


  

Issued share

capital

(in millions)


  

Shares held
by us,

directly or
indirectly
(%)


  

Principal

business


  

Establishment
date


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

Konami Computer
Entertainment School, Inc.

   Minato-ku, Tokyo    ¥490    100    Development and education of creators    March 1997

The Club At Yebisu Garden Co.,
Ltd.

   Meguro-ku, Tokyo    ¥200    70    Operation of sports clubs    January 1994

Takara Co., Ltd. (1)

   Katsushika-ku, Tokyo    ¥18,121    23    Toy manufacturer    June 1959

Hudson Soft Co., Ltd. (1)

   Sapporo City, Hokkaido    ¥4,347    45    Development of video game, mobile and online game software    May 1973

Genki Co., Ltd. (1)

   Shinjuku-ku, Tokyo    ¥684    37    Development of video game software    October 1990

One other company

                        

Overseas

                        

Konami Digital Entertainment,
Inc.

   Redwood City, California,  U.S.A.    U.S.$21.5    100    Sales of video game software    November 1982

Konami Marketing, Inc.

  

Los Angels,

California, U.S.A.

   U.S.$0.17    100    Sales of toy and hobby products and amusement arcade games    April 2003

Konami Gaming, Inc.

   Las Vegas, Nevada, U.S.A.    U.S.$1.7    100    Production and sales of gaming machines    February 1997

Konami Computer
Entertainment Hawaii, Inc.

   Honolulu, Hawaii, U.S.A.    U.S.$2.2    50    Development of video game software   

May 1997

Konami Corporation of America

   Redwood City, California, U.S.A.    U.S.$34.9    100    Holding company    October 1996

Konami Corporation of Europe
B.V.

   Amsterdam, Netherlands    €9.0    100    Holding company    November 1997

Konami of Europe GmbH

   Frankfurt am Main, Germany    €5.1    100    Sales of video game software    December 1984

Konami Marketing (Asia) Ltd.

  

Tsui, Kowloon,

Hong Kong, China

   HK$19.5    100    Sales of video game software and amusement arcade games    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

Konami Gaming (Australia) Pty
Ltd.

   New South Wales, Australia    A$0.01    100    Production and sales of gaming machines   

January 1999

One other company

                        

(1)   These companies are accounted for by the equity method.
(2)   Except as indicated in the notes above, there has been no change in respect of our subsidiaries and affiliates since March 31, 2004.

 

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D.    Property, Plants and Equipment.

 

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

 

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 information included in this annual report. Fiscal 2004 herein refers to the fiscal year ended March 31, 2004, 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 and health products and services provider. We develop, publish and distribute video game software for use by customers with home and handheld video game consoles, principally those manufactured by Sony and Nintendo. Since February 2001, we have also run the largest chain of health and sports clubs in Japan. We also produce toys, such as card games, including some that use characters from or are inspired by characters in our home video game software and other products. Finally, we produce and market a variety of entertainment and exercise machines and components, including amusement arcade games, token-operated games, LCD units for pachinko machines, gaming machines and fitness machines. We earn revenues and income and generate cash from sales of these products and services.

 

We divide our worldwide operations principally into five business segments for financial reporting purposes: Computer & Video Games, Toy & Hobby, Amusement, Gaming and Health & Fitness. The net revenue of these segments accounted for 33.8%, 21.0%, 13.0%, 4.0% and 28.9%, respectively, of our total net revenues, including intersegment revenues, in fiscal 2004. We have achieved constant growth in net revenues over the last six years, with revenue growth of 7.8% in fiscal 2004. Our consolidated net revenue for fiscal 2004 was ¥273,412 million, which was the highest since our founding.

 

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 our Yu-Gi-Oh! card game and our Yu-Gi-Oh! game software. We have been working to reduce volatility in our results by building a solid and well-balanced business portfolio with multiple segments, each featuring a growing number and variety of products and services. In the year ended March 31, 2004, for the first time, we had three segments with over ¥10,000 million in operating income and our other two segments turned profitable. This success was due to our concerted efforts to strengthen and diversify each of our segments. We are also diversifying our revenue sources by expanding our businesses overseas. Our Computer & Video Games and Toy & Hobby segments have been active in North American and European markets and our Gaming segment has actively developed its operations in North American market, the biggest gaming market in the world.

 

The overall Japanese entertainment industry has been expanding, reflecting an increasing social recognition of the importance of developing intellectual property and the rapid advance of technology. Among the businesses in the Japanese entertainment industry, the video game software business in which our Computer & Video Games segment operates 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, where our Toy & Hobby segment operates, faces problems, including a declining birth rate, children growing out of toys at younger ages due to earlier maturity, a decrease in disposable incomes due to the

 

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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 where our Amusement segment operates 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. 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.

 

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. Our revenue growth in the past two fiscal years has been driven primarily by international growth. For example, sales of our Yu-Gi-Oh! card game and game software with Yu-Gi-Oh! content increased substantially in North America in fiscal 2003 and in Europe in fiscal 2004. In the sports video game category, soccer titles such as the Winning Eleven series, including WORLD SOCCER WINNING ELEVEN 7 and Pro Evolution Soccer 3, gained popularity mainly in Japan and Europe and recorded sales of 4.5 million copies worldwide in fiscal 2004. We seek to continue expanding our business in these markets by introducing products which became hits in the Japanese market, however, new hit products may not be as successful abroad as in Japan due to different consumer tastes and different competitive environments in each market. Accordingly, we aim to diversify our overseas operations by deploying our products in other markets including China, where we recently released our first video game software, WORLD SOCCER WINNING ELEVEN 7 INTERNATIONAL for PlayStation 2.

 

Our main business strategies for each segment are as follows:

 

    In the Computer & Video Games segment, we strive to strengthen our international operations through acquiring and creating contents that are globally competitive and enhancing our PC game software business with an alliance with Vivendi Universal.

 

    In the Toy & Hobby segment, we are working to diversify our product lineups, including boy’s toys and educational toy products, toy products for infants and publishing, as well as standardizing the Yu-Gi-Oh! card game internationally for its further promotion.

