Business Risks

Management Policy

MegaChips has identified the following risks pertaining to its operations and other matters that may seriously affect investors' judgment.
Forward-looking statements in this section represent the judgment of MegaChips as of June 24, 2010.

Dependence on specific customers

Purchasers

MegaChips principally sells LSIs for storing game software (custom memories) for use in game consoles, LSIs for game consoles and their peripherals, LSIs for receiving 1seg digital terrestrial broadcasts, LSIs for digital cameras image processing, and digital video monitoring systems for security and monitoring applications. However, the proportion of net sales that involves providing LSIs for game software (custom memories) to Nintendo Co., Ltd. ("Nintendo") is particularly high.
Accordingly, our operating results may vary according to market trends for game software and the game consoles that use these products, as well as according to the extent to which Nintendo adopts our products.
Net sales to Nintendo amounted to 33,479 million yen in the fiscal year under review. They accounted for 87.0% of consolidated net sales.

Contract manufacturers (suppliers)

Since its foundation, MegaChips has adopted a business model in which it operates as a fabless enterprise to concentrate its management resources on research and development. Consequently, MegaChips contracts the manufacturing of products to third parties, enabling it to develop products that best meet customer needs based on its unique technological capabilities and expand its business without the need to invest in plant and equipment that require substantial investments. We work with a number of different contractors in Japan and overseas, although a very significant percentage of work is contracted to Macronix International Co., Ltd. ("Macronix"), which manufactures on our behalf LSIs for storing game software (custom memories) supplied to our major customer Nintendo and LSIs for game consoles and their peripherals.
Hence, should Macronix cease manufacturing, our operating results may fluctuate.
We have entered into contract manufacturing agreements with Nintendo and Macronix, respectively. We intend to build good and close ties with these companies to ensure a constant supply of products.

Business

Risks in the LSI Business

MegaChips has adopted a fabless model in which it owns neither manufacturing plant nor equipment of its own and instead contracts manufacturing to third parties. In the LSI business, manufacturing of products is contracted to semiconductor manufacturers.
Hence, demand and supply in the semiconductor market may affect the quantities and prices of products that we procure, and we may not be able to procure products in the quantities and at the prices that we have anticipated.
Our LSIs are used in state-of-the-art digital devices, and the pace of technological innovation in this field is quite rapid, so there is no guarantee that these products will continue to be used. Moreover, as equipment mounted with our LSIs is exposed to intense competition and demand volatilities, demand for our LSIs may swing sharply and widely.

Risks in the Systems Business

In the systems business, we mainly sell image recording and transmission system products that facilitate the development of digitization in the security and monitoring area. Demand for products in the security and monitoring area fluctuates based on trends in capital investment in this area and, accordingly, our operating results may be affected.
In addition, we have sought to maintain our technological edge in areas such as digital image processing and network technologies, and our competitive edge by supplying optimized specific image systems for customer operations. However, technological change in this area is rapid and technological trends and developments in the services of other companies may affect our operating results..
Moreover, in the event that a totally new market is created, the market may not grow as we foresee and our operating results may be affected.

Risks in strategic investment

In the event that we engage in strategic tie-ups, including equity participation, to accelerate the growth of our businesses, there is a possibility that the benefits that we anticipate, such as business synergies or increased earnings, may not materialize.

Research and development

Under the philosophy of expanding our business through "Innovation," remaining coexistent with customers through "Credibility," and continuing to contribute to society through "Creation," we have operated based on our technological development capabilities. Our competitiveness derives from "Specialization" in products for specific customers and for specific applications in the growing image, audio, and communication-related markets, a "Concentration" of our resources on research and development activities to provide the most advanced technologies and products to our customers, and the showing of our "Uniqueness".
We believe that we can continue to develop and introduce to the market innovative and attractive new products. However, our industry is exposed to constant technological change, and new technologies, new services, or other changes may quickly emerge. There is no assurance that we can always respond quickly to these changes and we may be required to invest a large sum in research and development.
This could in turn affect our operating results.

Recruitment

MegaChips operates based on its technological development capabilities in the areas of images, audio, and communication, each of which demands excellent engineers. We have take steps to establish a personnel management policy necessary for that purpose and have maintained excellent technological development capabilities in our business. However, if many excellent engineers were to leave MegaChips or new engineers can not be recruited in the future, we could become less competitive.

Management

Defending against acquisitions

MegaChips believes that defending against acquisitions that are not in the best interests of its shareholders is an important management issue. For this reason, we have been collecting information on recent acquisitions.

Accounting auditors

For any reason attributable to us or in the event that the accounting auditors violate or contravene laws or ordinances or we believe that the accounting auditors have offended public order or morals, the Board of Auditors shall deliberate on the dismissal or non-reappointment of the accounting auditors. In the event that we consider it appropriate to dismiss or not reappoint the accounting auditors, we shall request the Board of Directors to submit the "dismissal or non-reappointment of the account auditors" as a proposition to our General Meeting of Shareholders, and the Board of Directors shall deliberate.

Risk concerning the establishment of internal control systems

MegaChips has recognized the emphasis on legal compliance and the establishment of corporate governance as important managerial issues. We have consequently taken steps to strengthen and enhance risk management. In May 2006, we instituted fundamental policies on internal control pursuant to the Company Law, sought to improve internal control systems pursuant to the Financial Instruments and Exchange Law, and ensured that we operated in accordance with these rules. Accordingly, we have managed our businesses properly and lawfully, and has also made progress in establishing, improving, and evaluating our internal control systems, including internal control with regard to financial reporting.
However, if any extraordinary event not assumed under the internal control systems that we have established were to occur, the credibility and comprehensiveness of financial reporting and information disclosure by us may not be assured. In this case, we may lose the trust of our stakeholders and we may experience a material adverse effect on our financial position and operating results.
Note, however, that no such events have occurred thus far.

Intellectual property rights

As an R&D-oriented fabless enterprise, MegaChips recognizes that the protection of its intellectual property rights is material to its business development. For this reason, we have concentrated on building an internal system for intellectual property rights and strengthening cooperation with patent law offices to actively file applications to register patents and trademarks and protect the products and services we offer. We simultaneously investigate the rights of other companies thoroughly, to prevent any infringements.
However, there exists no assurance that all patents or trademarks for which we file applications will be registered. Additionally, as it is impossible to fully investigate the technologies and rights of other companies prior to publication thereof, we may infringe on the intellectual property rights of other companies and litigation may be filed against us. In this case, our operating results may be affected.

As of June 24, 2010, no litigation had been filed against us in respect to any intellectual property right.

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