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

(Source: Reports for the 179th Fiscal Period (FY2017))
(As of March 31, 2018)

The Company's accounting treatment issues include inappropriate accounting issues for which the Company received punishment from the Financial Services Agency in FY2015, a negative net worth resulting from high losses occurring in relation to WEC, which was a Group company of the Company, reassignment of the listed shares of the Company to the Second Section of the exchanges and delayed business results. 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.

Inappropriate Accounting Issues

In September 2015, the Company received dispositions from the Tokyo Stock Exchange and the Nagoya Stock Exchange (hereinafter referred to as the “two Exchanges”) designating the shares of the Company as “Securities on Alert” due to its inappropriate accounting issues 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.

Under the new management team set up in September 2015, through governance reforms, the Company has promoted strengthening of the supervisory function over top management centered on Outside Directors, enhancement of checks and balances by CFO and finance and accounting departments as well as internal controls through the reform of operating process and others, raising of awareness of the management group and employees and improvement of the disclosure system.

Consequently, the two Exchanges cancelled the designation of the Company's shares as “Securities on Alert” in October 2017, considering that reasonable improvements were made to its internal control systems. In order to recover the trust of all its shareholders, the Company will continue to take measures toward improvement and reform.

In relation to the inappropriate accounting issues, a total of 36 lawsuits for damages have been filed against the Company and the sum of amounts in controversy is approximately ¥174 billion. The Company will develop appropriate responses in light of the plaintiffs' claims in the lawsuits.

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Losses Relating to the Overseas Nuclear Power Business and the Negative Net Worth

In 2008, WEC received orders for U.S.-based projects (hereinafter the “Projects”) to build its new AP1000 nuclear reactors for 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”) under a consortium with CB&I Stone & Webster Inc. (hereinafter “S&W”), a subsidiary of Chicago Bridge & Iron Company (hereinafter “CB&I”). After receipt of the orders, design changes and others were required for additional safety measures mandated in the wake of the terrorist attacks in the U.S. on September 11, 2001 and the Great East Japan Earthquake. 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. In addition, as a result of an agreement reached with Southern Company and SCANA Corporation on the contract price and adjustment of completion dates, WEC signed an agreement with CB&I to acquire all S&W's shares in October 2015, acquiring the shares in December 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”). As a result, 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 in the third quarter of FY2016.

In March 2017, the Westinghouse Group filed a voluntary petition (hereinafter the “Voluntary Petition”) under Chapter 11 of the U.S. Bankruptcy Code, 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 under the U.S. Bankruptcy Code. 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.

Primarily as a result of posting these 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, which is necessary for its business execution, in December 2017, the renewal deadline. Accordingly, it was acknowledged that material uncertainty existed with regard to the assumption that the Company could continue as a going concern and “Notes Relating to Assumptions for the Going Concern” were included in the notes to consolidated financial statements for the previous fiscal year.

Moreover, the Company received notice from the two Exchanges that due to the negative net worth, its shares would be transferred from the First to the Second Section of the exchanges, and also listed as a security in a grace period pertaining to delisting based on the securities listing regulations and other rules of the two Exchanges. As of August 1, 2017, the shares of the Company were reassigned to the Second Section.

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Delayed Business Results

The aforementioned voluntary petition 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 Company's 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.

As a result, the Company was unable to submit the Annual Securities Report for the 178th fiscal year by the due date on June 30, 2017. After applying for an extension of the due date, the Company submitted the Annual Securities Report for the 178th fiscal year on August 10, 2017, the extended due date.

With regard to the Annual Securities Report, while losses on certain construction contracts needed to be recorded in the consolidated balance sheets as of March 31, 2016, these losses were not posted properly. The independent auditor expressed a qualified opinion with exceptions, considering that the failure to record these losses in the appropriate fiscal period has a material impact on the consolidated financial statements.

With regard to the internal control report for the Annual Securities Report, the Company judged that its internal controls over financial reporting were effective. However, the Company received a report on internal control audit from the independent auditor stating an adverse opinion on this internal control report because the internal control to review the appropriateness of the period in which the losses were recognized was not operated properly and deficiencies in the internal control were found.

