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KNBA > SEC Filings for KNBA > Form 10-Q on 13-Aug-2013All Recent SEC Filings

Show all filings for KINBASHA GAMING INTERNATIONAL, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for KINBASHA GAMING INTERNATIONAL, INC.


13-Aug-2013

Quarterly Report

Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We own and operate 21 pachinko parlors in Japan. Our revenues consist primarily of customer wagers at our parlors and to a lesser extent food and beverages sold at these parlors. Our costs include payoffs to customers, the costs of operating the pachinko parlors, and general and administrative costs.

Historically, in addition to our pachinko operations, we operated restaurants and two hotels. These businesses were generally unsuccessful and materially adversely affected our results of operations and financial condition. We closed or sold all of these more than two years ago except for three restaurants; we sold the business rights for these restaurants on July 1, 2012. In that sale, we retained the physical assets of the restaurants consisting of land, buildings and fixed assets, which we leased to the new operator, a related party.

Our functional currency is the yen, and accordingly our earnings and assets are denominated in yen. As a result, appreciation or depreciation in the value of the yen relative to the dollar would affect our financial results reported in dollars without giving effect to any underlying change in our business or results of operations. The average exchange rate was 98.75 yen to 1 dollar in the three months ended June 30, 2013, compared to 80.11 yen to 1 dollar in the three months ended June 30, 2012. Accordingly, our results of operations in the three months ended June 30, 2013 compared to the three months ended June 30, 2012, when reported in dollars appear much weaker than they are when expressed in yen.

Our revenues of $18.7 million in the three months ended June 30, 2013 were 21.7% lower than our revenues of $23.9 million in the three months ended June 30, 2012. The principal reason for this decrease was the change in the yen/dollar exchange rate. Our revenues, when expressed in yen, decreased less than 2% between these periods. Another reason for the decrease is that we sold the business rights for our three restaurants in July 2012, and thus we had no revenues from these restaurants during the three months ended June 30, 2013.

We had net income of $761,000 in the three months ended June 30, 2013, as compared to a net loss of $1.9 million in the three months ended June 30, 2012.
The improvement in net income was due primarily to imporved market conditons and the fact that in 2012 we were still recovering from the March 2011 earthquake.

We generally finance the costs of opening our pachinko parlors and pachinko machines and other fixed assets used in the parlors. This debt is usually secured by the real estate or equipment purchased. As of June 30, 2013, we had total debt of $122.5 million, of which $92 million was in default. We incurred most of the debt in default in the early 2000s. The debt was used to finance our expansion efforts. Since 2006, we have worked with our lenders and in many cases have obtained formal and informal forbearances and loan modifications that have allowed us to effectively extend the maturity of our debt through interest only and/or reduced principal payments, generally negotiated on a six month or annual basis. Lenders with whom we have not negotiated forbearances or loan modifications have accepted lower payments without bringing legal action or foreclosing on their security. As of the date of this report, we were not subject to any litigation or foreclosure proceedings with respect to our debt.

Our future success will depend in part upon our ability to restructure a substantial part of our defaulted debt to obtain forgiveness of some amount of principal and interest (including default interest) and/or the material extension of the maturity dates of the debt, or to refinance that debt on more favorable terms in Japan. There is no assurance that our lenders will agree to forgive any portion of our debt or continue to accept reduced payments or that we will be able to refinance the debt.

In addition, our plan to improve our financial performance is to follow the "chain store" model and open new pachinko parlors in order to take advantage of our centralized IT, marketing, employee training and machine maintenance infrastructure which we believe currently has the capacity to support up to 28 parlors. We have targeted two regions for expansion: (1) the Tokyo metropolitan area, which includes the Tokyo metropolis and the Chiba, Saitama and Kanagawa prefectures and (2) the Ibaraki prefecture.

With a GDP that exceeds the combined GDP of New York City and London, the Tokyo metropolitan area is a natural area for us to extend our brand and exploit our operational capabilities. We have demonstrated our ability to successfully operate in the highly competitive Tokyo market with the success of our parlors in this area. These parlors have been more successful than our Ibaraki parlors in part because of greater population and in part because these parlors have more machines. Mid-sized parlors with more than 500 machines have competitive advantages over small-sized parlors with fewer than 300 machines.

We are also considering opening or acquiring additional parlors in Ibaraki prefecture where we are the largest operator with 18 parlors. We are a dominant force in this region and have numerous strategic advantages over other pachinko parlor operators that have only one or two stores. Our concentration of operations in this region provides certain economies of scale in terms of technical support, advertising and brand awareness. Further, as one of the region's largest employers, we are often able to recruit the best qualified candidates and we maintain excellent relations with community leaders, an important factor in the highly regulated pachinko industry.

