The 72nd Annual General Meeting of Shareholders Q & A

The 72nd Annual General Meeting of Shareholders

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16	As a perk for consumers who pre-order software or purchase it in its launch period, some publishers sell packaged software with special features like a CD or a book, but in the digital distribution of other companies these special features are usually unavailable with the download version. Then we cannot help buying a packaged game for the special features despite preferring a download version. In making download versions available through both retailers and the Nintendo eShop, will this problem be solved?
16	Iwata: We are not currently planning to initiate the digital download sales with physical special features. This is because one of the advantages of this sales method is that retailers can sell products virtually without any inventory risk by making use of technology called POSA (Point Of Sales Activation). POSA is a computerized system where a product has no inventory value until it is processed by the POS register, and retailers have no trade payables accrued for a product until a consumer actually purchases it. More specifically, this is the system used for the Nintendo prepaid cards on the shelves at convenience stores (in Japan). We expect that digital download sales will make it easier for retailers to have a product available in their shops even when they are not certain about its sales potential. In fact, one of the challenges in the video game distribution industry in Japan is the higher inventory risk; it is a bigger challenge than ever before. Since it is common practice in this industry that retailers take the inventory risk, their profits from good sales can be easily wiped out by surplus stock. Therefore, when the sales pace of a game with a short lifespan is slower than expected, it is reasonable for retailers to reduce their prices. Previously, a retailer’s price cut was rather independent from others, but nowadays the information on a price markdown at one store is likely to affect other retailers in no time through the Internet, which results in a collapse of the market price. Consumers tend to see such a product as one with a bad reputation. In this way, some games which might have had commercial value lose their sales potential just because the proportion of the number of sales in the first week to the number of shipments is relatively small. On the other hand, something quite opposite is also happening; in fear of this, more retailers are eager for the minimum inventory levels. When you visit a store for a game only to hear from the clerk that it is now out of stock and the next shipment will not be until three weeks later, you will be discouraged to buy it. The demand sometimes does not lead to actual sales, like in the case I just mentioned. The reason we will start the digital download sales is that decreasing the inventory risk will be of great benefit to the video game business. As some consumers are still keen on physical special features attached to only the first copies of games, both Nintendo and other publishers will try various measures to satisfy them. First of all, however, we would like to show the public the number of “New Super Mario Bros. 2” or “Onitore” (temp.) have been sold by download so that those in this industry can make the next move after finding out the consumer behavior toward download versions. When they know the size of the digital distribution market, they might be inclined to accept a certain inventory risk to try the download sales with special features. I am afraid we cannot say anything specific today and we need to carefully manage the download sales with special features because, as I mentioned, they are not a good combination in some aspects. In the distant future, furthermore, it might be a valid business model to deliver physical special features to consumers at home after they have bought something by download. We hope to continue to explore various possibilities.

As a perk for consumers who pre-order software or purchase it in its launch period, some publishers sell packaged software with special features like a CD or a book, but in the digital distribution of other companies these special features are usually unavailable with the download version. Then we cannot help buying a packaged game for the special features despite preferring a download version. In making download versions available through both retailers and the Nintendo eShop, will this problem be solved?

Iwata:

We are not currently planning to initiate the digital download sales with physical special features. This is because one of the advantages of this sales method is that retailers can sell products virtually without any inventory risk by making use of technology called POSA (Point Of Sales Activation). POSA is a computerized system where a product has no inventory value until it is processed by the POS register, and retailers have no trade payables accrued for a product until a consumer actually purchases it. More specifically, this is the system used for the Nintendo prepaid cards on the shelves at convenience stores (in Japan). We expect that digital download sales will make it easier for retailers to have a product available in their shops even when they are not certain about its sales potential.