 

    In the Amusement segment, we plan to further enhance our e-AMUSEMENT service, which links amusement arcades throughout Japan, by strengthening existing contents.

 

    In the Gaming segment, we aim to increase our market share in North America with the increased production capacity of a new factory in Nevada and a full-scale operation for sales of mechanical slot machines.

 

    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.

 

Factors Affecting Our Results of Operations

 

Factors Affecting Combined Results of Operations

 

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

 

Hit Products

 

Most of our non-fitness related revenues come from sales of interactive entertainment software and devices and are dependent on our ability to anticipate or influence the kinds of games and products that are popular with

 

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consumers. Revenues for our Computer & Video Games, Toy & Hobby, Amusement and Gaming segments are strongly affected by whether individual products or a series of products become “hits” with consumers. A single hit product can generate very substantial revenues, which can continue over an extended period through the release of sequel products and through extension of the concept or characters from a popular game from one business segment to another business segment.

 

For example, our Toy & Hobby net revenues, including intersegment revenues, increased 25.1% from ¥45,948 million in fiscal 2003 to ¥57,468 million in fiscal 2004 due mainly to robust sales of our Yu-Gi-Oh! card game in North America, as well as increased sales of the card game in Europe. Our Computer & Video Games net revenues, including intersegment revenues, increased 5.8% from ¥87,476 million in fiscal 2003 to ¥92,520 million in fiscal 2004 due primarily to favorable sales of the Yu-Gi-Oh! game software in North America and Europe and an increase in sales of the WINNING ELEVEN series, soccer title, in Japan and Europe.

 

It is difficult to predict whether any particular product will become a hit. We seek to reduce the volatility of our net revenues by developing a large number of new titles each year in various categories and for various platforms. We have steadily increased the number of titles published by our home and handheld video game software business from 55 titles in fiscal 1999 to 120 titles in fiscal 2004. We have also decreased the volatility of our net revenues by entering the sports club business, which we believe will provide a more stable base of revenue.

 

Intellectual Property Licensing

 

One means we use to increase the likelihood that our products will succeed is licensing the right to utilize ideas and images from popular culture, such as comic book characters, sports and entertainment personalities and high visibility events. Thus, to some extent our revenues are dependent on successful identification and acquisition of rights to popular ideas and images. We have steadily increased the number of intellectual property licenses we hold from 13 licenses for 26 products in fiscal 1999 to 94 licenses for 154 products in fiscal 2004.

 

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

 

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

 

Seasonal Fluctuations

 

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

 

Investments and Acquisitions

 

As discussed in Item 4.B, “Business Overview”, of this annual report, in the last four years we have sought growth and diversification through investments and acquisitions in sectors that promise increased revenue

 

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stability and increased revenue growth. In particular, we have made investments in video game software development companies for our Computer & Video Games segment and we have acquired new consolidated subsidiaries for our Toy & Hobby, Gaming and Health & Fitness segments. These investments and acquisitions have made substantial changes in the composition of our assets, in particular increasing the amount of goodwill and intangibles on our consolidated balance sheet in fiscal 2001 and fiscal 2002. As explained below, we recognized an other-than-temporary impairment of most of the goodwill and some of the intangibles in fiscal 2003.

 

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

 

    acquisition of 23.0% of the common stock of TAKARA Co., Ltd.;

 

    acquisition of 45.5% of the common stock of HUSTON SOFT CO., LTD.; and

 

    acquisition of 37.2% of the common stock of Genki Co., Ltd.

 

Our investments allow us to develop closer ties with companies doing business in areas that we consider growth areas for our business, including sales of Toy & Hobby products and mobile and on-line video game software. Because these companies are equity method affiliates, our financial results are affected by our pro rata share of their net income or losses. As a result of our fiscal 2003 year-end annual examination of these investments, we recognized an other-than-temporary impairment and recorded a net-of-tax charge of ¥2,438 million with respect to the investment in HUDSON SOFT CO., LTD., due to a significant decline in its share value in the market. For fiscal 2004, our income statement included ¥252 million in equity in net income of affiliated companies.

 

We spent an aggregate of ¥76,664 million on the following acquisitions of consolidated subsidiaries in the last four fiscal years:

 

Toy & Hobby:

 

    acquisition of 77.8% of the common stock of Konami Träumer Inc., formerly known as Träumer Inc., in April 2003.

 

Gaming:

 

    acquisition of 100% of the common stock of Paradigm Gaming Systems, Inc. in August 2001; and

 

    acquisition of 100% of the common stock of Konami Australia Pty Ltd in October 2001.

 

Health & Fitness:

 

    acquisition of 54.6% of the common stock of Konami Sports Corporation, formerly known as PEOPLE CO., LTD. in February 2001;

 

    acquisition of 100% of the common stock of Konami Sports Plaza, Inc., formerly known as NISSAN SPORTS PLAZA CO., LTD., in June 2001;

 

    acquisition of 82.2% of the common stock of Konami Olympic Sports Club, Corporation, formerly known as DAIEI OLYMPIC SPORTS CLUB, INC., in February 2002; and

 

    acquisition of 100% of the common stock of Konami Athletics Inc., formerly known as NISSAY ATHLETICS COMPANY, in March 2003.

 

In connection with our acquisition of majority ownership of new consolidated subsidiaries in fiscal 2001 through 2004, we recognized an aggregate amount of goodwill of ¥39,359 million and acquired an aggregate amount of intangibles of ¥64,809 million, mostly related to the trademarks and other intangible property associated with our sports club business. Our acquisition related goodwill and other intangible assets were

 

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originally amortized over various periods. However, a change in U.S. GAAP means that such amortization for goodwill and indefinite lived intangibles ceased beginning on April 1, 2002 and that the remaining balances are required to be tested for impairment at least on an annual basis. Following the impairment review for fiscal 2003, we recognized impairment losses of ¥47,599 million with respect to our investment in Konami Sports Corporation. Approximately ¥36,717 million of this impairment related to the write-off of goodwill and the remaining ¥10,882 million related to the impairment of identifiable intangible assets such as trademarks and franchise contracts. This impairment was recognized as a component of our operating loss during fiscal 2003. For further information regarding this impairment, see “Critical Accounting Policies—Valuation of Intangible Assets and Goodwill” on page 81. We will continue to amortize intangibles with finite lives.

