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Business and Other Risks

Potential risk factors related to the Group's operations are described below. Forward-looking statements in the text below are forecasts based on the Company's judgment, targets, and assumptions as of the filing date of its latest financial report (May 26, 2016). Actual outcomes may differ from these forecasts. The risks enumerated below do not constitute an exhaustive list of all risks related to the Group's operations.

1-Common group risks
(1) Risk of sustained stagnation or further deterioration in the retail industry

The Group operates mainly in Japan and has captured a large share of the Japanese market in terms of sales. Its earnings are consequently heavily dependent on the Japanese retail market. For the past several years, the Japanese retailing industry has been in the doldrums due to a decline in personal consumption, general price deflation, and intense competition among retailers. Going forward, the Japanese economy and personal consumption may be adversely affected by electricity rate hikes, in addition to growth in consumption tax hike, healthcare costs and social insurance premiums.
If these factors result in further deterioration in Japanese personal consumption, the Group's operations, financial condition, and earnings could be adversely affected.

(2) Risk of intensification of competition

The Group competes against discount retailers that compete on the basis of low prices, specialty stores and E-commerce businesses without bricks-and-mortar stores in addition to retailers that operate GMSs, supermarkets, and convenience stores. These competitors may have advantages over the Group in terms of operating efficiency, marketing, or their ability to raise funds, hire personnel, acquire or lease store sites, source merchandise or services, or adapt to changes in consumers' tastes and preferences. The Group's operations, financial condition, and earnings could be adversely affected by intensification of competition with such other retailers.

(3) Risk of unseasonable weather

The Group's sales are affected by seasonal changes. The Group formulates sales plans based on seasonal merchandise trends, but if seasonal weather patterns change unexpectedly, demand for certain merchandise could decrease, potentially resulting in reduced sales and excess inventories. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

(4) Risks related to natural disasters and terrorism

If a major earthquake, typhoon, other natural disaster, or unforeseen accident that occurs in the vicinity of the Group's stores or other facilities and results in human casualties, physical damage to the stores or facilities, or disruption of sales, logistics, or supply-chain activities, the Group's operations, financial condition, and earnings could be adversely affected.
Additionally, the Group implements fire prevention measures on a priority basis at its stores and other facilities, but if a fire occurs inside a store or other facility due to unforeseen circumstances and results in human casualties, widespread damage to the building or facility, or disruption of Group's sales, logistics, or supply-chain activities, the Group's operations, financial condition, and earnings could be adversely affected.
If an outbreak of a communicable disease such as H1N1 influenza occurs in the vicinity of the Group's stores or other facilities and results in human casualties or disruption of the Group's sales, logistics, or supply-chain activities, the Group's operations, financial condition, and earnings could be adversely affected.
If some other event such as an accident, act of violence or terrorism or any other incident that affects the Group's suppliers or supply chain or logistics network were to occur and resulted in human casualties or disruption of the Group's sales, logistics, or supply-chain activities, the Group's operations, financial condition, and earnings could be adversely affected.

(5) Risks related to dependence on key management personnel

The success of the Group's business operations depends largely on the capabilities of its president and CEO, Motoya Okuda, and other top management personnel. If the Group is deprived of their services or is unable to recruit or retain future personnel with skills and experience comparable to those of its current management team, its operations, financial condition, and earnings could be adversely affected.

(6) Risk of inability to effectively capitalize on group companies' business activities

As of February 28, 2018, the Group has 291 consolidated subsidiaries (24 of which are publicly traded companies) and 31 equity-method affiliates. While pursuing overall optimality for the group as a whole, the Company also grants these subsidiaries and affiliates a high degree of management independence. The Company consequently may be unable to effectively coordinate these subsidiaries and affiliates' business activities or may encounter difficulty coordinating group business activities as a unified whole. The Group includes many publicly traded companies and companies in which the Company is a minority shareholder. Because these subsidiaries and affiliates are highly independent of the Company, there is a possibility that the Group cannot easily exercise effective control over them. This risk is expected to increase as the number of companies in the Group increases. If the Company is unable to exercise appropriate governance over the Group's subsidiaries and affiliates, the Group's operations, financial condition, and earnings could be adversely affected and the credibility of the Group's financial reporting could be impaired.

(7) Risks related to growth strategy stalement

Aeon will carry out innovation of existing business model as well as establish a new growth model so as to become the No.1 in each business field and region. As part of its growth strategy, the Group sometimes acquires or invests in other companies. However, the Group may not be able to achieve expected results due to various factors, including the following.

