Business Risks

Among the matters related to the business status and financial status, etc., described in this document, the following are the major risks that management perceives as likely to have a material impact on the financial status, operating results, and cash flow of the consolidated company. In addition, we shall disclose matters that do not necessarily fall under the category of business risks and other key factors in investors’ decisions.

The Group is aware of the potential of these risks and will strive to avoid them and to respond promptly when they do occur. We also believe that our investment decisions must be made after careful consideration of the information contained in this and other sections.

These forward-looking items are the present judgments of the Group and are not guaranteed to cover all risks that may arise in the future.

1. Risk Management System

The Management Committee is responsible for the Group’s integrated risk management, and the President is responsible for risk management. The Company's risk management system is as follows.

1. Based on the "Basic Sustainability Policy" and the "Basic Corporate Governance Policy," the Company shall establish the "Risk Management Regulations" common to the Group, position the Company's Executive Committee as the entity that oversees and promotes risk management for the entire Group, and establish and operate a risk management system.
2. The Executive Committee shall identify significant risks and opportunities from a perspective of business and cross-organizational risk management and shall decide upon policies for dealing with such risks and other important matters. It shall also report the status of its activities to the Executive Committee and the Board of Directors as appropriate.
3. From the viewpoint of the importance of internal control, the Company shall establish the Risk Management Committee, chaired by the President, as a subordinate organization of the Executive Committee for information security risks, legal risks, and reputation risks. This Committee shall promote routine risk management and establish a system to deal with crises promptly and appropriately as they occur.
   For information security, the Company shall establish and publicize the "Information Security Basic Policy" and establish an information security management system, which shall be properly maintained and continued.
4. With respect to information security, the Company shall establish and announce its "Basic Policy on Information Security," establish an information security management system, and properly maintain and continue the system.
5. In accordance with the "Risk Management Regulations," each Group company and division shall strive to identify and manage risks appropriately for each business or operation in charge and shall share information with other divisions to ensure early detection and prevention of risks.
   The Executive Committee shall periodically monitor the status of risk management at each Group company and division.
6. In the event of a major crisis, the Company shall promptly establish a task force, etc. headed by the President to deal with the crisis appropriately, including the appropriate dissemination of information internally and externally.

*For details of the risk management system and the status of the internal control system, please refer to this page.

2. Business Risks

(1) Risks related to the business

① Growth potential of the AI market

The AI market is characterized by technological innovation, expanding AI utilization in various industrial fields, and acceleration of DX (Digital Transformation) initiatives. The market growth rate is strong and is expected to continue to expand in the future. However, future market growth rates will be affected by external factors such as the introduction of new regulations and policies on AI technology, relevant market trends, and the contraction of user companies’ AI investments due to economic fluctuations. A slower market growth rate due to these effects may affect the Group’s business, financial condition, and performance.

② Technological innovation

The usefulness and importance of AI technology is now recognized globally. AI research and development is being advanced by research institutions, companies, and universities around the world. The pace of AI innovation is extremely fast, leading to further growth of the market and opportunities for business expansion by incorporating the latest technology. The Group’s business, financial condition, and performance will be affected if the Group is unable to respond to changes in the market environment due to the speed of innovation and the emergence of new business models.

③ Competitive trends

There are a large number of existing businesses in the AI market. Other businesses are expected to enter the market in the future, from large companies to specialized start-ups. The Group retains an overwhelming competitive advantage by focusing on AI services that combine proprietary technology with knowledge of various industries and operations; therefore, the growth of AI businesses does not pose an immediate competitive threat. However, the trends of other businesses with superior technological development capabilities, sales capabilities, brands, or popularity may affect our ability to acquire and maintain customers as expected by the Group.

The Group will continue to develop and provide AI services that differentiate it from other businesses, but the intensity of the competitive environment, etc. may affect the Group’s business, financial condition, and performance.

④ New businesses

The Group can provide AI services to a wide range of industries due to their product characteristics, and we will continue to expand to new services and new businesses. This may result in additional expenses, such as system investment and labor costs, which may reduce profit margins. Deviations from forecasted introductions, expansions, and the growth of new services and new businesses may affect the Group’s business, financial condition, and performance.