 

Foreign Currency Fluctuations

 

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

 

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

 

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

 

Factors Affecting Results of Business Segments

 

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

 

Computer & Video Games

 

Net Revenues.    We develop, publish and distribute video game software for use in home and handheld video game consoles, game content for mobile phones and software or content for personal computers and on-line games. We refer to this segment as our “Computer & Video Games” segment. Our video game software is sold mainly in the form of DVD-ROMs or proprietary discs for home video game platforms such as Sony PlayStation 2, Nintendo GameCube and Microsoft Xbox and ROM-cartridges for handheld video game platforms such as the Game Boy Advance.

 

In fiscal 2004, net revenues from the Computer & Video Games segment, including intersegment revenues, were ¥92,520 million, accounting for 33.8% of consolidated net revenues excluding intersegment revenues. This

 

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was derived primarily from strong sales of soccer titles such as WORLD SOCCER WINNING ELEVEN 7 and WORLD SOCCER WINNING ELEVEN INTERNATIONAL for PlayStation 2 in Japan and Pro Evolution Soccer 3 for PlayStation 2 in Europe. In North America and Europe, we achieved strong sales of Yu-Gi-Oh! titles, reflecting a synergy effect of the popularity of the Yu-Gi-Oh! Trading Card Game and the Yu-Gi-Oh! cartoon on television. In North America, the Yu-Gi-Oh! series, including Yu-Gi-Oh! Worldwide Edition: Stairway to the Destined Duel and Yu-Gi-Oh! The Sacred Cards for Game Boy Advance, recorded sales of 2.45 million copies, and in Europe, the Yu-Gi-Oh! series, including Yu-Gi-Oh! Worldwide Edition: Stairway to the Destined Duel for Game Boy Advance and Yu-Gi-Oh! DUELISTS OF THE ROSES for PlayStation 2, recorded sales of 2.24 million copies. As a result, the operating margin for the Computer & Video Games segment, including intersegment revenues, for fiscal 2004 was 17.4%.

 

Our sales of video game software are strongly influenced by our ability to develop or acquire popular game content. See “—Factors Affecting Our Results of Operations—Factors Affecting Combined Results of Operations—Hit Products, Intellectual Property Licensing.” Sales of video game software are significantly affected by sales volumes of video game consoles. The potential market for a software product designed for a particular video game system is determined by the total number of such video game consoles purchased by consumers, a number which is sometimes referred to as the “installed base” of such video game consoles. When new hardware systems are introduced, we 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 games 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.

 

Expenses.    A majority of our software titles are developed by our development subsidiaries. Costs and expenses that we incur in the development of new video game software titles are expensed as research and development fees until such games reach technological feasibility, at which point we begin to capitalize the expenses. We expense capitalized costs to cost of revenues upon commercial release of the resulting game, as the commercial life of our consumer software is of short duration.

 

The rapid technological advances in game consoles have significantly changed the software development process. The process of developing software for the new 128-bit consoles is extremely complex and we expect the process to become even more complex and expensive with the advent of more powerful future game consoles. According to our estimates, it currently takes between 6 and 24 months to develop a new title and the average development cost per title is generally between ¥100 million and ¥700 million, though the cost of our most technically complex titles may exceed ¥1,000 million.

 

Our cost of revenues for video game software also includes the costs of licenses from contents licensors. While some of our contents licenses include prepaid or guaranteed royalties, most of the royalties we pay are on a sales basis. We amortize the cost of prepaid royalties 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.

 

Toy & Hobby

 

Net Revenues.    In fiscal 2004, net revenues from the Toy & Hobby segment, including intersegment revenues, were ¥57,468 million, accounting for 21.0% of consolidated net revenues. This was derived primarily

 

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from robust sales of our popular Yu-Gi-Oh! trading card game series in North America and Europe. The operating margin for the Toy & Hobby segment, including intersegment revenues, for fiscal 2004 was 34.1%.

 

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

 

Our Toy & Hobby segment generates revenues principally from the sales of card games. As the extraordinary popularity of the Yu-Gi-Oh! official card game in the Japanese market has subsided, approximately 70% of our Toy & Hobby revenues were derived from sales of the Yu-Gi-Oh! trading card games in North America and Europe in fiscal 2004. We believe that sales of card games in these markets are principally affected by the popularity of the contents from comic or television cartoon, the timing of product introduction reflecting, for example, the television broadcasting schedule and other competitive products. In the European markets, sales are also affected by the recognition of card games in the toy market, as card games are relatively new in Europe, in contrast with the United States, where card game market existed already. We have been globally standardizing the cards through events such as the Yu-Gi-Oh! World Championship in order to raise international recognition of and promote the Yu-Gi-Oh! card game.

 

The toy industry in Japan, where our Toy & Hobby segment operates, faces problems including a declining birth rate, 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. However, the toy industry is holding firm 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. Accordingly, we are diversifying the range of our products for the Japanese market, especially boy’s toy products, in order to balance our business portfolio and improve attractiveness of our product lineups. For example, we introduced a variety of action figures and other toys for boys using characters appearing in a popular science fiction action hero television program, The Gransazers, which were well received by the market. Also, for the first time, we are participating in the production of animated contents, a new robot hero animation television program, Get Ride! AMDRIVER, and developing boy’s toys products based on the contents at the same time.

 

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

 

Amusement

 

Net Revenues.    In fiscal 2004, net revenues from the Amusement segment, including intersegment revenues, were ¥35,427 million, accounting for 13.0% of consolidated net revenues excluding intersegment revenues. Segment revenues were derived primarily from sales of popular video arcade games such as MAH-JONG FIGHT CLUB and Quiz MAGIC ACADEMY and token-operated game machines such as Fantasic Fever and GI-TURFWILD as well as sales of LCD screen software for pachinko machines. The operating margin for the Amusement segment, including intersegment revenues, for fiscal 2004 was 33.3%.

