Business and Other Risks

Listed below are the principal risks among the matters described in the securities report (only available in Japanese language) that the management recognize may have a significant impact on the financial position, operating results and cash flows of the consolidated companies. All forward-looking statements included herein reflect the judgment of the Leopalace21 Group management as of the end of the consolidated fiscal term under review.

(1) Revenue-related Risk

Leopalace21 apartments are primarily utilized by single persons, and corporate contracts typically involve short-term leases of apartments for use as temporary accommodation for business trips or as company dormitories. As a result, changes in the performance of the overall economy and corporate business results could affect employment trends or the demand for business trips, and this could impact on the use of apartment rooms. The risk came to surface by the outbreak of the novel coronavirus and adversely affect the Company's leasing business in a declined occupancy demand which is normally pushed by the seasonal new hiring and relocations.
We post order receipt at the time of concluding contracts for apartment building construction, and therefore the availability of financial institutions' loans for the clients are important risk factors. Changes in the willingness of financial institutions to provide credit, changes in the assessed value of real estate to be used as collateral, and fluctuations in interest rates could affect Company revenues and adversely affect the Company's business results.

(2) Cost of Sales

The Company concludes a master lease agreement with apartment owners to lease back the constructed apartment for a period of time and at a rent level that are both fixed at the time the contract is concluded. Therefore, fluctuations in the amount of rental income received from tenants during the contract period could adversely affect the Company's profitability.

(3) Risks Associated with Tangible Non-current Assets and Marketable Securities

Impairment losses or appraisal losses due to declines in the current market value of tangible non-current assets, marketable securities, or other assets could adversely affect the Company's business performance as well as its financial position.
Impairment losses have been recorded in the fiscal year ended March 31, 2020 for the tangible non-current assets related to Guam's resort business and international business based on the appraisal to net realizable values, for which the Company has a policy of withdrawal. However, depending on future developments in the real estate market and other factors, additional losses may be recorded, which may have an impact on the Group's results of operations.

(4) Reserve for Apartment Vacancy Loss

In order to prepare for a risk of losses due to an increase in apartment vacancies, Leopalace21 has established a "Reserve for apartment vacancy loss" which equals to the amount of loss that may be expected during a reasonably estimable period. The amount of this reserve is based on the rent levels set for individual leased units, the number of households, and occupancy rate forecasts calculated for each apartment building. Should any of these figures fall below the estimated values it could lead to an increase the amount of the reserve, and this could adversely affect the results of the Company's leasing business.
To cope with this risk, we will supply apartment buildings in the areas where high occupancy rates are expected in the future, as well as aiming for stable occupancy rates through product development tailored for foreign national tenants and senior citizens, and work to maximize the rent income by utilizing IT such as setting the rent based on a dynamic pricing model.

(5) Leasehold Deposits and Guarantee Deposits

Leopalace21 has long-term deposits from property owners held as an advance for apartment repair and renovation. These consist mainly of deposits received from property owners as a portion of future repair and renovation expenses, following the dissolution of Leopalace21 Owners Mutual Insurance Association. Leopalace21 makes a concerted effort as a leasing business operator to ensure the soundness of the apartment maintenance for the properties fully leased from the owners for management. However, an unexpected, large-scale repair or renovation could have an impact on Leopalace21's financial position and cash flows.
Leopalace21 also has deposits for Leopalace Resort memberships related to the Resort Business, most of which date to the opening of the resort complex in July 1993. Should there be an unexpected number of requests for reimbursement of these deposits, this could have an impact on Leopalace21's financial position and cash flows.

(6) Impact of Defects on Apartment Buildings which Leopalace21 Constructed

As announced on April 27, 2018, May 29, 2018, February 7, 2019 and May 29, 2019, it was discovered that there were construction defects such as parting walls in our construction buildings. We took it seriously because Leopalace21 should not have been involved in those defects as a builder for apartments, and we are making every effort to prevent the recurrence of such a problem.
In connection with this problem, loss related to repairs for the defects and related expenses, stagnant occupancy rate because of delayed repairs, and reduction in orders for building construction contracts due to damaged credibility could have an impact on the Group's consolidated results of operations.