In quarterly review reports for the quarterly report for the first quarter, the quarterly report for the second quarter and the quarterly report for the third quarter in the 179th fiscal year, a qualified conclusion with the exception of only figures in the corresponding period of the last year, which is the comparative period, was expressed.

In connection with these losses, the Company's Audit Committee, together with WEC, commissioned independent third parties including attorneys to perform investigations. On April 11, 2017 and August 10, 2017, the Audit Committee reported to the Company's Board of Members, as the outcome of the investigations, that (1) it was difficult for the Company and WEC to recognize the losses, or to judge that the Company and WEC could recognize the losses, with accuracy sufficient to reflect the losses in financial statements in or before December 2016, and that (2) internal controls of the Company and WEC over financial reporting were considered to have functioned effectively.

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Elimination of the Negative Net Worth by Means of Capital Increase through Third-party Allotment, Transfer of WEC-related Assets and Others

The Company took action to reverse its negative net worth and strengthen its financial standing by means of capital increase through third-party allotment, transfer of WEC-related assets and others as follows.

With regard to performance of parent company guarantees provided by the Company to Southern Company and SCANA Corporation in the Projects, the Company reached an agreement with Southern Company to set the maximum amount of liabilities at $3,680 million and pay the amount in installments for a period up to January 2021, and with SCANA Corporation to set the maximum amount of liabilities at $2,168 million and pay the amount in installments for a period up to September 2022. As a result, the maximum amount of liabilities for parent company guarantees to be borne by the Company was determined.

The Company's Board of Directors resolved to raise funds of approximately ¥600 billion by issuing new shares through third-party allotment in November 2017, and the payment in full was completed in December 2017. Due to this fundraising, the Company made early full repayment of the maximum amount of liabilities for its parent company guarantees in relation to the Projects in December 2017 and January 2018 and obtained the subrogated right (reimbursement right) against WEC. In January 2018, the Company entered into an assignment and purchase agreement with Nucleaus Acquisition LLC regarding this subrogated right and other claims held by the Company in association with Westinghouse Group, and a share purchase agreement with Brookfield WEC Holdings LLC regarding shares in holding companies for Westinghouse Group (two companies, namely Toshiba Nuclear Energy Holdings (US) Inc. and Toshiba Nuclear Energy Holdings (UK) Limited). The transfer of the claims was completed in January 2018. With regard to the transfer of the shares, the transfer of shares in Toshiba Nuclear Energy Holdings (US) Inc. was completed in April 2018, while the Company aims to complete the remaining transfer of shares in Toshiba Nuclear Energy Holdings (UK) Limited early. In the wake of approval gained for the rehabilitation plan of Westinghouse Group from the U.S. Bankruptcy Court in March 2018 and others, approximately ¥200 billion was recorded as tax loss for the current fiscal year with regard to the shares in the two companies based on related laws and regulations.

In addition to the above increase in capital by approximately ¥600 billion through the issuance of new shares, the completion of the transfer of claims including the subrogated right and the recognition of tax loss relating to shares in the holding companies for Westinghouse Group in conjunction with the approval for rehabilitation plan of Westinghouse Group and others resulted in a reduction in effects on the tax amount due to company split of the memory business into Toshiba Memory Corporation, leading to achievement of additional improvement in capital adequacy by approximately ¥440 billion. Furthermore, the Company improved the capital adequacy by a total of approximately ¥1,210 billion, together with the above issuance of new shares and the reduction of effects on the tax amount, by recording approximately ¥170 billion after deduction of taxes as gain on sale due to the transfer of the subrogated right and other claims. This led to elimination of the Company's negative net worth in the consolidated balance sheets for the fiscal year ended March 31, 2018.

