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Management Policies of the Toshiba Group Moving Forward (Issues to be Addressed)

(Source: Reports for the 178th Fiscal Period (FY2016))
(As of September, 2017)

The Company's accounting treatment issues include (1) extremely high losses (hereinafter “Losses”) resulting from the acquisition by the former Toshiba Group company Westinghouse Electric Company LLC (hereinafter “WEC”) of CB&I Stone & Webster Inc. (hereinafter “S&W”), a subsidiary of Chicago Bridge & Iron Company (hereinafter “CB&I”) and (2) extremely high losses resulting from the filing for a voluntary petition (hereinafter the “Voluntary Petition”) under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court of New York by WEC, its U.S. subsidiaries and affiliates, and Toshiba Nuclear Energy Holdings (UK) Limited, a holding company for Westinghouse Group operating companies outside the U.S. As a result of these accounting treatment issues, the trust of all of our stakeholders including our shareholders, investors, customers, and employees has been significantly harmed and for this the Toshiba Group sincerely apologizes.

Accounting Treatment Issues

In September 2015, the Company received dispositions from the Tokyo Stock Exchange and the Nagoya Stock Exchange designating the shares of the Company as “Securities on Alert” because it was recognized that the Company has serious problems in its internal control systems, etc. and that the improvement of those internal control systems, etc. is highly necessary, and in December 2015 the Company received an administrative monetary penalty payment order of JPY 7,373,500,000 from the Financial Services Agency. The Company has taken seriously the dispositions designating its shares as “Securities on Alert” and the administrative monetary penalty payment order for the largest-ever penalty amount, which is a measure proportional to delisting, and in September 2015 the Company established a management revitalization promotion structure, took measures to ensure sincere management based on compliance, and proceeded with corporate governance reform, and in December 2015 the Company established corporate governance guidelines.

Further, while the entire Company has been working to steadily implement measures to prevent any recurrence, it compiled an “Improvement Plan and Situation Report” in March 2016. In formulating the “Improvement Plan and Situation Report,” the Company once again analyzed the causes of the accounting treatment issues and, as a result, the Company has recognized that the events in question occurred because of a combination of multiple factors including pressure to meet targets from Atsutoshi Nishida, Norio Sasaki, and Hisao Tanaka, each of whom are former CEOs of the Company, performance assessment and budget control systems focused on net income that generated such pressure, insufficient checks and balances by the Finance Division (CFO) and business execution departments such as finance and accounting departments, dysfunction in the internal audit department, insufficient supervising of past CEOs and executive officers by the Board of Directors and bodies such as the Nomination Committee and the Audit Committee, a lack of awareness towards appropriate financial reports by past CEOs and executive officers, and reduced awareness towards appropriate financial reports in finance and accounting departments because the opinions of past CEOs were given priority.

In light of the results of cause analyses, in addition to inspecting and coordinating measures to prevent recurrence including what has been formulated and published to date, the Company has analyzed problems in its timely disclosure system and established new measures such as developing and operating a disclosure system aimed at proactive information disclosure.

On September 15, 2016, the Company submitted written confirmation of its internal management system to the Tokyo Stock Exchange and the Nagoya Stock Exchange and underwent examination and evaluation by the stock exchanges. On December 19, 2016, the stock exchanges acknowledged that measures had been implemented toward securing improvement across the Company, including review of a management policy that excessively pursued short-term profit, review of the composition of and changes to the ways in which the Board of Directors, the Audit Committee and other bodies operated; and reorganization and enhancement of the functionality of divisions that are supposed to exercise monitoring functions, etc. However, the stock exchanges also found that the Company needed to implement further measures in such areas as ensuring compliance and affiliate company management, which would require them to continue verifying the implementation and progress of such measures. Accordingly, Toshiba's shares would continue to be designated as “Securities on Alert.” On March 15, 2017, the Company's shares were designated as “Securities under Supervision (Examination)” and on the same date the Company resubmitted the written confirmation of its internal management system incorporating additional improvements including measures to strengthen risk management and monitoring through governance, and instilling an awareness of compliance that goes beyond mere observance of laws and regulations.