Our plans to acquire or develop any new pachinko parlors are mostly dependent on our ability to attract global investors to creative financing instruments in the form of high yield securitized convertible debt and equity offerings. And we are currently shaping up the strong attraction of Kinbasha. To date, however, we have not obtained any financing outside of Japan and we can give no assurance that we will be able to do so.

Results of Operations -- Comparison of Three Months ended June 30, 2013 and 2012

Net Revenues

Net gaming revenues as a percentage of total wagers were as follows for the
periods presented:

                                         Three months ended June 30,
                                           2013                2012
                                            (dollars in thousands)
               Total wagers        $ 109,217   100.0% $  134,906   100.0%
               Pay-outs               90,950    83.3     112,472    83.4
               Net gaming revenues $  18,267    16.7% $   22,434    16.6%

Our net gaming revenues decreased in the three months ended June 30, 2013 from the three months ended June 30, 2012 as a result of the change in the yen/dollar exchange rate. When expressed in yen, net gaming revenues increased 0.3% in the three months ended June 30, 2013 from the three months ended June 30, 2012.

Total wagers had been adversely affected due to a general decline in the Japanese economy. However, a parlor damaged by the earthquake reopened in April 2012, and total wagers had improved during this period.

Our pay-out ratio slightly decreased from 83.4% in the three months ended June 30, 2012 to 83.3% in the three months ended June 30, 2013. Our payout ratio decreased due to a change in the mix of pachinko machines played by our customers and marketing programs designed to promote the use of general prize payouts, which have a lower cost than special prizes.

Revenues from our food and beverage operations decreased from $835,000 in the three months ended June 30, 2012 to $74,000 in the three months ended June 30, 2013. The decrease was due to the sale of business rights for our three remaining restaurants to a related party on July 1, 2012, and therefore we did not generate any revenues from these restaurants in the quarter ended June 30, 2013 except for $21,000 of rental income.

Cost of Revenues

Cost of revenues as a percentage of net revenues was as follows for the periods
presented:

                                                   Three months ended
                                                        June 30,
                                                    2013         2012
             Salaries and wages                    19.2%       21.5%
             Depreciation                          27.9         31.8
             Facilities and other                  21.7         21.8
             Disposal of property and equipment    1.2          2.7
             Cost of revenues, other              0.2           1.4
             Total Cost of Revenues                70.2%       79.2%

Our cost of revenues decreased by $5.8 million from the three months ended June 30, 2012 to the three months ended June 30, 2013. This decrease was due primarily to the change in the yen/dollar exchange rate. Other reasons for the decrease are as follows. Salaries and wages decreased in part due to reduced employee benefits. Depreciation expense decreased in part because of a decrease in the unit cost of pachinko machines purchased. Facilities and other expense decreased in part because in the three months ended June 30, 2012 we had repairs and recovery from the damage caused by March 2011 earthquake. Cost of our food and beverage operations (Cost of Revenues, other) decreased in part due to the sale of the business rights for our remaining three restaurants on July 1, 2012.
Disposal of property and equipment expense decreased in part because we are using pachinko machines for longer periods to reduce the need to purchase of new pachinko machines.

Operating Expenses

Operating expenses as a percentage of net revenues were as follows for the
periods presented:


                                       13



                                               Three months ended
                                                    June 30,
                                               2013         2012
                Marketing and advertising     3.7%         4.5%
                General and administrative    13.6         15.2
                Total Operating Expenses      17.3%        19.7%

Operating expenses decreased from $4.7 million in the three months ended June 30, 2012 to $3.3 million in the three months ended June 30, 2013. This decrease was due primarily to the change in the yen/dollar exchange rate.

In addition, marketing and advertising expenses decreased due to a reduction in advertising expenditures following the adoption in July 2012 of regulations for Japanese pachinko parlors that limit conducting promotions offering higher payoffs by day or machine.

General and administrative expenses also decreased because of reduced retirement benefits. .

Other Income (Expense)

Interest expense decreased from $2.2 million in the three months ended June 30, 2012 to $1.7 million in the three months ended June 30, 2013. The decrease in interest expense was primarily due to the change in the yen/dollar exchange rate.

Financial Condition, Liquidity and Sources of Capital

Financial Condition

Property and equipment decreased from $104.9 million at March 31, 2013 to $98.8 million at June 30, 2013, principally because of the change in the yen/dollar exchange rate.

Other assets decreased to $11.4 million at June 30, 2013 from $12.1 million at March 31, 2013, due primarily to the change in the yen/dollar exchange rate.