⑤ Business expansion through joint ventures, investments, and acquisitions

The Group hopes to expand the functionality of exaBase at an early stage. Therefore, in addition to recruiting personnel for in-house development, strengthening the technology base, and expanding complementary functions, we are exploring possibilities such as joint ventures with appropriate partners, investment and acquisition, and carefully examining projects in light of profitability, financial soundness, and our management policy.

We will conduct a detailed investigation of the performance and financial condition of potential partners when developing joint ventures. We will also endeavor to avoid risk by agreeing in advance on a business plan, the definition of mutual roles, and a governance system for the joint venture. However, differences in the management policies of both parties may be discovered after the start of the joint venture, preventing it from achieving the intended synergistic effects. This may also make it difficult to recover investment funds and may affect the Group’s performance and financial condition.

We will conduct detailed due diligence with experts regarding the financial, tax, legal, contractual relationships, and business conditions of the target company for equity investments and acquisitions. We will reduce risk as much as possible, accounting for valuations from third-party appraisal agencies. The Group’s financial condition and operating results may be affected if the business does not progress as planned due to a sudden change in the business environment or other unforeseen reasons after investment and acquisition. It is also difficult to completely eliminate the risk of discovering unexpected contingent and/or unrecognized liabilities after the investment and acquisition, which may also affect the Group’s performance and financial condition.

If goodwill is recorded in connection with an acquisition, if there is an indication of an impairment due to the deterioration of the target company’s performance, etc., and the recoverable value representing the future effects becomes lower than the book value of the goodwill, the goodwill may become impaired and affect the Group’s performance and financial condition.

When conducting an acquisition, our basic policy is to raise funds by borrowing from financial institutions, issuing corporate bonds, and equity financing. There is no guarantee that the Company will be able to raise the required funds in a timely and appropriate manner. If the Company is unable to raise the necessary funds, or is forced to raise funds under unfavorable conditions, or if the new financing creates burdens, dilutes share value, changes equity capital, and uses new borrowing, the Group’s performance and financial condition may be affected by an increase in the burden of interest expenses, depending on market interest rate fluctuations.

⑥ Seasonal performance fluctuations

Many Japanese companies set March as the end of the fiscal year. Some of the Group’s services support business transformation and/or creation for these companies, meaning that the Group’s customers often expect the Group to provide services by the end of March. This causes the Group’s sales to fluctuate in Q4 (January to March), making it difficult to judge the Group’s full-year earnings forecast based only on quarterly results.

⑦ Risk of Changes in Investment Behavior of Specific Client Companies

The Group has transactions with a large number of client companies, and half of its consolidated net sales come from 10 specific client companies.
Maintaining good business relationships with these client companies is one of the Group's strengths. However, changes in their IT investment behavior, management policies, sudden changes in the business environment, and changes in regulations and systems in specific industries can affect the Group's operating results and sales activities.

⑧ System failures

The majority of the Group’s cloud AI services rely on the Internet. Therefore, it will be impossible to provide services when the Internet is disconnected due to a natural disaster or accident. In the event of a cyber-attack on our service infrastructure, a system failure may make it difficult to conduct business and may cause important business secrets to be leaked. Temporary overloads due to sudden access increases or other unforeseen events may require suspension of the Group’s services due to server downtime. These system failures will make it impossible to provide services in a stable manner, affecting the Group’s business, financial condition, and performance.

⑨ Intellectual property rights risks

Proprietary methods, technologies, patents, and other intellectual property rights developed or licensed by the Group are important parts of our business. The Group strives to acquire intellectual property rights for the content and services it operates, but failure to adequately protect our intellectual property rights may affect the Group’s business, financial condition, and performance.

We will also investigate possible intellectual property right infringements against third parties by the Group. However, it is difficult to fully understand the intellectual property rights of third parties in the Group’s business areas, and we cannot deny that the Group may unintentionally infringe upon the intellectual property rights of other companies. The payment of royalties and claims for damages, etc. in such cases, or any infringement of the Group’s intellectual property, may affect the business, financial condition, and performance of the Group.