(7) Financial covenants

Financial covenants have been set on the numerous agreements for loans and bonds which Leopalace21 concluded with financial institutions. Accordingly, should consolidated net assets, consolidated or non-consolidated operating and recurring profit, or debt-service coverage ratio (DSCR) of the solar power generation business violate the conditions of financial covenants, there is a possibility that the Company, at the behest of the financial institutions, could forfeit the benefit of the term for corporate bonds or other borrowings, which could have an impact on the Company's operating performance.

(8) Significant Events

Our group recorded operating losses the fiscal year ended March 31, 2020 due to construction defects in the parting walls which were discovered in the apartment buildings that Leopalace21 constructed and suffered for the second consecutive year from a net loss attributable to owners of the parent and a negative operating cash flow.
There is a violation of financial covenants with respect to Leopalace Power Corporation, a subsidiary of the Company and its loan agreement with a financial institution for which the Company acts as a guarantor. As a result, there are events or circumstances that raise significant doubts about the Company's going concern assumptions.
The Company has been concentrating its management resources on the repair works and accelerate with organizational efforts so that it can resume the tenant recruitment as soon as possible.
The recovery of business performance is indispensable for stably implementing the repair works. Therefore we determined to reallocate manpower and physical resources including to offer an early retirement program for the target of 1,000 applicants following the announcement of "Notice Concerning Implementing Structural Reforms based on Strategic Review Results for Drastic Business Strategies Reconstruction" dated June 5, 2020 and temporarily downsize the scale and organizational setup for the repair works in July 2020 so that we should prioritize to improve the business performance and restore financial conditions.

With regard to funding, while maintaining a sound financial balance, the Company endeavors to secure stable funds necessary for its business activities by the sale of marketable securities and non-current assets and maintain liquidity, thereby securing sufficient funds to meet anticipated demand based on its funding plans.
As a specific matter, at the Board of Directors' meeting held on June 26, 2020, the Company resolved to sell its investment securities for a listed company and began selling in July 2020.
In addition, we determined to reduce the remunerations for directors and executive officers and reduce the number of their positions.
As to the conflict with the financial covenant, the financial institution confirmed that they will not exercise the right of forfeiture of the benefit of time. As a result of the above, the Company believes that there are no significant uncertainties regarding the going concern assumptions.

(9) Risk of Novel Coronavirus Epidemic

We are working to maintain critical operations and minimize the impact on our business by establishing a Novel Coronavirus Emergency Response Headquarters in our group to formulate a company-wide response policy. Specifically, in addition to suspending regular visits and interviews with apartment owners and visits to companies in principle, we put top priority on the health and safety of customers and employees through staggered office hours, shift-based work, and the use of telework. In line with the policies of the central and local governments, and other relevant organizations, we strive to prevent the spread of infectious disease both inside and outside the Company.
We anticipate that the impact of the novel coronavirus epidemic will extend to the entire business of our group, and in particular the rental agreements in the core leasing business are assumed to lack buoyancy until June 2020, and the estimates are made based on these assumptions.
When it takes time to settle the epidemic and its impact on economic activities is prolonged, our group's performance, financial position and cash flows may be affected. However, it is difficult to reasonably estimate the financial impact as of July 22, 2020, when we filed the annual securities report.

(10) Information Leaks

The Leopalace21 Group holds a great deal of information, including personal information obtained through the consent of, or as a result of non-disclosure agreements with client companies. To control information security, the Company has drawn up the required information security guidelines, and set up a Compliance Committee to thoroughly train our executives and employees about information security issues. Nevertheless, in the unlikely event that a leak of information of some type should occur, there is a possibility that the Group's reputation could be damaged, and that business performance might be affected.

(11) Other Risks

The Group is aware that it incurs a variety of risks in the course of promoting its businesses, and it attempts to prevent, disperse or avoid such risks whenever possible. Nevertheless, the Group's business performance and financial position and cash flows may be affected by the changes in economic conditions, real estate market conditions, financial and stock markets, legal regulations, natural disasters, and a variety of other factors.

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