The Company hopes to regain the trust of shareholders, investors and all stakeholders by achieving a strong corporate constitution together with continuing to enforce measures to prevent recurrence. Other measures to regain trust include efforts to improve compliance, management of subsidiaries and affiliates, and other areas of concern that led to the continued designation of its shares as “Securities on Alert” and their subsequent designation as “Securities under Supervision (Examination).” Accordingly, the Company promotes the following measures: “Strengthening Internal Control Systems and Reforming the Corporate Culture,” “Decisive Action on Business Structural Reform,” “Reviewing the Business Portfolio and Operational Structure,” and “Reforming the Financial Base.”

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Losses Relating to the Overseas Nuclear Power Business

In 2008 WEC received orders for two U.S.-based projects (hereinafter the “Projects”) to build its new AP1000 nuclear reactors. The orders came from a subsidiary of Southern Company of the U.S. called Georgia Power Company (hereinafter referred to by the name of its parent as “Southern Company”) and a subsidiary of SCANA Corporation of the U.S. called South Carolina Electric & Gas Company (hereinafter referred to by the name of its parent as “SCANA Corporation”). The orders for the Projects were received after forming a consortium with S&W, and the work was divided between the two contractors: WEC was responsible for designing, manufacturing and procuring equipment associated with the reactors and turbines, while S&W was responsible for designing and procuring auxiliary equipment, as well as performing onsite engineering and construction work. After receipt of the orders, however, additional safety measures were mandated in the wake of the terrorist attacks in the U.S. on September 11, 2001, requiring design changes and reinspection to obtain official approval. In addition, the Great East Japan Earthquake, led to a situation in which even more thorough safety checks were required. This necessitated coordination between the consortium and its clients regarding additional costs and the adjustment of completion dates, but discussions failed to produce agreement, and Southern Company brought a lawsuit, while potential lawsuits by SCANA Corporation and S&W also became a concern. In order to resolve this situation and progress with the Projects, WEC established a structure capable of centralized management for the Projects in their entirety by acquiring S&W and taking over the operations that had been under its jurisdiction. At the same time, WEC started considering a plan to help its clients accept the postponed completion dates and increased contract prices. With regard to construction-related work, the plan called for the construction workers employed by S&W to be transferred to major U.S.-based engineering company Fluor Corporation, after which Fluor Corporation would be appointed as the subcontractor responsible for engineering and construction work and site management, while WEC would focus on management and supervision of the building works. Then, in October 2015, WEC signed an agreement with CB&I to acquire all S&W's shares, acquiring the shares on December 31, 2015.

After WEC acquired S&W, however, it obtained detailed estimates and assessed the value of S&W's assets in accordance with U.S. accounting standards. As a result, it found that the estimated costs of building, engineering and construction relating to the Projects far exceeded what it had assumed at the time of the acquisition. WEC also found that no progress had been made in improving the efficiency of the building, engineering and construction work. For these and other reasons WEC had to allow for a cost increase totaling US$6.1 billion (hereinafter the “Cost Increase”) comprising 1) personnel costs for onsite workers to complete the work remaining until completion of the building work, as well as indirect workers to undertake management and supervision, 2) costs for procurement of equipment and building materials, and outsourcing costs, and 3) additional compensation costs and contingency funds. When WEC included the Projects' losses due to the Cost Increase in goodwill recorded for the Nuclear Energy Systems & Services Division, then combined it with the Nuclear Energy Systems & Services Division's existing balance of goodwill to perform an impairment test, the full value of goodwill recorded for the division was subject to impairment.

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WEC's Voluntary Petition Filing

On March 29, 2017, the Westinghouse Group filed the Voluntary Petition with the U.S. Bankruptcy Court of New York, having determined that, in light of the need to maintain future cash flow prospects and business value following the Cost Increase, the best way to revive its business and serve the interests of all stakeholders was to rebuild it under the legal protection of the court. As a result of the filing, the Westinghouse Group was excluded from the Company's scope of consolidation in the full year business results for FY2016.