  • Inability to secure funding required for acquisitions or new store openings
  • Inability to identify suitable acquisition targets or find new store sites on the terms, or in locations, desired by the Group
  • Inability to integrate acquisitions or overseas operations with existing businesses, resulting in an inability to fully utilize the Group's supply chains, logistics, sales promotion, financial, management, IT, and back-office functions
  • Inability to retain or cultivate skilled staff required to expand operations or utilize IT systems
  • Inability to develop shopping centers or retail stores within an appropriate budget or timeframe or inability to recruit prime tenants for such retail stores
  • Failure to discover financial, tax, or legal problems of acquired companies prior to their acquisition and inability to subsequently resolve such problems
  • Inability to maintain a consistent quality level for goods or services provided by the Group following an acquisition
  • Inability to properly and effectively apply the Group's internal controls to acquired companies

If the Group's growth strategy is unsuccessful due to factors such as those listed above, the Group's operations, financial condition, and earnings could be adversely affected.

(8) Risks related to leaks of customer information

The Group retains and manages personal information obtained from customers of businesses operated by the Group, mainly Aeon Credit Service's cardholders and other financial services customers. To prevent leaks of such personal information, the Group has thoroughly implemented appropriate measures to ensure the security of its IT systems, but if a leak of personal information related to the Group's customers were to somehow occur, the Group may be liable to pay damages to aggrieved parties or suffer damage to its public repution. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

(9) Risks related to intellectural property

The Group owns trademarks, designs, and other intellectual property registered in Japan and overseas. The Group steadfastly endeavors to preserve these intellectual property rights, but the Group could lose the ability to exercise certain intellectual property rights due to disputes with third parties over those rights. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

(10) Risks related to increases in labor costs

The Group's personnel-related expenses may increase due to various factors, including prospective labor law amendments and increases in premium rates for employee pension insurance, unemployment insurance, and insurance from health insurance associations.
Additionally, if a major earthquake, typhoon, other natural disaster, or unforeseen accident occurs in the vicinity of the Group's stores or other facilities, the stores/facilities' business activities are curtailed, and the Group fully or partially indemnifies its employees for lost wages, the Group's operations, financial condition, and earnings could be adversely affected.

(11) Risks related to asset impairment

The Group owns large amounts of fixed assets, including store-related intangible fixed assets and goodwill. If accounting standards change or stores' book value becomes unrecoverable due to a decline in the stores' profitability, the Group may recognize impairment losses to write down the stores' book value. The Group recognized store-related impairment losses of \43,176 million and \48,000 million in the fiscal years ended February 28, 2017 and February 28, 2018. , respectively. The Group may incur additional impairment losses in the future.
Additionally, if the Group's market value of its shares or economic value of goodwill, etc. decreases in conjunction with group expansion, the Group may recognize a goodwill impairment loss. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

(12) Risks related to retirement benefit obligations

As of February 28, 2018, the Group has retirement benefit obligations of \189,952 million, pension plan assets valued at \180,519 million, and an unfunded retirement benefit obligation of \9,433 million. The fiscal year ended February 2016, the Group's retirement benefit expense was \16,354 million. A decline in prices of the financial assets that constitute the Group's pension plan assets could result in a reduction in the pension plan assets' value and the investment returns that they generate. Additionally, the Group uses many assumed values (e.g., discount rate, long-term expected rate of return) when calculating retirement benefit obligations and retirement benefit expense. If any of these assumed values is revised, the unfunded retirement benefit obligation could increase. In such an event, the Group's financial condition and earnings could be adversely affected.

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2 - Risks related to merchandise and store operation
(1) Risks associated with deteriolation in food safety or quality

The Group recognizes product quality and safety as one of its highest management priorities and conducts various activities to maintain quality and safety. Consumer concern about food safety and quality assurance has been rising in recent years due to such issues as avian influenza, residual agrochemicals, allergen indications on packaging, fraudulent food labeling, and contamination. Although the Group takes various measures to protect the safety and security of its food products, in the event that consumer confidence in the safety and quality of food products sold by the Group declines for any reason, or if the Group voluntarily suspends sales of food products at multiple stores due to contamination during a supplier’s manufacturing processes or during the sale of the products at a store, sales may decline at stores with food departments. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

(2) Risk related to private brand (PB) merchandise

The Group actively develops PB merchandise. It offers a wide range of food, apparel, and household merchandise under the Topvalu brand name, its core PB brand. Topvalu merchandise sales, including sales from supply of merchandise to affiliated companies, totaled \727.1 billion in the fiscal year ended February 28, 2018. In developing merchandise, the Group sets rigorous standards and implements diligent quality control, but if the Group's PB merchandise inadvertently causes harm to consumers, the Group may suffer a loss of trust from customers and brand impairment. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