In fact, one of the challenges in the video game distribution industry in Japan is the higher inventory risk; it is a bigger challenge than ever before. Since it is common practice in this industry that retailers take the inventory risk, their profits from good sales can be easily wiped out by surplus stock. Therefore, when the sales pace of a game with a short lifespan is slower than expected, it is reasonable for retailers to reduce their prices. Previously, a retailer’s price cut was rather independent from others, but nowadays the information on a price markdown at one store is likely to affect other retailers in no time through the Internet, which results in a collapse of the market price. Consumers tend to see such a product as one with a bad reputation. In this way, some games which might have had commercial value lose their sales potential just because the proportion of the number of sales in the first week to the number of shipments is relatively small. On the other hand, something quite opposite is also happening; in fear of this, more retailers are eager for the minimum inventory levels. When you visit a store for a game only to hear from the clerk that it is now out of stock and the next shipment will not be until three weeks later, you will be discouraged to buy it. The demand sometimes does not lead to actual sales, like in the case I just mentioned. The reason we will start the digital download sales is that decreasing the inventory risk will be of great benefit to the video game business. As some consumers are still keen on physical special features attached to only the first copies of games, both Nintendo and other publishers will try various measures to satisfy them. First of all, however, we would like to show the public the number of “New Super Mario Bros. 2” or “Onitore” (temp.) have been sold by download so that those in this industry can make the next move after finding out the consumer behavior toward download versions. When they know the size of the digital distribution market, they might be inclined to accept a certain inventory risk to try the download sales with special features. I am afraid we cannot say anything specific today and we need to carefully manage the download sales with special features because, as I mentioned, they are not a good combination in some aspects. In the distant future, furthermore, it might be a valid business model to deliver physical special features to consumers at home after they have bought something by download. We hope to continue to explore various possibilities.

17	When my family was enjoying interacting with other players, like people from abroad, with “Animal Crossing” on the Wii, modified data entered our game, and as a result of that we eventually stopped playing. The new “Tobidase Doubutsu no Mori” (Japanese title; for the Nintendo 3DS) will be launched as part of your efforts to expand your network business, but have you considered how you are going to handle and tackle the kind of problem that my family encountered?
17	Iwata: I deeply regret to learn that you had a very unpleasant experience while playing one of our products, and I would like to apologize for having lacked the ability to prevent it from taking place. What happened, I believe, is that a player circulated such modified data for “Animal Crossing” for the Wii, and meant for it to be a bad joke, only to cause a very unpleasant experience for those who witnessed what these modified data did with their game. To explain why this sort of incident happens, video game platforms are equipped with various security features to prevent unauthorized modifications and acts of piracy to play games for free, and in the beginning, these features were effective on the Nintendo DS and the Wii. However, there are people who share information with others through networks and try to break through security as a hobby, and eventually announce the results of their hacking activities through the Internet, resulting in a vicious cycle in which more people are encouraged to use these unauthorized methods. Once they break through our security, we make an effort to fix the security hole, but this turned out to be a futile cat-and-mouse chase as they quickly managed to make a hole in our security system again. As a result, we have been unable to put a complete halt to the circulation of such modified data. In developing the Wii U and the Nintendo 3DS, we recognized that security is an extremely important factor for the sake of our business and in making sure that our consumers feel that playing our products is safe. While some acts of piracy are still possible in its DS-compatibility mode, as we had to ensure that the Nintendo DS software could still be played on the Nintendo 3DS, the Nintendo 3DS itself still maintains a robust security system, even after this much time has passed since its launch. Various attempts have so far been made to compromise the security of the system, but of course, security is like a multilayered fire door. Even if the outermost layer is wrenched half open, as long as there are other layers behind it, I do not believe the system will be hacked in an overly short cycle. Of course, security that is designed by humans is never perfect, but at the same time, should our security fail, we have to come up with a way to update the system. These days, hardware features can be “updated” through a network by downloading a new system itself and replacing the old system with the new one. This does indeed enhance the overall security of the system, but in fact, all of our devices before the Nintendo 3DS had one major problem. They were structured in such a way so that unless the user proactively performed a system update him/herself, the update could never be done. Although consumers knew that it was better to perform system updates, many did not perform them, as it was often the case that they were simply never made aware that they were available. As with smartphones, tablets, computers and operating systems, many devices today have an auto-update feature, where updates are automatically downloaded when there is an Internet connection, and put on standby, and a message that says “Updates are available for your system. Would you like to proceed?” appears later before the user finally installs the updates. At the moment the Nintendo 3DS’s security remains robust, but we have prepared ourselves to minimize the damage should our security fail. Please note that, in a sense, we learned a very bitter lesson from the Nintendo DS and the Wii, and we have put it to good use in designing the Nintendo 3DS and the Wii U.