The Company posted a loss of approximately 1,240 billion yen on a net income (loss) basis in its full year business results for FY2016 as a result of factors including the aforementioned impairment of goodwill and deconsolidation of the Westinghouse Group, along with losses posted in relation to parent company guarantees provided by the Company to power utility companies for the Projects, and the Company's recording of an allowance for doubtful accounts with respect to the Company's claims against the Westinghouse Group.

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Material Uncertainty Regarding the Going Concern Assumption

Primarily as a result of posting the aforementioned extremely high losses, the Toshiba Group recorded a negative net worth, causing a breach of financial covenants in the Company's loan agreements and leading to a situation in which it will be unable to renew the Company's Special Construction Business License in December 2017. Accordingly, it is acknowledged that material uncertainty exists with regard to the assumption that the Company can continue as a going concern and “Notes Relating to Assumptions for the Going Concern” have been included in the notes to consolidated financial statements.

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Delayed Business Results

The aforementioned voluntary petition filed by the Westinghouse Group necessitated special accounting treatment for the portion of the filing relating to the Westinghouse Group, including careful examination of the value of liabilities relating to the voluntary petition filing and the timing for allocation of such liabilities. Moreover, following completion of account settlement and auditing procedures by the Westinghouse Group, the independent auditor had to perform the final auditing procedures required to complete the Toshiba Group's auditing, such as evaluating the results of auditing by WEC's auditors and completing internal procedures required within the audit corporation itself. In addition, with regard to the allowance for losses on construction contracts relating to the Westinghouse Group, it was necessary to investigate the proper period for recognizing the losses in question to confirm whether the period in which the losses were recognized was appropriate. The account settlement and auditing procedures therefore took a correspondingly long time.

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The Company's management policies in these circumstances are detailed below.

Ⅰ. Swiftly Recover and Strengthen the Financial Base

Following the aforementioned extremely high losses, the Company is taking action to reverse its negative net worth and strengthen its financial standing in order to restore sound management.

The Company transferred its Memory Business to Toshiba Memory Corporation on April 1, 2017. It is now following the procedures necessary to transfer a majority stake in the Memory Business with the aim of securing the management resources the business needs to grow further. In addition, the Company will continue to review the significance of its asset holdings without exceptions and sell off such assets.

Ⅱ. Strengthen the Toshiba Group's Organizational Management

The Company has decided on a fundamental policy of separating its four in-house companies off into independent companies. After separation, each operating company will strengthen collaboration amongst the Toshiba Group as it focuses on maximizing its own business value. At the same time, each company will establish an optimal structure to ensure business continuity, including the retention of any Special Construction Business License. Meanwhile, the Company's corporate functions will be focused on maximizing corporate value and strengthening the governance of the Toshiba Group as a whole.

1. Operating companies

After separation, each operating company will focus on maximizing its business value, including developing and expanding new businesses, as an autonomous business entity. Each company will strengthen its governance by establishing an internal control structure according to its own business characteristics and external circumstances, and by directly receiving outside auditing. The companies will also enhance governance further by making their affiliate companies directly owned subsidiaries in order to make business responsibilities clearer compared to the in-house company system. Each operating company will directly fulfill accountabilities to the market and customers.

The corporate separations take the form of company splits and follow the schedule detailed below.

(1) July 1, 2017

(i) Infrastructure Systems & Solutions Company

The Company split off its in-house Infrastructure Systems & Solutions Company, integrating it with Toshiba Electric Service Corporation, which holds a Special Construction Business License.

(ii) Storage & Electronic Devices Solutions Company

The Company split off its in-house Storage & Electronic Devices Solutions Company, transferring operations to a new company. In regard to the Electronic Devices Business (excluding memory), which includes discrete semiconductors, system LSIs, and HDDs, the Company intends to realize further continuous growth and maximize business value in its Electronic Devices Business by offering products and systems geared to improving business value for customers. In the Memory Business, Toshiba Memory Corporation was launched on April 1, 2017.

(iii) Industrial ICT Solutions Company

The Company split off its in-house Industrial ICT Solutions Company, integrating it with Toshiba Solutions Corporation, which holds a Special Construction Business License.