⑩ Legal regulations

There are currently no laws or regulations affecting the Group’s AI businesses. However, there are legal regulations regarding specific businesses (such as the “Act on Securing Quality, Efficacy and Safety of Products Including Pharmaceuticals and Medical Devices” for medical care, the “Banking Act” related to financial regulations for the electronic payment agency business, etc.) and general legal regulations (such as the “Act Against Unjustifiable Premiums and Misleading Representations,” the “Act on Specified Commercial Transactions,” and the “Act on the Protection of Personal Information”).

The Group is improving its management system to comply with these laws and regulations, including the development of a compliance system. However, we cannot deny that the content and services provided by the Group may conflict with legal regulations, and future changes to the above legal regulations, the enactment of new laws and regulations, and that changes in the interpretation of laws and regulations may restrict the Group’s business and affect the Group’s business, financial condition, and performance.

⑪ Impairment of goodwill risk

The Group accrues goodwill and intangible fixed assets arising from corporate acquisitions and amortizes them over a period of time. We have determined that goodwill appropriately reflects future profitability, but if the expected results are not obtained due to changes in the business environment or other reasons, an impairment loss may be recorded for the goodwill and may affect the Group’s performance and financial condition.

⑫ Impairment of intangible fixed assets (software) risk

The Group records its software for third-party purposes (cloud services) as intangible fixed assets only when it is recognized that future revenue will be earned, and then amortizes them over a period of time.

We monitor the market environment and other factors when developing software, but if the software cannot be expected to be used in the future due to sudden changes in the market or competitive conditions, etc., or if recovery of the investment cannot be expected due to decreased profitability, there is a risk of retirement or impairment.

Such circumstances may affect the Group’s performance and financial condition.

(2) Risks related to the business management system

① Recruitment and development of human resources

The Group is recruiting and developing engineers to create machine learning algorithms and software (infrastructure, application production, etc.), and consultants who promote customers’ digital and AI strategies and the business use of AI. Failure to develop or recruit human resources may affect the Group’s business, financial condition, and performance.

② Influence of specific person

Makoto Haruta, founder and Representative Director of the Group, plays a vital role in the work of the Group through his specialist knowledge and expertise in management and business strategies. The Group will strengthen its organizational structure by sharing information and transferring authority to officers and employees at meetings of the Board of Directors, etc., while maintaining a management system that minimizes management risks. If he leaves the Group, it may affect the Group’s business, financial condition, and performance.

③ Internal management system

To sustainably increase corporate value, the Group recognizes that effective corporate governance and proper and efficient utilization of human resources, capital, services, and information assets are essential to ensure proper operations, financial reporting reliability, and ensuring compliance with laws and regulations.

To this end, the Group strives to improve its internal management system. However, rapid business expansion in the future could make an adequate internal management system impossible, making it difficult to properly manage the business and potentially affecting the Group’s business, financial condition, and performance.

④ Compliance system

The Group believes that the compliance system must function effectively in order to sustainably increase corporate value. To achieve this, the Group formulates internal compliance regulations and conducts training for officers and employees. However, it is difficult to completely eliminate compliance risks, and future events that may cause the Group’s business operations to conflict with laws and regulations may affect the Group’s business, financial condition, and performance.

⑤ Information management

The Group’s AI may learn information that is important and/or sensitive to our customers’ business strategies. In addition, services provided by the Group deal with the personal information of users and that of third parties held by users. To handle this information properly, we have obtained information security management system (ISMS) certification and are striving to establish information management regulations. If information is leaked, misused, or improperly handled due to intent, negligence, accident, disaster, unauthorized access by a third party, or other unforeseen actions of employees and subcontractors, we may be liable for damages, incur a large expense to renovate the security system, and may be subject to administrative sanctions by the authorities. In addition, our business relationships may deteriorate due to loss of trust from customers, which may seriously affect the Group’s business, financial condition, and performance.

⑥ Continuous recording of losses

The Group recorded a net loss attributable to shareholders of the parent company in FY03/22 due to upfront investment in the AI product business. This was caused by hiring costs associated with organizational growth, system investments for new service development, and upfront labor costs.