When my family was enjoying interacting with other players, like people from abroad, with “Animal Crossing” on the Wii, modified data entered our game, and as a result of that we eventually stopped playing. The new “Tobidase Doubutsu no Mori” (Japanese title; for the Nintendo 3DS) will be launched as part of your efforts to expand your network business, but have you considered how you are going to handle and tackle the kind of problem that my family encountered?

Iwata:

I deeply regret to learn that you had a very unpleasant experience while playing one of our products, and I would like to apologize for having lacked the ability to prevent it from taking place. What happened, I believe, is that a player circulated such modified data for “Animal Crossing” for the Wii, and meant for it to be a bad joke, only to cause a very unpleasant experience for those who witnessed what these modified data did with their game. To explain why this sort of incident happens, video game platforms are equipped with various security features to prevent unauthorized modifications and acts of piracy to play games for free, and in the beginning, these features were effective on the Nintendo DS and the Wii. However, there are people who share information with others through networks and try to break through security as a hobby, and eventually announce the results of their hacking activities through the Internet, resulting in a vicious cycle in which more people are encouraged to use these unauthorized methods. Once they break through our security, we make an effort to fix the security hole, but this turned out to be a futile cat-and-mouse chase as they quickly managed to make a hole in our security system again. As a result, we have been unable to put a complete halt to the circulation of such modified data.

In developing the Wii U and the Nintendo 3DS, we recognized that security is an extremely important factor for the sake of our business and in making sure that our consumers feel that playing our products is safe. While some acts of piracy are still possible in its DS-compatibility mode, as we had to ensure that the Nintendo DS software could still be played on the Nintendo 3DS, the Nintendo 3DS itself still maintains a robust security system, even after this much time has passed since its launch. Various attempts have so far been made to compromise the security of the system, but of course, security is like a multilayered fire door. Even if the outermost layer is wrenched half open, as long as there are other layers behind it, I do not believe the system will be hacked in an overly short cycle. Of course, security that is designed by humans is never perfect, but at the same time, should our security fail, we have to come up with a way to update the system. These days, hardware features can be “updated” through a network by downloading a new system itself and replacing the old system with the new one. This does indeed enhance the overall security of the system, but in fact, all of our devices before the Nintendo 3DS had one major problem. They were structured in such a way so that unless the user proactively performed a system update him/herself, the update could never be done.

Although consumers knew that it was better to perform system updates, many did not perform them, as it was often the case that they were simply never made aware that they were available. As with smartphones, tablets, computers and operating systems, many devices today have an auto-update feature, where updates are automatically downloaded when there is an Internet connection, and put on standby, and a message that says “Updates are available for your system. Would you like to proceed?” appears later before the user finally installs the updates. At the moment the Nintendo 3DS’s security remains robust, but we have prepared ourselves to minimize the damage should our security fail. Please note that, in a sense, we learned a very bitter lesson from the Nintendo DS and the Wii, and we have put it to good use in designing the Nintendo 3DS and the Wii U.