(2) October 1, 2017

▪ Energy Systems & Solutions Company

The Company will split off its in-house Energy Systems & Solutions Company and Nuclear Energy Systems & Solutions Division, transferring their respective businesses to a new company and obtaining a Special Construction Business License for the new company.

2. Corporate functions

With regard to governance of the Toshiba Group as a whole, Toshiba Corporation, as the entity responsible for corporate functions, will collaborate with the operating companies to continue ensuring rigorous management of subsidiaries and affiliates. Toshiba Corporation's policy will be to focus on maximizing corporate value and strengthening the governance of the Toshiba Group as a whole. To this end, it will undertake strategic planning for the Toshiba Group, including flexible modification of the business portfolio, as well as appropriate resource allocation, and enhancement of risk management.

Ⅲ. Focus Business Domains

The Toshiba Group will continue to perform its role in sustaining modern life and society with a primary focus on social infrastructure, supplemented by the three other focus business domains of energy, electronic devices, and digital solutions. Drawing on the reliable technological capabilities it has cultivated to date, the Toshiba Group will create a wealth of new value and contribute to a sustainable society.

1. Social infrastructure business domain

The Toshiba Group regards its public infrastructure businesses such as water treatment, power transmission and distribution, disaster prevention, roads, broadcasting, air traffic control, and postal services as sources of stable profitability. The Toshiba Group is using the profits from these businesses to invest as necessary in businesses it regards as growth businesses, such as rechargeable batteries, elevators, air-conditioning, railway systems, and logistics systems. Furthermore, the Toshiba Group has designated China and India as growing regions, and is strategically expanding its businesses there. By continuously providing services that enhance customer value, the Toshiba Group is developing and expanding its “Spiral Lifecycle Business,” which enables its products and systems to be used repeatedly and more widely for long periods of time.

2. Energy business domain

The Toshiba Group is targeting stable profitability in service and retrofitting for power generation facilities, including thermal and hydro, as well as power transmission and distribution facilities. With regard to nuclear power within Japan, the Toshiba Group is continuing to fulfill its social responsibilities, focusing on restarting operation of idled nuclear power plants, undertaking maintenance, and decommissioning. Meanwhile, in the promising growth business of next-generation hydrogen-based energy, the Toshiba Group is continuing to pursue steady technological development to sow the seeds for future growth, including development of its H2One™ hydrogen-based autonomous energy supply systems, and working to expedite associated market launches.

3. Electronic devices business domain

The Toshiba Group is seeking to ensure stable profitability, leveraging its advantages in the industrial market centering on products such as discrete semiconductors and system LSIs. The Toshiba Group will also ensure profitability in hard disk drives by expanding its share with a focus on HDDs for enterprises. Meanwhile, in the rapidly growing IoT and automotive markets, the Toshiba Group is enhancing cooperation with customers to expand business.

4. Digital solutions business domain

In addition to ensuring stable profitability, particularly in system integration for government and manufacturing infrastructure, the Toshiba Group is also actively developing and expanding digital service solutions (service solutions that employ digital technologies) as a growth business. These solutions employ IoT and AI based on Toshiba's culture of monozukuri (making things) as well as its voice and image recognition technologies. The Toshiba Group will establish a structure that can handle development, manufacturing, and sales for ICT solutions centrally using technologies such as IoT and AI. This will enable the Toshiba Group to further expand its solutions businesses targeting manufacturing, industrial, and social infrastructure; distribution and finance; and government and local authorities. The Toshiba Group aims to be a business innovator that can respond promptly to the digital transformation of markets (whereby digital technologies are employed to use data of every description for revolutionizing people's lives and businesses) and create and deliver service value using its SPINEX IoT architecture. At the same time, moreover, the Toshiba Group will make use of ICT technologies to contribute to maximizing its corporate value.

This Web site contains projections of business results, statements regarding business plans and other forward-looking statements. This information is based on certain assumptions, such as the economic environment, business policies and other factors, as of the date when each document was posted. Actual results may differ significantly from the estimates listed here.

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