In October 2017, the Company reached agreement with WEC and Westinghouse Electric UK Holdings Limited (hereinafter “WECUK”) regarding the transfer of 70% of shares in Mangiarotti S.p.A owned by the Company to WECUK or its subsidiary, and the acquisition of 52% of shares in Nuclear Fuel Industries, Ltd. (hereinafter “NFI”) owned by WECUK by Toshiba Energy Systems & Solutions Corporation (hereinafter “ESS”). The transfer of shares in Mangiarotti S.p.A was completed in November 2017 and Mangiarotti S.p.A was deconsolidated from the Company. Moreover, with regard to NFI, Sumitomo Electric Industries, Ltd. and Furukawa Electric Co., Ltd. entered into a share transfer agreement in March 2018 that ESS would acquire 48% of the shares in NFI equally owned by Sumitomo Electric Industries, Ltd. and Furukawa Electric Co., Ltd. When the share transfer is fully completed, NFI will become a wholly owned subsidiary of the Company.

Almost all investment relationships between the Company and each Westinghouse Group company will be dissolved upon completion of the transfer of shares in the holding companies for Westinghouse Group and the transaction of shares in NFI as described above, and the remaining one is only the relationship with Advance Uranium Asset Management Ltd., a trading firm dealing in uranium in which 60% of shares are owned by the Company. The Company will also continue discussions with WEC on positioning of this firm.

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Memory business

In order to achieve further growth of the memory business through development of an agile and speedy management decision-making structure and strengthening means of fundraising and smoothly promote introduction of third-party capital in that business, the memory business of the Company was split off and taken over by Toshiba Memory Corporation (hereinafter “TMC”) in April 2017. While the Company carried forward procedures for sale of shares in TMC through bidding process among multiple candidate companies to secure repayment of borrowing and improve the financial standing, SanDisk LLC (a subsidiary of Western Digital Corporation that acquired SandDisk LLC), the alliance partner for the memory business, filed for arbitration and a lawsuit, claiming that the transfer of equity interests in a joint venture between the Company and SanDisk LLC (hereinafter the “Joint Venture”) to TMC and others violated the joint venture agreement.

In September 2017, the Company entered into a share transfer agreement with K.K. Pangea, a special purpose acquisition company formed and controlled by a consortium led by Bain Capital Private Equity, LP, to transfer all shares in TMC to the said company (hereinafter the “Transfer Agreement”), and the agreement was approved at the company's extraordinary shareholder's meeting in October 2017. In December 2017, the Toshiba Group agreed with Western Digital Corporation to settle the pending arbitration and lawsuit and further strengthen the collaboration associated with the flash memory business. The pending arbitration and lawsuit were dropped altogether.

For implementation of the Transfer Agreement, preconditions including obtaining necessary approval of competition authorities have been imposed. Although the Company aimed to complete the transfer by the end of March 2018, approval of some competition authorities could not be obtained by the end of March 2018 and hence the transfer of shares in TMC to K.K. Pangea was not completed during the current fiscal year.

Equity interests in the Joint Venture were taken over by TMC from the Company upon the company split of the memory business. However, the equity interests were then transferred to the Company, and again to TMC after the settlement was reached with Western Digital Corporation.

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Elimination of Material Uncertainty Regarding the Going Concern Assumption

As stated above, there were material events and conditions that raised the substantial doubt about the Company's ability to continue as a going concern. However, as a result of the increased probability that the transfer of shares in TMC will be realized, realization of the transfer of WEC-related assets and completion of capital increase through third-party allotment, elimination of concerns about the financial standing due to cash flow conditions and the negative net worth progressed. For the business that requires a Special Construction Business License, the Company implemented measures such as absorption-type company split which the licensed companies take over the business. Consequently, concerns about negative impact of failure to renew the Special Construction Business License on the business were eliminated. For these reasons, material events and conditions that raised the substantial doubt about the Company's ability to continue as a going concern were eliminated.

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

Ⅰ. Swiftly Recover and Strengthen the Financial Base

The Company continues to take action to strengthen its financial standing in order to restore sound management.

With regard to the memory business, although the transfer of shares in TMC to K.K. Pangea was not completed during the current fiscal year as mentioned above, the Company continues to aim to sell the shares in TMC early. Going forward, 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 separated 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. 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.