 

Although arcade game sales had been declining since the appearance of advanced interactive entertainment products, such as sophisticated video game consoles and mobile phones which offered competing entertainment options that one could only play in an amusement arcade about twenty years ago, sales of the Japanese amusement arcade industry increased in fiscal 2004 due primarily to an increase in the number of large-scale amusement arcades within multi-purpose commercial facilities involving cinema complexes, shopping centers and other commercial facilities that attract customers, especially families and women.

 

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

 

We derive sustained revenues from our token-operated machines in Japan. We recorded ¥11 billion in sales of token-operated machines in fiscal 2004 due primarily to robust sales of Fantasic Fever and FORTUNE ORB, and believe that we are one of the leading companies in the Japanese token-operated game machine industry. As the arcade operations industry in Japan has been consolidating, with the number of amusement arcades declining and the average size of each arcade increasing, large-size token-operated game machine such as Fantasic Fever that attract customers and are well suited to large-scale amusement arcades are gaining popularity.

 

The Amusement segment also generates revenues from the sale of software for LCD units in pachinko games machines. Revenues from pachinko LCDs are affected by the maturation of the market, consumer preference, regulatory standards, supply-demand balance of liquid crystal display units, competition within the market, product life cycles and general economic trends. In recognition that all software have a finite life-cycle, pachinko parlors regularly replace legacy machines experiencing declining pay levels with new machines incorporating enhanced entertainment value and improved player appeal generally every two months to one year. We recorded a decline in sales of LCD units in fiscal 2004, due primarily to our inability to introduce new products matching changing customers’ needs in a timely manner.

 

Also, the pachinko machine market has shown a slight decline due to the overall effects of recession in the past several years. The pachinko industry still remains highly regulated which restricts rapid development of our operations. All pachinko manufacturers in Japan are required to get approval from The Security Electronics and Communications Technology Association, supervised by National Police Agency, in order to engage in sales activities. The manufacturers of pachinko machines must also register with The Japan Crime Prevention Association. Licensing requirements can delay the development and release of new pachinko machine products. Changes in rules or regulations governing pachinko machines may adversely affect our sales of software for LCD units.

 

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

 

Gaming

 

Net Revenues.    In fiscal 2004, net revenues from the Gaming segment, including intersegment revenues, were ¥10,947 million, accounting for 4.0% of consolidated net revenues excluding intersegment revenues. The main revenue source for the Gaming segment is the sale of video slot machines and software contents in Australia and North America. Revenues for the Gaming segment are affected by the timing of product introductions, timing of regulatory approvals in various markets, ability to penetrate into foreign casino markets, number of casino players, casino gaming regulations in each market, our production capacity, competition within the market, normal product life cycles and general economic trends.

 

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Our sales of casino 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 world-wide sales (including leasing and others) of casino gaming machines for the year 2005 will be over ¥300 billion and the market will grow continuously.

 

Konami Australia Pty Ltd, which has licenses for sales and manufacturing of gaming machines in all Australian states, marketed casino gaming machines, including our main product Egyptagon. Although the dominance of the largest player in the Australian gaming markets has made it difficult for us to become a market leader quickly, we have made substantial in-roads and believe we are one of the largest sellers of gaming machines in the Australian market. However, 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, so 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.

 

In North America, the largest casino gaming machines market in the world, we currently hold licenses to manufacture and sell casino gaming machines in 23 states and to 105 tribes. We participated in the world’s largest gaming show held in Las Vegas in September 2003 with 17 product titles, thereby showing that we improved our line-up of gaming machines both in quantity and quality.

 

In contrast with Australia, we believe demand for casino gaming machines in North America has been increasing. Also, our application for license in New Jersey, one of the largest casino markets in North America, is currently being processed and, if we succeed in obtaining a New Jersey license, we expect to further expand our share in the market. In order to meet increasing demand, we are building a new gaming machine factory in Las Vegas, which is expected to double our current production capacity and is scheduled to commence its operation by the end of fiscal 2005.

 

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

 

Health & Fitness

 

Net Revenues.    We are the largest sports 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, 2004, we operated 208 sports clubs that collectively served approximately 844,000 members. Our Health & Fitness segment had ¥78,899 million in net revenues, including intersegment revenues, in fiscal 2004.

 

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

 

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

 

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believe that we are well positioned, being twice as large as the second largest operator according to the Leisure Paper, to identify opportunities to selectively acquire existing operators and facilities at attractive prices due to our dominant position in a fragmented market. During fiscal 2004, we increased the aggregate number of sports clubs we directly operate by four clubs.

 

We have taken actions to create a more powerful brand. To cement our position as the No. 1 brand in the sports club industry in Japan, we unified our collection of brands, including Eg-zas 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. Finally, we launched the first official i-mode (internet enabled cellular phone) site in the fitness industry, which provides various club facility information and health related information.

 

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 sports 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 2004.

 

Our Health & Fitness segment develops fitness-oriented games to consumers and fitness machines with entertainment quality mainly for our Konami Sports fitness clubs. As of March 31, 2004, we have developed four Health & Fitness machines under EZ series brand and these machines are now introduced in our Konami Sports fitness clubs. We also have several new machines in various stages of the development pipeline.

 

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

 

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

 

Expenses.    Operating expenses for our Health & Fitness segment include, for our health and sports 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 sports club, we often experience an initial period of club operating losses for the first 12 months, but this period can vary substantially depending on the individual club. Initial membership levels tend not to generate sufficient revenue for the club to generate positive earnings in its first full year of operation and substantially lower margins in its second full year of operations than a mature club. However, because most of our expenses are fixed, operating margins tend to improve with respect to each club as membership increases. Expenses for our fitness-related game and fitness equipment business are largely related to cost of parts and raw materials, manufacturing costs and research and development expenses.