Our accounts payable and accrued expenses increased to $21.5 million at June 30, 2013 from $21.0 million at March 31, 2013. The increase occurred because of an increase in electricity costs that more than offset a decrease resulting from the change in yen/dollar exchange rate.

Our debt, consisting of capital lease obligations, notes payable, bonds and related party debt, was $ 122.5 million at June 30, 2013 and $132.3 million at March 31, 2013. At June 30, 2013, the debt included $100.2 million of principal and $22.3 million of accrued interest (including default or penalty interest).
The bank debt and capital lease obligations were obtained principally to finance the purchase of equipment, the construction or renovation of our pachinko parlors, or in certain cases the land on which our pachinko parlors are located. These loans and leases are secured by the equipment, leasehold improvements or land purchased, and substantially all of our assets are collateral for one or more of our loans. Our bank debt, in the aggregate amount of $95.5 million at June 30, 2013, bears interest at fixed rates ranging from 0.09% per annum to 4.4% per annum (other than default rates). Our non -bank debt, in the aggregate amount of $27.0 million at June 30, 2013, bears interest at a weighted rate of approximately 17% per annum.

Debt in Default

At June 30, 2013, we were in default on debt in the aggregate amount of $92.0 million, as compared to $97.1 million at March 31, 2013. At June 30, 2013, debt in default included principal of $72.7 million and accrued interest (including default or penalty interest) of $19.3 million. This decrease in debt in default was due to the change in the yen/dollar exchange rate.

This debt has been in default for periods of up to seven years. Most of the debt provides for penalties or default interest upon default, generally at 14% per annum. To date, most of the lenders have not enforced this provision but there is no assurance they will not do so in the future.

For the past several years, we have worked with our lenders and in many cases have obtained formal or informal forbearances and loan modifications that have allowed us to effectively extend the maturity of our debt through interest only and/or reduced principal payments, generally negotiated on a six month or annual basis. Lenders with whom we have not negotiated forbearances or loan modifications have accepted lower payments without bringing legal action or foreclosing on their security. As of the date of this report, we were not subject to any litigation or foreclosure proceedings with respect to our debt.

The following table provides certain information regarding our debt in default with respect to each lender to whom our defaulted debt exceeded 5% of our total assets at June 30, 2013. The outstanding balances are as of June 30, 2013.

                 Origination
                    Years                Outstanding
                   (Default
Lender             Year)(1)     Principal Interest(2)  Total      Other Information(3)(4)
                                (dollars in thousands, except
                                   under Other Information)
Higashi-Nippon 14 loans         $25,872   A:          $25,877  Secured by 5 parcels of land
Bank           1994-2007 (2006)           $ 5                  and 6 buildings, including
                                          D:                   principal office of Kinbasha
                                          0                    Japan.  Lender has extended
                                                               maturity date in six month
                                                               intervals, with a current
                                                               maturity date 3/30/14.  In
                                                               fiscal 2014, we have been
                                                               making monthly payments of
                                                               $31,000.
Morgan Stanley 6 loans          $21,170   A:          $25,593  Purchased loans from
Credit         1996-2006                  $ 4,423              Mitsubishi Tokyo UFJ Bank in
Products Japan (2006)                     D:                   March 2012.  Secured by 3
Co., Ltd.                                 0                    parcels of land and 5
                                                               buildings.  No formal
                                                               extension of maturity.  In
                                                               fiscal 2014, we have been
                                                               making monthly payments of
                                                               $22,000.
Jogashima      12 loans         $8,794    A:          $9,213   Purchased loans from Joyo
Limited        1990-2006                  $ 419                Bank in September 2012.
Liability      (2006)                     D:                    Secured by 5 parcels of land
Company                                   0                    and 7 buildings.  In fiscal
                                                               2014, we have been making
                                                               monthly payments of $9,000.
Aozura Asset   4 loans          $5,852    A:          $10,354  Secured by 2 parcels of land
Company (5)    2003-2004                  $ 0                  and 2 buildings.  No formal
               (2006)                     D:                   extension of maturity.  In
                                          $ 4,502              fiscal 2014, we have been
                                                               making monthly payments of
                                                               $4,000.


(1)

Year of first default

(2)

A is accrued interest, D is default interest accrued.

(3)

All of the Company's real properties are collateralized by one or more mortgages, in some cases up to four mortgages.

