Operational Risks

Risks that could affect the performance or operations of SEGA SAMMY Group are given below.

Although the Group has identified significant, dormant risks within and beyond management, and is endeavoring to mitigate them, these risks are not a comprehensive list of the operational risks faced by the Group. However, based on an awareness of the following risks, the Group implements measures to prevent the occurrence of incidents arising from those risks and respond to such incidents in the event of their occurrence. In addition, forward-looking statements in the following text are the judgments of the Group as of June 26, 2017.

1. Statutory Regulations and Reliance on the Pachislot and Pachinko Machine Business

Among mainstay businesses, the Pachislot and Pachinko Machine Business segment accounts for the majority of the Group’s net sales and operating income. Securing stable revenues from this segment is an important management task going forward. The products the Group sells must conform to technical specifications pursuant to the Public Safety Commission’s “regulations for the verification of licenses, formats, and other aspects of pachislot and pachinko machines”, which are based on the Entertainment Establishments Control Law of Japan and related laws and statutory regulations.

Also, in July 2004, revisions were enacted to regulations pertaining to the Entertainment Establishments Control Law that mainly curbed gambling elements and sought to prevent the improper modification of pachislot and pachinko machines. In the Group, the Ethics Committee regulates expressions that could encourage excessive gambling or invite misunderstanding. In addition, the Group has established an office tasked with preventing improper manipulation of machines for profit, which continually collects market information with a view to building machines that are resistant to improper manipulation.

In addition, based on the Agreement for the Handling of Pachislot and Pachinko Machines with High Payout Volatility which was released by industry groups for the purpose of further restoration of a sound pachislot and pachinko machine industry

2.Changes in Market Conditions

① Pachislot and Pachinko Machine Business

Due to factors such as the decrease in number of players and adapting to various voluntary regulations set by industry groups, the Pachislot and Pachinko Machine Business segment is likely to continue facing challenging business conditions. Furthermore, amid intensifying competition among pachinko halls to attract customers, purchasing of new-model machines by pachinko hall operators is increasingly focusing on some pachislot and pachinko machines for series with good track records.

In response to this change in market conditions, the Group is concentrating efforts on developing a product lineup that features new types of gameplay and meets the needs of a wide range of players while making efforts to improve profitability through further strengthening of cost improvements attributed to reuse of parts and such, and reduction of development expenses, etc. However, progress in the development of new-model machines, the outcomes of format examinations, the Group’s ability to acquire official licenses, future progress in discussions concerning measures against gambling and other addictions, product malfunctions, and changes in user preferences could significantly affect the Group’s business results.

② Entertainment Contents Business

With regard to the field of digital game software, which is positioned as a growth business in the Entertainment Contents Business, the predominance of leading publishers is continuing. SEGA SAMMY Group aims to maximize profits by building appropriate business structures that adapt to changes in environment, speeding up managerial decision making and responding to diversifying client needs while focusing managerial resources on investment in the continuously growing smartphone contents business.

However, the Group’s business results might be affected by factors such as statutory laws and regulations beyond the Group’s control, a trend of longer development lead times and higher operating costs due to higher-quality content being expected as the markets mature, and valuation losses being recognized for assets related to game titles as some titles fail to gain initially expected positive feedback.

With regard to the packaged game field, expectations are rising for future expansion of the market due to the penetration of next-generation hardware in addition to current generation hardware of home video game console. In Europe, the U.S., and Asia, large markets have been developed for PC games. The Group is making effort to launch titles of highly popular series centering on mainstay IP titles, etc.

Changes in consumer spending trends, market trends, or player needs in the Amusement Machine Sales field could lead amusement center operators to curb capital investment, which could affect the Group’s business results. Mindful of the need to cater to such market changes through development that reflects player needs, in recent years the Group has been concentrating on the development of products that exploit networks to offer new types of gameplay. In addition, the Group intends to focus efforts on revitalizing the overall amusement center industry by continuing to offer a revenue-sharing business model that enhances investment efficiency for amusement center operators while providing the Group with long-term, stable revenues.

The Amusement Center Operations field will continue strengthening the operational management capabilities of its amusement centers to further improve revenues. However, because this business segment is susceptible to trends in consumer spending, its ability to introduce amusement arcade machines that meet diverse player needs could affect the Group’s business results. Furthermore, the Amusement Center Operations field segment is subject to regulation based on the Entertainment Establishments Control Law and other related statutory laws and regulations, including cabinet orders and ministerial ordinances. The Group complies with this law and related statutory laws and regulations. However, the enactment of new laws or revisions to this law and related statutory laws and regulations could affect the Group’s business results.

③ Resort Business

In the Resort Business which is positioned as the growth business, the Group is making progress in accumulating expertise through methods such as developing and operating resort facilities in Japan as well as developing and operating integrated resorts facilities overseas and accelerating prior investment for realizing integrated resorts business in Japan. However, the SEGA SAMMY Group’s business results might still be affected by factors such as statutory laws and regulations beyond the Group’s control, changes in the market environment, natural disasters or political risks, etc. as well as taking extended periods of time to launch the business in full-scale due to the future progress in promotion of the establishment of specified integrated resort areas and such.