 

In fiscal 2003, we had substantial additional operating expenses in our Health & Fitness segment because we recognized impairment losses of ¥47,599 million with respect to our investment in Konami Sports Corporation. Under U.S. GAAP, impairment loss is treated as an operating expense. Approximately ¥36,717 million of this impairment related to the write-off of goodwill and the remaining ¥10,882 million related to identifiable intangible assets such as trademarks and franchise contracts. These impairment losses were attributed to the fact that the growth of this segment did not meet our expectations as a result of negative trends in general economic conditions in Japan. In fiscal 2004, we did not recognize any impairment losses.

 

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Results of Operations

 

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

 

     Millions of Yen

    Thousands of
U.S. Dollars


 
     2002

    2003

    2004

    2004

 

NET REVENUES:

                                

Product sales revenue

   ¥ 165,154     ¥ 178,766     ¥ 196,136     $ 1,855,767  

Service revenue

     60,426       74,891       77,276       731,157  
    


 


 


 


Total net revenues

     225,580       253,657       273,412       2,586,924  
    


 


 


 


COSTS AND EXPENSES:

                                

Costs of products sold

     104,192       112,364       115,229       1,090,255  

Costs of services rendered

     50,459       62,515       63,953       605,100  

Impairment charge for goodwill and other intangible assets

     —         47,599       —         —    

Selling, general and administrative

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


 


 


 


Total costs and expenses

     207,493       275,527       232,699       2,201,713  
    


 


 


 


Operating income (loss)

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


 


 


 


OTHER INCOME (EXPENSES):

                                

Interest income

     244       373       488       4,617  

Interest expense

     (767 )     (938 )     (865 )     (8,184 )

Gain on sale of subsidiary shares

     4,655       904       —         —    

Other, net

     459       (565 )     (229 )     (2,166 )
    


 


 


 


Other income (expenses), net

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


 


 


 


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

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

INCOME TAXES:

                                

Current

     17,276       14,912       18,686       176,800  

Deferred

     (5,609 )     (8,726 )     (651 )     (6,159 )
    


 


 


 


Total

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

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

     11,011       (28,282 )     22,072       208,837  

MINORITY INTEREST IN INCOME (LOSS) OF CONSOLIDATED SUBSIDIARIES

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

EQUITY IN NET INCOME (LOSS) OF AFFILIATED COMPANIES

     755       (1,288 )     252       2,384  
    


 


 


 


NET INCOME (LOSS)

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


 


 


 


 

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Comparison of Fiscal 2004 with Fiscal 2003

 

Net Revenues

 

Net revenues increased ¥19,755 million, or 7.8%, to ¥273,412 million in fiscal 2004 from ¥253,657 million in fiscal 2003 due primarily to increases in the sales of each segment, especially robust sales of the Yu-Gi-Oh! card games in Europe and North America that recorded sales of ¥49.5 billion, continuous popularity of soccer game titles and the Yu-Gi-Oh! game titles that recorded worldwide sales of 4.6 million and 5.0 million copies, respectively, in the Computer & Video Games segment, and solid sales of our main casino gaming machines in North America. For additional information regarding the increases 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 ¥4,303 million, or 2.5%, to ¥179,182 million in fiscal 2004 from ¥174,879 million in fiscal 2003 due primarily to increased aggregate unit sales in our Computer & Video Games, Toy & Hobby, and Gaming segments, despite a decrease in cost of revenues for our Amusement segment reflecting lower unit costs due to increased production of amusement games.

 

Impairment Charge for Goodwill and Other Intangible Assets

 

We recorded an impairment charge of ¥47,599 million for goodwill and other intangible assets in fiscal 2003, but did not record any impairment charges in fiscal 2004.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased ¥468 million, or 0.9%, to ¥53,517 million in fiscal 2004 from ¥53,049 million in fiscal 2003. The increase in expenses was due primarily to a ¥1,673 million increase in advertising expenses.

 

Operating Income (Loss)

 

As a result of the foregoing, our operating income (loss) increased ¥62,583 million to ¥40,713 million in fiscal 2004 from ¥(21,870) million in fiscal 2003. As a percentage of net revenues, operating income increased 23.5% to 14.9% in fiscal 2004 from (8.6)% in fiscal 2003.

 

Other Income (Expenses), net

 

Other expenses, net increased ¥380 million to ¥606 million in fiscal 2004 from ¥226 million in fiscal 2003 due primarily to the absence of gain recognized from sales of subsidiaries’ shares in fiscal 2004 compared to ¥904 million of such gain in fiscal 2003.

 

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

 

As a result of the foregoing, our income (loss) before income taxes, minority interest and equity in net income (loss) of affiliated companies increased ¥62,203 million to ¥40,107 million in fiscal 2004 from ¥(22,096) million in fiscal 2003.

 

Income Taxes

 

Income taxes increased by ¥11,849 million, or 191.5%, to ¥18,035 million in fiscal 2004 from ¥6,186 million in fiscal 2003. This increase in income taxes was due to an increase in the income before income taxes reflecting the recognition of an impairment charge for goodwill in 2003. As a result, the effective tax rate increased by 73.0% to 45.0% in fiscal 2004 from (28.0%) in fiscal 2003.

 

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Minority Interest in Income (Loss) of Consolidated Subsidiaries

 

Minority interest in income (loss) of consolidated subsidiaries increased ¥3,271 million to ¥2,220 million in fiscal 2004 from ¥(1,051) million in fiscal 2003 due primarily to a ¥2,632 million minority interest in the impairment charge related to goodwill and identifiable intangible assets incurred by Konami Sports Corporation in fiscal 2003, which more than offset an overall increase in income of our consolidated subsidiaries.

 

Equity in Net Income (Loss) of Affiliated Companies

 

Equity in net income (loss) of affiliated companies increased ¥1,540 million to ¥252 million in fiscal 2004 from ¥(1,288) million in fiscal 2003 due primarily to the recognition of ¥2,438 million other-than-temporary decline in the value of our investment in Hudson Soft Co., Ltd in fiscal 2003.

 

Net Income (Loss)

 

As a result of the foregoing, our net income (loss) increased ¥48,623 million to ¥20,104 million in fiscal 2004 from ¥(28,519) million in fiscal 2003.