(4)

Since the initial defaults in 2006, we have been making monthly payments in amounts based on discussions with our lenders, with an agreed upon interest rate of 3.5% per annum. The amount of the payments varies from time to time (generally on an annual basis), based primarily on the amount of principal payments we advise the lenders we can make. The principal payment ratio was 1%, 0.5% and 0% in fiscal year 2013, 2012 and 2011 respectively. While most of our lenders have accepted payments at these rates in the past, they have not been obligated to do so there is no assurance they will continue to accept such payments in the future.

(5) In April 2013, Sumitomo Mitsui Banking Corporation assigned this debt to Aozora Asset Company.

Our debt in default not disclosed in the table consists of approximately 125 loans held by 12 lenders.

Our future success will depend in part upon our ability to renegotiate a substantial part of our defaulted debt or refinance the debt on more favorable terms. We will seek to obtain forgiveness of some amount of principal and interest (including default interest) and/or the material extension of the maturity dates of the debt.

Cash Flows

During the three months ended June 30, 2013 and 2012, we generated $8.5 million and $10.5 million, respectively, of cash flows from operating activities. The decrease in cash flows from operating activities was due to the change in the yen/dollar exchange ratio, as expressed in yen cash flows from operating activities increased.

During the three months ended June 30, 2013 and 2012, we used cash of $4.9 million and $10.2 million, respectively, for investing activities. This decrease was due in part to the fact that in the 2012 quarter we had $5.8 million in purchases of equipment and pachinko machine due to the reopening of a pachinko parlor in April 2012.

During the three months ended June 30, 2013 and 2012, we used cash of $3.9 million and $0.9 million, respectively, for financing activities, primarily to pay debt. We are generally required to apply any net positive cash flow from our operating and investing activities to repay debt.

Liquidity

Although we had net income in the three months ended June 30, 2013 and in fiscal year 2013, prior to that we incurred substantial net losses. Starting in 2006, we had begun experiencing financial problems, which has caused us to become delinquent in repayment of a large portion of our debt.

We do not have financial resources or liquidity to repay our debt that is in default. Most of this debt has been in default since 2006. During this period, we have worked with our lenders and in many cases have obtained formal or informal forbearances and loan modifications that have allowed us to effectively extend the maturity of our debt through interest only and/or reduced principal payments, generally negotiated on a six month or annual basis. Lenders with whom we have not negotiated forbearances or loan modifications have accepted lower payments without bringing legal action or foreclosing on their security.
As of the date or this report, none of our lenders had brought litigation or foreclosure proceedings with respect to any of our debt.

Assuming our lenders continue to accepts payments at levels comparable to our payment levels during the past several years and do not initiate other collection or foreclosure actions, and assuming there is no material adverse change in the pachinko industry generally, we believe our business will generate sufficient cash from operations to pay our expenses when due for the next twelve months.

However, at current levels, we are not generating sufficient cash flows to make any substantial reduction in our outstanding debt in fiscal year 2014. We will attempt to renegotiate a substantial part of our debt to obtain the forgiveness of some amount of principal and accrued interest (including default interest) and/or the material extension of the maturity dates of the debt. We can provide no assurance that our lenders will agree to any of these changes or will not seek to collect their loans through litigation or foreclose actions.

We also plan to open or acquire pachinko parlors to generate greater positive cash flow. To do this, we will need additional financing.

Our condensed consolidated financial statements do not reflect any adjustments to the carrying value of assets or liabilities as a result of the uncertainty about our ability to pay obligations as they become due. Our independent registered public accounting firm has included an explanatory paragraph in their report on our most recent annual audited financial statements expressing substantial doubt about our ability to continue as a going concern because of these matters, as required by auditing standards of the Public Company Accounting Oversight Board (United States).

Foreign Currency Adjustments

Our functional currency is the yen. Our condensed consolidated financial statements are translated into United States dollars at period-end exchange rates for assets and liabilities, and weighted-average exchange rates for revenues and expenses. The resulting translation adjustments are included in determining comprehensive income. The accumulated foreign currency translation adjustment account is also recorded as a separate component of shareholders' deficit. Transaction gains and losses, if any, in foreign currencies are reflected in operations.

The exchange rate was 99.10 yen to 1 dollar at June 30, 2013, and 94.16 yen to 1 dollar at March 31, 2013. The average exchange rate was 98.75 yen to 1 dollar in the three months ended June 30, 2013, compared to 80.11 yen to 1 dollar in the three months ended June 30, 2012. Even when we experience an increase or decrease in our results of operations, the results in dollars may not reflect the correlational results due to fluctuation of the currency rate in the market.
For example, when the yen gets weaker versus the dollar from one period to the next period, our financial results will appear stronger when expressed in dollars comparing the first period to the next period.

Item 3.

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