(3) Risks related to supply chain and logistics network disruptions

The Group has been building a supply chain and its own nationwide logistics network by actively utilizing IT. It aims to continue to reduce Group-wide sourcing and logistics costs through broad and effective utilization of its logistics network by its affiliated companies. However, the Group may be unable to successfully implement such a strategy due to reasons such as incompatibilities between its network and its affiliated companies' respective supply chains and logistics operations. Additionally, the Group's network may experience disruptions due to various factors, including transport delays, computer viruses, earthquakes or other natural disasters, labor strikes, supply shortages, and human error. In the event of a sustained disruption of the Group's supply chain or logistics network due to such factors, the Group may be affected by merchandise damage or spoilage, sales declines, loss of business opportunities, interruption of settlement or loyalty point functions, loss of data, loss of trust from customers or suppliers, or extra maintenance or repair expenses. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

(4) Risks related to the City Planning Act, the Building Standards Act, and the Large-Scale Retail Store Location Act

(City Planning Act and Building Standards Act)
Development of commercial facilities (large-scale customer-drawing facilities) with total floor area in excess of 10,000m2 is resticted by the City Planning Act and Building Standards Act. Its intention is to restrict development of large-scale consumer facilities in suburban areas and promote redevelopment of municipalities' central districts. As a general rule, development of large-scale customer-drawing facilities is prohibited except in areas zoned for commercial, neighborhood commercial, or light industrial uses. Additionally, development of a large-scale customer-drawing facility on land in undesignated areas within an undivided city planning area or a quasi-city planning area requires such land to be designated for such use by the prefectural governor or a relaxation of the district planning system regarding such use. Although the Group places priority on cooperating with local municipalities and contributing to local communities, urban plans may impose restrictions on its suburban store development activities. Such restrictions could impede the Group's growth strategy or increase its store development costs.

(Large-Scale Retail Store Location Act)
The Large-Scale Retail Store Location Act is intended to preserve the living environment in the vicinity of large-scale retail stores, and the Group's existing and planned stores are subject to the provisions of the act. Pursuant to this act, the Group may be prevented from opening new stores or enlarging or reformatting existing stores as originally planned.

(5) Risks associated with real estate price appreciation

The Group acquires and leases real estate in its retailing and development operations. If real estate prices rise, the Group's real estate acquisition and leasing expenditures would increase. The Group also subleases real estate to tenants, but it may not be able to collect sufficient rental revenues from tenants to offset increases in rent expense.
Additionally, if the risk of owning real estate increases due to amendment of laws related to real estate or changes in accounting standards, the Group's operations, financial condition, and earnings could be adversely affected.

(6) Risks related to environmental problems involving real estate

The Group owns land with a book value of \828,326 million as of February 28, 2018. Pursuant to the Soil Contamination Countermeasures Act, in the event that soil from the land owned becomes contaminated by a toxic substance, the land's owner may be ordered to investigate and report on the state of contamination, decontaminate the property, or implement other measures, regardless of whether the owner had knowledge of the contamination.
Additionally, if land owned by the Group is found to be affected by a previously unknown environmental problem, the land may decrease in value and the Group may be forced to incur substantial remediation expenses. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

(7) Risks related to overseas transactions and operations

The Group imports from overseas some of the merchandise it sells domestically. It also derives a portion of its consolidated operating revenues from overseas stores, mainly in Asia. In the event of a slowdown in economic growth or personal consumption, political or economic instability, changes in laws or government policies, terrorism, or a communicable disease outbreak overseas, or if logistical, quality control, or taxation problems occur with respect to overseas transactions or operations, the Group's operations, financial condition, and earnings could be adversely affected.
Especially from China, the Group imports substantial merchandise and plans to continue to deploy its domestic business model in packaged form there. China's legal system is still developing and the Chinese government exercises broad discretion in terms of industrial regulation, including regulation of foreign investment. Material changes to regulations' content, implementation, or interpretation may frequently occur. Additionally, the Group's operations in China could be adversely affected in case of occurrence of violence or boycotts motivated by anti-Japanese sentiment.