 

Comparison of Fiscal 2003 with Fiscal 2002

 

Net Revenues

 

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

 

Cost of Revenues

 

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

 

Impairment Charge for Goodwill and Other Intangible Assets

 

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

 

Selling, General and Administrative Expenses

 

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

 

Operating Income (Loss)

 

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

 

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Other Income (Expenses), net

 

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

 

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

 

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

 

Income Taxes

 

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

 

Minority Interest in Income (Loss) of Consolidated Subsidiaries

 

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

 

Equity in Net Income (Loss) of Affiliated Companies

 

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

 

Net Income (Loss)

 

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

 

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 five reportable operating segments for which separate financial information is available and reported in our consolidated financial statements. Our chief operating decision maker regularly evaluates this data in deciding how to allocate resources and in assessing performance. The operating segments are managed separately as each segment represents a strategic business unit that offers different products and serves different markets. As required by SFAS No. 131, we present our business segment information in the accompanying consolidated financial statements as it is presented in reports to our management, derived from our U.S. GAAP financial statements.

 

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Effective the second quarter ended September 30, 2003, we combined the results of our other segment with our corporate and eliminations. In accordance with this change, results for the years ended March 31, 2002 and 2003 have been reclassified to conform to the presentation for the year ended March 31, 2004.

 

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

 

The following tables present net revenues, both including and excluding intersegment revenues, operating expenses and operating income (loss) for fiscal 2002, 2003 and 2004, by segment, which are the primary measures used by our chief operating decision makers to measure our operating results and to measure segment profitability and performance. The year-to-year comparisons following the tables discuss comparisons of net revenues, including intersegment revenues, operating expenses and operating income (loss) for each year.

 

Year Ended

March 31, 2002


   Computer
& Video
Games


   Toy &
Hobby


   Amusement

   Gaming

    Health
& Fitness


   

Other,
Corporate

and

Eliminations


    Consolidated

 
     (Millions of Yen)  

Net revenue:

                                                     

Customers

   ¥ 88,762    ¥ 25,213    ¥ 36,649    ¥ 3,063     ¥ 65,619     ¥ 6,274     ¥ 225,580  

Intersegment

     1,367      388      1,269      —         31       (3,055 )     —    
    

  

  

  


 


 


 


Total

     90,129      25,601      37,918      3,063       65,650       3,219       225,580  

Operating expenses

     71,777      18,400      29,318      5,789       70,273       11,936       207,493  
    

  

  

  


 


 


 


Operating income (loss)

   ¥ 18,352    ¥ 7,201    ¥ 8,600    ¥ (2,726 )   ¥ (4,623 )   ¥ (8,717 )   ¥ 18,087  
    

  

  

  


 


 


 


Year Ended

March 31, 2003


   Computer
& Video
Games


   Toy &
Hobby


   Amusement

   Gaming

    Health
& Fitness


   

Other,
Corporate

and

Eliminations


    Consolidated

 
     (Millions of Yen)  

Net revenue:

                                                     

Customers

   ¥ 85,891    ¥ 45,887    ¥ 33,105    ¥ 8,215     ¥ 78,437     ¥ 2,122     ¥ 253,657  

Intersegment

     1,585      61      1,200      —         88       (2,934 )     —    
    

  

  

  


 


 


 


Total

     87,476      45,948      34,305      8,215       78,525       (812 )     253,657  

Operating expenses

     73,489      29,319      27,035      8,384       127,937       9,363       275,527  
    

  

  

  


 


 


 


Operating income (loss)

   ¥ 13,987    ¥ 16,629    ¥ 7,270    ¥ (169 )   ¥ (49,412 )   ¥ (10,175 )   ¥ (21,870 )
    

  

  

  


 


 


 


Year Ended

March 31, 2004


   Computer
& Video
Games


   Toy &
Hobby


   Amusement

   Gaming

    Health
& Fitness


   

Other,
Corporate

and

Eliminations


    Consolidated

 
     (Millions of Yen)  

Net revenue:

                                                     

Customers

   ¥ 90,105    ¥ 57,335    ¥ 34,547    ¥ 10,947     ¥ 78,875     ¥ 1,603     ¥ 273,412  

Intersegment

     2,415      133      880      —         24       (3,452 )     —    
    

  

  

  


 


 


 


Total

     92,520      57,468      35,427      10,947       78,899       (1,849 )     273,412  

Operating expenses

     76,436      37,889      23,630      10,255       76,127       8,362       232,699  
    

  

  

  


 


 


 


Operating income (loss)

   ¥ 16,084    ¥ 19,579    ¥ 11,797    ¥ 692     ¥ 2,772     ¥ (10,211 )   ¥ 40,713  
    

  

  

  


 


 


 


 

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Year Ended

March 31, 2004


   Computer
& Video
Games


   Toy &
Hobby


   Amusement

   Gaming

   Health
& Fitness


  

Other,
Corporate

and

Eliminations


    Consolidated

     (Thousands of U.S. Dollars)

Net revenue:

                                                 

Customers

   $ 852,540    $ 542,483    $ 326,871    $ 103,577    $ 746,286    $ 15,167     $ 2,586,924

Intersegment

     22,850      1,259      8,326      —        227      (32,662 )     —  
    

  

  

  

  

  


 

Total

     875,390      543,742      335,197      103,577      746,513      (17,495 )     2,586,924

Operating expenses

     723,209      358,493      223,578      97,029      720,286      79,118       2,201,713
    

  

  

  

  

  


 

Operating income (loss)

   $ 152,181    $ 185,249    $ 111,619    $ 6,548    $ 26,227    $ (96,613 )   $ 385,211
    

  

  

  

  

  


 

 

Comparison of Fiscal 2004 with Fiscal 2003

 

Computer & Video Games

 