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 the four business domains of social infrastructure, 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, etc. for power generation facilities using natural energy, including hydraulic power, geothermal heat and sunlight, as well as existing thermal power plants and power transmission and distribution facilities to respond to changes in the market for decarbonization and decalcification across the globe. 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 and in-vehicle market centering on products such as discrete semiconductors and system LSIs. In order to expand the business in the automotive-related market, which is expected to grow in the future, the Toshiba Group established the Automotive Solutions Strategic Planning Division in October 2017 and is strengthening marketing and product planning functions in the medium to long term. For HDDs, the Toshiba Group makes efforts to increase its share and ensure stable profitability by launching 14-terabyte HDD and other high-capacity models for datacenters for which the market continues to expand, ahead of other companies. The Toshiba Group is bringing the world's first and top-performance product lines one after another into the world and promoting development of new markets and business expansion.

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 information and communications technologies are employed to generate new value through promotion of digitalization) and create and deliver service value using its SPINEX™ IoT architecture. At the same time, the Toshiba Group will make use of ICT technologies to contribute to maximizing its corporate value. To promote these efforts, the Toshiba Group appointed a Chief Digital Officer (CDO) to spearhead a company-wide strategy of growth through digital transformation and established the Digital Transformation Strategy Acceleration Division as a corporate promotion division effective April 1, 2018. In addition, Toshiba Digital & Consulting Corporation, which provides consistent services from consulting to creation of value in the new digital business, was established effective April 2, 2018.

Ⅳ. Maximizing corporate value

Nobuaki Kurumatani took office as Representative Executive Officer and Chairman and CEO effective April 1, 2018, and the Toshiba Group will aim to maximize its corporate value under the new management team. While devising and implement various short-term measures, the Toshiba Group will develop a transformation plan for each business and announce a business plan for the next five years as “Toshiba Next Plan” within 2018.
As a short-term measure, Toshiba will strengthen core earning power by concentrating on measures to “build strong management infrastructure”, “improve operations” and “further structural reform”. To build strong management infrastructure, the Company will determine and visualize KPI for individual businesses that can be shared on both the management and operation sides. The Company will also expand confirmation procedures for handling daily expenses, and continue to enhance accounting compliance confirmation processes, so as to broaden internal audit functions. To improve operations, the Company will cut the cost of sales ratio with a thoroughgoing reform of value chains, extending from procurement and engineering to manufacturing and sales. It will also reinforce project evaluation and monitoring functions by refining the process to confirm the profitability of new orders and oversee their execution, in addition to the current checks in the accounting process. For further structural reform, the Company will strengthen its constitution and build a muscular organization by focusing on restructuring in areas that include the energy business domain, indirect staff, and the number of group companies. Details of actions to be taken will be disclosed as decided.
In the development of a transformation plan by business, Toshiba will create a mid-term strategy for each business based on targets set by benchmarking the world's leading companies. In achieving those targets, each business will focus on free cash flow and return on invested capital, which better indicate the power to generate cash than net sales figures.
Building on each business's mid-term strategy, Toshiba intends to use digital solutions to promote the transformation of its businesses to a profitable “recurring business” model. Defining the ideal image of each business over the next five years, and then combining their strengths with Toshiba's digital technologies for AI (artificial intelligence) and IoT (all “things” are connected to the Internet), will drive forward a shift enabling the businesses to deliver more services and solutions that maximize Toshiba's value to customers. Through this approach, Toshiba aims to transition to a recurring business model that realizes consistently profitable results.
From a viewpoint of maximizing corporate value, Toshiba will consider comprehensive resource allocation, including shareholder returns, in addition to funds necessary for investment for growth and transformation, financial health and rating in line with the development of “Toshiba Next Plan.”

The Company has been implementing the reforms set out above and once again sincerely apologizes for harming the trust of all of its stakeholders including shareholders and investors significantly. The management team and the entire Company will continue making their best efforts to recover the trust of all the Company's stakeholders.

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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