(8) Risks associated with consumption tax hike

Japan's consumption tax rate will be raised from 8% to 10% in October 2019. When the consumption tax was raised 5% to 8% in April 2014, personal consumption temporarily fell. When the demand surge that preceded the consumption tax hike is taken into account, the 1997 consumption tax hike did not have a major impact on the Group's sales. However, if the consumption tax rate is raised again, personal consumption may temporarily fall like in 1997. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

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3 - Risks related to Financial Services Business
(1) Regulatory risks in Financial Services Business

In Japan, consolidated subsidiaries that operate financial services businesses in the Group are subject to various financial laws and regulations, including the Banking Act, Installment Sales Act, Insurance Business Act, Money Lending Business Act, Servicer Act, and the Financial Instruments and Exchange Act, as well as oversight by financial regulatory authorities. Overseas business activities are likewise subject to the laws and regulations of the country or region in which they are conducted and to oversight by local financial regulatory authorities.
Aeon Bank, Ltd., which conducts the Group's banking business, and its parent company, Aeon Financial Service Co., Ltd., a bank holding company, and its Group are subject to capital adequacy ratio regulations prescribed by the Banking Act. Although the Aeon Financial Service Group has established a structure to manage its capital adequacy ratio, if the Aeon Financial Service Group or Aeon Bank, Ltd. fails to maintain a capital adequacy ratio above the required level, it may be subject to administrative sanctions imposed by the Financial Services Agency, including partial or full suspension of business operations.
The Act imposes a cap on the effective annual percentage rate of interest of all loan products offered by consolidated companies that operate financial services businesses. Customers in Japan may assert claims for refunds of interest previously paid in excess of the interest rate cap. The Group has set aside an allowance for loss on refund of interest received to cover refund claims, but if refund claims exceed expectations, the Group's earnings could be adversely affected.
Additionally, such laws and regulations may be newly enacted, amended or repealed in the future. Such legislative action, depending on its content, could restrict provision of certain products or services or otherwise adversely affect the Group's operations, earnings and financial condition.

(2) Risk of fluctuations in value of the Company's asset holding

The Group owns a variety of market-traded assets. If its asset holdings decline in value due to financial market turmoil or other such factors, the Group could incur impairment losses or valuation losses on its securities holdings or pre-existing impairment or valuation losses could be exacerbated. In such an event, the Group's financial condition and earnings, could be adversely affected.

(3) Risks related to uncollectible debts

The Group sets aside an allowance for doubtful accounts by setting standards for self-assessment, write-offs and loan loss provisions, mainly for the Financial Services Business's retail loans and other receivables.
However, in case the Group's allowance for doubtful accounts, credit costs including write-offs, and non-performing loans increase more than expected, the Group's operating performance and financial condition could be adversely affected.

(4) Risks related to growth of Financial Services Business

The Group's Financial Services Business operates various businesses, most notably credit card and banking businesses. Additionally, the Group is branching into new business spheres and forming various business alliances in response to deregulation and customers' increasingly diverse and sophisticated needs. The Group has established systems to appropriately manage various risks associated with such new businesses. However, if an unanticipated risk manifests, the Group's operations, earnings, and financial condition could be adversely affected. The group consequently has to raise large amounts of funding to expand its financial services business. If it is unable to do so, it would be forced to curtail its expansion plans for its financial services business. Additionally, the Group's financial services business tends to grow in parallel with the Group's retailing operations' scale. The financial services business thus benefits substantially from intragroup synergies, but if the Group is unable to expand its retailing operations, the financial services business's growth may be constrained.

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4 - Risks related to Finance
(1)Interest rate risk

As of February 28, 2018, the Group has outstanding bank borrowings, straight bonds, convertible bonds with stock acquisition rights, commercial paper, and lease obligations totaling \2,344,300 million. Although the Group is endeavoring to reduce its bank borrowings and other debt through various means, its bank borrowings and other debt may increase further in conjunction with its growth strategy. If long- or short-term interest rates rise, the resultant increase in borrowing costs could adversely affect the Group's operations, financial condition, and earnings.

(2)Currency risk

As of February 28, 2018, the Group has 133 overseas consolidated subsidiaries. Consolidated subsidiaries' foreign-currency-denominated financial statement account balances are converted to Japanese yen in the Company's consolidated financial statements. The Company's consolidated financial statements are consequently affected by changes in the yen's exchange rate relative to overseas subsidiaries' local currencies. Additionally, although the Group operates mainly within Japan, it conducts overseas transactions also. Such transactions are likewise affected by changes in exchange rates. In the event of anomalous exchange rate movements, the Group's operations, financial condition, and earnings could be adversely affected.

(3) Financing-related risks

The Group must raise funds for its growth strategy and other purposes. It continuously assesses various financing instruments and has developed the capability to swiftly respond to changes in the financial environment. Additionally, it continuously develops and maintains positive relationships with counterparty financial institutions.
However, the Group may be unable to raise funds in a timely manner on the terms it desires, as a result of a general economic recession including credit contraction, deterioration in its creditworthiness ensuing such as rating demotion or other factors, or business outlook. In such an event, the Group's operations, financial condition, and earnings could be adversely affected.

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