18	Since 1981 (when the consolidated financial result announcements began), as reported by newspapers and other media, Nintendo has suffered a loss for the first time ever. Nintendo, shareholders and everyone recognize that this is a severe situation. What is reported in this circumstance is the 300 million yen of bonus to be paid to the 11 board members. I also understand that bonuses are paid to employees. Considering the current social situation, are the amounts reasonable? I would like to hear your thoughts on this.
18	Iwata: First I would like to explain about the directors’ compensation as I recognize that there is a partial misunderstanding. As you can see (in the slide), this is the total compensation for all the directors. The 72nd fiscal year is the most recent fiscal year ended in March 2012. The 71st fiscal year is the previous year and the 70th fiscal year is the year before that. Financial results for the 70th fiscal year were good. Accordingly, the variable compensation was a significant amount and the total directors’ compensation was larger. Total compensation to all the directors for the 72nd fiscal year was 302 million yen, which is 439 million yen lower than the total of 741 million yen for the 71st fiscal year. The main reason for the reduction is, since the full year operating income result was in the red, the performance-based variable compensation, which is what is defined as the directors’ bonus, is not payable at all at the end of June this year. So, if I can refer to the premise of the question that as much as 300 million yen of directors’ bonuses are paid to the board of directors, I would have to say that it is not the case. Of course, we have no intention to say we put up with this financial result because we did not receive any bonus. In this situation, it is our intention to firmly direct our company to the path it should follow and we will continue to make every effort to be able to say, “Our financial result was revitalized this way” when we report the financial results next year. In addition, there is a portion of fixed compensation (to directors). At the time of the first quarter financial results announcement, for the fiscal year ended March 2012, at the end of July last year, when we announced the significant price reduction of the Nintendo 3DS and then financial forecasts for the fiscal year were revised downward significantly, we also announced that, for the fixed compensation, a 50% cut would be made for the president, a 30% cut for the other representative directors and a 20% for the other directors. With respect to Nintendo’s way of thinking about directors’ compensation, in the 67th Annual General Meeting of Shareholders, it was approved that compensation payable to directors consists of fixed compensation of up to 500 million yen per year and performance-based variable compensation of up to the amount of 0.2% of the consolidated operating income of the fiscal year. This variable compensation is directly linked to the operating income, as I mentioned earlier, so no amount is payable for the fiscal year ended March 2012 based on the computation. Fixed compensation to each director, within 500 million yen per year, is determined by the board of directors based on his duty position and the contribution he has made in previous years. Specifically for the last fiscal year ended in March 2012, as I just mentioned, fixed compensation to directors was also reduced. As a result, the total amount was 302 million yen, which is 99 million yen lower than the previous year. For your information, during the period of April 2011 through March 2012, reduction of fixed compensation was made in August 2011 and after then. Therefore, the compensation reduction was effective for the eight months out of a 12-month period. Taking the current business environment into consideration, the fixed compensation reduction is determined to continue for this current fiscal year. As a result, the compensation reduction is applicable throughout the fiscal year starting from April 2012. We would like to tell you that this means a further fixed compensation reduction. Meanwhile, we were asked a question about whether there are any directors whose annual compensation was more than 100 million yen last year. In case you ask the same question, I would like to say that there is no one who receives annual compensation of 100 million yen or over now. The only director who was applicable in that respect last year was Satoru Iwata and my total annual compensation for the fiscal year ended March 2012 was 45 million yen. This is the whole compensation since Nintendo abolished the retirement benefit system (for directors and auditors) at the 65th Annual General Meeting of Shareholders and does not have non-cash compensation such as stock options for directors and auditors. Another point raised in the question was “Does Nintendo pay bonuses to its employees in this situation?” For our employees, they have their own lives, and the bonus to our employees was not drastically raised when our financial performance was very good and when Nintendo could pay a large sum of dividends to our shareholders. The video game business is known for the characteristic that it is pretty hard to forecast a sales outcome before the subject product is actually launched in the market. If employees cannot work comfortably due to a concern for the fluctuations of their compensation condition in accordance with such ups and downs, we cannot create a working environment where they can steadily create unique, out-of-box products because although these products may be called revolutionary later on after being widely accepted in the world, they are more likely to be criticized as crazy ideas in the beginning. In order to create such a product steadily, it’s our policy not to place our employees in a situation where they have to be excessively influenced by our immediate financial performance. Even when our financial performance was improving, we did not raise their bonuses drastically and, by the same token, we do not reduce the bonus immediately when our financial performance is in a downturn. Nonetheless, since we were experiencing a severe loss situation on a full-year basis, in terms of bonuses to employees, we don’t think what we have done before can be applied to the current situation as a pre-owned right for the employees. Therefore, we made reductions to employees’ bonuses to some extent. We are not indulging our employees. Thank you for your understanding.

Since 1981 (when the consolidated financial result announcements began), as reported by newspapers and other media, Nintendo has suffered a loss for the first time ever. Nintendo, shareholders and everyone recognize that this is a severe situation. What is reported in this circumstance is the 300 million yen of bonus to be paid to the 11 board members. I also understand that bonuses are paid to employees. Considering the current social situation, are the amounts reasonable? I would like to hear your thoughts on this.