Net revenues of our Computer & Video Games segment, including intersegment revenues, increased ¥5,044 million, or 5.8%, to ¥92,520 million in fiscal 2004 from ¥87,476 million in fiscal 2003 due primarily to an increase in sales of soccer titles in Japan and Europe and favorable sales of the Yu-Gi-Oh! series overseas. Soccer titles, including WORLD SOCCER WINNING ELEVEN 7 and WORLD SOCCER WINNING ELEVEN 7 INTERNATIONAL for PlayStation 2 in Japan and Pro Evolution Soccer 3 for PlayStation 2 in Europe, recorded 4.6 million sales copies worldwide, including Asia and North America. Also the Yu-Gi-Oh! titles, including Yu-Gi-Oh! The Sacred Cards for Game Boy Advance and The Falsebound Kingdom for Game Cube, recorded total sales of 2.45 million copies in North America. In Europe, the Yu-Gi-Oh! titles, including Yu-Gi-Oh! The Sacred Cards and Yu-Gi-Oh! Worldwide Edition Stairway to the Destined Duel, recorded total sales of 2.24 million copies. Worldwide sales of the Yu-Gi-Oh! titles, including Japan and Asia, amounted to 5.01 million copies. In addition, TEENAGE MUTANT NINJA TURTLES gained popularity as a result of synergy with broadcast of television cartoons mainly in the United States and the title for PlayStation 2, Game Cube, Xbox, Game Boy Advance and PC recorded total sales of 1.48 million copies worldwide. As a result, we recorded an increase in sales to 24.7 million copies in fiscal 2004, including 21.6 million copies of our titles and 3.1 million copies of titles from other third party companies, from 23.7 million copies in fiscal 2003, including 21.0 million copies of our titles and 2.7 million copies of titles from other third party companies.

 

Operating expenses increased ¥2,947 million, or 4.0%, to ¥76,436 million in fiscal 2004 from ¥73,489 million in fiscal 2003. Such increase includes a ¥1,893 million increase in cost of revenues and a ¥1,056 million increase in selling, general and administrative costs including advertising costs relating to the Yu-Gi-Oh! titles.

 

Operating income increased ¥2,097 million, or 15.0%, to ¥16,084 million in fiscal 2004 from ¥13,987 million in fiscal 2003, reflecting the fact that both revenues and costs increased.

 

Toy & Hobby

 

Net revenues of our Toy & Hobby segment, including intersegment revenues, increased ¥11,520 million, or 25.1%, to ¥57,468 million in fiscal 2004 from ¥45,948 million in fiscal 2003. This increase was due primarily to an increase in sales of the Yu-Gi-Oh! trading card games in Europe to ¥14,000 million from ¥500 million in the previous year. We commenced sales of the Yu-Gi-Oh! trading card game in the U.K. in December 2002, in France in March 2003 and in Germany, Italy and other European countries during fiscal 2004. Sales of the Yu-Gi-Oh! trading card game in Europe increased substantially from the beginning of fiscal 2004 until the Christmas season, reflecting the popularity of the Yu-Gi-Oh! cartoon broadcasted on television and the Yu-Gi-Oh! game software. We also recorded approximately ¥26,000 million and ¥9,500 million sales of the Yu-Gi-Oh! card game in North America and in Asia including Japan, respectively. As a result, worldwide sales of the Yu-Gi-Oh! card

 

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game increased to ¥49,500 million in fiscal 2004 from ¥38,000 million in fiscal 2003. We also recorded solid sales of The Gransazers series, toys using characters appearing in the popular science fiction action hero television program, The Gransazers.

 

Operating expenses increased ¥8,570 million, or 29.2%, to ¥37,889 million in fiscal 2004 from ¥29,319 million in fiscal 2003. The increase consists primarily of an increase in cost of revenues of ¥6,215 million due mainly to an increase in cost of revenues for the Yu-Gi-Oh! card games and an increase in selling, general and administrative costs due mainly to an increase in advertising costs in North America and Europe.

 

Operating income increased ¥2,950 million, or 17.7%, to ¥19,579 million in fiscal 2004 from ¥16,629 million in fiscal 2003, reflecting the fact that revenues increased more than costs.

 

Amusement

 

Net revenues of our Amusement segment, including intersegment revenues, increased ¥1,122 million, or 3.3%, to ¥35,427 million in fiscal 2004 from ¥34,305 million in fiscal 2003. This increase was due primarily to the increase in sales of token-operated games to ¥11,000 million in fiscal 2004 from ¥7,400 million in fiscal 2003, resulting from the introduction of our new large-sized token-operated machines in a timely manner that are suitable for large-scale amusement arcades that attract customers. Sales of token-operated games include GI-WINNING SIRE and GI-TURFWILD, which have a realistic “right there in the midst of it” feel, and Fantasic Fever and FORTUNE ORB, large-sized “penny-falls”, game machines popular for their entertaining stage effects. Also, sales of video game products recorded ¥18,400 million in fiscal 2004 due primarily to the favorable market acceptance of e-AMUSEMENT products for amusement arcades such as the MAH-JONG FIGHT CLUB series and the expansion of the line-up of music simulation games such as pop’n music, GUITARFREAKS and drummania and gun shooting games such as the WARTRAN TROOPERS. On the other hand, sales of pachinko LCD units decreased to ¥6,000 million in fiscal 2004 from ¥7,200 million in fiscal 2003, resulting from our inability to introduce new products meeting rapidly changing market needs in a timely manner.

 

Operating expenses decreased ¥3,405 million, or 12.6%, to ¥23,630 million in fiscal 2004 from ¥27,035 million in fiscal 2003, reflecting a decrease in the rate of cost for amusement arcade games to 52.8% in fiscal 2004 from 63.6% in fiscal 2003, reflecting an increase in production which lowered unit costs.

 

Operating income increased ¥4,527 million, or 62.3%, to ¥11,797 million in fiscal 2004 from ¥7,270 million in fiscal 2003, reflecting increased net revenue and lower operating expenses.