④ Foreign currency exchange rate fluctuation and other factors

The Group conducts sales activities, parts procurement and other operations in overseas markets including North America, Europe and Asia. As a result, the fluctuation in foreign currency exchange rates could affect the Group’s overall business results. In addition, the Group could be affected by deterioration in the international geopolitical situation related to such factors as overseas wars, conflicts, and terrorist incidents. Further, as the fluctuation in foreign currency exchange rates causes the fluctuation in net assets of the Group’s overseas subsidiaries and affiliates through foreign currency translation adjustment, it might affect the Group’s financial position.
The future consumption tax hike may also affect the Group’s business results as it could harm consumer spending.

3.Sales Opportunity Loss

Due to the short production lead time of pachislot and pachinko machines, the Group produces machines in response to order trends. Because the life cycles of products are short and marketing periods are very short, product shipments are concentrated in the initial stage of product launches. Although the Group is taking measures such as standardizing parts, shortening lead time for parts procurement and enforcing control of inventory assets, the Group may not be able to procure a sufficient quantity of raw materials for production of large orders placed in the initial stage of product launches. On the other hand, surplus components might emerge if launch periods for products coincide with that of popular products of competing companies and the production falls below orders planned. In case such surplus components are unable to be utilized in other products, the Group may incur loss on disposal of components and other losses.
The time required for the production of amusement machines is comparatively long. Consequently, the Group produces those machines based on demand estimates. However, demand for products could change due to changes in user preferences, changes in business environment, uncertainty in growth and other factors, which might lead to an impact on the operating results of the Group.
Home video game software and toys are susceptible to seasonal factors with demand centering on such periods as Christmas and the year-end shopping season. If the Group is unable to supply new products during such selling periods, surplus inventory could result and the Group may incur loss on disposal of obsolete inventories and other losses.

4.Entry into Overseas Markets

The Group conducts operations in overseas markets, including markets in North America, Europe, and Asia, including China. The Group plans to increase sales in overseas markets centered on the Amusement Machine Sales Business, Amusement Center Operations, and the Consumer Business segments. As a result, fluctuation in foreign currency exchange rates could affect the Group’s performance or operations. Further, the Group could be affected by deterioration in the international geopolitical situation related to such factors as overseas wars, conflicts, and terrorist incidents.

5.Adoption of Asset-Impairment Accounting

The Company adopted asset-impairment accounting. Depending on shifts in business conditions and future cash flows, the Company may be unable to recoup the value of certain investments and would be required to record a loss. If such a case were to occur, it could have a material adverse effect on the Company’s operating results.

6.Investment Securities

The Group holds investment securities for such purposes as building business relationships and earning an investment return. In FY 2010, due to write-downs of securities, a substantial loss on revaluation of investment securities was recorded. The valuation of investment securities is made in accordance with such factors as stock market trends and the financial positions and results of operations of the issuers. Accordingly, in the future, in the event that impairment processing is implemented due to declines in market prices or declines in effective prices, the Company’s operating results could be affected by the recording of a loss on reevaluation of investment securities.

7.Deferred tax assets

The Group recognizes deferred tax assets after careful consideration of the recoverability of tax loss carried forward and deductible temporary differences by reasonably estimating future taxable income. In case the estimated amount of taxable income fluctuates due to changes in future business results or tax rate being changed through tax reform, the balance of deferred tax assets will change and might impact on the Group’s business results.

8.Information Security

Almost all of the operations of the Group are supported by an information system which is advancing every year. Although the Group conducts various measures to improve its reliability and establishes systems to enable continuous business operations, system failures or malfunctions might occur due to external factors such as hacking and natural disaster, as well as human error, computer virus, etc. The Group’s business results may be affected if its operations were ceased due to these factors.

9.Management of Personal Information

The Group may obtain information regarding privacy or credit of customers, etc. (including personal information, etc.) or receive such information from other companies, etc. as part of its business activities. Although the Group place the utmost attention to confidentiality so as avoid a leak of information, there still is a possibility that such information will leak to external parties due to unforeseen circumstances. In such cases, the Group’s business results could be affected as a result of paying damage reparation and other costs, as well as the Group’s brand image being damaged.

10.Compliance

The Group is promoting enhancement of its system for legal and other compliance. However, in the case it has violated statutory regulations such as the Companies Act, which serves as the base in implementing business activities, the Financial Instruments and Exchange Law, competition laws including the Anti-Monopoly Act and the Subcontract Act, and labor laws including the Labor Standards Act, and becomes subject to any punishment by supervisory agencies or filed suits, etc., the Group’s business results could be affected as a result of the Group’s brand image being damaged.

Further, in cases of products or services provided by the Group violating the rights of third parties, malfunctions or the like arising in products manufactured and sold by the Group, or users making unexpected complaints or such, lawsuits might be filed and the Group’s business results could be affected as a result of the Group’s brand image being damaged.

11.Effect of Disasters

The Group includes crisis management rules in its company regulations, identifies its business activities’ inherent risks, and takes measures to mitigate risks and prevent crises as a matter of normal practice. In addition, the Group has established and maintains systems to respond immediately to major crises. However, the interruption of manufacturing activities or sales activities as a result of greater than anticipated physical damage or casualties among personnel at the headquarters, operating bases, or manufacturing bases of Group companies or those of the Group’s business partners due to large-scale natural disasters such as earthquakes, fires, or floods-or terrorist attacks or changes in political conditions could affect the business results of the Group.

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