Iwata:

First I would like to explain about the directors’ compensation as I recognize that there is a partial misunderstanding. As you can see (in the slide), this is the total compensation for all the directors. The 72nd fiscal year is the most recent fiscal year ended in March 2012. The 71st fiscal year is the previous year and the 70th fiscal year is the year before that. Financial results for the 70th fiscal year were good. Accordingly, the variable compensation was a significant amount and the total directors’ compensation was larger. Total compensation to all the directors for the 72nd fiscal year was 302 million yen, which is 439 million yen lower than the total of 741 million yen for the 71st fiscal year. The main reason for the reduction is, since the full year operating income result was in the red, the performance-based variable compensation, which is what is defined as the directors’ bonus, is not payable at all at the end of June this year. So, if I can refer to the premise of the question that as much as 300 million yen of directors’ bonuses are paid to the board of directors, I would have to say that it is not the case. Of course, we have no intention to say we put up with this financial result because we did not receive any bonus. In this situation, it is our intention to firmly direct our company to the path it should follow and we will continue to make every effort to be able to say, “Our financial result was revitalized this way” when we report the financial results next year. In addition, there is a portion of fixed compensation (to directors). At the time of the first quarter financial results announcement, for the fiscal year ended March 2012, at the end of July last year, when we announced the significant price reduction of the Nintendo 3DS and then financial forecasts for the fiscal year were revised downward significantly, we also announced that, for the fixed compensation, a 50% cut would be made for the president, a 30% cut for the other representative directors and a 20% for the other directors. With respect to Nintendo’s way of thinking about directors’ compensation, in the 67th Annual General Meeting of Shareholders, it was approved that compensation payable to directors consists of fixed compensation of up to 500 million yen per year and performance-based variable compensation of up to the amount of 0.2% of the consolidated operating income of the fiscal year. This variable compensation is directly linked to the operating income, as I mentioned earlier, so no amount is payable for the fiscal year ended March 2012 based on the computation. Fixed compensation to each director, within 500 million yen per year, is determined by the board of directors based on his duty position and the contribution he has made in previous years. Specifically for the last fiscal year ended in March 2012, as I just mentioned, fixed compensation to directors was also reduced. As a result, the total amount was 302 million yen, which is 99 million yen lower than the previous year. For your information, during the period of April 2011 through March 2012, reduction of fixed compensation was made in August 2011 and after then. Therefore, the compensation reduction was effective for the eight months out of a 12-month period. Taking the current business environment into consideration, the fixed compensation reduction is determined to continue for this current fiscal year. As a result, the compensation reduction is applicable throughout the fiscal year starting from April 2012. We would like to tell you that this means a further fixed compensation reduction. Meanwhile, we were asked a question about whether there are any directors whose annual compensation was more than 100 million yen last year. In case you ask the same question, I would like to say that there is no one who receives annual compensation of 100 million yen or over now. The only director who was applicable in that respect last year was Satoru Iwata and my total annual compensation for the fiscal year ended March 2012 was 45 million yen. This is the whole compensation since Nintendo abolished the retirement benefit system (for directors and auditors) at the 65th Annual General Meeting of Shareholders and does not have non-cash compensation such as stock options for directors and auditors.

Another point raised in the question was “Does Nintendo pay bonuses to its employees in this situation?” For our employees, they have their own lives, and the bonus to our employees was not drastically raised when our financial performance was very good and when Nintendo could pay a large sum of dividends to our shareholders. The video game business is known for the characteristic that it is pretty hard to forecast a sales outcome before the subject product is actually launched in the market. If employees cannot work comfortably due to a concern for the fluctuations of their compensation condition in accordance with such ups and downs, we cannot create a working environment where they can steadily create unique, out-of-box products because although these products may be called revolutionary later on after being widely accepted in the world, they are more likely to be criticized as crazy ideas in the beginning. In order to create such a product steadily, it’s our policy not to place our employees in a situation where they have to be excessively influenced by our immediate financial performance. Even when our financial performance was improving, we did not raise their bonuses drastically and, by the same token, we do not reduce the bonus immediately when our financial performance is in a downturn. Nonetheless, since we were experiencing a severe loss situation on a full-year basis, in terms of bonuses to employees, we don’t think what we have done before can be applied to the current situation as a pre-owned right for the employees. Therefore, we made reductions to employees’ bonuses to some extent. We are not indulging our employees. Thank you for your understanding.