However, the AI platform business has recorded a surplus, sales have grown significantly, and we are steadily increasing our profitability centered on this AI platform business. Our management strategy assumes that future AI platform business sales will continue to grow, and that the Group will continue and expand its surplus, improve profitability, and invest in the AI product business.

However, if the upfront investment for future sales growth is larger than expected, or if the sales growth is not achieved as expected, the Group’s performance and cash flow may be affected due to the inability to recover the amount invested.

(3) Other risks

① Large-scale natural disasters, etc.

The Group is establishing a crisis management system to prepare for emergencies. Natural disasters such as typhoons, earthquakes, tsunamis, or infectious diseases that occur on a scale that exceeds expectations may affect the business activities of the Group or its counterparties and affect the Group’s business, financial condition, and performance.

② Impact of the Spread of Infectious Diseases

To mitigate the risks associated with the spread of infectious diseases, the Group will develop and strengthen remote working environments and promote internal communications online. In addition, we are strengthening our business foundation by providing vaccination opportunities for all employees and disseminating work policies for dealing with suspected infections and ill health. Also, with regard to the Group’s sales and recruitment activities, engineer development processes, and service infrastructure operation and maintenance systems, we will establish systems that will allow us to continue our business activities with customers under the premise of remote working environments. However, a large-scale pandemic can cause unanticipated changes in the business environment and prevent planned business developments, affecting the Group’s operating results and financial condition.

③ Litigation, etc.

There is currently no pending litigation in the Group. However, there is always the possibility of unforeseen troubles or lawsuits in the future. Such litigation may affect the Group’s performance, financial condition, and business development, depending on the nature of the litigation.

④ Dilution of share value through exercise of share options

The Company grants share options to provide incentives to officers and employees of the Group. The percentage of potential shares in relation to the total number of issued shares at the end of March 2023 is 7.7%. If these share options are exercised, the Company’s shares will be issued and the value of the shares held by existing shareholders and proportional voting rights may be diluted.

⑤ Dividend policy

The Company recognizes the return of profits to shareholders as an important management issue. However, we believe that the Group is currently in the process of growth, and that improving internal retention, allocating funds to invest in future business development, strengthening management structure, and further business expansion will lead to a maximum return of profits to shareholders. In the future, we will implement a policy of stable and continuous profit returns to shareholders by strengthening profitability and improving the business base, accounting for improvements in internal retention and the business environment surrounding the Group. However, dividend payment sand payment timing are currently undetermined.

⑥ Use of funds

We plan to allocate funds raised in a public offering to product development investments, recruitment costs, marketing costs, loan repayment, working capital, and research and development expenses.

To acquire more flexibility in a rapidly-changing business environment, funds may also be used for other purposes. Even when funds are used in accordance with the plan, underperforming investments may have an impact on the Group’s operating results and financial condition.

⑦ Deficit carried forward

The Group has a deficit carried forward for tax purposes. This reduces our corporate tax liability and is expected to improve cash flow by reducing the amount of tax payable within the scope of the usage restriction for the carry-forward period of the deficit carried forward.

If that taxable income exceeds the deficit carried forward due to the Group’s steady performance, and in the event of deficit carried forward due to the lapse of the carry-forward deadline due to under-performance of the Group, etc., deductions from taxable income will not be received, and tax liabilities such as corporation tax based on the normal tax rate may be incurred, which may affect the Group’s performance and cash flow.

⑧ Number of years since the establishment of the Company

The Company was founded in February 2016. The Group recognizes that it is currently growing and will continue to require aggressive growth investments, and that profit and loss may temporarily deteriorate depending on the timing and outcome of such investments. In addition, although the Group has a policy of actively disclosing the state of its business through IR and public relations activities, the Company’s operating results for the past fiscal years are not sufficient analytical materials regarding the performance of those periods, and therefore may not be sufficient information for forecasts of future performance.

Translation: This document is a translation of the original Japanese document and is only for reference purposes. In the event of any discrepancy between this translated document and the original Japanese document, the latter shall prevail.

Translation: This document a translation of the original Japanese document and is only for reference purposes. In the event of any discrepancy between this translated document and the original Japanese document, the latter shall prevail.