Business and Other Risks

Listed below are the principal risks among the matters described in the Annual 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 (the "Group") management as of the end of the consolidated fiscal year ended March 2021.

(1) Revenue-related Risk

Leopalace21 (the "Company") 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.
The Group posts 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 the Group revenues and adversely affect the Group'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 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. Impairment losses have been recorded in the fiscal year ended March 2021 for the tangible non-current assets related to international business based on the recoverable value. 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, the Company 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 and occupancy rate forecasts calculated for each apartment building. Should any of these figures deteriorate against the estimated values it could lead to an increased amount of the reserve, and this could adversely affect the results of the Company's Leasing Business.
To cope with this risk, the Company will supply apartment buildings in the areas where high occupancy rates are expected in the future; aim for stable occupancy rates through offering web-based contract conclusion service and convenience of smart apartment by utilizing IT; and work to maximize the rent income through proper review of master lease rent payable to the property owners.

(5) Leasehold Deposits and Guarantee Deposits

The Company 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. The Company 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 the Company's financial position and cash flows.
The Company also has deposits for Leopalace Resort memberships related to the resort business, most of them have been deposited since 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 the Company's financial position and cash flows.

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

It came to light that there were construction defects such as parting walls and others in our construction buildings as announced in May 2018, February and May 2019, following the announcement in April 2018 about the parting wall defects in attics. The Company took it seriously because it should not have been involved in those defects as a builder for apartments, and has been making every effort to prevent the recurrence of such a problem.
In connection with this problem, 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) Significant Events

The group recorded operating losses for the fiscal year ended March 2020 due to construction defects in the parting walls which were discovered in the apartment buildings that the Company constructed and suffered for the second consecutive year from a net loss attributable to owners of the parent and a negative cash flows from operating activities.
The Company was back on a track to business recovery due to the progress of repair works and resumption of tenant recruitment for the fiscal year ended March 2021. However, the Company saw an operating loss of JPY 29,182 million, net loss attributable to shareholders of the parent of JPY 23,680 million, and negative cash flows from operating activities of JPY 40,816 million, owning to stagnant occupancy rate resulting from a reduced number of relocations by the corporate customers, a core customer segment for the Leasing Business due to the spread of COVID-19 pandemic. As a result, there are events or circumstances that raise significant doubts about the Company's going concern assumptions.
The Company, as a countermeasure, raised total funds of JPY 57,215 million on November 2, 2020 by issuance of new shares through third-party allotment, by a loan with share subscription rights, and by issuance of preferred stock by Leopalace Power Corporation, a consolidated subsidiary.
The Company have been reviewing all the cost items and implemented the cost-cutting measures such as transferring or withdrawing from non-core unprofitable business including sale of owned real estate and investment securities and transfer or dissolution of subsidiaries; offering the voluntary early retirement and decreasing directors' remuneration; reviewing the personnel expenses structure through revised HR management system; controlling the cost of operation and administration of the Leasing Business and decreasing the fixed cost through leasing offices integration; reducing the advertisement and sales promotion expenses; and abolishing the shareholder benefit program, based on the announcement "Notice Concerning Implementing Structural Reforms based on Strategic Review Results for Drastic Business Strategies Reconstruction" dated June 5, 2020.
The Company will increase the occupancy rate and stabilize the business through continuing the afore-mentioned measures; promoting web-based service offering for customer service, room viewing and rental contract; strengthening ties with real-estate agents; implementing area focused sales strategies backed by quicker decision making process with increased authority over revenue and profit. The Company will also realize business recovery and improve financial conditions through properly renewing the master-lease rent, reducing the administration cost, and adjusting the pace of repair works for stabilized financial position.
As to the liquidity of the funds, the balance of cash and cash equivalents were JPY 54,863 million which is deemed sufficient to the business continuation for the time being.
The important assumptions of profitability estimate are the number of leasing agreement, the number of occupied rooms, the amount from rent income, successful renewal of master-lease rent and decrease of administration cost. Despite a certain level of uncertainty related to these assumptions, the Company believes that there are no significant uncertainties regarding the going concern assumptions.

(8) Risk of COVID-19 Pandemic

The Group has been working to maintain critical operations and minimize the impact on our business by establishing the COVID-19 Emergency Response Headquarters to formulate a Group-wide response policy. Specifically, in addition to suspending regular visits and interviews with apartment owners and visits to companies in principle, the Group 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 COVID-19 both inside and outside the Company.
The Company anticipates that the impact of COVID-19 pandemic will extend to the entire business of the Group, and in particular the core Leasing Business will continue to suffer from reduced number of relocations and hiring by the corporate customers, the main customer segment, and stagnant demand resulting from prevailed online lectures at the universities and strict immigration control for foreign nationals.
Whilst the Group estimates that the COVID-19 start to diminish its impact on the business in the second half of the fiscal year ending March 2022, the Group will have its impact throughout the said fiscal year and therefore, the recoverability of deferred tax assets for the current fiscal year is measured based on these assumptions. earnings forecast and tax planning used at the end of the previous fiscal year continue to affect the business.
In case it takes longer time for COVID-19 to be made under control and the economic suffering continues accordingly, it could have an impact on the Group's financial position, results of operations, and cash flows.

(9) Information Leaks

The 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 Group has drawn up the required information security guidelines, and set up a Compliance Committee to thoroughly train the 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.

(10) Other Risks

The Group is aware that it incurs a variety of risks in the course of operating its businesses, and it attempts to prevent, disperse or avoid such risks whenever possible. Nevertheless, the Group's financial position, business performance, 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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