19	Let me ask something fundamental. Isn’t Nintendo’s business model becoming outdated? What kind of growth strategy would you specifically propose? Please explain clearly what your growth strategy is as I believe Nintendo’s share price will quickly rise once you have announced it to the media.
19	Iwata: As you have just suggested, clearly indicating our growth strategy is probably one way to look at the issue of improving our share price immediately, and speaking as a shareholder of 5,600 shares myself, I understand very well that you are dissatisfied with Nintendo’s current stock price. However, I would like you to look back on what we have done so far. We said, “We are going to sell the Nintendo DS in this way and expand the gaming population.” We did as we said we would. Did the share price rise at the time of our making this statement? No, it did not. It only rose once the Nintendo DS started to sell well. We also said, “With the Wii, we are going to get people who have never played games to play games.” We achieved what we said we would. But the share price did not rise (at the time of announcing this vision) but it only did so after (the Wii started to sell well). In the end, it’s all about results. Therefore, we believe what we need to do now is show results. I am of course aware that some people say, “Nintendo’s business model is perhaps now outdated.” Some concern themselves over what Nintendo needs to adapt itself to, and one particular problem they see is how we are going to utilize the Internet and decide what to keep of our existing business model, and what to change from it. As we have already announced the other day, one of our answers to this problem is digital distribution of packaged software, in which “by digitally distributing packaged software, Nintendo will build upon its strengths and prepare itself against changes in the times, and also changes in our business environment.” Again, since this endeavor has no precedent, I do not believe that you will be able to acknowledge the significance of it until we can say how much our digital business has produced in sales and how much it has contributed to our earnings. Of course, it is one of my duties to talk about the future of Nintendo through IR and PR opportunities, and in regard to the criticism that because my remarks, “lack persuasiveness, the share price is at this level,” I would like to sincerely accept it as an opinion. On the other hand, we are doing everything that we can do and have prepared ourselves well, and I do believe that it is now a matter of showing the results. We would like to fulfill our duties upon showing to you how our work bears fruit and materializes itself in the form of Nintendo 3DS and Wii U sales figures and profit.

Let me ask something fundamental. Isn’t Nintendo’s business model becoming outdated? What kind of growth strategy would you specifically propose? Please explain clearly what your growth strategy is as I believe Nintendo’s share price will quickly rise once you have announced it to the media.

Iwata:

As you have just suggested, clearly indicating our growth strategy is probably one way to look at the issue of improving our share price immediately, and speaking as a shareholder of 5,600 shares myself, I understand very well that you are dissatisfied with Nintendo’s current stock price.

However, I would like you to look back on what we have done so far. We said, “We are going to sell the Nintendo DS in this way and expand the gaming population.” We did as we said we would. Did the share price rise at the time of our making this statement? No, it did not. It only rose once the Nintendo DS started to sell well. We also said, “With the Wii, we are going to get people who have never played games to play games.” We achieved what we said we would. But the share price did not rise (at the time of announcing this vision) but it only did so after (the Wii started to sell well). In the end, it’s all about results. Therefore, we believe what we need to do now is show results.

I am of course aware that some people say, “Nintendo’s business model is perhaps now outdated.” Some concern themselves over what Nintendo needs to adapt itself to, and one particular problem they see is how we are going to utilize the Internet and decide what to keep of our existing business model, and what to change from it. As we have already announced the other day, one of our answers to this problem is digital distribution of packaged software, in which “by digitally distributing packaged software, Nintendo will build upon its strengths and prepare itself against changes in the times, and also changes in our business environment.” Again, since this endeavor has no precedent, I do not believe that you will be able to acknowledge the significance of it until we can say how much our digital business has produced in sales and how much it has contributed to our earnings.

Of course, it is one of my duties to talk about the future of Nintendo through IR and PR opportunities, and in regard to the criticism that because my remarks, “lack persuasiveness, the share price is at this level,” I would like to sincerely accept it as an opinion. On the other hand, we are doing everything that we can do and have prepared ourselves well, and I do believe that it is now a matter of showing the results. We would like to fulfill our duties upon showing to you how our work bears fruit and materializes itself in the form of Nintendo 3DS and Wii U sales figures and profit.

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