 

Gaming

 

Net revenues of our Gaming segment increased ¥2,732 million, or 33.3%, to ¥10,947 million in fiscal 2004 from ¥8,215 million in fiscal 2003. This increase was due primarily to an increase in revenues from sales of casino gaming machines by our U.S. subsidiary, Konami Gaming, Inc. with robust sales of our main products, Mariachi Madness and Solstice Gold. Although sales of casino gaming machines through our Australian subsidiary, Konami Australia Pty Ltd. decreased slightly in fiscal 2004, sales were maintained with our main product Egyptagon, while the Australian market has been leveling off.

 

Operating expenses increased ¥1,871 million, or 22.3%, to ¥10,255 million in fiscal 2004 from ¥8,384 million in fiscal 2003 due primarily to increased sales of gaming machines.

 

Operating income was ¥692 million in fiscal 2004, an increase of ¥861 million from operating loss of ¥169 million in fiscal 2003, as the increase in net revenues outpaced the increase in operating expenses.

 

Health & Fitness

 

Net revenues of our Health & Fitness segment, including intersegment revenues, increased ¥374 million, or 0.5%, to ¥78,899 million in fiscal 2004 from ¥78,525 million in fiscal 2003. This increase was due primarily to the increase in the amount of revenues earned per member due to improvements in the quality of our services and our offering of a wide range of health-related value-added services.

 

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Operating expenses decreased ¥51,810 million, or 40.5%, to ¥76,127 million in fiscal 2004 from ¥127,937 million in fiscal 2003 due primarily to a charge taken in connection with the impairment of goodwill and other intangible assets relating to this segment of ¥47,599 million in fiscal 2003 and a decrease in the amortization of membership lists to ¥339 million in fiscal 2004 from ¥2,533 million in fiscal 2003.

 

Operating income was ¥2,772 million in fiscal 2004, an increase of ¥52,184 million from operating loss of ¥49,412 million in fiscal 2003.

 

Comparison of Fiscal 2003 with Fiscal 2002

 

Computer & Video Games

 

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

 

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

 

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

 

Toy & Hobby

 

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

 

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

 

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

 

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Amusement

 

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

 

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

 

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

 

Gaming

 

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

 

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

 

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

 

Health & Fitness

 

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

 

Operating expenses increased ¥57,664 million, or 82.1%, to ¥127,937 million in fiscal 2003 from ¥70,273 million in fiscal 2002 due primarily to a charge taken in connection with the impairment of goodwill and other intangible assets relating to this segment of ¥47,599 million, the inclusion of a full year of operating expenses incurred by Konami Olympic Sports Club Corporation and costs of opening 16 new sports clubs.

 

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

 

Critical Accounting Policies

 

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

 

Acquisitions

 

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

 

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

 

Valuation of Intangible Assets and Goodwill

 

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

 

    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

 

    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.

 

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

 

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

 

In the fourth quarter of fiscal 2003, however, using the same methodologies and again considering the independent appraiser’s findings, we determined that the fair value of our Health & Fitness segment was lower than the carrying value. As a result of the subsequent reassessment of fair values of goodwill and other intangible assets which were allocated to the segment, an aggregate non-cash impairment charge of ¥47,599 million was recognized for these intangible assets as a component of operating loss for fiscal 2003. The impairment charge consisted of ¥36,717 million for goodwill and ¥10,882 million for trademarks. These impairment losses were attributed to the segment’s failure to meet previous growth expectations as a result of a significant slow-down in the growth rate of the industry in which it operated as well as negative trends in general economic conditions in Japan that accelerated in the later half of fiscal 2003.

 

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

 

Software Development

 

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

 

Revenue Recognition

 

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

 

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

 

Delivery Has Occurred.

 

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

 

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

 

The Price is Fixed or Determinable.

 

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

 

Collection is Probable.

 

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

 

Accounting Developments

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The Statement also includes required disclosure for financial instruments within its scope. For Konami, the Statement was effective for instruments entered into or modified after May 31, 2003 and otherwise will be effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For certain mandatorily redeemable financial instruments, the Statement will be effective for Konami on January 1, 2005. The effective date has been

 

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deferred indefinitely for certain other types of mandatorily redeemable financial instruments. Konami does not expect the adoption of this statement will have a material effect on its consolidated financial statements.

 

Capital Expenditures

 

Our capital expenditures amounted to ¥20,681 million, ¥17,919 million and ¥11,562 million on an accrual basis during fiscal 2002, 2003 and 2004, respectively. During fiscal 2002, our capital expenditures consisted mainly of purchases and leases of computer and other product development equipment in the amount of ¥9,615 million. During fiscal 2003, our capital expenditures consisted mainly of the acquisition of Konami Super Campus for ¥3,010 million and funds for the opening and repair of sports clubs in the amount of ¥4,638 million. During fiscal 2004, our capital expenditures consisted mainly of funds for the opening and repair of sports clubs in the amount of ¥2,073 million and the development of in-house software in the amount of ¥1,239 million. We expect our capital expenditures for fiscal 2005 to be approximately ¥15,000 million on an accrual basis, which will relate to purchases and leases of computers, other product development equipment and the opening and repair of sports clubs.

 

B.    Liquidity and Capital Resources

 

Our principal needs for cash are: fees for manufacturing and royalty payments to video game hardware manufacturers who produce our game software; payments to content licensors; purchase of parts and raw materials; selling, general and administrative expenses such as research and development expenses; payments for the acquisition of companies targeted under our acquisitions strategy; employees’ salaries, wages and other payroll costs; lease payments for sports 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 2005 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).

 

Cash Flows

 

The following table sets forth certain information about our cash flows during fiscal 2002, 2003 and 2004:

 

     Fiscal year ended March 31,

 
     2002

    2003

    2004

    2004

 
     (millions of yen and thousands of dollars)  

Net cash provided by operating activities

   ¥ 11,119     ¥ 27,711     ¥ 34,326     $ 324,780  

Net cash used in investing activities

     (16,024 )     (12,242 )     (7,001 )     (66,241 )

Net cash provided by financing activities

     12,613       (16,443 )     (14,141 )     (133,797 )
    


 


 


 


       7,708       (974 )     13,184       124,742  

Effect of exchange rate changes on cash and cash equivalents

     667       466       (979 )     (9,263 )